EBF Ref.:D0481D
Brussels, 30 March 2012
Launched in 1960, the European Banking Federation is the voice of the European banking
sector from the European Union and European Free Trade Association countries. The EBF
represents the interests of almost 5000 banks, large and small, wholesale and retail, local and
cross-border financial institutions. Together, these banks account for over 80% of the total
assets and deposits and some 80% of all bank loans in the EU only.
EBF comments on ESMA future guidelines on UCITS Exchange-Traded
Funds (UCITS ETFs) and other UCITS-related issues
Key points:
• The EBF welcomes ESMA’s approach of awaiting the outcome of MiFID in relation to the
issue of complexity.
• As there might be other ETFs, which are not compliant with UCITS, the “UCITS-brand”
should appear in the name in order to avoid confusion.
• The term “exchange-traded” makes it clear that units can only be bought and sold on an
exchange. Therefore secondary market investors should not have a right to direct redemption
of ETF units by the issuer.
• Regarding EPM, the EBF suggests the application of reconciliation with the counterparty of
trades that are collateralized. Furthermore, it points out that it is usual for this third party to
seek re-imbursement through a fee sharing arrangement rather than charging a flat fee.
• The EBF does not believe that incorporating collateral with other assets to calculate
compliance with UCIT diversification rules is practically achievable or necessary.
• The EBF is of the view that a high correlation requirement should not be applied for EPM
techniques.
• Limiting the proportion of the portfolio that can be lent, by counterparty or at portfolio level
would limit the opportunities for UCITS in securities lending and lead to reduced
competitiveness.
• It remains unclear to us who may qualify as an independent valuation agent. Involving a third
party would cause high costs while the added value compared with an affiliated valuation
agent is questionable.
•
•
Contact Person: Joe McHale (j.mchale@ebf-fbe.eu)
Related documents: http://www.esma.europa.eu/system/files/2012-44_0.pdf
EBF a.i.s.b.l
ETI Registration number: 4722660838-23
10, rue Montoyer B-1000 Brussels
+32 (0)2 508 37 11 Phone
+32 (0)2 511 23 28 Fax
www.ebf-fbe.eu
Introduction
The European Banking Federation (EBF) welcomes the opportunity to comment on the draft
future guidelines on UCITS Exchange-Traded Funds (UCITS ETFs) and other UCITS-related
issues. It recalls the messages of its in September 2011 response to ESMA and is happy to see
that the authority has decided to await the outcome of MiFID in relation to the issue of
complexity. That said it is now very unclear what the purpose of the proposed guidelines is. This
confusion unfortunately makes it rather difficult to give a comprehensive answer to the
individual questions. The EBF has therefore focused on the issues which clearly present some
challenging obstacles to market participants.
General Remarks
The EBF would like to raise a technical point with respect to transitional provisions for collateral
posted to Structured UCITS which were launched prior to publication of CESR 10-788. ESMA
correctly stipulates that pre-existing Structured UCITS with pre-defined payout terms should be
exempt from any of their new guidelines that would have an economic impact requiring a change
in their payout terms. However, CESR 10-788 included no such transitional provisions. ESMA
later issued supplementary paper ESMA/2011/112 which explicitly exempted pre-existing
Structured UCITS from Boxes 1-25 of the guidelines on global exposure in CESR 10-788, due to
their potentially detrimental impact on the fund payout. The EBF believes the same principle is
equally applicable to Box 26 of CESR 10-788, and the same exemption should apply to Box 26
for Structured UCITS launched before CESR 10-788 was published. Structured UCITS payout
terms are designed based on collateral costs for specific collateral assets, with such costs fixed
for the life of the fund. Any post-launch change to the collateral rules would impact the predefined payout terms set out in the fund documentation, which would not be a good outcome for
investors. This is purely a technical point to address the apparent anomaly between the CESR
and ESMA provisions in respect of transitional arrangements.
Box 3 - Definition of UCITS ETFs and identifier
With regards to the issue of a potential ETF identifier, the EBF thinks that the purpose of the
definition (including the effects besides the demand for labeling) needs to be clear, before the
identifier is decided. That said it seems that the definition now includes all the features which
make them safe for the investor to invest in. In order to take account of jurisdictions with tailor
made marketplaces where trades take place on the basis of NAV and restrictions apply to the
activity of market makers, the EBF suggests the following minor underlined amendments to the
ETF definition:
1. A UCITS exchange-traded fund (UCITS ETF) is a UCITS at least one unit or share class
of which is continuously tradeable on at least one regulated market or multilateral
trading facility (MTF) with at least one market maker which takes action to ensure that
the stock exchange value of its units or shares does not significantly vary from its
indicative net asset value without being restricted by the UCITS in this action.
