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Reflections of the CEO

SFTR | Shareholder Rights Directive II

On 14 July, we will see the start of the daily reporting of securities financing transactions (SFTs) under Article 4 of the SFTR legislation. In many ways, SFTR represents the single biggest change to our industry in living memory. As we are prepare for this important date that will form part of our collective histories, I feel that it is appropriate to pause for a few moments and reflect on how we got to where we are now, and most importantly what a post-SFTR implementation world may look like.

For many of us, it may feel as though SFTR has been with us forever, and to an extent set against the short termism that often defines how we think about our businesses today, it probably has! The long journey to next Tuesday effectively started in late 2012, with the publication of the Financial Stability Boards (FSB) policy framework for addressing shadow banking risks in securities lending and repos. That initial paper outlined some thirteen recommendations that led directly to the creation of the FSB Workstream 5 (WS5), which went on to define the foundations of SFTR here in Europe. SFTR was formally adopted within the Official Journal of the European Union in December 2015.

It is perhaps forgotten that the SFTR also sought to create better transparency and disclosure requirements for those using SFTs. These came in the form of Articles 13 and 14, which required the reporting and use of SFTs by funds in both periodical reports and pre-contractual documents, such as prospectuses and other offering documents. Article 15 required recipients of collateral to disclose reuse to collateral providers. It is the daily reporting regime however, that is defined under Article 4 of the legislation that demanded most attention.

In terms of longevity, it is worth reflecting that from those early days of FSB Workstream 5, SFTR in all of its incarnations has seen three different European Commissions, three different UK Prime Ministers, and has survived both Brexit and a global health emergency. There is no doubt that the world today is very different to the immediate post-financial crisis period of 2008-10, and that to an extent SFTR could be a solution to a problem that has long since passed into history. Today, regulatory disclosure requirements mean that institutional clients are better equipped to understand how their securities lending programmes operate and where they assume risk. ISLA and others have led the way on bringing greater transparency across our markets, and in particular we have advocated strongly the importance of a well-run and properly functioning securities lending market to the operation of the broader capital markets.

Once the industry has worked its way through the inevitable teething problems associated with an exercise of this scale, we can begin to think about what the provision of data of this magnitude and scope will mean to the regulatory community. There has been a constant debate around what regulators may do with the SFTR data set, and what relevance such detailed data has in the context of financial stability, which was the main focus of the original work of the FSB. When regulators start looking at SFTR data, I am confident that it will reveal an industry that is well run and prudently managed. For instance, agent lenders have specific counterpart exposure limits that naturally restrict any concentration of exposures across the industry. Similarly, securities lending markets have robust collateral management operating frameworks that call for daily revaluations of collateral and on-loan positions. Both would have been tested by the trading conditions in March, and had SFTR been live during this period, it would have revealed how well our community dealt with these extremes.

Furthermore, if used in conjunction with other metrics and indicators, data can provide signposts or warning signals that add to our understanding of markets. A lot has already been said and written about Wirecard, but at its very essence it would appear that the short-side markets saw something within that company that led them to feel that it was overvalued. Whilst it is not appropriate to comment further on this specific case, I would stress how a signal such as increased  borrowing activity on the back of a short position, could be an early warning signal. This combined with other financial and non-financial indicators may warrant further investigation. The point here is not to overplay the role of lending, but to highlight how it can add colour and understanding within financial markets.

Wirecard also highlights how important shareholder engagement and the role of investors is in terms of scrutiny, particularly so when we think about how investor sentiment and objectives are changing. The shape of this engagement here in Europe is increasingly being defined by the European Commission. Its current consultation on sustainable finance seeks respondents views on how investors should be thinking about companies around their sustainable agenda, and how we should judge these metrics. More specifically, the Shareholders Rights Directive II sets out a clear path for broader and more effective shareholder engagement, as Europe looks to develop a broadly market-based eco system. Ahead of the September go live, there is still much to do to understand and define how the practical implications of this Directive will work. We are therefore calling for member firms to participate in our SRD II working group to help establish and harmonise operational best practice within the industry. The next meeting of the group will be Tuesday 14 July at 15:00BST, so if you are interested in joining the group and therefore the session, please email regtech@isla.co.uk. More information on the working group can also be found here.

In closing, I would like to return to SFTR. Whilst SFTR is likely to become a permanent feature of our industry, we are at the end of a long and at times challenging journey towards implementation that will shape much of what we do in the future. I would therefore like to thank all of the team here at ISLA, both past and present who have been involved in this initiative, as well as all of our member firms who have rallied to our call to mobilise, over the past three years. Finally, none of this would have happened without the close collaboration and input from our friends in the regulatory community. Yesterday, we submitted our final letter ahead of phase 1 go-live, to ESMA and a number of NCAs (AMF, AFM, BaFIN, CBI and the FCA), highlighting on behalf of the industry some of the ongoing challenges on the road to compliance, but also reinforcing the relationship between us. We have already had positive and thankful feedback from members and regulators alike, therefore I would like to offer my thanks for their proactive and pragmatic approach (a copy of the letter can be found here).

Andrew Dyson, CEO

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