Why new Euro rules won't mean ETF fee hikes

10 August 2012 | By Gary Jackson

Speculation that new guidelines on securities lending will lead to higher costs for exchange-traded funds has been refuted by the industry.

The European Securities and Markets Authority’s recently published ETFs and Other Ucits Issues guidelines make a number of proposals to strengthen investor protection and harmonise regulatory practices across the European Union – including informing investors about securities lending practices and returning all net revenues to the fund.

Some commentators have suggested low-cost funds such as ETFs could become more expensive as providers increase fees to make up for lost revenues. However, others have argued that the guidelines build on the progress already made in the ETF industry and are unlikely to see investors hit with higher costs.

International Securities Lending Association chief executive Kevin McNulty says: “Unfortunately the guidelines have 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 and stems from a misunderstanding of how the securities lending market works.”

Isla “broadly” welcomes Emsa’s guidelines and says they include principles it fully supports, such as running securities lending programmes for the benefit of Ucits investors and that fund managers should not be unduly compensated through charging additional fees.

“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,” McNulty adds. “Such fees would be regarded as part of the direct and indirect costs which the guidelines state may be deducted from revenue.”

“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”

This suggests that very little will change for ETF providers engaged in securities lending – the guidelines make it likely that they will continue to receive revenue in the form of commercial fees before handing back the remaining returns to the fund. Indeed, this already appears to be the approach taken by the bulk of the industry.

BlackRock, which owns ETF family iShares, says Esma’s guidelines are “a positive step” when it comes to issues such as making sure investors have a better understanding of the advantages and risks of ETFs and other Ucits products.

“BlackRock has long campaigned for greater disclosure and transparency. As fiduciaries, we are committed to working with Emsa and national regulators to continually raise the standards of practice in the interests of our clients,” the asset manager says.

“BlackRock intends to work with Emsa 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.”

Vanguard ETF product manager Tim Huver says the guidelines can be seen as part of the ongoing retailisation of the ETF market and welcomes the extra transparency they deliver.

“For Vanguard, in our securities lending programme 100 per cent of the net revenues have always been credited to the fund so we are in support of the Esma guidelines. We feel that it removes the conflict of interest that may have existed prior to the guidelines,” Huver says.

“We think the removal of conflict of interest is good and aligns the shareholders’ interests with the managers. It’s consistent with how we operate today.”

ETF Securities head of regulatory affairs Townsend Lansing says Esma’s guidelines reinforce trends already being seen in the ETF industry.

“A lot of what Esma was doing was making clear a lot of the things that providers already do,” he says. “Of course, now it’s a guideline it’s going to have more force and people will look at it more closely to make sure they are complying.”

“Now the guidelines are out, I expect the conversation to be much more about how ETFs can solve investment needs rather than what the risks are”

Lansing says the most important thing to draw from the review is that the regulator has “taken a very fine tooth comb over the industry” and failed to identify any major problems with ETFs. This should go some way to dispel the “hype” over the perceived risks of the products, he argues.

“Let’s move forward to a point where we realise ETFs provide inexpensive, transparent and diversified exposure to a wide variety of assets and that’s what they’re there for,” he says. “Now the guidelines are out, I expect the conversation to be much more about how ETFs can solve investment needs rather than what the risks are.”

Esma’s report is still being digested by the ETF industry and concerns such as the guidelines leading to higher charges for investors remain in the realm of speculation.

However, given how low costs are one of the main reasons for ETFs’ popularity, it seems difficult to imagine a provider or the industry as a whole throwing this advantage away if Esma’s guidelines do end up changing how they carry out their securities lending activities.

Meanwhile, Moody’s expect the industry to ultimately benefit from the guidelines after the short-term impact has passed.

“Despite our expectation of higher operating costs for asset managers, the new regulatory guidelines increase transparency, help restore investor confidence in ETFs and will likely lead to greater use of ETFs across Europe,” the ratings agency concludes.

“Increasing confidence in ETFs for all these reasons bodes well for the ability of asset managers to attract more assets under management and eventually improve profitability over time.”

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