The European Securities and Markets Authority (ESMA), the EU’s financial markets regulator and supervisor, today published a Statement on securities lending to retail clients.
Certain firms in the EU engage in securities lending and other securities financing transactions (SFTs) in relation to retail client financial instruments. While SFTs may bring the benefit of generating extra returns on financial instruments, SFTs are also a risky and complex practice that is difficult to understand for the average retail client. MiFID II therefore imposes strict requirements regulating the use of client financial instruments.
From the perspective of the investor, SFTs may bring the benefit of generating extra return on his or her financial instruments, where these are lent out. However, they also bring additional risks, such as counterparty and collateral shortfall risk.
In addition, measures taken by the firm to safeguard the client’s ownership rights will not apply to financial instruments used in securities financing transactions (SFTs) such as securities lending. Simply put, the investor lending out his or her financial instruments will incur a loss if the external borrower is not able to return the borrowed financial instrument and if the value of the collateral is insufficient to cover the loss of the financial instrument that is lent out and the investment firm is unable to compensate for the loss.
- ESMA warns that revenues from securities lending should directly accrue to the retail client, net of a normal compensation for the firm’s services.
- Also, express prior consent should not be sought by way of the firm’s general terms and conditions.
To ensure that clients are aware of the risks of SFTs when providing their express prior consent, firms should, in good time before requesting this consent, provide clients with adequate information on the risks involved. For example, in the additional and distinct step in the client’s onboarding process, information can be provided on the risks involved, before requesting the client’s express prior consent.
ESMA 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.
