Jonathan Lee, senior regulatory reporting specialist at Kaizen, examines the introduction of new SFTR validation rules in the UK, indicating that this is the time for firms to reassess their control environments, ensure that all in-scope transactions are reported and to consider implementing quality assurance
Monday 11 April saw new Securities Financing Transactions Regulation (SFTR) validation rules come into force for UK SFTR. The validation rules provide a framework for how the reporting schema, the ISO 20022 XML format, must be populated in relation to each transaction type and lifecycle event carried out by an SFT business and reported to a trade repository (TR). Be aware that the validation rules are the most basic conditions that need to be met to submit transaction and lifecycle event reports to a trade repository; they do not offer any further guarantees that reporting is complete or accurate.
These new rules are already very familiar to reporting counterparties with EU obligations, given that they are essentially a carbon copy — and those rules went live on 31 January 2022. It has certainly been a challenging two and a half months for firms with obligations under both jurisdictions as they have had to run a two speed validation rule process, continuing to apply the old rules in the UK while adopting the new rules for transactions routed through the EU trade repository. There is quite a significant change for those that only have an obligation under UK SFTR.
Essentially, the changes require more granular counterparty data across more action types and a number of clarifications around the loan and collateral data fields. This represents a tightening up of the original validation rules and the removal of some of the loopholes. This should, in theory, make it easier for regulators to monitor the lifecycle and evolution of transactions, enhancing the link between loans and their respective collateral.
Optional fields
The opportunity to mop up all of the optional fields with appropriate conditionality was sadly missed. Unfortunately, some reporting counterparties have taken it upon themselves not to report any fields marked in the validation rules as optional, which is not in keeping with the spirit of the regulation. Regulators have repeatedly stated that optional does not really mean optional if the field in question is applicable to the transaction or lifecycle event and known. For example, if the SFT involves loaned securities or securities used as collateral, it remains optional to state who the Central Securities Depository (CSD) participant or indirect participant is – which is clearly known at point of execution. Reading the regulatory technical standards and guidelines makes it clear that these fields are required, but these requirements are not rigidly applied through the validation rules. Contradiction and multiple permissible field populations are the bane of reporting counterparties, particularly in relation to reconcilable fields.
The new validation rules are a baby step towards providing the industry with far greater regulatory certainty. However, they do not go nearly far enough in addressing widespread data quality issues or being sufficiently prescriptive to reduce the operational burden on reporting firms. This operational burden is represented by the number of manual touchpoints for each transaction to ensure that the reports are accepted by the TR, they pair and match where reconcilable and that the necessary controls are in place to ensure that reports are complete, accurate and timely. The data quality concerns are amplified every time we test valid but wrong reports (that have passed the validation rules at the trade repository) but still contain incorrect data.
Neither the validation rules nor the schemas prevent fields being populated with wholly spurious data. Given the severely limited scope of trade pairing and matching through the trade repository reconciliation process – around 90 per cent of UK SFTR reports are single sided — many reports are entering the TR completely unchecked.
Evidence is mounting of growing regulator scrutiny. The latest European Securities and Markets Authority (ESMA) Data Quality report (see page 31 and chart 34) highlighted an instance in which action was taken by a national competent authority (NCA) to correct a reporting counterparty’s failure to terminate their open trades — which is the most public example of this. Ultimately, regulator investigations are likely to evolve from private review towards more public censure and fines. The data quality report also highlighted that “Reporting counterparties are expected to have processes, systems and controls in place to ensure completeness, accuracy and timeliness of the reported information.”
Ahead of the Financial Conduct Authority (FCA) publishing their own guidelines, Q&A and data quality reports, UK counterparties should also take note. Now is certainly the time for firms to re-assess their control environments, ensure that all reportable transactions and lifecycle events are reported and to consider implementing quality assurance through regulatory testing solutions.
