ISLA: Liquidity aims of CMU face obstacles
24 March 2017 London
Image: Shutterstock
EU legislators should open up UCITS fund securities lending and pay closer attention to the lending of government bonds to meet its liquidity targets when developing the capital markets union, the International 麻豆传媒 Lending Association has said.
Responding to an ongoing European Commission consultation on the capital markets union, ISLA said there is an increasingly disproportionate imbalance between securities held by UCITS funds that are available for lending and securities actually on loan, 鈥渟howing major untapped potential for improving liquidity in the market鈥�.
The continued developing trend of government bonds, in particular EU government bonds, being used in securities lending transactions also shows potential for rising risks of a liquidity squeeze in those instruments, which could affect EU governments鈥� costs of funding, ISLA warned.
ISLA blamed the availability-utilisation imbalance on particular UCITS directive provisions, such as those that favour the use of title transfer arrangements in respect of any collateral received from borrowers, forcing them to look for alternative sources of supply when they prefer to pledge.
鈥淭his also means that UCITS cannot consider any central clearing models for securities lending or repo transactions, which often rely on pledge structures. It seems strange that the regulatory drive to move to central clearing is currently closed to these institutions.鈥�
ISLA summarised: 鈥淔rom a market liquidity and broader market stability perspective, although the supply of assets made available for lending from UCITS funds remains broadly unchanged at circa 鈧�6.6 trillion, the demand for these assets has dramatically fallen since 2014.鈥�
鈥淭his means there are fewer securities available in the market to cover potential settlement fails and to support market making and efficient hedging of risk.鈥�
The European Commission should review those elements of the UCITS directives that restrict these funds鈥� ability to fully engage with securities lending, ISLA recommended.
The situation with government bonds is more complex, but boils down to demand increasing as supply has fallen, with ISLA warning: 鈥淪hould this trend persist (and notably as further liquidity requirements, such as the net stable funding ratio, are implemented), EU government bond markets could experience significant stress.鈥�
鈥淔rom a capital markets union perspective, and in particular for smaller member states, we believe it is essential for Europe to have liquid and sustainable government bond markets鈥攅ven more so post-Brexit. Therefore, in addition to the important work that the commission is coordinating on corporate bond market liquidity, we encourage the commission to consider conducting a similar effort for EU sovereign bond markets.鈥�
ISLA recommended setting up an expert group to analyse potential upcoming liquidity stresses in the EU government bond market.
Responding to an ongoing European Commission consultation on the capital markets union, ISLA said there is an increasingly disproportionate imbalance between securities held by UCITS funds that are available for lending and securities actually on loan, 鈥渟howing major untapped potential for improving liquidity in the market鈥�.
The continued developing trend of government bonds, in particular EU government bonds, being used in securities lending transactions also shows potential for rising risks of a liquidity squeeze in those instruments, which could affect EU governments鈥� costs of funding, ISLA warned.
ISLA blamed the availability-utilisation imbalance on particular UCITS directive provisions, such as those that favour the use of title transfer arrangements in respect of any collateral received from borrowers, forcing them to look for alternative sources of supply when they prefer to pledge.
鈥淭his also means that UCITS cannot consider any central clearing models for securities lending or repo transactions, which often rely on pledge structures. It seems strange that the regulatory drive to move to central clearing is currently closed to these institutions.鈥�
ISLA summarised: 鈥淔rom a market liquidity and broader market stability perspective, although the supply of assets made available for lending from UCITS funds remains broadly unchanged at circa 鈧�6.6 trillion, the demand for these assets has dramatically fallen since 2014.鈥�
鈥淭his means there are fewer securities available in the market to cover potential settlement fails and to support market making and efficient hedging of risk.鈥�
The European Commission should review those elements of the UCITS directives that restrict these funds鈥� ability to fully engage with securities lending, ISLA recommended.
The situation with government bonds is more complex, but boils down to demand increasing as supply has fallen, with ISLA warning: 鈥淪hould this trend persist (and notably as further liquidity requirements, such as the net stable funding ratio, are implemented), EU government bond markets could experience significant stress.鈥�
鈥淔rom a capital markets union perspective, and in particular for smaller member states, we believe it is essential for Europe to have liquid and sustainable government bond markets鈥攅ven more so post-Brexit. Therefore, in addition to the important work that the commission is coordinating on corporate bond market liquidity, we encourage the commission to consider conducting a similar effort for EU sovereign bond markets.鈥�
ISLA recommended setting up an expert group to analyse potential upcoming liquidity stresses in the EU government bond market.
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