Revision of the provisions on diversification of collateral in ESMA’s guidelines on ETFs and other UCITS issues

ESMA issued its consultation paper on Revision of the provisions on diversification of collateral in ESMA’s guidelines on ETFs and other UCITS issues in December 2013 in response to concerns that the requirements on collateral diversification in the Guidelines, which came in to force on 18 February 2013, were having a significant adverse impact on UCITS’ collateral management policies.

In its response of 31 January 2014 the AMIC welcomes the distinction made between collateral diversification and diversification of assets held by funds – as suggested by ESMA’s approach, but considers that the proposal in this consultation paper is not consistent with a coherent UCITS investor protection policy.

The AMIC response to the paper is available here.

On 26 July 2012 the European Commission launched a public consultation entitled "UCITS Product Rules, Liquidity Management, Depositary, Money Market Funds, Long-Term Investments on a number of regulatory issues related to money market funds, eligible assets, the use of derivatives, and depositary passports". At this stage, it appears that the consultation will form the basis for "UCITS VI", so as to build on the recent UCITS IV Directive and the upcoming UCITS V Directive. The Commission has requested responses to the consultation from interested parties by 18 October 2012.
In the Consultation, the Commission has posed a series of broad, open questions relating to eight different areas of the UCITS regime:
  • eligible assets and use of derivatives: evaluation of the current practices in UCITS portfolio management and assessment of certain fund investment policies;
  • efficient portfolio management techniques: assessment of current rules regarding certain types of transactions and management of collateral;
  • OTC derivatives: treatment of OTC derivatives cleared through central counterparties, assessment of the current framework regarding operational risk and conflicts of interest, frequency of calculation of counterparty risk exposure;
  • extraordinary liquidity management rules: assessment of the potential need for uniform guidance in dealing with liquidity issues;
  • depositary passport: assessment of whether or not to introduce a cross-border passport for the performance of the depository functions set out in the UCITS Directive;
  • money market funds: assessment of the potential need to strengthen the resilience of the MMF market in order to prevent investor runs and systemic risks;  
  • long-term investments: assessment of the potential need for measures to promote long-term investments and of the possible form of such measures (including investments in social entrepreneurship);
  • addressing UCITS IV: assessment of whether or not the rules concerning the management company passport, master feeder structures, fund mergers and notification procedures might require improvements.
In its press release, the Commission specifically mentions that this consultation is to be seen as complementary to its on-going shadow banking work. The consultation aims to further clarify the interaction between the debate on shadow banking and the role of investment funds.

The AMIC response to the consultation is available here.

ESMA Consultation Paper on recallability of repo and reverse repo arrangements

In its response, AMIC members explain they are concerned in general that ESMA guidelines are setting principles on a key topic already in discussion at other international or European bodies levels. For instance the FSB will make by the end of the year its own recommendations on securities lending and repos based on the extensive work they have undertaken under the G20 work programme. UCITS VI will also look into some of the aspects of collateral management. AMIC members believe there is a need for coherence and consistency in the approach on this topic at all regulatory levels.

AMIC members are also concerned about the limitations proposed in the guidelines, which in effect, affect the UCITS access to the repo market. Restricting the ability of a UCITS to enter into non-recallable repo transactions for instance would ultimately increase frictional cost, reduce the number of counterparties willing to take on the additional risk of fully recallable repo transactions and suppress activity in the repo market. End-investors benefit most when the capital transfer mechanism is as efficient as possible; indeed efficient capital transfer mechanisms create liquidity and liquidity ultimately reduces costs for end-investors.

AMIC members are concerned by the wording of paragraph ‘40.e. Collateral diversification’ of the guidelines on ETFs and other UCITS issues – referred to in point 3.c of the proposed guidelines. The new guidelines from ESMA could be interpreted so as to require such managers to accept collateral which is riskier and may not be as liquid in comparison to their own collateral management policy – and create new market risks.

Finally, the impact of the proposed guidelines should be considered in the context of the increased demand for cash that will result from implementation of the European Market Infrastructure Regulation (EMIR) as currently drafted. If variation margin collateral requirements under EMIR are not expanded to include highly liquid securities as well as cash, the buy-side will have to increase its use of the repo markets to raise the necessary cash to meet the CCPs’ variation margin requirements. Any proposed restrictions on repo transactions would therefore impact the ability of market participants to meet the variation margin requirements under EMIR, and could lead to forced sales of assets to generate alternative sources of cash.
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