Participants in Asia’s securities lending market may be forgiven for thinking that the EU’s new SFTR rules do not apply to them. And they would be right. But it would be wrong to think that they won’t have any impact at all. Nick Lord looks at the many ways that SFTR is likely to affect the Asian market.
153 separate data fields. T+1 settlement. Full disclosure via LEIs of ultimate counterparties. For those involved in the securities lending and borrowing markets in Asia the requirements of Europe’s new SFTR regulation look like the stuff of nightmares. But generally, you wake up from nightmares and realize it didn’t really happen. Well this is different: it is happening, and it is still scary.
The institutions that are in scope of the regulation are technically all those operating in Europe and European institutions operating outside the EU via their European branches. But to just think of who is and isn’t in scope or the regulations or not is to miss the point.
SFTR is in effect a global regulation, which is being administered by the EU. “To bring greater transparency to the shadow banking market is a goal conceived at the global level via the Financial Stability Board and the EU has taken the lead in implementing it via the SFTR,” says Stephen Song, a partner at global law firm Linklaters in Hong Kong. “The SFTR will have some impact on Asia, but it is likely to be relatively limited.”
European regulations have form when it comes to extra-territorial impact. Just ask the banks whose trading activities were affected by EMIR, or research departments who are still struggling to find a way to manage the implementation of Mifid II while offering a global service. Securities lending is no less a global business than these and so it will be impossible for there to be no impacts outside Europe.
“The impacts will be largely indirect and secondary, but they will be real,” says Dean Bruyns, Senior Product Manager at Broadridge, a global fintech firm. “Asian lenders lending into Europe will find their counterparties in scope for the regulation and they will have to comply with some elements. But I think banks in Asia will be less impacted than the lenders and their smaller funds who do not have LEIs. For them, it will mean more operational headaches.”
What might seem like the most obvious way to avoid getting sucked into the detail of SFTR would be for European institutions to simply decide to book all their securities lending business out of Asian entities, rather than EU
“EU institutions could tweak theirbusiness model so that contracts are entered into by their Asian or other non-EU branchesor entities (pending more clarity), especially if clients want less onerous requirements,” says Udit Gambhir, Managing Director of SGG in Singapore. Such exercises in entity swapping are not without difficulty and paperwork although it would generally be a one-time chore as opposed to an ongoing, systemic process of change.
At the same time as this process is playing out, other experts in the market believe that Asia could capture overall market share, as securities lending that is currently carried out in Europe shifts to the region. “As long as the Asian market has not implemented something similar to SFTR, there could be a shift in business that is currently conducted in Europe to somewhere like Singapore,” says Bodo Windmöller, Chief Product Officer RegTech at management and technology consultancy BearingPoint.
Others agree that for a while at least, Asia could win at the expense of the EU when looking at the global market as a whole.
“Borrowing stock from out-of-scope entities may prove to be more attractive than from in-scope entities, as the reporting obligation becomes single-sided, avoiding the dual-sided complexity,” says Bruyns at Broadridge. “I can see there being potential for a few years of regulatory arbitrage.”
Asian institutions - whether borrowers or lenders - could win market share from their European peers. “At the end of the day, these additional requirements make European institutions less competitive globally,” says Gambhir. “It also reduces the viability of alternative investment fund managers to raise money from Europe and/or transact with EU counterparties, thus reducing the global scope and attraction for European institutional investment.”
Such regulatory arbitrage could end up becoming slightly more hostile, especially if, as some predict, SFTR could end up clashing with local laws and regulations.
“Like we saw with EMIR, when it comes to trade reporting, there are some jurisdictions in Asia that have secrecy laws, which led to a conflict of laws,” says Song at Linklaters. “European institutions might want to try to report on a masked identity basis so they can comply with state secrecy requirements in place such as China and Korea, but at present there is no regulatory safe harbour permitting this practice.”
Such an approach would need a level of forbearance from the EU regulators that some think is unlikely. After all, the whole point of SFTR is to provide transparency, so that the regulators can see what is happening in the market. It is a requirement to register trades precisely to see who is doing what. Therefore, any attempts to dilute this transparency risk running against the whole grain of SFTR.
“The big issue I see is with the agent lenders being able to share details of principal lenders with EU regulators,” says David Raccat CEO and Founder at securities financing platform Wematch in London.
At the moment, under the Asian Lending Disclosure process, it is agent lenders who are put down at the point of trade, not the principal lenders and only a very few members of a banks credit and risk teams see who the ultimate lender is.
Under SFTR this would be impossible as the principal will be identified by their LEI. “Discreet, Asian funds who do not like disclosing details of their positions may actually decide to withdraw from the business altogether,” says Bruyns at Broadridge.
The new level of transparency will also have profound impacts at the granular business level.
According to Gambhir at SGG, the fee basis for a transaction alongside portfolio weights of such exposures will have to be filed. Though it would lead to increased transparency, this does risk making the industry uncompetitive due to confidential information on fee and investment strategy such as portfolio weights and leverage in funds, becoming available in a public domain.
Overall, it would increase the cost of operations and compliance, eroding the EU’s competitive advantage as a jurisdiction. Indeed, the valuation standards being discussed would boost mark to market standardization, with financial reports more accurately reflecting the state of an institution.
As some players pull back, so the business will go elsewhere. And in all likelihood, it will probably go to those banks and funds who decide to make a full business decision to win SFTR impacted business. In this way, the new regulation risks increasing the concentration in the market. In many ways, this is the price of transparency.
“These regulations make compliance so expensive that only the big players can comply, so market concentration risks could increase,” says Alexander Becht, Product Manager for ABACUS/Transactions at BearingPoint. “Not just in Asia, but around the world, there will be a shift, as there are many smaller triparty agents which will not be able to comply completely.”
Becht’s colleague Dirk Jaensch, Practice Leader, BearingPoint Singapore, agrees. “The whole world is in Singapore, but they all have small offices. They are all looking for ways to reduce costs and increase efficiency in their back offices.”
How this all plays out over the next 12-24 months will be fascinating as the effects become clear. One group who will be watching closely will be the regulators in Asia. As mentioned above, while this is being rolled out via the EU, it is conceived globally. And as such the regulators in Asia are looking at the roll out before promulgating their own sets of similar rules.
The next phases of implementation will contain both costs and opportunities for securities lenders and borrowers in Asia. The final technical standards that will be issued by ESMA imminently include the timetable of the phased roll out (forecast to be from Q2 2020). After that, market players can expect to see a period of implementation, compliance and review. Once that has been completed, we could then potentially see new, local regulations.
“The Asian regulations will probably be similar to SFTR,” says Bruyns. “But hopefully less onerous.” Securities lenders in Asia will not be able to escape fully from the tentacles of SFTR. And the advice from all contacted for this article is that they need to start understanding their obligations and the wider impacts as soon as they can.