Funds groups challenged over securities lending practices
Questions asked about whether all revenues earned from stock lending are being returned to investors
BlackRock, UBS Asset Management and Deka have been challenged on the revenues generated by their securities lending activities, reigniting a debate about an opaque but lucrative part of the fund industry.
Securities lending is the practice of institutional investors loaning assets to each other for a fee. As margins are squeezed, asset managers are turning to securities lending to lower the cost of running funds.
Many index and exchange traded fund providers — which are at the forefront of the price war, the ferocity of which was shown by the first “zero-fee” funds last year — have substantial securities lending programmes.
Under rules issued by the European Securities and Markets Authority in 2012, asset managers cannot profit from securities lending. Esma states that fund investors must receive all securities lending revenues net of any costs involved in carrying out the activity.
Analysis by Better Finance, the consumer group, has revealed large variations in the proportion of securities lending proceeds that investors receive, raising questions over whether asset managers are pocketing revenues not due to them.
Guillaume Prache, managing director of Better Finance, raised concern over whether “a part of securities lending profits is not returned to fund investors”, as required by the EU rules.
The ETF managers analysed by Better Finance return a fixed portion of gross revenues from securities lending to fund investors, with the remaining portion used to cover the securities lending agent’s fee.
In its analysis, Better Finance found that Vanguard investors receive almost double the amount of gross revenue that Deka investors do. Vanguard pays 95 per cent of gross income to investors, while Deka returns 51 per cent. This means that Deka retains almost 10 times more gross income than Vanguard to cover costs.
“We do not understand how asset managers can have costs as a proportion of revenues that vary from one to 10,” Mr Prache said.
He said it was especially surprising given that most of the asset managers analysed used in-house securities lending agents.
“When the securities lending activity is carried out in-house, it probably mostly generates fixed costs such as personnel and IT, which is therefore not proportional to the revenue or volume of lending securities of the funds’ portfolios,” said Mr Prache.
He called on the EU to investigate why costs of securities lending varied so significantly and suggested that the cost of securities lending should be capped at 5 per cent of revenues, with outliers forced to disclose why they charged more.
Better Finance has asked asset managers including BlackRock, UBS, Deka and Amundi to explain why they incur significantly more costs and how they ensure compliance with EU rules.
BlackRock retains 37.5 per cent of gross income to cover the cost of securities lending. The company told FTfm: “BlackRock engages in securities lending to generate income for fund investors that they otherwise would not receive.
“On a net revenue basis, which is what ultimately matters to our clients, BlackRock’s returns are often the strongest in the industry.”
Frank Muesel, senior manager for ETF platform management at UBS, said the manager’s 40 per cent cut of gross income reflected the cost of checks involved in its securities lending. The Swiss asset manager pays an external securities lending agent, State Street, but also remunerates its parent company for additional due diligence.
Deka said it returned 100 per cent of revenues from securities lending to investors, adding that it did not make use of the 49 per cent threshold “in practice”. Deka added that its securities lending agent, DekaBank, “acts as a third-party provider” despite being a sister entity.
Amundi said it regularly reviews its revenue split thresholds “to improve them whenever possible” and the revenues it generates from securities lending.
Better Finance also wrote to Commerzbank, despite the fact that the German bank’s ETFs do not engage in securities lending. Mr Prache highlighted concern with the framework Commerzbank set out in its documentation for potential securities-lending activity. The bank told FTfm it did not intend to conduct securities lending in the “foreseeable future”.
State Street, DWS and Lyxor were also cited in Better Finance’s report. State Street said it was fully compliant with all local regulation and provided transparency on its approach to securities lending. DWS declined to comment and Lyxor did not respond to a request for comment.