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Fund securities lending guidelines spark confusion

Major asset managers are keeping up to 40% of gains from securities lending, despite new guidelines requiring them to return all revenues to investors, after costs.

The European Securities and Markets Authority (Esma) guidelines on exchange traded funds (ETFs) and other Ucits issues, which came into effect on 18 February, require Ucits products engaging in securities lending to return all revenues, net of operating costs, back to the fund.

However, some asset managers have yet to change their policies and are still pocketing large chunks of revenue generated by securities lending in ETFs, which in the case of BlackRock and State Street Global Advisors (SSgA) amounts to 40%.

Although both SSgA and BlackRock, for example, have yet to change their fee-split arrangements, it is unclear whether they will have to alter their securities lending programmes, even though they claim they comply with the guidelines.

A SSgA spokesperson said: ‘While the ESMA guidelines became effective [on Monday], there are transitional provisions (section XIV) included in the guidelines that detail when specific guidelines must be implemented.

'Some rules had no transitional period (cash collateral and ETF primary market provision) while others have a 12-month transitional period that began yesterday. We intend to be fully compliant with the Esma guidelines in consideration of the stated transitional provisions.’

However, a major issue is Esma’s lack of clarity about what constitutes ‘cost’ and how much of the revenue can be used to cover the expense of engaging in securities lending. SSgA said: ‘On the issue of direct expense, we do believe that the fee paid to a securities lending agent – the revenue split – should be recognised as an operating expense and as such would not be prohibited or directly influenced by the Esma guidelines.’

Only 12 of its 45 European SPDR ETFs engage in securities lending, with 40% of revenues going to the custody lending agent, which in this case is State Street Global Markets.

BlackRock engages in securities lending across a large proportion of its iShares range, but does not use a securities lending agent, instead running its securities lending programme in-house.

Although this issue also affects actively managed funds, the lack of accessible and clear information means ETFs are coming under greater scrutiny by comparison, due to their greater transparency.

Fidelity said its Luxembourg Sicav range lends securities, but it only takes 0.5% to cover costs with 90% benefiting the fund.

A spokesperson for Fidelity said: ‘Our Luxembourg SICAV ranges participate in a limited, low risk programme to lend securities, mainly for dividend yield enhancement purposes, in order to generate incremental revenue for shareholders.'

Alan Miller, co-founder of SCM Private, pointed out to Esma the clear conflicts of interest in securities lending, which he said could be significantly mitigated by ensuring the fund received any associated income net of direct costs. 

‘We also suggested when this was in-house it should be in line with third party independent costs as we cynically expected some providers to simply get round any rules otherwise,’ he said.

‘So far some ETF providers, such as HSBC, have decided to return all the income rather than iShares and some others retaining 40% or more of the income. 

‘Previously around 25 to 30% of the revenue earned from securities lending activities by HSBC’s range of exchange traded funds was retained by the business.  Furthermore HSBC outsources its securities lending operations to agents selected through a tender process to ensure that agents’ fees remain competitive.’

Esma is due to provide further guidance in March regarding the details of its guidelines, but Miller said it seems pretty evident that if iShares continue to charge a ‘direct cost’ for such securities lending amounting to 40% then it is clearly ‘flouting the spirit’ of the new rules.

‘Esma needs to show BlackRock that even though they are a big player this does not prevent them from following the spirit of the rules and if necessary BlackRock’s ETFs and other funds involved in securities lending should be banned by Esma in describing themselves as UCITS funds,’ said Miller.

‘Astonishingly there has been a stony silence from the many fund management groups that have taken a cut from securities lending in their UK mutual funds in recent years - M&G, Threadneedle, Schroders, SWIP, BNY Mellon, BlackRock, Henderson, Scottish Widows amongst others regarding how they will be changing - if at all - their securities lending policies following the new rules.’

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