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2. A UCITS ETF should use an identifier, in its name and in its fund rules or instrument of
incorporation, prospectus, KIID and marketing communications, which identifies it as an
exchange-traded fund. The identifier should be ‘UCITS-ETF’.
3. A UCITS which does not fall under the definition of UCITS ETF in paragraph 1 of this
Box should not use the ‘UCITS-ETF’ identifier in its name or in its fund rules or
instrument of incorporation, prospectus, KIID or any marketing communications.
Besides that, a further distinction between synthetic and physical ETFs is not necessary, as both
ways of “rebuilding” the relevant index are common market practice and an identifier should be
short and simple, it is not necessary to capture the technique in the identifier. Nevertheless, the
distinction can be made and should be made in the prospectus (cf. Question 8).
Box 5 – Secondary markets investors
Q12: Which is your preferred option for the proposed guidelines for secondary market
investors? Do you have any alternative proposals?
Secondary market investors should not have a right to direct redemption of ETF units by the
issuer. The term “exchange-traded” makes it clear that units can only be bought and sold on an
exchange. A right of this kind would make it extremely difficult to differentiate between ETF
products and products that can be either returned to the asset management firm or sold on the
stock exchange. Therefore, EBF members prefer Option no. 1.
Q13: With respect to paragraph 2 of option 1 in Box 5, do you think there should be
further specific investor protection measures to ensure the possibility of direct
redemption during the period of disruption? If yes, please elaborate.
No. Due to the market-making obligation (Option 1) there is no necessity for a direct
redemption.
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Box 6 - Efficient Portfolio Management Techniques
Q16: Do you agree with the proposed guidelines in Box 6? In particular, are you in
favour of requiring collateral received in the context of EPM techniques to comply with
CESR’s guidelines on Risk Measurement and Calculation of Global Exposure and
Counterparty Risk for UCITS?
The EBF would like to raise important points concerning paragraph’s 2 & 6 in box 6. For the
other points, it agrees in general with the proposed guidelines with the exception of:
•
part of paragraph 3
•
paragraph 7
In addition, the EBF suggests the application of reconciliation with the counterparty of trades
that are collateralized. This is critical step which is often overlooked. Following the negotiation
of the collateral agreement but before it is acted upon with margin calls being made; it is
recommended that firms perform a detailed trade-by-trade position reconciliation. Reconciliation
allows the two parties to agree on the number and exposure of any existing trades. If the portfolio
has not been reconciled and agreed, any collateral that flows back and forth between the parties
is based on what may be an estimate of true exposure. The frequency of reconciliation should
depend on the turnover of the portfolios (stable portfolios being less subject to discrepancies than
portfolios with high turnover) and there should be“practicality” criteria (access to industry
utilities).
Proposed guidelines in paragraph 2
It is important that investor information is not confined in technical terms to explaining the risks
related to securities lending; the objective would be better achieved by applying clear concise
language to disclose such risks to investors. Whilst we agree that information should be available
to clients, there should be a more practical approach in displaying the collateral parameters,
particularly as these can change frequently based on market conditions.
Proposed guidelines in paragraph 3
In terms of disclosure the EBF agrees that fee arrangements should be disclosed in the
prospectus of the UCIT. However, paragraph 3 suggests that “as a general rule” all fees should
be returned to the UCIT. Securities Lending is a complex and costly activity which is usually
undertaken by a third party specialist (this may be the asset manager, custodian or independent
third party) who has invested in specialist systems and expertise to manage the process in a risk
controlled manner. It is usual for this third party to seek re-imbursement through a fee sharing
arrangement rather than charging a flat fee. This ensures that the UCIT only incurs costs when
revenues are generated and aligns the interests of the third party to the UCIT in respect of
ensuring that the activity is profitable for the UCIT.
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Proposed guidelines in paragraph 6
Whilst the qualitative criteria set by Box 26 in the CESR Guidelines are helpful, appropriate
controls at a firm/industry level would go much further in mitigating the concerns which the
proposed policy aims to address: firms should apply an effective risk management framework,
haircut policy and indemnification; once these are supplemented by the qualitative criteria set by
policy, the overall policy objectives are likely to be achieved.
