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COLL 5.4 Stock lending

Application

COLL 5.4.1R

1This section applies to an ICVC, the depositary of an authorised fund and an authorised fund manager in any case where the authorised fund is a UCITS scheme or a non-UCITS retail scheme.

COLL 5.4.1AG

6COLL 6.6B sets out additional FCA rules applicable to a depositary of a UCITS scheme in relation to the re-use of UCITS custodial assets.

Permitted stock lending

COLL 5.4.2G

  1. (1)

    This section covers techniques relating to transferable securities and approved money-market instruments which are used for the purpose of efficient portfolio management. It3 permits the generation of additional income for the benefit of the authorised fund, and hence for its investors, by entry into stock lending transactions for the account of the authorised fund.

  2. (2)

    The specific method of stock lending permitted in this section is in fact not a transaction which is a loan in the normal sense. Rather it is an arrangement of the kind described in section 263B of the Taxation of Chargeable Gains Act 1992, under which the lender transfers securities to the borrower otherwise than by way of sale and the borrower is to transfer those securities, or securities of the same type and amount, back to the lender at a later date. In accordance with good market practice, a separate transaction by way of transfer of assets is also involved for the purpose of providing collateral to the "lender" to cover him against the risk that the future transfer back of the securities may not be satisfactorily completed.

Stock lending: general

COLL 5.4.3R
  1. (1)

    6An authorised fund may only enter into a stock lending arrangement or repo contract in accordance with the rules in this section if the arrangement or contract is:

    1. (a)

      for the account of and for the benefit of the scheme; and

    2. (b)

      in the interests of its Unitholders.

  2. (2)

    An arrangement or contract in (1) is not in the interests of Unitholders unless it reasonably appears to the ICVC or authorised fund manager of an authorised fund to be appropriate with a view to generating additional income for the authorised fund with an acceptable degree of risk.

11144

Stock lending: requirements

COLL 5.4.4R

  1. (1)

    An ICVC, or the depositary of an authorised fund acting in accordance with the instructions 6of the authorised fund manager4, may enter into a repo contract, or a1 stock lending arrangement of the kind described in section 263B of the Taxation of Chargeable Gains Act 1992 (without extension by section 263C), but only if:

    444
    1. (a)

      all the terms of the agreement under which securities are to be reacquired by the depositary for the account of the ICVC, AUT or ACS4 are in a form which is acceptable to the depositary and are in accordance with good market practice;

      44
    2. (b)

      the counterparty is:1

      1
      1. (i)

        an authorised person; or1

      2. (ii)

        a person authorised by a Home State regulator; or1

      3. (iii)

        a person registered as a broker-dealer with the Securities and Exchange Commission of the United States of America; or1

      4. (iv)

        a bank, or a branch of a bank, supervised and authorised to deal in investments as principal, with respect to OTC derivatives by at least one of the following federal banking supervisory authorities of the United States of America:1

        1. (A)

          the Office of the Comptroller of the Currency;1

        2. (B)

          the Federal Deposit Insurance Corporation; 1and8

        3. (C)

          the Board of Governors of the Federal Reserve System; and1

        4. (D)

          [deleted]8

          1
    3. (c)

      high quality and liquid 6collateral is obtained to secure the obligation of the counterparty under the terms referred to in (a) and the collateral is:

      1. (i)

        acceptable to the depositary;

      2. (ii)

        adequate; and

        1
      3. (iii)

        sufficiently immediate.

        1
  2. (2)

    The counterparty for the purpose of (1) is the person who is obliged under the agreement referred to in (1)(a) to transfer to the depositary the securities transferred by the depositary under the stock lending arrangement or securities of the same kind.

  3. (3)

    (1)(c) does not apply to a stock lending transaction made through Euroclear Bank SA/NV's Securities Lending and Borrowing Programme.1

Stock lending: treatment of collateral

COLL 5.4.5G

Where a stock lending arrangement is entered into, the scheme property remains unchanged in terms of value. The securities transferred cease to be part of the scheme property, but there is obtained in return an obligation on the part of the counterparty to transfer back equivalent securities. The depositary will also receive collateral to set against the risk of default in transfer, and that collateral is equally irrelevant to the valuation of the scheme property (because it is transferred against an obligation of equivalent value by way of re-transfer). COLL 5.4.6 R accordingly makes provision for the treatment of the collateral in that context.

Treatment of collateral

COLL 5.4.6R

  1. (1)

    Collateral is adequate for the purposes of this section only if it is:

    1. (a)

      transferred to the depositary or its agent;

    2. (aa)

      6for a UCITS scheme, received under a title transfer arrangement;

    3. (ab)

      6for a UCITS scheme, at all times equal in value to the market value of the securities transferred by the depositary plus a premium;

    4. (b)

      for a non-UCITS retail scheme, at all times 6at least equal in value 6to the value of the securities transferred by the depositary; and

    5. (c)

      for a non-UCITS retail scheme,5in the form of one or more of:

      1. (i)

        cash; or

      2. (ii)

        [deleted]1

        1
      3. (iii)

        a certificate of deposit; or

      4. (iv)

        a letter of credit; or

      5. (v)

        a readily realisable security; or1

        1
      6. (vi)

        1commercial paper with no embedded derivative content; or

      7. (vii)

        1a qualifying money market fund.

