Spain
06 August 2019
Current restrictions prevent locally domiciled funds from fully engaging in securities lending, but industry experts are optimistic that this could be relaxed
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Securities lending can play a vital role in the well-functioning of the secondary markets and can be an important enabler for market-making programmes and covered short selling, industry experts have suggested.
Currently, there are restrictions in Spain which prevent locally domiciled mutual funds from fully engaging in securities lending, however, the industry is closely watching to see if there will be a relaxation of these restrictions.
Market participants have argued that this marks one of the main challenges for the Spanish securities lending market.
Benoit Dethier, head of sales and RM, Citi Securities Services, Iberia, highlights that Spain is probably the last European market that does not allow it.
He adds: “Having said that, many holders of Spanish assets are domiciled outside Spain and do have access to lending. Only the Spanish funds cannot access the lending market. By nature, this excludes them from this industry, which is bad for the local asset managers, their clients and end-investors, and in general for the local industry.”
Harpreet Bains, executive director, agent lending, global product head, J.P. Morgan, says that if the relaxation of current restrictions were introduced, this change would be another step closer to achieving greater harmonisation across EU regulatory frameworks that address securities lending for similar fund types in other domiciles.
Bains explains: “Importantly, it would be providing additional liquidity to the marketplace by making available securities that are otherwise shut away in portfolios, as well as generating additional income for fund investors, which can be significant in respect of comparable fund performance.”
Current restrictions
According to Dethier, the restrictions on securities lending are still in place initially because the local industry has not seen this as a priority and asset managers have not been openly asking for this limitation to be removed.
He outlines: “The local asset manager association, Inverco, has always understood this was important and defended the relaxation of this limitation, but the asset managers themselves have not pushed for it. One explication is that the Spanish fund industry is very much retail-driven. This means that the competition takes place at the retail banks level and not really between asset managers that, being part of the same group, were automatically getting the retail client investment flow, without having to fight directly for the business.”
Dethier notes that in 2007/2008, there was hope to get the new regulation signed and that some asset managers showed interest in lending the assets of their funds. However, they would not openly ask for it because of reputational risk, at a time when securities lending was very badly regarded in Spain, often because of the lack of understanding or other interests. He explains that this has significantly improved with the crisis, as regulators and academic reports have confirmed the contribution of short selling and securities lending to healthy markets.
He comments: “As an entity involved in securities lending, we are actively working on educating the Spanish industry, both the asset managers and their depositaries, on the mechanic and dynamic of securities lending, reviewing the business potential, the operational and legal set up as well as the risk management angles. Recently, the CNMV, the Spanish supervisor, strongly defended the necessity to finally remove this limitation that hurts the competitiveness of Spanish-domiciled funds.”
Dethier continues: “The second Markets in Financial Instruments Directive (MiFID II) is also contributing by forcing to embrace open architectures allowing retail clients to also access funds that do not belong to the AM of the banking group they bank with. This obviously facilitates the comparison between the returns of the funds and allows the competition to force changes.”
Trends and opportunities
In terms of trends, Boaz Yaari, CEO, Shargain, notes that there are offshore fund managers, operating in the Spanish market, who are not bound by Spanish regulation, are able to enhance their returns and reduce their expense ratios by lending out their securities. Yaari also observes that there are onshore Spanish fund managers who aren’t able to benefit, which is creating a competitive disadvantage to the latter. He says: “As a result, we are seeing Spanish asset managers looking to open offices in other European countries, in order to overcome this disadvantage.”
Also discussing the disadvantages, Dethier states: “Today, mutual funds domiciled in Spain play at a disadvantage, as they cannot access one of the instruments described by the European Securities and Markets Authority (ESMA) as an efficient portfolio management technique. There is, therefore, no level playing field for Spanish-domiciled funds. The very same fund domiciled in Luxembourg, for example, has the opportunity to enhance their return by accessing the lending market.”
However, in terms of the opportunities that the relaxation of current restrictions could provide, Dethier affirms: “Relaxing that limitation would automatically open an opportunity to improve the returns of the Spanish funds, allowing them to better compete and generating new revenues for the investors. This is clearly in the best interest of the end investors and the local industry in general.”
