ESMA declines SFTR amendment – What happens next?
On 4 September, ESMA formally rejected the European Commission’s (EC) request to make minor amendments to its draft SFTR level II legislation. ESMA delivered this news in the form of a formal opinion with an accompanying covering letter.
The “turf war” that we discussed previously continues.
We were tempted to analyse the detailed legal argument by both sides, but decided instead to focus on the practical implications for the industry.
Three questions are of relevance:
- What is the dispute about?
- What are the implications for the industry of ESMA’s formal rejection?
- What happens next?
1 – What is the dispute about?
On 31 March 2017, ESMA discharged its duty to provide the European Commission with draft level II SFTR legislation that included the all-important transaction reporting details and formats.
The EC then “may endorse the draft regulatory technical standards in part only, or with amendments”
The EC informed ESMA of its “intention to endorse” ESMA’s draft but requested minor amendments.
What amendments were requested?
The EC was unhappy with a single phrase ‘endorsed by ESMA’ that empowered ESMA to make future amendments regarding LEIs and UTCs to take account of future industry developments. The EC insisted that it was the EC not ESMA who would be empowered to make any future changes.
Per above, ESMA rejected this request. While it cited legal reasons, subtle hints were dropped that ESMA regards the EC as lacking expertise and/or capacity to fulfil this role in points 46-47 of its Opinion. At any rate, the ball is back in the EC’s court.
2- What are the implications of ESMA’s formal rejection?
In terms of substance. None. The dispute is related to a single issue regarding who has the right, ESMA or the EC and is further restricted to future changes to UTIs and LEIs.
In terms of timing, this has the potential to delay the formal adoption of the level II legislation, as we shall explain. ESMA and the EC are now at loggerheads. Even though 99.9% of the legislation is not in dispute, this single issue is.
Let me put it bluntly: this is a power struggle.
ESMA has dug its heels in and ‘squared up’ to the EC. On one level, I welcome this. A truly independent EU regulator is important.
While ESMA has no formal power to prevent the EC from amending ESMA’s draft legislation and then presenting it to the Parliament and Council for final consideration, should the EC do so, it can expect a rocky three months as its legislation is considered by the Parliament and Council. Why?
ESMA might choose to privately (informally) lobby sympathetic parliamentarians to raise objections to the legislation. Should the Parliament or Council vote to object, then SFTR will be holed up in a legislative holding pattern while the EC and Parliament & Council work out a compromise.
Will the EC back down? I can’t see it happening. Given that the EC sees itself as the epicentre of the European Union, as well as its front face, it is likely Commissioners will consider any climb down as a loss of face and prestige.
The best we can hope for is a face-saving fudge.
But as stated, the EC needs to play this one with extreme sensitivity. Come across too bellicose and ESMA might privately politic to encourage sympathetic parliamentarians to scupper the legislation’s progress.
3- What happens next?
Scenario 1 – EC accepts ESMA draft sans amendments
Let’s assume the EC backs down (unlikely), accepts ESMA’s Opinion and adopts the level II legislation today, 7 September without amendments. Per Article 13 , the legislation will enjoy 1 month’s scrutiny by the Parliament and Council. Absent objections, it will automatically enter the Official Journal. That would make it 7 October. The legislation states it will achieve legal force 20 days later. This would make the beginning of November 2018 for legal force.
Banks and MiFID II firms will report 12 months later = November 2019.
Our opinion = unlikely.
Scenario 2 – EC amends ESMA’s draft
The EC proceeds to make amendments and presents SFTR level II legislation to the Parliament and Council on 1 October. As the EC has amended ESMA’s draft, the period of Parliamentary and Council scrutiny increases to 3 months. Should there be no objection then 1 Jan + 20 days means 20 January for SFTR legal force.
Our opinion = possible.
As per scenario 2, but the Parliament and/or Council raise objections. Under this scenario legislation could be subject to protracted delays.
Our opinion = possible.
Is a delay bad?
To recap, we have 99.9% of the legislation agreed upon. The 0.1% in dispute is the uncertainty.
A delay in project initiation would make rational sense where there was uncertainty regarding the content of the level II legislation. Why spend money building something when it could change?
But we know it will not change in any material way – the EC has stated in writing its intention to adopt as is.
The only uncertainty is the precise timings. Under such circumstances, surely a delay should be welcomed. We previously had 13 months till go-live. We now have 15-17 months. Great! An extra 3+ months to get ready!
Unfortunately, not all actors are rational. To digress into economics, this is precisely the reason why the Efficient Markets Hypothesis is discredited. Real life data confirms the underpinning assumption all investors are rational simply does not hold true.
While rational actors are quite sensibly ploughing ahead with SFTR projects, there remains shocking indifference in significant quarters. Many of these very firms will either fail to be compliant on time or, in the finest traditions of penny wise, pound foolish, delay and end up paying above-market rates for contractors and vendors later as they scamper to get over the line.
How can Market FinReg help?
Market FinReg hosted the largest dedicated SFTR conference to be held to date on 5 September in London. A consistent message from all speakers was the necessity to get started immediately and not delay.
We fully endorse this message.
For our part, we have been training the industry on SFTR Transaction Reporting since March 2018, having produced the first fully-endorsed SFTR training course in the world – some 6 months before copycat firms jumped on the bandwagon. Get your key staff trained up now.
Our SFTR course is fully endorsed and is available in person or online in a university modular format. View the syllabus here.
Equally we can provide short bursts of expertise to help get your in-house BAs and PMs up to speed. Please contact us!