However, one key exception applies: this concerns the criteria for reinvestment of cash collateral
for stock lending: there should be more flexibility applicable to the reinvestment of collateral.
Proposed guidelines in paragraph 7
The EBF does not believe that incorporating collateral with other assets to calculate compliance
with UCIT diversification rules is practically achievable or necessary.
EBF members believe that this requirement will raise various issues depending of the nature of
collateral:
1) Collateral received in transferable securities or money market instruments
Collateral is designed to be liquidated as soon as possible. It is not designed to act as a
substitute investment, and with a counterparty default it will need to be liquidated
whereas the other assets will not.
Market practice is that assets given as collateral must be suitable for both the collateral
taker and the collateral giver (criteria for determining collateral eligibility, haircut rate).
Consequently, the eligibility criteria does not depend on UCITS diversification rules that
only apply to the collateral taker and that could change the nature of collateral at any
time. The EBF believes that ESMA’s proposal (Box 6 – paragraph 6) is sufficient to
provide an ensured recovery rate in the event of the counterparty default.
2) Collateral received in cash
The holding of a deposit at a site held at the depositary may be justified to cover
payments. Requiring that at any time a UCITS shall hold no more than 20 % of the
portfolio composed of both its assets and of the collateral received in ancillary liquid
assets and cash received as collateral and deposits with the depositary will lead to the
transfer of cash collateral to third party agents .This will result in a credit exposure to
these third party agents.
Furthermore, if received collateral falls within the scope of custody under UCITS V the
EBF believes that depositaries will not accept an obligation to return cash-reinvestment in
assets held at a third party in case of loss of these assets by the third party .
Therefore the EBF suggests:
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i) that the review of UCITS V should lay down that UCITS are entitled to be preferred
before other creditors of the depositary in case of bankruptcy of the depositary;
ii) to raise the threshold of 20% in case the cash is held by the depositary.
Q19: Would you be in favour of requiring a high correlation between the collateral
provided and the composition of the UCITS’ underlying portfolio? Please explain your
view.
The EBF is of the opinion that this requirement would be useless and inefficient:
-
In the event of a default by the counterparty, what really matters with collateral received
or securities purchased is to be able to quickly resell the assets. A high correlation
criterion would be useless. Furthermore, in many cases it would be very difficult to find
enough correlated securities. Basically, the only collateral which would be totally
correlated to the securities lent would be the securities themselves.
-
A high correlation requirement may give rise to inefficiency, since any changes in the
collateral or securities composition, required to ensure that the correlation criteria is
enforced, would involve costs, ruining the initial purpose of securities lending/borrowing
and repurchase agreements/reverse repurchase agreements as efficient portfolio
management techniques and causing intermediaries to be paid with no upside for the
investors.
In the end, bearing in mind that correlation is a non trivial input (as a market parameter, it can
vary over time and over maturities), a high correlation requirement between the collateral
received or provided, or the securities purchased or sold, and the composition of the UCITS
underlying portfolio would lead to non efficiency. The EBF is thus of the view that a high
correlation requirement should not be applied for EPM techniques.
Q20: Do you agree that the combination of the collateral received by the UCITS and the
assets of the UCITS not on loan should comply with the UCITS diversification rules?
Please refer to Q16 above
Q21: With regards to eligibility of assets to be used as collateral, do you have a
preference for a list of qualitative criteria (as set out in CESR’s guidelines on risk
measurement) only or should this be complemented by an indicative list of eligible
assets?
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The EBF believes that the best approach would be defining qualitative criteria for eligible
collateral without further expansion. This allows a level of flexibility for the UCIT to react to
changes in market conditions without the need to amend regulations whilst ensuring that the
quality of collateral is always maintained.
Q24: Do you agree that entities to which cash collateral is deposited should comply with
Article 50(f) of the UCITS Directive?
The EBF agrees with this approach.
Q25: Do you believe that the proportion of the UCITS’ portfolio that can be subject to
securities lending activity should be limited? If so, what would be an appropriate
percentage threshold?
Limiting the proportion of the portfolio that can be lent, by counterparty or at portfolio level
would limit the opportunities for UCITS in securities lending and lead to reduced
competitiveness. Provided the risk management techniques are robust and appropriate collateral
and haircuts are applied limits are not necessary and will be detrimental to the UCITS ability to
ensure best pricing and to maximise returns.
