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What are Securities Financing Transactions (SFTs)?
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Securities Financing Transactions (SFTs) are trading transactions aimed to create cash flow for companies. By using their owned shares or bonds as collateral, businesses lend these assets in order to raise money, and buy them back at a later date.
In 2015, the European parliament developed a framework for regulating these transactions, known as the Securities Financing Transactions Regulation. This was followed by further securities lending regulations in the UK jurisdiction in 2020.
What are SFTs?
Securities financing transactions are the exchange of assets for cash. A firm will loan their bonds or shares to investors for a fixed period of time in exchange for cash. Then, once the bond or loan has matured, it will be bought back by the original owner.
Each of the following are examples of SFTs:
- Securities loan: lending stocks or other commodities to an investor in a collateral arrangement
- Repurchase agreement: also known as repo’s, which are a deal to sell commodities to a financial counterparty at a specified price with the agreement for a repurchase transaction at a later date for a higher agreed price
- Buy / sell-back: a simultaneous transaction, the first being the purchase of a security, and the second being the selling back of this commodity at a later date
A brief history of Securities Financing Transactions
The 2008 crash highlighted more than just our global lack of preparation for a recession. It also emphasised the real lack of awareness around risk and transparency for securities products and financial transactions.
Without transparency around data, it was difficult for investors and bond issuers to be informed about risks. This led to chaotic management practices, with many post-recession reports calling for regulation.
What are the benefits
SFTs are attractive to investors since they increase leverage in the market. By lending to those keen to increase their liquidity, banks and private investors receive a ‘higher value’ asset. It’s just that this isn’t as liquid as the cash they are providing.
Alternatively, companies may choose to raise cash through SFTs because they guarantee funding. The process is much easier than a traditional loan through a credit institution, since companies will risk their own commodities as collateral. Then, the access to increased cash flow means that companies can grow faster and beat competitors to new developments.
What is Securities Financing Transaction Regulation (SFTR)?
With regulation introduced in 2015, the European Commission oversees the regulatory framework associated with securities. It states that:
- All SFTs (except those involving central banks) must be reported to trade repositories and be recorded in a central database. The SFTR reporting obligation is the most-enforced feature.
- Prior to investment, proposed SFT information must be disclosed to investors in pre-invest documents
- There is a level of minimum transparency which must be met when securities transactions do not include collateral
The UK’s SFTR came into effect in 2020. It is incredibly similar to the European Union version of the regulation.
Who must comply?
The SFTR is a set of regulations relating to financial institutions, and those market participants who engage with them. This means that any company involved in the lending, borrowing or temporary buying of a financial instrument is subject to SFTR.
Under SFTR, all transactions must be reported and monitored. This framework strongly intertwines with another regulatory code, the Markets in Financial Instruments Directive (MiFiD II), and its iterations. This is because some of the delegated reporting exemptions for central counterparties under SFTR are actually still required, through MiFid.
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