In 2016, as a response to the many risks posed by shadow banking, the European Union introduced the Securities Financing Transaction Regulation. Its aim was to give regulators more information about Securities Financing Transactions or STFs.

The regulation affects entities in the European Union that take part in SFTs (including all EU and non-EU branches) and non-EU entities that conclude SFTs through branches in the EU. It affects Undertakings for Collective Investment in Transferable Securities or UCITS, Alternative Investment Funds or AIFs, pension funds, central counterparties (CCPs), Central Securities Depositories (CSDs), insurance carriers, reinsurers, banks, investment firms and non-financial counterparties (NFCs).

When the SFT counterparty is a UCITS or AIF, the reporting obligation applies to the management company or AIFM as opposed to the fund itself.

What is an SFT?

Broadly speaking, an SFT is any transaction by which a market participant uses securities to borrow cash, or vice versa.

An SFT gives the market participant the opportunity to access secured funding through the temporary exchange of its collateralised assets as a guarantee. Lending or borrowing securities and commodities, repurchase (repo) or reverse repurchase transactions (reverse repo) and buy-sell back or sell-buy back transactions, including collateral and liquidity swaps, are some typical examples of SFTs.

In each of the cases above, ownership of the securities temporarily changes in return for cash.

At the end of an SFT, the ownership of the securities reverts to the original owner, leaving both counterparties in their original positions, plus or minus a small fee (depending on the purpose of the transaction).

In this respect, SFTs act in a way similar to collateralised loans.

SFTR overview

The SFTR introduces, among other things:

• a transaction reporting obligation in respect of securities financing transactions;
• an obligation to make prescribed pre-contractual disclosures to UCITS and AIF investors in respect of SFTs and total return swaps in every UCITS/AIF prospectus and annual return; and
• provisions for "minimum transparency requirements" relating to the “re-use” of collateral (financial instruments only) under financial collateral agreements.

SFTR reporting obligation

The SFTR requires both financial and non-financial market participants to report details of their SFTs to an approved EU Trade Repository or TR. This is in addition to any requirement to report transactions that might arise from the European Market Infrastructure Regulation (EMIR) or Markets in Financial Instruments Directive/Regulation (MiFID/MiFIR) and is part of a general move to increase transparency in the capital markets.