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Securities Financing Transactions Update

The regulation of Securities Financing Transactions (SFTs) has occupied an increasing number of column inches since the adoption by the EU Parliament on 29 October 2015 of the proposed regulation on “reporting and transparency of securities financing transactions”.  Below are a couple of further updates forming part of the same broad theme.

BCBS Consults on Minimum SFT Haircuts

On 5 November 2015, the Basel Committee on Banking Supervision (BCBS) published a consultation paper on “Haircut floors for non-centrally cleared securities financing transactions” (the “BCBS Consultation Paper”).  The consultation paper remains open for comment until 5 January 2016.

The consultation paper follows the Financial Stability Board’s (FSB) October 2014 report on “Strengthening Oversight and Regulation of Shadow Banking: Regulatory framework for haircuts on non-centrally cleared securities financing transactions”.  This report introduced a framework for haircut floors for non-centrally cleared SFTs and recommended that the BCBS incorporate them into the capital requirements for non-centrally cleared SFTs by setting significantly higher capital requirements for transactions with haircuts traded below the haircut floors.

The BCBS consultation paper applies to SFTs entered into by banks.  However, its stated purpose is not to require banks to hold more collateral.  Rather, it is to create incentives for banks to set their collateral haircuts above the floors.  It states that higher capital requirements will apply at the transaction level to SFTs with a haircut below the haircut floors set out in the table below:

  • that are non-centrally cleared;
  • which represent “cash-lent-for-collateral with non-banks” or “collateral-lent-for-collateral with non-banks”;
  • which do not reference government securities;
  • which are not traded with central banks;
  • where the primary motive is to borrow securities rather than lend cash; and
  • which do not involve “collateral-lent-for-collateral” where collateral received is not re-hypothecable.

Residual maturity of collateral

Haircut level
Corporate and other issuers Securitised products
<= 1 year debt securities, and floating rate notes 0.5% 1%
> 1 year, <= 5 years debt securities 1.5% 4%
> 5 years, <= 10 years debt securities 3% 6%
> 10 years debt securities 4% 7%
Main index equities 6%
Other assets within the scope of the framework 10%

Broadly, in all cases, the haircut of an actual transaction (“H”) (which to be compared with the minimum haircuts detailed in the table above (“f”)) is simply the value of collateral given minus the value of collateral received, all as a proportion of collateral given.  The consultation paper details how to calculate the haircut in a number of scenarios – from the very simple (a single cash-lent-for-collateral SFT) to the more complex (portfolio-level margining).  If, for any SFT transaction (or netting set of SFT transactions), H < f, then the bank must treat the transaction as an unsecured loan for the sake of calculating capital requirements.

The consultation paper also includes a number of high level principles and guidance regarding:

  • the mitigation of risk associated with the reinvestment of cash collateral;
  • stress testing requirements in relation to the ability to return cash collateral; and
  • disclosure requirements regarding the composition and valuation of the portfolio of securities on loan as well as cash collateral reinvested.

Contractual Stays Over SFTs Just Around the Corner?

Separately, Bloomberg is reporting that a group of at least 18 banks is preparing to extend to SFTs the principle of contractual stays on the right to terminate in the event of a firm entering resolution.  Presumably, the action taken by the group will be a protocol, similar to the ISDA Resolution Stay Protocol through which the group of 18 implemented contractual stays in relation to transactions executed under ISDA Master Agreements and which itself is currently closed to new adherents pending an upgrade.  Indeed, the article suggests that ISDA is “overseeing the rewrite”, although ISDA is not the trade association responsible for drafting the most commonly used form of securities financing master agreements.

As with the ISDA Resolution Stay Protocol, once published, we are likely to see attempts to extend the scope of any SFT resolution stay protocol to include buy-side firms, so this is one that all sides need to watch.

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