  2. (1A)

    Where the collateral is invested in units in a qualifying money market fund managed or operated by (or, for an ICVC, whose ACD is) the authorised fund manager of the investing scheme or an associate of that authorised fund manager, the conditions in COLL 5.2.16 R (Investment in other group schemes) must be complied with whether or not the investing scheme is a UCITS scheme or a non-UCITS retail scheme.1

  3. (2)

    Collateral is sufficiently immediate for the purposes of this section if:

    1. (a)

      it is transferred before or at the time of the transfer of the securities by the depositary; or

    2. (b)

      the depositary takes reasonable care to determine at the time referred to in (a) that it will be transferred at the latest by the close of business on the day of the transfer.

  4. (3)

    The depositary must ensure that the value of the collateral at all times meets the requirement of either (1)(ab) or (1)(b), as appropriate6.

  5. (4)

    The duty in (3) may be regarded as satisfied in respect of collateral the validity of which is about to expire or has expired where the depositary takes reasonable care to determine that sufficient collateral will again be transferred at the latest by the close of business on the day of expiry.

  6. (5)

    Any agreement for transfer at a future date of securities or of collateral (or of the equivalent of either) under this section may be regarded, for the purposes of valuation under COLL 6.3 (Valuation and pricing) or this chapter, as an unconditional agreement for the sale or transfer of property, whether or not the property is part of the property of the authorised fund.

  7. (6)

    Collateral transferred to the depositary is part of the scheme property for the purposes of the rules in this sourcebook, except in the following respects:

    1. (a)

      it does not fall to be included in any valuation for the purposes of COLL 6.3 or this chapter, because it is offset under (5) by an obligation to transfer; and

    2. (b)

      it does not count as scheme property for any purpose of this chapter other than this section.

  8. (7)

    Paragraph (5) and (6)(a) do not apply to any valuation of collateral itself for the purposes of this section.

COLL 5.4.6AG

5As regards the collateral adequacy of a UCITS scheme and restrictions on collateral that take the form of cash for a UCITS scheme, authorised fund managers are referred to paragraph 43 of the ESMA Guidelines to competent authorities and UCITS management companies on ETFs and other UCITS issues (ESMA 2012/832)7

https://www.esma.europa.eu/sites/default/files/library/2015/11/2012-832en_guidelines_on_etfs_and_other_ucits_issues.pdf7

Revision of the provisions on diversification of collateral in ESMA’s Guidelines on ETFs and other UCITS issues (ESMA 2014/294)7

https://www.esma.europa.eu/sites/default/files/library/2015/11/2014-294_final_report_revision_of_guidelines_etfs_and_other_ucits_issues.pdf7

Limitation by value

COLL 5.4.7R

There is no limit on the value of the scheme property which may be the subject of repo contracts or1 stock lending transactions within this section.

Guidance relating to the use of cash collateral

COLL 5.4.8G
  1. (1)

    2The use of stock lending or the reinvestment of cash collateral should not result in a change of the scheme's declared investment objectives or add substantial supplementary risks to the scheme's risk profile.

  2. (2)

    Collateral taking the form of cash may only be invested in:

    1. (a)

      one of the investments coming within COLL 5.4.6 R (1) (c) (iii) to (vii) (Treatment of collateral); or

    2. (b)

      deposits, provided they:

      1. (i)

        are capable of being withdrawn within five business days, or such shorter time as may be dictated by the stock lending agreement; and

      2. (ii)

        satisfy the requirements of COLL 5.2.26 R (1) (Investment in deposits).

COLL 5.4.9G

3Where a scheme generates leverage through the reinvestment of collateral, this should be taken into account in the calculation of the scheme's global exposure.

[Note: CESR's UCITS eligible assets guidelines with respect to article 11 of the UCITS eligible assets Directive (part)]

COLL 5.4.10G

5Authorised fund managers of UCITS schemes are advised that ESMA has issued guidelines which, in accordance with the UCITS implementing Directive, authorised fund managers should comply with in applying the rules in this section in relation to UCITS schemes:

Guidelines to competent authorities and UCITS management companies on ETFs and other UCITS issues (ESMA 2012/832)7

https://www.esma.europa.eu/sites/default/files/library/2015/11/2012-832en_guidelines_on_etfs_and_other_ucits_issues.pdf7

Revision of the provisions on diversification of collateral in ESMA’s Guidelines on ETFs and other UCITS issues (ESMA 2014/294)7

https://www.esma.europa.eu/sites/default/files/library/2015/11/2014-294_final_report_revision_of_guidelines_etfs_and_other_ucits_issues.pdf7