Repo markets: COVID-19, the validation of the electronification model and SFTR
‘Working from home’ and delayed SFTR launch are two notable outcomes of the Covid-19 crisis
The Covid-19 crisis has not only had repercussions for repo market participants by delaying the regulatory deadlines of 2020, like the EU’s Securities Financing Transactions Regulation (SFTR), but has significantly altered the trading environment. During the exceptionally stressed conditions experienced in February and March, repo markets stood up well according to a recent survey published by the International Capital Market Association (ICMA). Interestingly, the crisis has validated the electronic model and added greater weight to the debate that embedding electronic workflows is not only necessary for regulatory alignment, but can help market participants navigate the unique set of conditions they have been forced to operate in.
While the repo market has endured recent market turbulence well, it hasn’t been immune to challenges. Pre-Covid-19, repo trading relied heavily on in-person interactions: via squawk boxes, speed dials and shouting over the floor. Finding new ways to collaborate has become essential as workforces have been dislocated by home working and unable to rely on face-to-face relationships to get voice trades done.
As business practices adapt, firms are also reminded of the importance of audit trails: a key benefit offered by electronic workflows. The Financial Conduct Authority recently placed the spotlight on the obligation of participants to uphold the Senior Managers’ Regime, to improve conduct and enhance accountability.
Electronic trading has helped smooth out many of the complications working from home has presented. Traders new to this type of execution have been impressed by the ease and speed in which multiple participants are touching and responding to trades. In fact, a number of larger players have noted that servicing their clients over the past couple of months would not have been possible without a platform like Tradeweb.
Being able to work from home, access and provide market liquidity with a secure compliance approved trading platform that also offers straight-through-processing and an audit trail, has added significant depth and robustness to the continuity plans of dealers and clients.
Even though the implementation date of SFTR has been pushed back by ESMA for dealers from April to July 2020, the regulation still remains around the corner for buy-side participants. While they only need to start reporting in October this year, many will treat July as the go-live date as they are being encouraged by dealers to on board early. Above all, the complex reporting requirements and the numerous challenges posed for firms remain unchanged - particularly if they continue to operate on a manual basis.
SFTR requires counterparties to report their SFTs to a trade repository registered with ESMA. Every trade falling into scope will need to have a unique trade identifier (UTI), an execution timestamp, and data input into up to 155 fields, across numerous categories including margin, transaction, re-use and counterparty data amongst others. Given the high number of repo trades executed daily and the demands of the new regulation, clients may find complying with the reporting obligation difficult if operating on a non-electronic basis.
Arguably, the greatest challenge comes not from the volume of data to be reported but from the requirement that data provided by both counterparts be reconciled. Electronic trading platforms can help firms facilitate compliance with SFTR in three specific ways. First, automatic execution on a trading platform creates a golden source of the electronically executed trade that can then be consumed by the parties and facilitates matching of dealer and client trades in the trade repository. Second, by the automatic generation and distribution of UTIs and finally, by distributing the same execution timestamp to both counterparts. SFTR is expected to move the buy-side ever closer towards electronic repo trading, further streamlining what has historically been a business primarily traded manually via voice and messaging.
What to expect in 2020?
For the rest of this year, we expect to see a continued shift to electronic trading in two ways, partly driven by SFTR. We expect clients with more intricate fund structures to increase activity on electronic platforms. Much of the business that has moved electronic to date, has been from entities with simpler fund structures. While there are hurdles to overcome in moving more complex clients to electronic trading, the potential dividends for successfully managing this transition are large, particularly in managing trade splits and SFTR reporting.
We also expect to see electronification of repo trading move to asset classes beyond government bonds that we have recently moved onto our platform. These include credit, emerging markets, covered bonds and Supranationals. These pose a greater challenge (in general, and for SFTR compliance purposes) as they are typically traded on an open basis which requires management and reporting of lifecycle events. In our view, electronificiation will aid this and will also result in some standardisation of lifecycle management across the street. We have already seen to some extent and further expect the buy-side to move ahead of its October deadline.
The ability to trade new asset classes via electronic platforms, additional split functionalities, and SFTR are all factors that are extending the appeal of trading on-venue.
Validation of electronic trading
The recent crisis has been a huge validation of the electronic trading model for repo markets. It has added options for firms whose capacity would have been limited due to working from. It has also added an important security factor, with an automated audit trail giving extra comfort to senior managers held personally accountable to supervisory rules.
The importance of these operational functions will also become relevant to repo markets imminently when reporting requirements under SFTR begin. With regulatory change on the horizon, participants have been busy upgrading their electronic methods to assist with data capture required for reporting ahead of the deadlines. By having an electronic RFQ platform counterparts will be able to report and reconcile their repo transactions in a much more efficient way.
The year 2020 will serve to emphasise how participants, both working from home and those concerned with upcoming regulatory compliance, can apply the many benefits electronification has to offer.