ISLA welcomes ESMA's easing on collateral
20 February 2014 London
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ESMA’s proposal to ease up on certain collateral diversification rules contained in its guidelines for ETFs and other UCITS has been met with open arms by the International Securities Lending Association.
The European and Securities Market Authority’s current guidelines require that no more than 20 percent of the NAV of a UCITS may be held in collateral from any one issuer.
In the consultation, ESMA consider allowing a derogation from this provision for government issued collateral in certain circumstances. The proposal is that this derogation should be limited to money market fund UCITS only to allow them to use higher volumes of reverse repo against a single government issuer.
ISLA argues that whilst it supports the proposal, the derogation should be available to all UCITS, and not just money market funds (MMF).
“Whilst recognising the specific difficulties faced by MMFs in their use of reverse repo, the complexity of compliance with the current requirements will also have a significant negative impact on other UCITS in their management of collateral, and we see no clear rationale to exclude any UCITS from the derogation of the 20 percent diversification requirement,” said the association in a letter.
It added that diversification is, in most cases, an appropriate risk mitigant, but there are circumstances where its application may increase or negatively affect the level of risk or cost associated with EPM techniques. “The current diversification rules may drive UCITS to take risk that they otherwise would not take, such as cross currency risk and in some cases cash re-investment risk.”
“Whilst our members believe that all UCITS funds may be restricted in their activity relative to other comparable retail funds, the diversification rules may disproportionally disadvantage smaller, specialist or niche UCITS that may achieve higher levels of exposure to EPM techniques than 20 percent of their NAV because of the nature of their portfolio,” continued the statement.
It added that the guidelines also have a very direct impact on fixed income or government bond specific UCITS which may wish to employ EPM techniques with a narrow collateral policy focused only on government bonds (for example, a UCITS invested in US fixed income securities may wish to restrict collateral to US government bonds only).
Such funds would be forced to restrict EPM techniques to 20 percent of their NAV or would be required to accept some currency, market or country risk in their collateral pool.
“Restricting EPM techniques, such as securities lending, will negatively affect investment performance for these funds and may serve to increase the costs of management and administration (which are ultimately borne by investors),” said the association.
The European and Securities Market Authority’s current guidelines require that no more than 20 percent of the NAV of a UCITS may be held in collateral from any one issuer.
In the consultation, ESMA consider allowing a derogation from this provision for government issued collateral in certain circumstances. The proposal is that this derogation should be limited to money market fund UCITS only to allow them to use higher volumes of reverse repo against a single government issuer.
ISLA argues that whilst it supports the proposal, the derogation should be available to all UCITS, and not just money market funds (MMF).
“Whilst recognising the specific difficulties faced by MMFs in their use of reverse repo, the complexity of compliance with the current requirements will also have a significant negative impact on other UCITS in their management of collateral, and we see no clear rationale to exclude any UCITS from the derogation of the 20 percent diversification requirement,” said the association in a letter.
It added that diversification is, in most cases, an appropriate risk mitigant, but there are circumstances where its application may increase or negatively affect the level of risk or cost associated with EPM techniques. “The current diversification rules may drive UCITS to take risk that they otherwise would not take, such as cross currency risk and in some cases cash re-investment risk.”
“Whilst our members believe that all UCITS funds may be restricted in their activity relative to other comparable retail funds, the diversification rules may disproportionally disadvantage smaller, specialist or niche UCITS that may achieve higher levels of exposure to EPM techniques than 20 percent of their NAV because of the nature of their portfolio,” continued the statement.
It added that the guidelines also have a very direct impact on fixed income or government bond specific UCITS which may wish to employ EPM techniques with a narrow collateral policy focused only on government bonds (for example, a UCITS invested in US fixed income securities may wish to restrict collateral to US government bonds only).
Such funds would be forced to restrict EPM techniques to 20 percent of their NAV or would be required to accept some currency, market or country risk in their collateral pool.
“Restricting EPM techniques, such as securities lending, will negatively affect investment performance for these funds and may serve to increase the costs of management and administration (which are ultimately borne by investors),” said the association.
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