From the desk of John Arnesen
Consulting lead, Pierpoint Financial Consulting
SFTR is heavy to say the least. Whether one thinks it’s over-kill or not, the discussion is over with the final report published on January 6th, 2020. Not everyone will be satisfied, particularly if they remain unclear over an issue important to them but to coin an awful expression, “it is what it is” and, in my opinion will be followed at some point by SFTR II given the scope and breadth of the reporting. Let’s not forget that MiFID went through a similar evolution.
The concern over Legal Entity Identifier (LEI) coverage is a valid one. While ESMA have quoted that 88% of European issuers have an LEI code, it’s the global reach of securities lending in many countries outside of Europe that is of concern. ESMA have identified that only 30% of issuers outside of the European Union have sought an LEI. The US has a form of entity identifier with multiple codes adopted by differing segments within an institution. This challenge has slowed progression toward a single LEI in the US.
This got me thinking about the territorial reach of regulation and its implications.
Since the creation of the charter of the LEI Regulatory Oversight Committee in November 2012 and its subsequent establishment in January 2013, the take-up has been impressive. ISLA produced a very informative paper last year that provided statistics that are both alarming and encouraging. The alarming figure is that a data provider has established that 70% of all asset issuers do not have an LEI. Clearly of more interest to the securities finance community is the percentage coverage of assets that are actively lent and used as collateral.
European adoption is high with many countries achieving 85-97%. The UK and Ireland are dragging somewhat at 75% and 43% respectively. However, come April 2020 if these figures don’t reach 100% for EU member countries there will be a reduction in the volume of business.
The 12-month reprieve is obviously a pragmatic temporary solution but judging from the figures in the ISLA report, something will have to give if we are going to avoid a real impact to the business. The chart below highlights concerning levels for some active markets outside of Europe that are showing weak take-up.
By April 2021, without a wholesale shift in governance focus, either there will be a material impact to securities lending activity booked inside the European Union or an extension to the reprieve will be needed. The question is whether securities financing activity is enough of a motivator for those non LEI entities to take action where they may not receive any benefit from the activity and are somewhat indifferent to it.
In the final report, ESMA states that it expects agent lenders and triparty agents to take up the mantle to ensure issuers are encouraged to seek an LEI and are aware of the consequences of not doing so. Are these the right bodies to do this? Clearly both have a vested interest in seeing a far greater adoption but their respective relationships tend to be with investors, not the issuers themselves.
Remember the Foreign Account Tax Compliance Act (FATCA)? In short it required non-U. S financial institutions to identify all clients that were US citizens or entities that had a connection to the US, particularly aimed at those living outside the US. Non-compliance required the application of a 30% withholding tax on certain payments. In effect, custodians and third-party asset holders became de facto tax collectors for the IRS. It was received with a lot of irritation in Europe as some cost was incurred in order to systemically comply and to put it more bluntly it was common to hear sentiment along the lines of “why should we do their job for them?”
So, what similarities do these two regulations share? They both require action, resources and expense from those outside of the regulator’s territorial borders in order to be successful. In the case of FATCA, a number of bills have been introduced in the US House and Senate to repeal it and it’s ironic the US itself is not effectively FATCA compliant given its part failure to provide reciprocity to partner countries. With regards to SFTR, in order not to disrupt liquidity in the securities finance markets, an onus is placed on institutions outside of ESMA’s geographical reach which could result in a muted response. An LEI is clearly beneficial to institutions for myriad reasons and the number issued since the first in 2012 suggests it resonates with institutions involved in financial transactions that are keen to improve transparency across the capital markets. However, it isn’t yet mandatory and I’m not sure the triparty agents and agent lenders have sufficient influence over those issuers that have yet to seek one.
A large swathe of regulation emerged from the ashes of the global credit crisis. The G20 expanded its agenda in 2008 and the creation of the Financial Stability Board in 2009 was clearly in direct response to the need for a more globally concerted effort to restore stability to the world’s financial markets. Although not regulatory bodies themselves, G20 and FSB’s memberships do have input and influence over domestic regulatory bodies in their respective countries. The effort to encourage the establishment of LEI’s globally would be well served by direction and support from these bodies, including ESMA itself and if necessary, a little arm twisting.