Risk Management

Navigating collateral reporting under SFTR

In this article, Jonathan Lee and Tony Weedon of Kaizen Reporting provide
their recommendations for addressing the challenges of collateral reporting

Macro and micro regulation wrapped This desire to capture both macro systemic and
up in a single reporting regime micro trade level risks in the SFT markets presents a
significant and challenging compromise in the nature
The Securities Financing Transactions Regulation of reporting. Indeed, the periodic, settled position level
(SFTR) challenge is made more complicated by reporting required by other jurisdictions is far less
the dual purpose of the regulation. The European complex to provide and far more straightforward to
Securities and Markets Authority (ESMA) states that the interpret from a regional and global macro-prudential
regulation is intended to “assess the risks related to the perspective. From a collateral reporting perspective,
integrity of price formation and the orderly functioning this added desire to perform trade level surveillance
of the SFT markets” and “a trade state report will also and market monitoring underlines the importance of
allow the authorities to access the most granular trade- maintaining the direct link between loans and collateral.
level data, i.e. the latest state on all the outstanding If it weren’t for the micro surveillance requirements, it
trades that are required for financial stability, market would make far more sense to report all collateral on
monitoring and surveillance of bank-like risks and level a net exposure basis. However, this added complexity
of interconnectedness of the financial system.” should provide clarity around collateral scarcity, tight

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collateral conditions, the dynamics of collateral reuse, or simply take the approach of using single-sided reports in
and the loan rates. order to complete their analysis of regional market activity.
Clearly this pessimistic view is in direct conflict with the
There is a conflict in these dual purposes. Trade level intention of the regulators.
reporting is inherently messy. Timely trade level timely data
is subject to nuances in the settlement cycle and a lack Difficulty resolving the data set
of stored reference data to classify it. Trade data in itself
with every lifecycle event doesn’t lend itself to accurate Firms’ relationship with collateral is often fleeting. It is a means
position level data. This is because you do not have a base to obtain lower cost financing, manage dealer inventory
starting position (exacerbated by the lack of a backloading and maintain capital adequacy requirements and liquidity
requirement). So it will take longer to establish positions as buffers. On many transactions, collateral is only disclosed on
historic trades work their way out of the system. settlement date and, given its varied and often illiquid nature,
it is unlikely to pre-exist in every case in a firm’s books and
Also, by insisting on such a large number of matchable and records. Therefore, the regulators’ insistence on passing all
reconcilable fields from both parties, you risk never (or only of the classification requirements onto counterparties rather
very latterly) achieving a clean dataset of consistent values than using golden sourced reference data, presents a unique
because many transactions are left in an unreconciled state and unprecedented challenge.
with fundamental differences indefinitely.
While MiFID II transaction reporting only requires the
To illustrate this, if a larger dealer is executing 10,000 new ISIN and CFI codes, SFTR requires everything including
trades every day across several hundred counterparties, the kitchen sink! For loaned securities and collateral,
in its current state, it seems unrealistic to ever expect all firms are required to populate the ISIN code, issuer LEI,
of these transactions to match in their entirety. Either credit quality, CFI code, maturity date, jurisdiction of the
regulators will need to come to terms with only partially issuer, collateral type (an FSB bespoke field) or a series
matched data (in which neither party is necessarily correct) of commodity details if the collateral is a commodity. In

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 Risk Management

effect, regulators are testing the firm’s reference data the following business day as a modification (MODI). If
abilities just as much as they are testing their ability to bilaterally agreed, it is a modification and not a correction
provide timely economic transaction reports. As far as (CORR). We appreciate that this exacting interpretation
regulators are concerned, their ability to dish out fines of the regulation is somewhat in conflict with normal
does not involve a ranking of the importance of fields. securities lending practice of only recognising
Getting the classification of a piece of collateral right is transactions subject to settlement finality.
often said to be just as important as getting the price or
the quantity right. Regulators deem that if they can’t trust In our view this latter approach is not in keeping with the
one value, they cannot trust any aspect of the report. spirit of the regulation as a whole.
This whole task needs to be taken very seriously.
Closing transactions – where
Full disclosure is required settlement finality matters
Don’t try to be too clever. There are no fields that are intended When it comes to correctly reporting the ‘off’ leg of a
by regulators to be entirely optional: they simply couldn’t transaction, again it is important to keep regulators on
write enough validation rules to make every field conditional. top of developments in the contract. If you have agreed to
close a contract on a future date (the anticipated settlement
Don’t try second-guessing what is or isn’t acceptable. date), then this should be reported as a closing leg with a
Be as open and transparent as possible. If you are fully maturity date (end date) added to the transaction using a
aware of details of the collateral at the point of execution modification (MODI).
(irrespective of whether the collateral is allocated on
a later date), then you must disclose all of the known Alternatively, if the intended closure is the same day,
details in the new transaction report (NEWT), within the then this can be reported using a termination (ETRM).
confines of the validation rules. Ensure that your collateral Having reported this, if the return doesn’t take place, then
reporting (along with the loan and other aspects of the the maturity date (end date) and other economic details
transaction) is as complete and accurate as possible. should be modified (MODI) on the next business day. If a
Reference data and market data sourcing should be kept termination (ETRM) was booked, then this report should be
under constant review, keeping your vendors on their suppressed if it doesn’t take place. Again, the alternative
toes and ensuring that every data item has an owner - a approach suggested by elements of the securities lending
data guardian. As soon as you are aware of any changes community is to wait for settlement finality before reporting
in collateral, its pricing or classification, this should be the intention to close a transaction. We do not believe to
reported by close of business the following business day. be consistent with the regulatory intent.

