The European Securities and Markets Authority (ESMA) published today their expected “Guidelines on ETFs and other UCITS issues.” The document is the conclusion of several years worth of discussion on what role securities lending and collateral should play with UCITS funds, what should UCITS funds charge and what kind of transparency should they offer. Some of the guidelines mark major shifts in market practices. In the same document, ESMA also issues a consultation on repo arrangements. This article looks at some of the new commentary and offers analysis on its impact.
The ESMA guidelines on securities lending are part of ESMA’s efficient portfolio management transactions rules. ESMA has made the decision to not isolate securities lending but rather to keep seclending rules together with repo, OTC derivatives and other EPM concepts. Here are the main impacts:
– The bombshell that may not be, really: “ESMA decided to recommend that all the revenues arising from efficient portfolio management techniques, net of direct and indirect costs and fees should be returned to the UCITS.” This is a change from current market practices and will directly affect all asset managers lending on behalf of UCITS funds including the biggest (BlackRock, Deutsche Bank, Goldman Sachs, etc.). The next step will be defining direct and indirect costs. An internal desk is a direct cost, and probably an agent lender fee split is a direct cost too. How about indirect costs, and could there be a profit margin there? What about a fee for managing the movements of collateral? Collateral needs to be held with a depositary (custodian) as per ESMA’s new guidelines, but an asset manager can still charge a fee for administration. Our favorite: if an asset manager lends UCITS securities through a bank affiliate, is the affiliate still considered the manager under the rule? There is wiggle room written into this. (Note: the Financial Times had a headline today on the ESMA report as “Fund managers to lose securities lending profits.” We’re not so sure this is accurate.)
– No limits to UCITS funds lending their securities. Although some funds may follow BlackRock’s example and voluntarily limit the amount of securities they lend, there is no ESMA mandate to do so. (Note: our analysis in Asset Ops and Strategy suggests that for BlackRock, these limits were a great public relations win with little to no financial impact.)
– The Securities Markets and Stakeholders Group advocates what may turn out to be the impossible: that a “lending agent must be required to indemnify the UCITS when a counterparty defaults for all types of ETFs (synthetic and physical).” We’re not sure that the Group has heard about Basel III and potential serious limitations on indemnification. Likewise, we aren’t sure quite how this requirement for indemnification can be met unless the amount of assets being loaned by UCITS funds drops precipitously.
– “A UCITS should ensure that it is able at any time to recall any security that has been lent out or terminate any securities lending agreement into which it has entered.” No term securities loans for UCITS funds. The verdict on term repo is still out and is part of the ongoing consultation.
– A greater ability of UCITS funds to invest cash collateral from all efficient portfolio management transactions.
– ESMA added additional criteria for collateral acceptance and transparency of holdings and counterparties to loan; these were expected.
– No rehypothecation of non-cash collateral.
The ESMA report solidifies some market practices, establishes clear guidelines in others and seeks to protect investors. While it may have some impacts on the business models of asset managers lending securities, we think that overall the ESMA rules are good for investors and the markets, as they make securities lending more obvious, understood and accepted.
The ESMA report is here.