ISLA warns against Ireland’s relaxation limit
24 October 2014 Dublin
Image: Shutterstock
The International Securities Lending Association (ISLA) has hit out at the Central Bank of Ireland, criticising its proposal to limit the collateral diversification relaxation in the European Securities and Markets Authority (ESMA) guidelines on exchange-traded funds and other UCITS.
The collateral diversification relaxation, which was initially intended to apply to UCITS money market funds (MMFs), was extended to all UCITS funds in ESMA’s final report in March, following market support for the move.
But the Central Bank of Ireland is worried that the extension could result in funds holding on to sovereign collateral of deteriorating credit quality in stressed market conditions.
ESMA’s guidelines require all collateral to be of “high quality” and no UCITS fund can have exposure of more than 20 percent of its collateral basket to any single issuer. UCITS MFFs are exempt from this, as long as they receive securities from at least six different issuers, and no single issuer accounts for more than 30 percent of the collateral received.
The Central Bank of Ireland, in its 28 July consultation paper, said high quality is not adequately defined to warrant the relaxation being extended to all UCITS funds.
“The vagueness of that requirement was acceptable under the original guidelines because it was counter-balanced by the precision of the 20 percent diversification requirement.”
The Central Bank of Ireland wants a rule introduced requiring a UCITS fund to only be able to accept high quality collateral. A determination of whether the collateral is sufficiently high quality would be made before accepting it.
In response, ISLA argued in a comment letter that the ESMA derogation allows a UCITS to be fully collateralised in transferable securities issued by a member state as long as diversification levels are maintained at an issue level.
“These requirements are amongst the strictest in the world for funds and institutions participating in EPM (efficient portfolio management) techniques. There are a number of additional safeguards, alongside diversification in the guidelines that apply to all collateral (including government bonds) and therefore we do not believe that further safeguards are not required.”
Existing market practices dictate that where accepted collateral deteriorates in credit quality to less than is acceptable to the UCITS, “this will be identified immediately and the collateral issue replaced with acceptable collateral”, according to ISLA.
“It is well established practice that collateral in securities lending and repo markets is reviewed by the parties on a daily basis.”
“We therefore believe that the concerns are better addressed through the requirement that the UCITS must ensure that collateral meets the criteria in the guidelines on an ongoing basis and that arbitrarily further restricting the collateral that can be accepted is not necessary.”
ISLA added that the suggested collateral management framework, which the Central Bank of Ireland acknowledged would implement a different approach for Irish UCITS than other European UCITS, would be disadvantageous to nationally domiciled funds.
The collateral diversification relaxation, which was initially intended to apply to UCITS money market funds (MMFs), was extended to all UCITS funds in ESMA’s final report in March, following market support for the move.
But the Central Bank of Ireland is worried that the extension could result in funds holding on to sovereign collateral of deteriorating credit quality in stressed market conditions.
ESMA’s guidelines require all collateral to be of “high quality” and no UCITS fund can have exposure of more than 20 percent of its collateral basket to any single issuer. UCITS MFFs are exempt from this, as long as they receive securities from at least six different issuers, and no single issuer accounts for more than 30 percent of the collateral received.
The Central Bank of Ireland, in its 28 July consultation paper, said high quality is not adequately defined to warrant the relaxation being extended to all UCITS funds.
“The vagueness of that requirement was acceptable under the original guidelines because it was counter-balanced by the precision of the 20 percent diversification requirement.”
The Central Bank of Ireland wants a rule introduced requiring a UCITS fund to only be able to accept high quality collateral. A determination of whether the collateral is sufficiently high quality would be made before accepting it.
In response, ISLA argued in a comment letter that the ESMA derogation allows a UCITS to be fully collateralised in transferable securities issued by a member state as long as diversification levels are maintained at an issue level.
“These requirements are amongst the strictest in the world for funds and institutions participating in EPM (efficient portfolio management) techniques. There are a number of additional safeguards, alongside diversification in the guidelines that apply to all collateral (including government bonds) and therefore we do not believe that further safeguards are not required.”
Existing market practices dictate that where accepted collateral deteriorates in credit quality to less than is acceptable to the UCITS, “this will be identified immediately and the collateral issue replaced with acceptable collateral”, according to ISLA.
“It is well established practice that collateral in securities lending and repo markets is reviewed by the parties on a daily basis.”
“We therefore believe that the concerns are better addressed through the requirement that the UCITS must ensure that collateral meets the criteria in the guidelines on an ongoing basis and that arbitrarily further restricting the collateral that can be accepted is not necessary.”
ISLA added that the suggested collateral management framework, which the Central Bank of Ireland acknowledged would implement a different approach for Irish UCITS than other European UCITS, would be disadvantageous to nationally domiciled funds.
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