The first is securities lending, where Esma indicates clearly that all, net of operational costs, should be returned to the fund. This may come as a surprise to some industry participants. The problem of transparency has been brought up before, but Esma went much further than expected. The new rule drastically changes the situation and the business model of ETF providers that have chosen physical replication since securities lending represented a considerable source of revenue for asset management firms.
These revenues did not correspond to disproportionate profits, but allowed ETFs to show lower management fees. As a result of receiving all lending profits, ETF management fees are expected to increase. The arrangement will nonetheless have the merit of clarifying the real costs of replication and the profits associated with the risk taken in securities lending.
While it is only fair that investors receive the full benefits from risks taken on their behalf, a more modest approach was advocated that relied on disclosure and competition to improve terms for investors. The Esma decision will force a rapid reshaping of the European securities lending industry, in part through the volumes handled on the market. The market is fundamental in increasing the liquidity and efficiency of equity markets and would require constant study. The fact that Ucits ensure that any security lent out can be recalled at any time also has its own disruptive potential.
The second area is the new requirements in the area of financial indices. I am very satisfied that the European regulator has taken a major step towards transparency in an industry that, with some exceptions, was characterised - under the pretext of protecting intellectual property - by the low level of information given to investors on index methodologies and compositions.
Esma, through these recommendations, is putting a logical end to these practices, and is allowing all stakeholders to access details on the methodology, which should allow the investor to replicate the index and its composition without any additional cost.
Esma’s position is sensible given the importance of indexed investment and the fact that it seems difficult for a provider to claim that their indices are a reference without giving exhaustive information on that reference. From that perspective, I feel it important that any financial index marketed on the basis of its track record - which itself is produced on the basis not only of live performance, but also of historical simulation - be able to justify that track record both through systematic, clear ground rules or discretionary decisions, and through compositions that correspond to those ground rules.
