03 February 2014

Responses to ESMA's consultation on proposals to amend collateral diversification rules for ETFs and other UCITS: AFG, ALFI, EFAMA, ISLA

AFG

The Association Française de la Gestion financière (AFG) responds to ESMA’s consultation paper on the Revision of the provisions on diversification of collateral in ESMA’s guidelines on ETFs and other UCITS issues and proposes to apply a 20 per cent issue diversification ratio.

AFG agrees that ESMA should revise the rules for the diversification of collateral received in the context of efficient portfolio management techniques and OTC transactions. However, the Association also points out that all UCITS should be targeted by the revision, not only money market funds.

AFG urges ESMA to confirm that, by exception, the collateral received through EPM technics can be posted as initial or variable margin in the specific context of EMIR regulation on derivatives in order to fulfil with the newrequirements introduced by this directive. On this point, these two regulations are incollisions and create tremendous difficulties, even impossibilities, for asset managers.It is of utmost importance to coordinate, according to AFG.

AFG believes that no additional safeguards for government bonds received as collateral should be introduced. There is no need for additional requirements on government bonds received as collateral. The exemption from the 20 per cent concentration limit for government bonds does not exempt UCITS and their manager to assess the high quality and liquidity of the instruments received and ask for appropriate haircuts. These parameters depend on the market’s evolution and may clearly move more rapidly than any regulation.

Full response

ALFI

The Association of the Luxembourg Fund Industry welcomes ESMA’s initiative to review the provisions on the diversification of collateral in its guidelines on ETFs, but finds that granting more flexibility in terms of diversification of collateral to the sole money market funds and not to other types of UCITS discriminatory.

ALFI does not deem it necessary to impose additional safeguards for government bonds received as collateral (such as specific issuer limit) to ensure a certain level of diversification. Counterparty selection standards and the existing level of collateral monitoring already protect the end-investors, ALFI belives.

In response to the proposed requirement to diversify the government securities across at least six different issues, ALFI underlines that in the original UCITS Directive the condition for receiving securities from at least six different issues aimed at ensuring that a UCITS portfolio invested in government bonds meets the definition of a UCI (i.e., diversification test). The purpose of the collateral is to enable the manager to replace a trade in case of defaultfrom the counterparty. Hence, the sole requirement is that the collateral must be in any casehighly liquid and of high quality as foreseen in the guidelines. Moreover, ALFI is concerned that the systems used by the reverse purchase agreement market and collateral manager do not have control mechanisms able to ensure compliance with the proposed rule.

Full response

EFAMA

EFAMA strongly believes that the derogation from the 20 per cent issuer limit proposed by ESMA should be extended to all UCITS funds and not just to MMFs. There does not appear to be a market rationale for making a distinction in this respect between MMFs and other UCITS. EFAMA urges ESMA to consider extending the scope of the proposed exemption to all UCITS funds which receive government securities as collateral.

EFAMA also finds that the revisions of the collateral diversification rules proposed by ESMA will temporarily place UCITS managers in an uncomfortable situation. To  avoid unnecessary costs and efforts, EFAMA would welcome a clarification by ESMA that market participants will not be expected to comply with the 20 per cent issuer limit until ESMA has decided on a possible amendment of Paragraph 43(e) of the Guidelines

ISLA

ISLA has submitted a response to ESMA’s consultation on proposals to amend the collateral diversification rules contained in its guidelines for ETFs and other UCITS. The current guidelines require that no more than 20 per cent of the NAV of a UCITS may be held in collateral from any one issuer.

ESMA considers allowing a derogation from this provision for government issued collateral in certain circumstances. The proposal is that this derogation should be limited to money market fund UCITS only to allow them to use higher volumes of reverse repo against a single government issuer. ISLA argues that whilst it supports the proposal, the derogation should be available to all UCITS (not just MMFs). “We strongly believe that there should be a consistent approach to the diversification Guidelines for all UCITS and urge ESMA to avoid creating a two tier approach which would result from the implementation of option 1 of the proposal. We believe that this approach will have unintended consequences and will result in inconsistencies in collateral policies and procedures for funds within the same UCITS ranges", the statement by ISLA reads.

Implementing a diversification requirement by number of issues received adds complexity without necessarily mitigating any risk. The appropriate level of diversification will depend on a number of factors which are already considered in the Guidelines, such as quality of issuer and liquidity.

ISLA also points out that amending diversification rules only for MMFs will make cash collateral re-investment more restrictive as these funds will be disqualified as investment options as they may no longer meet the diversification requirements for non-MMFs.

Full-ISLA-response

Original consultation