The Regulation on transparency of securities financing transactions and of reuse (the Regulation) came into force on 12 January 2016 and applies in relation to securities financing transactions (SFTs) and total return swaps (TRSs).
SFTs are defined in the Regulation as:
- repurchase transactions (including reverse repurchase transactions);
- securities lending and securities or commodities borrowing (where there is a commitment to return equivalent securities or commodities);
- buy-sell back or sell-buy back transactions; andmargin lending transactions.
TRSs are defined in the Regulation as derivative contracts in which one counterparty transfers the economic performance to another counterparty. Economic performance includes income from interest and fees, gains and losses from price movements and credit losses of a reference obligation.
The Regulation introduces new requirements on the transparency of SFTs and TRSs and the reuse of financial instruments under a collateral arrangement. Under Articles 13 and 14, managers of UCITS and authorised AIFMs must make certain disclosures in a fund's periodic reports and prospectus about the use of SFTs and TRSs. The information to be disclosed under the two Articles is specified at Sections A and B of the Annex to the Regulation.
Amendments to the FCA Handbook
The FCA's Consultation Paper CP 16/14 was published on 1 May 2016. The Consultation Paper, inter alia, proposes amendments to the FCA Handbook in order to reflect certain measures in the Regulation, which will affect the Collective Investment Schemes sourcebook (COLL) and the Investment Funds sourcebook (FUND).
Disclosures in periodic reports
Under Article 13, UCITS management and investment companies and authorised AIFMs must inform investors on their use of SFTs and TRSs by providing information in their period reports (biannual for UCITS; annual for AIFs). The FCA proposes to incorporate the Article 13 disclosure requirements into COLL 4.5 as an EU provision, which would be included alongside the existing disclosure provisions for periodic reports. To avoid duplication, the new EU provision would then be cross-referenced in COLL 8.3 for QISs and FUND 3.3 for AIFMs.
The information to be disclosed would fall under the following headings (proposed COLL 4.5.8AD EU):
- global data;
- concentration data;
- aggregate transaction data for each type of SFTs and TRSs separately to be broken down according to categories set out in COLL 4.5.8AD EU;
- data on reuse of collateral;
- safekeeping of collateral received by the collective investment undertaking as part of SFTs and TRSs;
- safekeeping of collateral granted by the collective investment undertaking as part of SFTs and TRSs; and
- data on return and cost for each type of SFTs and TRSs.
For further details of the disclosure requirements please see Section A of the Annex of the Regulation or contact us for advice.
Disclosures in prospectuses
Under Article 14, UCITS management and investment companies and authorised AIFMs must specify in their pre-contractual documents the SFTs and TRSs they are authorised to use. They must also include a clear statement that those transactions and instruments are indeed used. Again, the FCA proposes to incorporate the Article 14 disclosure requirements as an EU provision, which would be included alongside the existing disclosure provisions for prospectuses in COLL 4.2. These provisions would then be cross-referenced in COLL 8.3 for QISs and FUND 3.2 for AIFMs.
The proposed amendments set out the following headings for disclosures to be made in the fund's prospectus (proposed COLL 4.2.5C EU):
• general description of the SFTs and TRSs used and the rationale for their use;
• overall data for each type of SFT and TRS including;
- types of assets that can be subject to SFTs and TRSs;
- maximum and expected proportion of assets under management that will be subject to each type of SFT and TRS;
• criteria used to select counterparties;
• description of acceptable collateral;
• collateral valuation methodology used and its rationale, and whether daily mark-to-market and daily variation margins are used;
• risk management including a description of the risks linked to SFTs and TRSs and collateral management;
• how assets subject to SFTs and TRSs and collateral received are safe-kept;
• specification of any restrictions (regulatory or self-imposed) on reuse of collateral); and
• policy on sharing of return generated by SFTs and TRSs.
For further details of the disclosure requirements please see Section B of the Annex of the Regulation or contact us for advice.
Full-scope UK AIFMs of a NURS or QIS must publish this information in the scheme prospectus rather than in any other pre-contractual documents (proposed COLL 4.2.5A G (3) and COLL 8.3.2A G (3) respectively). The Consultation Paper adds that "investors and managers will both benefit from having the Regulation disclosure alongside the other relevant information about the fund and the fund manager in the prospectus".
Funds which are authorised to enter into SFTs/TRSs but do not engage in them
It has previously been unclear whether or not disclosures under Article 13 or 14 must be made where a fund is authorised to enter into SFTs and TRSs but does not in fact do so. This is because the Regulation sets out that information on SFTs and TRSs should be provided in relation to those which the UCITS management or investment company or AIFM is authorised to use. However, the proposed guidance clarifies that firms which are not using SFTs or TRSs (even if authorised to do so) are not required to make any disclosures in relation to the Regulation.
For example, the draft guidance applicable to a UCITS or NURS prospectus suggests the following wording (proposed COLL 4.2.5A G (4)):
An authorised fund manager of a UCITS scheme or a non-UCITS retail scheme that does not engage in securities financing transactions or total return swaps is not required to include any additional information in the prospectus or other pre-sale documents.
This wording is replicated in relation to QIS and there is similar wording in relation to the disclosure requirements in periodic reports under the Regulation.
If these suggestions are incorporated in the amendments to the FCA Handbook, the Article 13 and 14 disclosure requirements will not apply to UCITS management or investment companies or AIFMs of funds or sub-funds which do not enter into SFTs and TRSs, even if they are authorised to do so.
The FCA has asked for responses to the following questions by 19 July 2016.
- Do you agree with our proposed amendments to the Handbook resulting from the Regulation? If not, please provide reasons.
- Are there any other points we should address in relation to the Regulation?
The periodic reports disclosure requirements will apply to all relevant funds from 13 January 2017. The prospectus disclosure requirements currently apply to relevant funds and sub-funds constituted after 12 January 2016 (including sub-funds of an umbrella scheme which was constituted before that date), and will apply to all funds and sub-funds from 13 July 2017. The FCA has set out that its guidance will be aligned with these transitional periods. Until such time that the FCA guidance is in place, fund managers will need to take a view on the grey area of prospectus disclosures in the scenario where the funds and sub-funds are authorised to enter into SFTs and TRSs but do not do so.
More broadly, it should be noted that the Regulation goes further than the FCA Handbook rules and guidance at various points. For example, Article 15 sets out requirements on the reuse of financial instruments received under a collateral arrangement which extends beyond the Client Asset sourcebook provisions on the reuse of assets (CASS 6.4). Fund managers will need to make sure that the Regulation is complied with in its entirety even where the FCA Handbook does not cover its requirements.
If you require further information on anything covered in this briefing please contact Rachel Lowe or your usual contact at the firm on 020 3375 7000. Further information can also be found on our Finance page.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, June 2016