ESMA highlights concerns over ETF securities lending fee practices

Industry body ordered further investigation into cost-sharing agreements

The European Securities and Markets Authority (ESMA) has highlighted several concerns regarding ETF securities lending fee practices, including the allocation of fees and revenues between asset managers and securities lending agents, according to a new report.

The report titled, 2021 Joint Supervisory Action (CSA) Final Report on Costs and Feesfound that securities lending agents – those who facilitate the lending transaction – working on fixed fees retain between 10 and 50% of the gross revenue generated by the transaction, with the rest going to the UCITS fund.

Of this amount, according to ESMA, only 50-65% of the gross revenue was passed on to the end investor by the asset manager, with retail investors getting a particularly gross supply.

“This [return] is consistent with the findings of the Better Finance research paper which indicated wide discrepancy regarding the percentage of revenue passed on to investors and questioned the reasons for this,” the report states.

“In this context, some National Constituent Authorities (NCAs) have expressed the view that it would be useful to clarify ESMA’s guidance on ETFs and other UCITS issues in order to ensure a greater level of prudential convergence on the issue of cost allocation.”

Securities lending, a long-standing practice on ETFs or mutual fund investment vehicles, involves lending stocks or bonds to seek incremental increases in shareholder returns. One of the main attractions for many people considering securities lending is the ability to offset the impact of fees, even if issuers take significant fees from securities lending revenue.

ETFs currently represent only a fraction of all securities lending – 2.6% of the total value – but their share has fallen from a 1.8% stake since 2017. ETF securities lending has nearly doubled between 2017 and mid-2021, according to data from EquiLend, with ETF loan value rising 76.9%, from $37.5 million to $66.3 million.

However, the “fixed” nature of fee agreements could result in “overcharging” investors, ESMA found, as it does not reflect market conditions and prices, meaning services “remain at a level consistently high, despite competitors offering the same services”. with a similar level of quality and at a better price”.

In addition, ESMA also found that the managers did not provide a documented assessment to justify the costs deducted from the gross income, despite asserting it.

“Furthermore, UCITS managers who have reviewed their securities lending structures have often not made a clear distinction between indirect and direct costs,” he added.

Asset managers have also been accused of providing a ‘lack of detailed information’ on lending practices, particularly in areas such as risk, conflict of interest, impact on UCITS fund performance and cost/revenue distribution.

“Another issue mentioned by ANCs is the use of generic language by UCITS managers about what efficient portfolio management (EPM) techniques they use and why,” he said. . “Instead, NCAs observed many instances where the same information was used across the entire fund range of UCITS managers or even the group without sufficient consideration of the specifics of the individual fund and the EPM agreement.”

ESMA concluded: “In light of the divergent market practices and the doubts expressed by some NCAs, ESMA is of the opinion that the issue of the cost allocation arrangement merits further investigation and analysis. “

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