SFTs are risky, complex and difficult to understand for some retail clients, says ESMA
13 July 2023 Europe
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The European Securities and Markets Authority (ESMA) has released a public statement highlighting the risks of securities lending in regards to retail client financial instruments, and how MiFID II rules apply in this area to protect investors.
While securities finance transactions (SFTs) may bring extra returns on financial instruments, ESMA says, SFTs are also a “risky and complex practice” that can present counterparty and collateral shortfall risk.
SFTs can also be difficult to understand for the average retail client, the Authority claims.
MiFID II imposes strict requirements regulating the use of client financial instruments. The regulation imposes rules on securities lending in the area of client consent, provision of collateral and information disclosure.
ESMA indicates that the investor lending out financial instruments will incur a loss if the external borrower is not able to return the borrowed financial instrument, the value of the collateral is insufficient to cover the loss of the financial instrument lent out, or if the investment firm is unable to compensate for the loss.
While securities lending is possible for retail clients, it notes that the bar for investor protection is higher when a firm uses retail client financial instruments.
Article 5 of the MiFID II Delegated Directive specifies that firms entering into SFTs which involve use of client financial instruments, should obtain written consent from clients regarding how these client assets will be used.
Further, ESMA clarifies that the firms involved should adopt specific arrangements to ensure that the borrower of client financial instruments provides appropriate collateral.
The firm must monitor the “continued appropriateness” of such collateral and take steps to maintain the balance with the value of the client financial instruments.
For written agreements and provision of information, firms are required to provide adequate information to the client on an ex-ante and ex-post basis, also providing transparency in terms of obligations and responsibilities held by the firm with respect to the use of those financial instruments.
In its public statement, ESMA highlights the practical application of MiFID II requirements to securities lending in relation to retail clients.
The Authority states that revenues from securities lending should directly accrue to the retail client, net of a normal compensation for the firm’s services.
More broadly, it indicates that firms should always act honestly, fairly and professionally in accordance with their clients’ best interests, as pinpointed by Article 24 (1) of MiFID II.
While securities finance transactions (SFTs) may bring extra returns on financial instruments, ESMA says, SFTs are also a “risky and complex practice” that can present counterparty and collateral shortfall risk.
SFTs can also be difficult to understand for the average retail client, the Authority claims.
MiFID II imposes strict requirements regulating the use of client financial instruments. The regulation imposes rules on securities lending in the area of client consent, provision of collateral and information disclosure.
ESMA indicates that the investor lending out financial instruments will incur a loss if the external borrower is not able to return the borrowed financial instrument, the value of the collateral is insufficient to cover the loss of the financial instrument lent out, or if the investment firm is unable to compensate for the loss.
While securities lending is possible for retail clients, it notes that the bar for investor protection is higher when a firm uses retail client financial instruments.
Article 5 of the MiFID II Delegated Directive specifies that firms entering into SFTs which involve use of client financial instruments, should obtain written consent from clients regarding how these client assets will be used.
Further, ESMA clarifies that the firms involved should adopt specific arrangements to ensure that the borrower of client financial instruments provides appropriate collateral.
The firm must monitor the “continued appropriateness” of such collateral and take steps to maintain the balance with the value of the client financial instruments.
For written agreements and provision of information, firms are required to provide adequate information to the client on an ex-ante and ex-post basis, also providing transparency in terms of obligations and responsibilities held by the firm with respect to the use of those financial instruments.
In its public statement, ESMA highlights the practical application of MiFID II requirements to securities lending in relation to retail clients.
The Authority states that revenues from securities lending should directly accrue to the retail client, net of a normal compensation for the firm’s services.
More broadly, it indicates that firms should always act honestly, fairly and professionally in accordance with their clients’ best interests, as pinpointed by Article 24 (1) of MiFID II.
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