If limits were imposed on securities lending activity for UCITS the EBF would expect similar
restrictions to apply to synthetic instruments that have a similar effect in other funds.
Q30: In relation to the valuation of the collateral by the depositary of the UCITS, are
there situations (such as when the depositary is an affiliated entity of the bank that
provides the collateral to the UCITS) which may raise risks of conflict of interest? If yes,
please explain how these risks could be mitigated? The question is also valid for
collateral received by the UCITS in the context of total return swaps.
It is permitted under the AIFM Directive that, provided it has functionally and hierarchically
separated the performance of its depositary functions from its other tasks as a services provider, a
depositary may also provide:
•
services to finance or execute transactions in financial instruments as counterparty ,
securities lending, customised technology and operational support facilities if the
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potential conflicts of interest are identified, managed, monitored and disclosed to the
investors in the fund.
•
Nav calculation and valuation of individual assets (including collateral).
It is recognised that AIFMD establishes a stringent regulatory framework addressing risks in
relation to investors. The EBF therefore believes that the AIMFD provisions are sufficient to
mitigate these risks.
Box 7 - Total Return Swaps
Most of questions raised by ESMA in this box for Total Return Swaps are similar to those for
Box 6 - EPM techniques. Consequently the EBF’s comments are the same as those mentioned
for EPM.
Box 8 - Strategy indices
The proposed guidelines on strategy indices are an important step towards enhanced quality and
standardised requirements of index-tracking UCITS. The EBF appreciates these developments as
they will ideally further improve the stability and transparency of the fund market. Nevertheless,
EBF members would like to comment on some of the guidelines as stated on page 29 of the
consultation paper as follows:
Proposed guidelines in paragraph 6
In our view, this criterion is too narrow as it effectively limits the world of indices in which
investors may participate. For example, in regard to portfolio diversification indices with intraday balancing can contribute significant value as an additional asset class in investors' portfolios.
Clients may request products that are linked to indices which rebalance more frequently as they
appreciate those as investment opportunities that are otherwise not accessible to them.
Furthermore, indices which are oriented on shorter terms are also capable of representing their
respective markets appropriately. For instance, FX indices can require intra-day rebalancing in
order to capture FX market movements reliably. In this regard, the fact that intra-day rebalancing
does not meet this requirement appears somehow random. Therefore, the EBF suggests deleting
it completely.
Proposed guidelines in paragraph 12
The EBF agrees that a standard due diligence on the quality of the index is a must. As a result the
overall quality of funds should increase.
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Proposed guidelines in paragraph 13
The EBF understands that an independent assessment of the underlying index may enhance the
quality of the valuation of the fund. However, it is yet unclear to us what independent assessment
means or what the requirements are. The workload as well as costs and time spent on this
assessment depend greatly on these requirements.
In our view, a feasible solution would be a plausibility check by the management company of the
fund. In this way, additional costs could be limited.
Proposed guidelines in paragraph 14
It remains unclear to us who may qualify as an independent valuation agent. In our view, a third
party valuation agent would genuinely go too far. Again, involving a third party would cause
high costs while the added value compared with an affiliated valuation agent is questionable. In
our view, the costs involved with an independent valuation of the financial index would cause
the extinction of strategy indices. Therefore, this matter appears somewhat disproportionate.
The process of pricing the underlying index is of high importance and a key quality criterion.
Besides, the valuation is a mandatory element in the due diligence on the quality of the index.
The EBF suggests mentioning in the fund prospectus if an independent valuation of the financial
index will be carried out. Especially, it seems important to outline the relationship between the
index sponsor and the valuation agent, whether they are external third parties or affiliated.
Q40: Do you think that further consideration should be given to potential risks of
conflict of interest when the index provider is an affiliate of the management company?
In many cases, the index sponsor, valuation agent and management company will be affiliated,
and may even operate as different departments of the same legal entity. By law, these entities are
obliged to implement appropriate control measures to prevent conflicts of interest. Regulation
authorities are supervising these measures and ascertain that the entities comply with these
requirements on an ongoing basis.
In the context of this control setup the EBF suggests that a proper disclosure of the relationship
between the index sponsor, valuation agent and management company in the relevant fund
prospectus is sufficient. By including this matter as an additional risk factor the EBF considers
the disclosure as an appropriate form of disclosure to investors that there may be potential risks
of conflict of interest. Therefore, further consideration is not required from our point of view.
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