The European Fund and Asset Management Association (EFAMA) recently ventured that the European Securities and Markets Authority (ESMA) had exceeded its powers and mandate by issuing “quasi-regulation (...) on topics which were not previously regulated at EU level.” The representative body for the European investment management industry specifically targeted the ESMA Guidelines on ETFs and other UCITS issues and its provisions in terms of securities lending, collateral management, or the use of financial indices.
EDHEC-Risk Institute, which, like EFAMA, has contributed to the consultation process that led to these guidelines, takes exception to this language and interpretation and wishes to underline the considerable investor protection and competition advances introduced by ESMA, notably with respect to the mitigation of counterparty risk and the quality and transparency of financial indices.
These guidelines clarify the provisions of the UCITS and Eligible Assets Directives and, where relevant, update pre-existing guidelines; aiming to promote consistent, efficient and effective supervisory practices, they are within the scope of the ESMA mandate.
Recognising that securities lending and other “efficient portfolio management” (EPM) techniques carry counterparty risk, ESMA requires their risk exposure to be taken into account for the computation of UCITS risk limits, along with that arising from OTC derivatives. Consistently, it builds upon the rules for the mitigation of counterparty risk in the context of OTC derivatives to propose a uniform approach to collateral management.
The ESMA guidelines restrict UCITS’ choice of indices to those that are built and managed in a systematic manner and for which index providers avail of full and complimentary transparency of both methodology and historical information; they also require UCITS to perform documented due diligence on the quality of indices. This level of transparency corresponds to that advocated by EDHEC-Risk Institute as it allows investors to independently replicate the track record of an index, gauge the systematic character of its methodology and conduct performance and risk analyses to assess its relevance and suitability against specific investment and risk management goals. It is the opinion of EDHEC-Risk Institute that, faced with the emergence of new forms of indices and indexation, ESMA has struck the right balance between innovation and investor protection and created a benchmark for transparency and information-based competition in an industry, which, under the pretext of protecting intellectual property, has traditionally deprived the public of the information required for pre-investment due diligence.
Against this backdrop, EDHEC-Risk Institute calls upon European lawmakers to transpose the advances pioneered by ESMA in the UCITS space to other Packaged Retail Investment Products so as to promote high uniform standards of investor protection and reduce opportunities for regulatory arbitrage within the EU. EDHEC-Risk Institute also encourages worldwide authorities reviewing the regulation of financial indices and benchmarks to adopt standards of transparency on par with those of the ESMA guidelines to establish the necessary conditions for the sustainable growth of an industry that can play a major role in enhancing investor welfare.
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