Settled vs contractual? The moment Unfortunately, regulators take a dim view of system
an SFT deal is struck, it becomes limitations in providing this reporting. Links between risk
reportable management, booking systems and back-office systems
may well need upgrading but this is not a concern of
As soon as an SFT transaction is agreed, it becomes regulators. Regulators also believe that by implicitly
reportable on the next business day. Regardless of requiring firms to upgrade their systems, they are playing a
whether the ‘on’ leg of the transaction settles and is valuable part in reducing systemic risk across the industry.
followed through or not, it is a reportable event. If the
on leg doesn’t settle and both parties agree to cancel Settlement status – how SFTR differs
the transaction then from a reporting perspective this
should be reported as a termination (ETRM) because Other regulatory reporting regimes, such as for MiFID II,
it existed as a legal contract, even if only temporarily. transaction reporting are satisfied by assuming perfect
If alternatively, both parties agreed to move the value settlement. Given that this regulation is placing a part of
date (start date) forward then this should be reported the very fabric of the capital market under scrutiny and

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 Risk Management

provides a picture of leverage, collateral and liquidity the current state of the bilateral margins should be reported
risk, there is a need to understand outstanding risks with a collateral update using the other counterparty LEI
rather than just contractual risks. This is why settlement and Master agreement details but no UTIs.
status becomes key. This requirement differs from other
transaction reporting regimes that focus on traded The value of each piece of open trade level collateral
market risk rather than exposure risk and will allow you should also be updated using collateral updates including
to assume perfect settlement. the UTIs. On this basis, the collateral can be aggregated
and trade level collateral updates will not interfere with
Why collateral reporting is so bilateral margin collateral updates.
fundamental to understanding the
functioning of the repo market? [See diagram: Repo Bilateral Margin Reporting Process]

Trade level collateral reporting gives a clear view of Kaizen’s Recommendations:

the relative pricing of the market, the market’s view on
particular credit and demand for individual securities, • Install data guardians. Ensure every data item is
asset classes, credit quality etc. It provided perspective appropriately sourced and has an accountable owner.
on shorts in the market and where particular pieces of • Devote significant effort to sourcing SFTR data
collateral (seen through the pricing of loans) become very internally or around installing effective governance
expensive because they are behind other investment around externally sourced vendor data. Make your
strategies. Collateral reporting provides a gauge of vendors earn their keep!
liquidity and credit conditions and a barometer of the • Prioritise data sources i.e. ESMA demand official
health of the outright cash securities markets. sources for data points such as CFI codes, so use
official sources such as the numbering agencies and
Repo bilateral margin FIRDS rather than data vendors wherever possible.
collateral reporting • Be upfront, transparent and timely in all of your
SFTR reporting including the collateral. Do not
One of the greatest collateral reporting challenges under withhold know transaction details and ensure
SFTR has been how to report bilateral margins for repo daily collateral updates of changes and pricing.
transactions (discretely) from their trade level collateral Ensure executions are always reported on a
in accordance with the Global Master Repurchase trade date +1 basis.
Agreement (GMRA). Even to this day, the ESMA • If the pricing of collateral or the quantity of collateral
guidelines have still not presented any clear examples has changed in relation to open and outstanding
that enable firms to report in line with the contract. term transactions then provide settlement date +1
collateral updates accordingly.
The European Repo & Collateral Council (ERCC) division • Stay honest to the transactions: if the master agreement
of the International Capital Market Association (ICMA) has indicates that the transaction is collateralised at the
worked closely with the industry and trade repositories trade level, then report accordingly. Do not allow net
(TRs) to provide a model for reporting repo collateral that collateralisation reporting to absorb what should be
is consistent with the transactions, the GMRA and the TR trade level collateral reporting if this is not consistent
validation rules. with the contract.
• Follow ICMA ERCC best practice on bilateral
The approach proposed is to maintain distinct trade level margin reporting for repo until such time that ESMA
collateral and bilateral margin collateral. This involves have provided a Q&A or clear guidelines regarding
reporting new bilateral repo transactions on trade date +1 any alternative approach. This process will involve
with their trade level collateral details, unique transaction maintaining two distinct sets of collateral and
identifiers (UTIs) and the collateralisation of the net collateral updates (trade level and portfolio level) in
exposure field when it’s marked true. On settlement date +1, relation to the repo book.

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