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Stock lending profits should go to fund investors, says IMA
The Investment Management Association says European regulators are right to insist all stock lending profits go back into funds.
The UK trade body for fund managers has backed calls for investment groups to pay all profits they earn from stock lending to investors.
A recent survey by SCM Private showed that half of the largest UK fund managers lent out stock and on average pocketed a third of the income generated.
The Investment Management Association (IMA) said this was wrong and compared the income from stock lending to the dividends paid on shares or the coupons on bonds.
Julie Patterson, an IMA director, said: ‘Frankly, they [the stocks being lent] are the fund’s assets. There is a risk to that lending and there should be a return to the fund’s investors. These assets don’t belong to the fund manager.’
Patterson’s comments follow moves by European regulators this week to force fund managers to disclose more information about their stock lending activities.
The European Securities and Markets Authority (Ema) issued guidelines to operators of exchange traded funds (ETFs), including a requirement to give all lending profits, after costs, to their funds.
The European Commission yesterday responded with a consultation paper proposing to make the requirement binding on all investment funds controlled by Europe’s Ucits legislation. This would cover actively managed funds as well as passive index trackers.
Patterson said: ‘Although Esma’s guidelines are not binding they clearly set the tone forwhat the regulators think.’
However, she defended fund managers' use of 'sale and repurchase' agreements in which a fund sells some stock but agrees to buy it back. In rocky markets these were a useful way of raising cash quickly, which fund managers could use to buy derivatives to alter their market exposure.
Dangers of stock lending
Since the 2008 financial crisis regulators have grown concerned that although retail fund managers are a main source of stock lending, most fund investors are unaware of the practice and the potential risks it poses.
The main dangers from stock lending are that the counterparty borrowing the shares goes bust and is unable to pay back the shares, although lenders can be insured against this.
There is also a risk that the collateral left by the borrower – in addition to the payment of a fee – falls in value and does not cover the shares on loan. This is quite possible as the collateral is often a completely different asset to the stock being lent – for example, shares in Japanese companies being used as collateral for UK shares.
Defenders of stock lending say it helps to keep stock markets liquid and to ensure share transactions settle on time.
Groups such as BlackRock and HSBC also say it enables them to keep fund charges low.
However, Patterson said it would be more transparent if fund managers revealed their charges both gross and net of stock lending income.
Mark Dampier, head of research at Hargreaves Lansdown, a leading funds platform, agreed that all stock lending profits should go back to the fund. ‘I don’t understand why it wouldn’t,’ he said.
Data on Hargreaves Lansdown’s website shows the wide range of practice by investment groups.
BlackRock, the world’s largest investment group, can lend up to 95% of the shares held by its tracker funds and gives just 60% of lending income back to the fund. The same applies to iShares, the ETF provider it owns.
HSBC Asset Management challenged the information on Hargreaves’ website showing its tracker funds could lend 70% and shared 60% of the income. A spokeswoman said this was wrong and the most one of its funds could lend was 20% with 75% of income returned to the fund. The 25% retained by HSBC was just to cover costs and included no profit.
With HSBC’s ETF range the situation was slightly different. Again the most that could be lent was 20%, said the spokeswoman, but the amount of income share given to the fund dropped to 60%. Of the remaining 40%, 25% went to HSBC Securities Services as a lending fee to cover costs and 15% went to the asset management business as profit.
Vanguard, the US tracking fund specialist, can lend up to 100% of the shares in its funds but gives 100% of the proceeds back to the funds.
Fidelity can lend up to 50% of a fund’s assets and gives away 92% of the proceeds.
Legal & General and M&G don’t stock lend at all on their index-tracking funds
In a statement, BlackRock described the Esma guidelines as ‘a positive step’ and said it had campaigned for greater disclosure and transparency.
It added: ‘BlackRock intends to work with Esma and national regulators to understand the application of the guidelines, as they move towards implementation, to preserve the benefits of securities lending for our clients and the broader capital markets.'
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