A certain excitement spread through the securities lending market during August 2012. A new set of guidelines from ESMA (European Securities and Markets Authority) that govern securities lending for UCITS (Undertakings for Collective Investments in Transferable Securities) and ETFs (Exchange-Traded Funds) were published. These guidelines, due to come into force in February 2013, had the laudable objective of strengthening and harmonizing regulatory practices, but one particular aspect was jumped on and, unfortunately, misinterpreted.
It is entirely appropriate for ESMA to underline that any investment vehicle is run for the benefit of the investor, but this was interpreted by some as guidance over how services are provided to those funds and how they pay for them. Those misinterpreting the guidance hailed the end of payments to agent lenders for providing securities lending services, whereas it seems the focus was intended to be on the third-party splits that fund managers themselves take from the lending revenue.
The International Securities Lending Association stepped quickly into the breach and gave a clear message about just what ESMA had intended. But is ESMA right? Or is there a place for a third split paid to the fund manager? HSBC Asset Management does not seem to think so, announcing on August 23 that it would be “returning all profits from securities lending operations” across its UCITS range.
Many asset managers, including those managing ETFs, are believed to charge some level of “oversight” or management charge for stock lending, and it is rumored that in some cases these are as much as 70 percent of lending revenue. If so, once the agent lenders’ fee split has been taken out, there would be precious little left for the fund. While it is clear that some charges can be excessive, if the manager is providing an actual oversight function for their clients, then there is an argument for charging a fee of some sort. Such fees should, of course, be proportionate and transparent, allowing the investor to make an informed decision as to what service provider he or she selects.
Returning more of the securities lending revenues directly to the funds will no doubt improve their overall performance and returns, which will in turn benefit the fund and its managers. However, using legislation to cut off another source of revenue for banks and asset managers will place yet more strain on a system that is already under pressure. To be clear, there is no room and no defense for inflated fees that do not pass “the blush test” in terms of value for money. But investors can make their own choice between high and low cost providers without the help of a regulator.
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