An international trade body for the securities lending industry has said media speculation that new European regulation will lead to higher fees for exchange-traded funds is based on a misunderstanding of how the industry works.

The International Securities Lending Association said that new guidelines by the European Securities Markets Authority had "unfortunately...been the subject of some speculation in the press concerning the charging of fees for securities lending services, much of which is inconsistent with the guidelines."

At the end of last week, the Financial Times carried a report, in which several analysts and experts were quoted, where it said that recent proposals by the ESMA, for example that all profits made by fund managers who lend out stocks be returned to investors, could lead to higher charges. Stock lending is very common in the ETF industry.

“If you take away the revenue from stock lending then the cost of running the funds will go up and someone is going to have to pay that cost,” Peter de Proft, the director general of European Fund and Asset Management Association, was quoted as having said.

The ISLA said it broadly welcomes the new guidelines, which it believes which will increase "the level and the quality of information provided by UCITS to their investors, clarify the criteria for the management of collateralised transactions such as securities lending, repo and reverse repos and OTC derivatives, and set out the types of financial index in which UCITS may invest".

"In our opinion there is nothing in the guidance that precludes a securities lending agent, be that the fund manager, custodian or third party, from charging a commercial fee for their services," the trade body said. "Such fees would be regarded as part of the direct and indirect costs which the guidelines state may be deducted from revenue."

BlackRock, the owner of ETF giant iShares, said in a statement: “ESMA’s guidelines represent a positive step in a number of areas towards ensuring investors better understand the risks and attributes associated with ETFs and other UCITS products. 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.”

The key provisions in the guidelines by the European regulator are the following (source: ESMA):

•    UCITS that fall under the definition of UCITS ETFs will have to carry the identifier “UCITS ETF” in their name;
•    UCITS ETFs will have to ensure appropriate redemption conditions for secondary market investors by opening the fund for direct redemptions when the liquidity in the secondary market is not satisfactory;
•    UCITS entering into efficient portfolio management (EPM) techniques like securities lending activities will have to inform investors clearly about these activities and the related risks. All revenues net of operating costs generated by these activities should be returned to the UCITS. When a UCITS enters into securities lending arrangements, it should be able at any time to recall any securities lent or terminate any agreement into which it has entered;
•    UCITS receiving collateral to mitigate counterparty risk from OTC financial derivative transactions or EPM techniques should ensure that the collateral complies with very strict qualitative criteria and specific limits in relation to the diversification; and
•    UCITS investing in financial indices will have to ensure that investors are provided with the full calculation methodology of financial indices. Also, UCITS should only invest in financial indices which respect strict criteria regarding, inter alia, the rebalancing frequency and their diversification.