Securities lending education
The current restrictions in place raise questions over whether there is a lack of education about securities lending in Spain. Dethier states: “Back in 2007 and 2008 when we first hoped to get securities lending allowed for mutual funds (until Lehman went down and stopped the process at the very final stage), the lack of education was evident. Short selling was considered as evil and securities lending was the tool that made it possible.”
“Today, short selling is much better-understood thanks to the numerous academic analysis published since the crisis, as well as the statements from several regulators around the world defending the usefulness of the securities lending to healthy financial markets.”
He continues: “But securities lending is still a new concept for most local entities and we actively work on ensuring securities lending is better understood in order to allow the industry to take an educated decision on whether they want to develop this activity. We have done much progress over the last two years, but there is still work to be done.”
Meanwhile, Dethier says that his biggest surprise is that most local asset manager does not actively consider an Efficient Portfolio Management Technique that would generate new returns and make the funds more competitive.
He adds: “But as soon as the first one will move into it, I have no doubt the rest of the pack will at least have to review it and decide what to do.”
Yaari comments: “We had numerous meetings with Spanish asset managers, many of whom would be keen to utilise securities lending to generate additional revenue when Spanish regulation will allow it. More education is always needed as we have found that firstly, there is some degree of scepticism surrounding securities lending, particularly with reference to the role it played in the 2008 global crisis; and secondly, securities lending is perceived to only be for the benefit of large financial institutions.”
Additionally, Yaari points out that many small and medium asset managers are unaware of their ability to benefit from securities lending and that this is a basic right and an important practice that should be in everyone’s toolkit.
Predictions for the future
While the new regulation was anticipated to be signed over a decade ago, industry experts expect that the new regulation could, in fact, be signed within the year.
Dethier comments: “We were already convinced to get the new regulation signed in 2008 and 12 years later we are at the same stage. But, call me an optimist or even utopist, I would say that the new regulation allowing the Spain-domiciled funds to lend their assets will be signed within 12 months.”
“The ministerial order required already exists and probably just needs to get signed at this stage. I believe that the local authorities understand how negative for the local industry the current situation can be, at a time when they increasingly see Luxembourg as a threat.”
He concludes: “At the same time MiFID II makes it easier to compare the returns of the local funds compared to funds domiciled in other jurisdictions where securities lending is allowed. Finally, it becomes important to get ready to compete with entities that are used to fight for institutional business, where each bips of return counts. In a market where we expect a significant development of the private pension system, it will be very important to fight for those bips.”
Currently, there are restrictions in Spain which prevent locally domiciled mutual funds from fully engaging in securities lending, however, the industry is closely watching to see if there will be a relaxation of these restrictions.
Market participants have argued that this marks one of the main challenges for the Spanish securities lending market.
Benoit Dethier, head of sales and RM, Citi Securities Services, Iberia, highlights that Spain is probably the last European market that does not allow it.
He adds: “Having said that, many holders of Spanish assets are domiciled outside Spain and do have access to lending. Only the Spanish funds cannot access the lending market. By nature, this excludes them from this industry, which is bad for the local asset managers, their clients and end-investors, and in general for the local industry.”
Harpreet Bains, executive director, agent lending, global product head, J.P. Morgan, says that if the relaxation of current restrictions were introduced, this change would be another step closer to achieving greater harmonisation across EU regulatory frameworks that address securities lending for similar fund types in other domiciles.
Bains explains: “Importantly, it would be providing additional liquidity to the marketplace by making available securities that are otherwise shut away in portfolios, as well as generating additional income for fund investors, which can be significant in respect of comparable fund performance.”
Current restrictions
According to Dethier, the restrictions on securities lending are still in place initially because the local industry has not seen this as a priority and asset managers have not been openly asking for this limitation to be removed.
He outlines: “The local asset manager association, Inverco, has always understood this was important and defended the relaxation of this limitation, but the asset managers themselves have not pushed for it. One explication is that the Spanish fund industry is very much retail-driven. This means that the competition takes place at the retail banks level and not really between asset managers that, being part of the same group, were automatically getting the retail client investment flow, without having to fight directly for the business.”
Dethier notes that in 2007/2008, there was hope to get the new regulation signed and that some asset managers showed interest in lending the assets of their funds. However, they would not openly ask for it because of reputational risk, at a time when securities lending was very badly regarded in Spain, often because of the lack of understanding or other interests. He explains that this has significantly improved with the crisis, as regulators and academic reports have confirmed the contribution of short selling and securities lending to healthy markets.
