The Regulation on Transparency of Securities Financing Transactions (SFTR) came into force on 12 January 2016 (see our previous article here) with some transitional periods for certain provisions, including Article 15 regarding the right of reuse of financial instruments under a collateral arrangement.

This provision applies from 13 July 2016 and both financial and non-financial counterparties are in scope. A “financial counterparty” includes a UCITS, UCITS ManCo, AIFs, AIFMs and investment firms authorised under MiFID. The rules will affect all existing and future title transfer and security collateral arrangements under a variety of financial agreements, such as the ISDA Master Agreements & Credit Support Annexes/Credit Support Deed (under both English and New York law), GMRA, GMSLA and prime brokerage agreements amongst others.

Under the SFTR, all parties that accept collateral are obliged to inform their counterparties of the risks involved in entering a title transfer arrangement or granting a right to reuse collateral under a security arrangement.

Specifically, from 13 July 2016 the right of receiving counterparties to reuse financial instruments received as collateral is subject to the following requirements:

• The providing counterparty must be duly informed in writing by the receiving counterparty of the risks and consequences that may be involved in one of the following:
  • Granting consent to a right of use of collateral provided under a security collateral arrangement in accordance with Article 5 of Directive 2002/47/EC (Financial Collateral Directive, transposed into Irish law by European Communities (Financial Collateral Arrangements) Regulations 2010 (S.I. No. 626 of 2010) (as amended)). At a minimum the providing counterparty should be informed in writing of the risks and consequences that may arise in the event of the default of the receiving counterparty.
  • Concluding a title transfer collateral arrangement (that is an arrangement, including repurchase agreements under which a collateral provider transfers full ownership of, or full entitlement to financial collateral to a collateral taker to secure or otherwise cover the performance of relevant financial obligations; that is, obligations secured by a collateral arrangement, which give a right to cash settlement and/or delivery of financial instruments).
• The providing counterparty has granted its prior written consent to reuse in a security collateral arrangement (in accordance with the Financial Collateral Arrangements Directive) or has expressly agreed to provide collateral by way of a title transfer collateral arrangement.
• Any exercise of the right to reuse must be undertaken in accordance with the terms specified in the particular collateral arrangement and only once the financial instruments received under the collateral arrangement are transferred from the account of the providing counterparty.

Under the SFTR, “reuse” means the use of financial instruments received under a collateral arrangement by a receiving counterparty, in its own name and on its own account or on the account of another counterparty, but does not include use that comprises liquidation of a financial instrument in the event of default of the providing counterparty. The reuse requirements apply where the reusing counterparty is established in the EU (whether or not it is acting through a third country branch); or the counterparty is established in a third country and it is effecting the reuse through an EU branch; or the collateral is provided to it for reuse from a counterparty established in the EU, or having a branch in the EU.

Practical requirements

Receiving counterparties should consider whether they have entered into collateral reuse arrangements and if so prepare a disclosure statement to issue to the providing counterparty. The Association for Financial Markets in Europe (AFME), FIA, the International Capital Market Association (ICMA), the International Swaps and Derivatives Association, Inc. (ISDA) and the International Securities Lending Association (ISLA) have jointly published a statement that can be used to help market participants comply with new requirements.

Contributed by Patricia Taylor