European ETF sec lending revenue hit €40 million in 2011
31 August 2012 London
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A survey has found that approximately €40 million in net revenue was generated from securities lending in European physical replication exchange traded funds (ETFs) last year.
Information and data provider Morningstar’s survey of 10 European providers of physical replication ETFs comes after the European Securities and Markets Authority (ESMA) released controversial guidelines on ETFs and other UCITS issues that affect securities lending in July.
The guidelines were developed following a review of the current regulatory regime in Europe. ESMA found it to be “insufficient to address the specific features and risks associated with” index-tracking UCITS and UCITS ETFs and the efficient portfolio management techniques, such as securities lending, repo and reverse repo, that they may carry out.
Some commentators have said that under the guidelines all revenue that is made from securities lending must be returned to a UCITS fund and its investors.
The ratings agency Moody’s called the guidelines “credit negative for asset managers”.
Moody’s said that while the guidelines aim to increase investor protection and harmonise regulatory requirements within the EU, they are credit negative for asset managers that sponsor ETFs in Europe, such as BlackRock and State Street, and will hurt profitability as a result of higher compliance costs and curtailment of their profitable securities lending activities.
It said: “Securities lending provides ETF sponsors extra revenue to compensate for slim ETF management fees.”
The guidelines, which Moody’s does not expect to be implemented until early next year, could force ETF sponsors to return securities lending revenue. It said: “[A]ll securities lending revenues, net of operating costs, must be returned to the ETF to compensate investors for assuming the associated counterparty risk.”
In a recent statement, the International Securities Lending Association’s chief executive, Kevin McNulty, said that the normal method of compensation for securities lending services is for an agent to charge a commission.
“In our opinion there is nothing in the guidance that precludes a securities lending agent, be that the fund manager, custodian or third party, from charging a commercial fee for their services. Such fees would be regarded as part of the direct and indirect costs which the guidelines state may be deducted from revenue.”
An ESMA spokesperson confirmed that all net revenue must be returned, but this does not include the cost of running a securities lending programme.
In a report on the survey, Morningstar analysts and its authors, Hortense Bioy and Gordon Rose, said: “Revenue sharing arrangements vary greatly across providers. At present, securities lending fees returned to funds range from 45% to 70% of gross revenues, with the ETF issuer and/or the lending agent retaining the balance, part or all of which is used to cover operational costs. Meanwhile, a couple of providers simply say they return 100% of the revenues, net of costs.”
The analysts said that there is “no guarantee” that more money will be returned to fund shareholders, adding that “they may only change the way they disclose their arrangements going forward”.
“[They may state] that 100% of lending revenue is returned to the ETF, minus the fees paid to the fund manager and/or the lending agent, which may effectively be equivalent to the share of gross revenue they are retaining today. Thus, any changes to current practices made to comply with ESMA’s new guidelines may be more a matter of semantics than economics.”
“Ultimately, our hope is that the additional transparency required by the regulator will serve to drive down the costs associated with securities lending by allowing competitive pricing pressure to come to bear. This, in turn, will hopefully lead to enhanced fund performance.”
Information and data provider Morningstar’s survey of 10 European providers of physical replication ETFs comes after the European Securities and Markets Authority (ESMA) released controversial guidelines on ETFs and other UCITS issues that affect securities lending in July.
The guidelines were developed following a review of the current regulatory regime in Europe. ESMA found it to be “insufficient to address the specific features and risks associated with” index-tracking UCITS and UCITS ETFs and the efficient portfolio management techniques, such as securities lending, repo and reverse repo, that they may carry out.
Some commentators have said that under the guidelines all revenue that is made from securities lending must be returned to a UCITS fund and its investors.
The ratings agency Moody’s called the guidelines “credit negative for asset managers”.
Moody’s said that while the guidelines aim to increase investor protection and harmonise regulatory requirements within the EU, they are credit negative for asset managers that sponsor ETFs in Europe, such as BlackRock and State Street, and will hurt profitability as a result of higher compliance costs and curtailment of their profitable securities lending activities.
It said: “Securities lending provides ETF sponsors extra revenue to compensate for slim ETF management fees.”
The guidelines, which Moody’s does not expect to be implemented until early next year, could force ETF sponsors to return securities lending revenue. It said: “[A]ll securities lending revenues, net of operating costs, must be returned to the ETF to compensate investors for assuming the associated counterparty risk.”
In a recent statement, the International Securities Lending Association’s chief executive, Kevin McNulty, said that the normal method of compensation for securities lending services is for an agent to charge a commission.
“In our opinion there is nothing in the guidance that precludes a securities lending agent, be that the fund manager, custodian or third party, from charging a commercial fee for their services. Such fees would be regarded as part of the direct and indirect costs which the guidelines state may be deducted from revenue.”
An ESMA spokesperson confirmed that all net revenue must be returned, but this does not include the cost of running a securities lending programme.
In a report on the survey, Morningstar analysts and its authors, Hortense Bioy and Gordon Rose, said: “Revenue sharing arrangements vary greatly across providers. At present, securities lending fees returned to funds range from 45% to 70% of gross revenues, with the ETF issuer and/or the lending agent retaining the balance, part or all of which is used to cover operational costs. Meanwhile, a couple of providers simply say they return 100% of the revenues, net of costs.”
The analysts said that there is “no guarantee” that more money will be returned to fund shareholders, adding that “they may only change the way they disclose their arrangements going forward”.
“[They may state] that 100% of lending revenue is returned to the ETF, minus the fees paid to the fund manager and/or the lending agent, which may effectively be equivalent to the share of gross revenue they are retaining today. Thus, any changes to current practices made to comply with ESMA’s new guidelines may be more a matter of semantics than economics.”
“Ultimately, our hope is that the additional transparency required by the regulator will serve to drive down the costs associated with securities lending by allowing competitive pricing pressure to come to bear. This, in turn, will hopefully lead to enhanced fund performance.”
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