AGA - n 4205_01/Div. ESMA 103 Rue de Grenelle Paris

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1 AGA - n 4205_01/Div. ESMA 103 Rue de Grenelle Paris Paris, 30 January 2014 AFG comments 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 Ref.: ESMA/2013/1974 The Association Française de la Gestion financière (AFG) 1 welcomes ESMA s consultation paper on the Revision of the provisions on diversification of collateral in ESMA s guidelines on ETFs and other UCITS issues. We thank ESMA for the opportunity to express the French asset management s opinion on the issue, especially as our industry manages a complete spectrum of asset classes and techniques within the UCITS Directive. General Comments AFG is very pleased with the ESMA s initiative to reopen the guidelines it has drafted on very specific subjects that need to be addressed/rectified. We strongly believe that the force of 1 The Association Française de la Gestion financière (AFG) 1 represents the France-based investment management industry, both for collective and discretionary individual portfolio managements. Our members include 411 management companies. They are entrepreneurial or belong to French or foreign banking or insurance groups. AFG members are managing 2600 billion euros in the field of investment management, making in particular the French industry the leader in Europe in terms of financial management location for collective investments (with nearly 1600 billion euros managed from France, i.e. 23% of all EU investment funds assets under management), wherever the funds are domiciled in the EU, and second at worldwide level after the US. In the field of collective investment, our industry includes beside UCITS the employee savings schemes and products such as regulated hedge funds/funds of hedge funds as well as a significant part of private equity funds and real estate funds. AFG is of course an active member of the European Fund and Asset Management Association (EFAMA) and of the European Federation for Retirement Provision (EFRP). AFG is also an active member of the International Investment Funds Association (IIFA).

2 ESMA s guidelines lies precisely in their power of adaptation, especially when there is a collision risk with other regulations or with market practices. We thus totally agree with the ESMA s proposal which makes it possible to rectify targeted problems, like the collateral government diversification. AFG fully supports the ESMA s initiative to amend paragraph 43(e) of the Guidelines on the diversification of collateral received by UCITS in the context of efficient portfolio management techniques and OTC transactions and is of the opinion that ESMA should indeed revise the diversification rules set out in such paragraph. We thus agree to the exception proposed, AFG has always advocated for a derogation for government collateral. We propose to apply a 20% issue diversification ratio, which seems to us a more appropriate calculation from an operational standpoint. We strongly believe that this derogation must apply to all UCITS - not only to the Short-Term Money Market Funds and Money Market Funds, because it is not the type of assets in the fund that matter when it comes to collateral rules, but an indisputable rule of higher quality of collateral (to the detriment of diversification for instance). We would like to recall that AFG totally agrees with ESMA s approach to consider collateral (including securities received in a Reverse Repo transaction) as a specific portfolio totally different from assets held by the fund. The collateral is a risk mitigation factor and its composition should not interfere with the investment decisions of the asset manager. Each portfolio must independently comply with specific requirements. However, the ability to hold up to 100% of collateral in government securities is an exception that perfectly makes sense. In addition, AFG would like to insist on ESMA s role to ensure a consistent implementation of its guidelines throughout all Members State, especially on, matters where the wording of the guidelines leaves room for interpretation or is ambiguously drafted. It is our experience that some countries prefer gold plating when others take a more pragmatic view. It is not our intention to discuss ESMA s guidelines that are now implemented. However, in the same spirit of targeted amendments, AFG would like also to bring ESMA s attention to 3 other narrow subjects that need to be amended: - EMIR and the reuse of collateral: 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 new requirements introduced by this directive. On this point, these two regulations are in collisions and create tremendous difficulties, even impossibilities, for asset managers. It is of utmost importance to coordinate. - Indices: o AFG would like to recall that European fund managers are important users of financial indices, both for benchmarks and for investment purposes and our members have serious concerns with the practical implementation of the section XIII of the guidelines that places significant obligations and due diligence requirements on fund managers in order to be able to continue to invest in financial indices. Our objective is not to exempt asset managers from their due diligence obligations, but to help ensure that the due diligence process is done within a reasonable framework where index providers are also incentivized to better disclose required proprietary information which asset managers have no other means to obtain. We believe that in the light of the proposed European benchmark regulation, ESMA should incentivize through its Guidelines index providers to declare compliance with Guidelines and 2

