ESMA says lower trading commissions don’t justify securities lending risks for retail clients
“The prospect of any indirect ‘benefit’, such as lower trading commissions, may not justify exposing a retail client to the risks of securities lending. Furthermore, such an indirect ‘benefit’, if any, would not necessarily and proportionately accrue to all retail clients exposed to the risks arising from the lending of their securities, but to retail clients exhibiting more active trading behaviour. “
The European Securities and Markets Authority (ESMA) has made public its investor protection concerns related to securities financing transactions (SFTs), namely securities lending.
In a statement published yesterday, the EU’s financial markets regulator and supervisor outlined the obligations of firms engaging in this practice.
Moreover, ESMA has shared the agency’s expectations for firms’ compliance with the relevant MiFID II requirements regarding:
- Revenues from securities lending should directly accrue to the retail client, net of a normal compensation for the firm’s services
- Express prior consent of retail clients should not be sought by way of the firm’s general terms and conditions
ESMA added it will continue to monitor the practice of securities lending to retail clients and, if needed, issue further technical advice to the European Commission on this topic.
Securities lending involves a loan of securities by one party to another, often facilitated by a brokerage firm, and is used for several trading activities, such as short selling, hedging, arbitrage, and other strategies.
ESMA says firms are unprofessional if returns don’t accrue to retail clients
ESMA noted that the regulatory body is aware that some firms engaging in SFTs in relation to retail client financial instruments retain revenues arising from this activity.
The additional returns from securities lending do not accrue to the client, while the client does incur the higher risk due to lending out his or her financial instruments.
Some firms using securities lending in this way argue that the practice still benefits their clients because it enables lowering trading commissions charged to clients.
In ESMA’s view, a firm using retail client financial instruments to generate additional revenues for the firm may not be acting fairly and professionally in accordance with the best interests of its retail clients, in accordance with MiFID II.
Lower trading commissions don’t justify risks for retail clients
Securities lending is a highly complex practice that exposes retail clients to significant additional risks; ESMA therefore expects that any revenue arising from securities lending and other SFTs, save for a normal compensation for the firm’s services (i.e. direct and indirect operational costs and a fair and proportionate fee), accrues directly to the retail client whose financial instruments are being lent out.
ESMA stressed that the amount of normal compensation deducted from the revenues arising from securities lending should be included in any costs and charges information provided to the client whose financial instruments are being, or have been, lent out.
“The prospect of any indirect ‘benefit’, such as lower trading commissions, may not justify exposing a retail client to the risks of securities lending. Furthermore, such an indirect ‘benefit’, if any, would not necessarily and proportionately accrue to all retail clients exposed to the risks arising from the lending of their securities, but to retail clients exhibiting more active trading behaviour. “
