ESMA securities lending draft "lacks specifics"
06 February 2012 London
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New requirements for securities lending practices introduced by European financial markets watchdog, ESMA, come up short on details, according to Morningstar.
Though noting that the financial regulator has been clear about the need for greater and more frequent disclosure, Ben Johnson, director, European ETF Research for Morningstar Europe, also points out that there are still gray areas in terms of definitions to some of the requirements, for example, in how fees are reported.
Morningstar recently conducted their own audit and found a wide range of securities lending practices across Europe. For example, levels of counterparty exposure linked to securities lending varied significantly from provider to provider and from fund to fund while ETF issuers offer different levels of investor protection.
In terms of revenue sharing, while some ETF issuers will pass on all of the income derived from securities lending to the fund, net of the costs, others will retain up to 50 per cent of the proceeds, with the ETF issuer and lending agent covering all operational costs.
“[An ETF fund] may be reporting that revenues are split 60/40 in favour of the fund, but what are the actual costs associated with that? We are of the belief that if the investor is assuming all of the associated risk and there is no borrower indemnification in place, then [investors] should be receiving all of those revenues net of the actual costs. Whether providers are reporting splits in net or gross of fees, there is still haziness around what is being split, who it is being split with and what the associated costs are with these practices,” Johnson said.
In its draft rules for investment funds, ESMA focuses on investor protection with a call for standards on margins and haircuts applicable to collateral while also seeking to improve the quality of information provided to investors to allow them to make informed investment decisions.
“Operationally, the questions are - how are [funds engaged in securities lending] going to go about measuring and subsequently reporting any relevant data that is now being required to provide greater disclosure around the details of securities lending practices?” notes Johnson, adding that the lack of detail makes it difficult to gauge exactly what form greater transparency will take.
Morningstar recommends best practices such as daily publication of the amount of securities on loan and the maximum amount of securities on loan over the last 12 months as well as the amount and composition of actual collateral received by the fund. In addition, the firm recommends that issuers regularly disclose net return to the fund generated by their securities lending activities and strongly affirm that investors have the right to know the percentage split of gross securities lending revenue between the fund on the one hand and the ETF issuer and lending agent on the other, together with the factors that determine this split.
Comments on ESMA's draft rules will be accepted to 30 March and final guidelines are expected to be ready for adoption by mid-2012.
Though noting that the financial regulator has been clear about the need for greater and more frequent disclosure, Ben Johnson, director, European ETF Research for Morningstar Europe, also points out that there are still gray areas in terms of definitions to some of the requirements, for example, in how fees are reported.
Morningstar recently conducted their own audit and found a wide range of securities lending practices across Europe. For example, levels of counterparty exposure linked to securities lending varied significantly from provider to provider and from fund to fund while ETF issuers offer different levels of investor protection.
In terms of revenue sharing, while some ETF issuers will pass on all of the income derived from securities lending to the fund, net of the costs, others will retain up to 50 per cent of the proceeds, with the ETF issuer and lending agent covering all operational costs.
“[An ETF fund] may be reporting that revenues are split 60/40 in favour of the fund, but what are the actual costs associated with that? We are of the belief that if the investor is assuming all of the associated risk and there is no borrower indemnification in place, then [investors] should be receiving all of those revenues net of the actual costs. Whether providers are reporting splits in net or gross of fees, there is still haziness around what is being split, who it is being split with and what the associated costs are with these practices,” Johnson said.
In its draft rules for investment funds, ESMA focuses on investor protection with a call for standards on margins and haircuts applicable to collateral while also seeking to improve the quality of information provided to investors to allow them to make informed investment decisions.
“Operationally, the questions are - how are [funds engaged in securities lending] going to go about measuring and subsequently reporting any relevant data that is now being required to provide greater disclosure around the details of securities lending practices?” notes Johnson, adding that the lack of detail makes it difficult to gauge exactly what form greater transparency will take.
Morningstar recommends best practices such as daily publication of the amount of securities on loan and the maximum amount of securities on loan over the last 12 months as well as the amount and composition of actual collateral received by the fund. In addition, the firm recommends that issuers regularly disclose net return to the fund generated by their securities lending activities and strongly affirm that investors have the right to know the percentage split of gross securities lending revenue between the fund on the one hand and the ETF issuer and lending agent on the other, together with the factors that determine this split.
Comments on ESMA's draft rules will be accepted to 30 March and final guidelines are expected to be ready for adoption by mid-2012.
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