Stock Lending Fees Should be Made More Transparent, Says Law Commission

The statutory independent body in the U.K., created in 1965 to keep law under review, has recommended that stock lending fees be considered as part of the government’s review of the charge cap for default funds in pensions schemes used for auto-enrollment in 2017.
By Janet Du Chenne(59204)
The statutory independent body in the U.K., created in 1965 to keep law under review, has recommended that stock lending fees be considered as part of the government’s review of the charge cap for default funds in pensions schemes used for auto-enrollment in 2017.

The Law Commission’s recommendations originate from a review published by Professor John Kay in July 2012 into U.K. Equity Markets and Long-Term Decision Making. The Department for Business, Innovation and Skills and the Department for Work and Pensions, which commissioned the review, asked the Law Commission to consider how fiduciary duties currently apply to those working in financial markets, and to clarify how far those who invest on behalf of others may take account of factors such as social and environmental impact and ethical standards.

On Nov. 22 2012 the Government published its response to the Review in which it stated it supported the Kay Review’s analysis and conclusions. The Law Commission’s review is commissioned jointly by BIS and DWP to give effect to the Review’s recommendation.

As a result of the Kay Review, the Government is introducing a charge cap for default funds in pensions schemes used for auto-enrolment in April 2015. This cap will not apply to transaction costs. “We think that there is a possibility that this may create inappropriate incentives to trade,” says the Law Commission’s review. “We recommend that, as part of its review of the charge cap in 2017, the Government should specifically consider whether the design of the cap has incentivized trading over long-term investment.”

In reviewing stock lending the review notes the risks of a potential borrower default of securities, and the collateral may prove insufficient. Secondly, losses may be caused by the way that cash collateral has been invested. These risks are typically borne by the client, notes the review. “Stock lending also introduces a conflict of interest into the system, with the long-term interests of, for example, a pension fund diverging from the short-term interests of the speculator who is lent stock.”

However, the review says that despite this potential conflict, stock lending has become a central part of the way that capital markets work.

The commission has decided against recommending a review of stock lending at this stage. “Instead, we think the emphasis must be on making the amount of stock lending fees retained by intermediaries more transparent, under the Government’s commitment to ensure the transparency of all pension costs and charges.”

The Law Commission also says that stock lending fees should be considered at the same time as the review of the default fund charge cap in April 2017. “It will need to consider what risks are being taken, whether adequate disclosure is being made, and whether there are any new requirements for transparency or controls in this area. We hope that trustees and Investment Governance Group (IGCs) will be able to provide evidence about the stock lending fees and expenses which are charged to pension schemes, and whether further controls are needed.”

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