3 provide in a standard format information that today is difficult to obtain on an individual basis; o also, indices due diligences asked from UCITS managers when investing in an index should be presumed to be in conformity in instances that are in consideration of the proposed European benchmark regulation; for example, when using indices traded through future contracts on regulated markets eligible for UCITS, asset managers should be entitled to rely on the due diligences conducted by local authorities that agreed the contract. - Cash collateral: securities resulting from cash collateral reinvestment should be considered in the concentration ratio of the assets of the fund only and not in addition in the collateral portfolio; currently the FAQ published in July 2013 suggests a double monitoring which is unnecessary in terms of risk control and difficult to manage operationally. It would be detrimental to all actors not to raise those targeted and narrowed subjects/difficulties that arise with the implementation of the ESMA Guidelines. It would be incoherent and erroneous from our side to occult these other subjects when we have the opportunity to precisely make known by ESMA the difficulties that the industry at large encounters with the Guidelines. Please see our detailed responses below: Question 1. Do you believe that ESMA should revise the rules for the diversification of collateral received by UCITS that take the form of money market funds in the context of efficient portfolio management techniques and OTC transactions? If yes, do you agree with ESMA s proposal? Yes. We agree that ESMA should revise the rules for the diversification of collateral received in the context of efficient portfolio management techniques and OTC transactions. All UCITS should be targeted by the revision, not only money market funds. We strongly agree to option 2 of the Cost/Benefit analysis. Regarding ESMA s proposal we think that the currently proposed option 1 is not a balanced solution as it is unreasonably restricting the issuer diversification exemption to a specific class of UCITS. Indeed, the proposed limitation to MMFs seems to result from a misunderstanding. If MMFs are probably among the largest users of reverse repo and particularly hit by the existing rule, all UCITS are concerned. AFG would like to stress that MMFs are an example and that the reference to MMFs that principally hold government bonds is a way to illustrate with a paroxysmal case the inadequacy of the rule concerning all UCITS. We recall that EFAMA s letter expressly recommended an amendment to the rule not limited to MMFs. MMFs are neither the only nor the most impacted UCITS. Any UCITS that would invest more than 20% of its asset portfolio in reverse repo would be. For example many structured 3

4 UCITS like Formula Funds invest in reverse-repo up to 100% of their asset, especially when the Fund must be able to face strong redemptions or anticipated maturity dates. We would like to recall that collateral diversification rules and UCITS assets diversification rules have two distinct objectives which should not be confused: the purpose of the asset diversification is to prevent excessive concentration of investments. As collateral is taken in order to reduce counterparty risk, we remain convinced that good credit quality and liquidity of the collateral are much more important than diversification. Thus considering the specific objective of collateral explained above, we do not see why the type of UCITS should be considered as a relevant criterion for the application of this derogation. As a consequence, we cannot agree with ESMA s proposal if it is limited to MMFs. It does not rely on the strong basis of a fundamental analysis of risk resulting from reverse repo on government bonds but seems an exemption offered for purely pragmatic reasons. Furthermore, we consider that a specific regulation of MMFs being currently discussed before the European Parliament, it would be wiser to postpone any decision that targets them. Conversely we strongly support option 2 as expressed in Annex II, because it provides a justified flexibility to all UCITS. For instance, the implementation of option 2 would address the following difficulty: a UCITS, whatever kind of UCITS it is, would not be compelled to refuse good quality collateral because of the 20% ratio per issuer. As explained above, what is capital in our view is the quality of collateral, not its diversification, in order to mitigate counterparty risk. Question 2. Do you think that ESMA should introduce additional safeguards for government bonds received as collateral (such as a specific issuer limit) in order to ensure a certain level of diversification? Please give reasons for your answer. AFG believes that no additional safeguards for government bonds received as collateral should be introduced. Indeed, there is no need for additional requirements on government bonds received as collateral. The exemption from the 20% 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. Question 3. Do you agree with the proposed requirement to diversify the government securities across at least six different issues? For collateral, we would like to reiterate the principle following which liquidity and credit quality are far more important than diversification. If our members do not object to some concentration limits, they believe that they should be economically and operationally adapted. 4

5 The rule to diversify among 6 issues none of which shall exceed 30% is not necessary and somehow confusing when applied to collateral. Collateral received does not respond to the same logic like an investment decision on the asset side and operationally the set-up is very different. It would sound more logical to maintain the 20% ratio that is the reference in the ESMA s guidelines and indicate that no single issue should exceed 20% of the NAV. We believe that this proposal is more effective in terms of risk, since 20% is lower than 30% for any issue, and would prevent threshold management difficulties when reaching 30% and having to split the position in 6 issues. In case of collateral representing 100% of the fund assets, there will be theoretically a minimum of 5 issues, but in practice (because of threshold management) a minimum of 6 issues. We strongly believe that this proposal: - retains the appropriate level of investor protection; - ensures that the cost of compliance with regulation is not excessive for investors; - is in line with market practices; - does not raise unnecessary operational burdens. If you need any further information, please don t hesitate to contact Eric Pagniez, at ([email protected]) or Adina Gurau Audibert, at ([email protected]) or myself at ([email protected]). Sincerely Yours, Pierre Bollon 5