LMA consults with European Commission to request inclusion of loans within UCITS framework23 October 2012
The LMA, in consultation with a working party consisting of both bank and non-bank members, has responded to a European Commission ("Commission") consultation to request that the list of eligible assets under Article 50 of the UCITS IV Directive be expanded to include certain types of loan.
Above all, the LMA considers that loans are a safe, liquid, remunerative and transparent asset class, and as such is appropriate for retail investment. In addition, whilst the LMA understands, and is fully supportive of, the need to ensure that any asset held as part of a UCITS investment is sufficiently liquid, the LMA also strongly believes that liquidity should not be the sole factor taken into consideration when looking at asset classes appropriate to UCITS funds.
Key points arising as part of the LMA's response include:
1. Loans are an established product from an investment perspective
The LMA has stressed that the UCITS framework would be particularly appropriate for senior, secured non-investment grade loans, which form the bulk of non-investment grade debt raising, have a long history of institutional investment and are traded on a well-established and active secondary market.
2. Loans are not a complex product from an investment perspective
The LMA has highlighted that, unlike more complex products that are already eligible for UCITS investment, loans do not require a highly sophisticated investment strategy in order to generate returns.
3. Loans present an attractive investment and risk profile
Whether in terms of average return, income generation, volatility, default rates or recovery rates, loans show themselves to be an attractive investment, particularly when compared to other UCITS compliant products.
4. Loans are sufficiently liquid, negotiable and transferable
The LMA believes that loans have the relative degree of liquidity to be included as eligible assets within the UCITS framework.
5. Loan funds could be structured to increase liquidity
The LMA has emphasised that loan funds could be structured to improve overall liquidity. This could, for example, be achieved either via a liquidity facility to bridge the receipt of sales proceeds, or by co-mingling loans with bonds and other more traditionally liquid securities in order to maintain enough diversity within the portfolio to ensure redemptions within the required time periods.
6. Inclusion of Loans within UCITS will benefit borrowers and the wider economy
In addition to benefiting retail investors, the LMA has also emphasised that extending the UCITS framework to loans would result in substantial benefits to borrowers of loans themselves, particularly in the current economic climate, where access to credit is increasingly limited.
7. Inclusion of Loans within UCITS will prevent regulatory arbitrage
The LMA is of the view that regulators should try, to the extent possible and practicable, to align regulatory regimes between European and Non-European financial markets. Without any form of international convergence, there is the potential for financial markets in Europe to suffer from severe competitive disadvantages. For example, the current restrictive nature of the UCITS framework has already resulted in a split between Europe and the US, with only the latter allowing loan investment to be channelled into retail funds. This has resulted in an evident resurrection of liquidity within the US non-investment grade loan market, which is not currently present in Europe
Clare Dawson, Managing Director LMA, commented:
"Much has been publicised recently about the need to stimulate the credit markets for the benefit of the wider economy. Whilst funds are largely willing to help bridge the funding gap, for so long as their access to the full spectrum of potential investors remains limited, it is difficult to see how they will be able to make a meaningful impact."
"Whilst we understand the importance of liquidity in the retail market (and believe that loans have the relative degree of liquidity to be included as eligible assets within the UCITS framework) we also believe that assets should be assessed for inclusion based on other inherent benefits. In the case of loans, this would include their long history of institutional investment, their relative lack of complexity as a debt product and their proven reputation of providing investors with attractive returns, low volatility and low loss given default rates, all of which are important factors from a retail investor perspective."