The European Securities and Markets Authority (ESMA), the independent European authority overseeing the EUs financial system, issued guidelines Wednesday for exchange-traded funds and other UCITS issues that would apply to national securities markets regulators and UCITS management companies.
Significantly, ESMA says all revenue net of operating costs generated by securities lending and other efficient portfolio management techniques in a UCITS fund should be returned to the fund.
In a securities lending arrangement, UCITS funds must also be able at any time to recall any securities lent or terminate any agreement into which is has entered, according to an ESMA statement. They must also inform investors clearly about the securities lending arrangements they have as well the related risks.
ESMA issued a number of other guidelines in addition to the securities lending limitations, including that any UCITS ETF must be clearly identified with UCITS ETF in its name. Additionally, such UCITS ETFs must allow direct redemptions when liquidity in the secondary market is not satisfactory.
Furthermore, collateral received by UCITS to mitigate counterparty risk from OTC derivatives, securities lending or other types of transactions must comply with strict qualitative criteria and limits for diversification purposes. Finally, UCITS investing in financial indices must provide to investors the full calculation methodology of the indices and invest only in indices with specific criteria regarding rebalancing frequency and diversification.
ESMA says the guidelines were developed following a review of the current regulatory regime, which was insufficient to address the specific features and risks associated with these types of funds and techniques, according to the statement.
The authority is also seeking feedback on the treatment of repo and reverse repo agreements in the context of the new UCITS guidelines. ESMA is considering allowing a proportion of a funds assets to be non-recallable at any time in repo and reverse repo arrangements. The proposal would include safeguards to ensure that the counterparty risk arising from these arrangements is limited and that UCITS entering into such arrangements can continue to execute redemption requests, ESMA says.
These comprehensive guidelines are aimed at strengthening investor protection and harmonizing regulatory practices across this important EU fund sector, Steven Maijoor, chair of ESMA, said in a statement. They increase the level and the quality of information provided by UCITS to their investors, clarify the criteria for the management of collateralized transactions such as securities lending, repo and reverse repos and OTC derivatives, and set out the types of financial index in which UCITS may invest.
The new guidelines will come into effect two months after the final rule set is established for repo and reverse repo arrangements.