18 October 2012

ISLA responds to the European Commission's consultation on UCITS

ISLA believes that a UCITS' fund board should be able to define policies for the use of EPM techniques within a robust principle-based regulatory framework, and with full disclosure to the underlying investors.

The International Securities Lending Association (ISLA) believes that the work undertaken by ESMA strengthens the current, comprehensive regulation although some aspects of their guidance requires further clarification which ISLA will be contacting them directly to discuss.

In Europe it is most common for collateral to be title transferred and held on behalf of the UCITS by a specialist, well-recognised and independent third party collateral manager, with oversight by the agent lender and fund board. ISLA is concerned that the ESMA guidelines seem to state that collateral must be held by the Depositary. This may preclude the use of tri-party collateral managers, although this requires further clarification. This restriction may significantly increase costs and settlement risks for the UCITS.

Securities lending is collateralised and marked to market daily and, unlike most OTC derivative activity, the collateral is transferred between counterparties on the same day and usually no minimum threshold applied.

Collateral will be eligible under the UCITS Directive but may not be under the UCITS fund’s investment policy. The objective of collateral is to provide security in the event of a counterparty default, when it is sold to raise capital to replace the assets originally lent. Under the securities lending agreement, the UCITS does not obtain any economic exposure to the collateral (unless there is a counterparty default, in which case collateral would be liquidated). The purpose of collateral is very different from its investments and therefore requiring that collateral must adhere to the fund’s investment policy may not be appropriate. For example the investment policy of an equity fund may prevent the taking of high-quality sovereign debt but this does not mean it is not appropriate collateral.

In Europe it is most common for collateral to be title transferred and held on behalf of the UCITS by a specialist, well-recognised and independent third party collateral manager, with oversight by the agent lender and fund board.

There are a limited number of tri-party collateral managers in the market because it is an information technology and resource intensive service offering. Each of the tri-party agents are sophisticated and experienced in handling non-cash collateral accounts for EPM techniques, including securities lending and repo.

Full response

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