He comments: “As an entity involved in securities lending, we are actively working on educating the Spanish industry, both the asset managers and their depositaries, on the mechanic and dynamic of securities lending, reviewing the business potential, the operational and legal set up as well as the risk management angles. Recently, the CNMV, the Spanish supervisor, strongly defended the necessity to finally remove this limitation that hurts the competitiveness of Spanish-domiciled funds.”
Dethier continues: “The second Markets in Financial Instruments Directive (MiFID II) is also contributing by forcing to embrace open architectures allowing retail clients to also access funds that do not belong to the AM of the banking group they bank with. This obviously facilitates the comparison between the returns of the funds and allows the competition to force changes.”
Trends and opportunities
In terms of trends, Boaz Yaari, CEO, Shargain, notes that there are offshore fund managers, operating in the Spanish market, who are not bound by Spanish regulation, are able to enhance their returns and reduce their expense ratios by lending out their securities. Yaari also observes that there are onshore Spanish fund managers who aren’t able to benefit, which is creating a competitive disadvantage to the latter. He says: “As a result, we are seeing Spanish asset managers looking to open offices in other European countries, in order to overcome this disadvantage.”
Also discussing the disadvantages, Dethier states: “Today, mutual funds domiciled in Spain play at a disadvantage, as they cannot access one of the instruments described by the European Securities and Markets Authority (ESMA) as an efficient portfolio management technique. There is, therefore, no level playing field for Spanish-domiciled funds. The very same fund domiciled in Luxembourg, for example, has the opportunity to enhance their return by accessing the lending market.”
However, in terms of the opportunities that the relaxation of current restrictions could provide, Dethier affirms: “Relaxing that limitation would automatically open an opportunity to improve the returns of the Spanish funds, allowing them to better compete and generating new revenues for the investors. This is clearly in the best interest of the end investors and the local industry in general.”
Securities lending education
The current restrictions in place raise questions over whether there is a lack of education about securities lending in Spain. Dethier states: “Back in 2007 and 2008 when we first hoped to get securities lending allowed for mutual funds (until Lehman went down and stopped the process at the very final stage), the lack of education was evident. Short selling was considered as evil and securities lending was the tool that made it possible.”
“Today, short selling is much better-understood thanks to the numerous academic analysis published since the crisis, as well as the statements from several regulators around the world defending the usefulness of the securities lending to healthy financial markets.”
He continues: “But securities lending is still a new concept for most local entities and we actively work on ensuring securities lending is better understood in order to allow the industry to take an educated decision on whether they want to develop this activity. We have done much progress over the last two years, but there is still work to be done.”
Meanwhile, Dethier says that his biggest surprise is that most local asset manager does not actively consider an Efficient Portfolio Management Technique that would generate new returns and make the funds more competitive.
He adds: “But as soon as the first one will move into it, I have no doubt the rest of the pack will at least have to review it and decide what to do.”
Yaari comments: “We had numerous meetings with Spanish asset managers, many of whom would be keen to utilise securities lending to generate additional revenue when Spanish regulation will allow it. More education is always needed as we have found that firstly, there is some degree of scepticism surrounding securities lending, particularly with reference to the role it played in the 2008 global crisis; and secondly, securities lending is perceived to only be for the benefit of large financial institutions.”
Additionally, Yaari points out that many small and medium asset managers are unaware of their ability to benefit from securities lending and that this is a basic right and an important practice that should be in everyone’s toolkit.
Predictions for the future
While the new regulation was anticipated to be signed over a decade ago, industry experts expect that the new regulation could, in fact, be signed within the year.
Dethier comments: “We were already convinced to get the new regulation signed in 2008 and 12 years later we are at the same stage. But, call me an optimist or even utopist, I would say that the new regulation allowing the Spain-domiciled funds to lend their assets will be signed within 12 months.”
“The ministerial order required already exists and probably just needs to get signed at this stage. I believe that the local authorities understand how negative for the local industry the current situation can be, at a time when they increasingly see Luxembourg as a threat.”
He concludes: “At the same time MiFID II makes it easier to compare the returns of the local funds compared to funds domiciled in other jurisdictions where securities lending is allowed. Finally, it becomes important to get ready to compete with entities that are used to fight for institutional business, where each bips of return counts. In a market where we expect a significant development of the private pension system, it will be very important to fight for those bips.”
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