Income generated from stock lending should not be used to reduce disclosed fund charges, Julie Patterson, Investment Management Association (IMA) director, Authorised Funds and Tax, told Global Custodian.
Responding to the European Securities and Markets Authoritys (ESMA) guidelines, released Wednesday of last week, on ETFs with regard to securities lending, Patterson said the IMA agrees with ESMA that profits from securities lending (i.e. income net of reasonable costs) should be returned to the fund. It is the investors who are exposed to the risk, so it is right that they benefit from the returns, said Patterson. ESMAs guidelines are not binding but set the tone for the industry.
Commenting further on income generated from lending, Patterson said it is important that charges paid by the fund are shown gross.
Patterson added: We welcome the further consultation on the use of repo arrangements. These are typically linked to an investment decision. It may be that a derivative transaction is the most cost-effective way to deliver that decision. A repo is then used to generate the cash needed for that derivative transaction. The advent of central clearing of OTC derivatives is likely to lead to a greater need for cash. If repo activity is unnecessarily limited, then funds would have to hold more in cash, which would distort their investment objective.
ESMA said that 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.
ESMAs Steven Maijoor said in a statement that the guidelines are aimed at strengthening investor protection and harmonizing regulatory practices across this important EU fund sector. The new guidelines will come into effect two months after the final rule set is established for repo and reverse repo arrangements.
Offering an academic commentary on the guidelines, industry research body EDHEC-Risk Institute, said the guidelines are consistent with the conclusions of its research on ETF risks and ESMAs consultation paper. Responding to ESMAs guidelines on returning the profits from lending to the fund they said the new rule changes the business model of ETF providers who have chosen physical replication because securities lending represented considerable sources of revenue for the asset management firms.
As a result of receiving all of the lending profits, the ETF can now expect its management fees to increase; the arrangement will nonetheless have the merit of clarifying the real costs of replication and the profits associated with the risk taken in the area of securities lending, said the Institute.
EDHEC-Risk added acknowledged that the new rules on securities lending by UCITS would have a strong impact on the volumes handled on the securities lending market. This market is an important factor in ensuring a good level of liquidity and improving the efficiency of equity markets, said the Institute. It would therefore be important for an impact study to be produced in order to reinforce ESMAs decision.
(JDC)