SFTR

EU Regulation on Transparency of Securities Financing Transactions and of Reuse (2015/2365/EC (EUR Lex)), aka the securities financing transaction regulation and colloquially SFTR, is a large and pointless EU Regulation which causes unassuaged excitement amongst lawyers and profound ennui amongst everyone else.

This is the regulatory initiative that, so say some commentators, nearly caused the boredom heat death of the universe, when some well meaning industry associations produced a 5,000 word disclosure document explaining to seasoned industry professionals (whom you would think would know) what was meant by “title transfer”.

SFTR versus EMIR: Regulatory Deathmatch

Can you be in scope for SFTR transaction reporting and in scope for MiFID trade reporting? Some ESMA guidance is a little ambiguous on this point, espectially since, if you wanted to, yhou could dress up a stock loan to look a lot like a derivative:

To me the difference between a swap which really is a derivative and is therefore out of scope for SFTR and a swap which is secretly a repo/stock loan and is in scope for SFTR is this:

• Under “real derivative” swap transactions:
  • The reference asset is struck at a negotiated price – therefore best execution is important;
  • There is a specified term, or at least an asymmetry in the parties’ termination rights so at least one party has some option value in the transaciton
  • The transaction can swing around in value (reflecting the price of the embedded option) - the transaction in isolation is not intrinsically collateralised: at any time after trade date it will have a mark-to-market value
  • Any collateral arrangements take place outside the terms of specific transactions (and will be aggregated to cover net exposures under all transactions under the Master). So, as you know, the CSA under an Template:TISDA is deemed to be a separate transaction.
  • Therefore variation margin regulations are relevant to swaps, because the transactions themselves aren’t intrinsically collateralised.
• “Real SFTR” transactions
  • The asset is physically delivered, rather than executed at a price, with a corresponding physical return obligation, so “best execution” on the asset in question is not relevant;
  • There is usually not a specific term, and either party can cancel at any time (therefore there is no option value)
  • Each transaction has its own collateral leg and is thus intrinsically collateralised: its value is “zeroed” each day
  • While operationally these collateral legs are usually aggregated across all outstanding transactions, the collateral movement on any day is not a “separate transaction in any sense”
  • Margin being built in, the variation margin regulations are less relevant.

The bloody minded amongst you could, no doubt, configure an ISDA transaction to have all the characteristics of a “real SFTR” transaction, but it would take quite a bit of legal engineering and it is hard to see why you would do it (other out of sheer professional pride in your capacity to be bloody-minded, a force of nature one should not take lightly):

• Initial exchange: Physical delivery of the reference asset against delivery of eligible collateral assets – hence “execution price” is moot
• Daily re-striking of the transaction at zero against a commensurate transfer of eligible collateral assets one way or the other
• Physical return of the same asset at termination against physical return of the equivalent prevailing collateral assets
• General termination right for either party on a standard settlement cycle notice by redelivery of assets

A trade having these characteristics ought not trigger CSA movements as it would be permanently zeroed at the time where collateral demands were calculated. Such a trade would still come within the MiFID definition of a derivative contract (“options, futures, swaps, forward rate agreements and any other derivative contracts relating to securities, currencies, interest rates or yields, emission allowances, or other derivative instruments, financial indices or financial measures which may be settled physically or in cash”) but I defy you to come up with a better solution for what ESMA thinks it means when it talks about liquidity swaps that don’t meet the MiFID definition of "derivatives".

Does this help?