While nearly all institutional investors feel confident that ESG investing and securities lending are complementary, there is still a way to go in ensuring that securities lending programmes are fully compatible with ESG principles.
That is the conclusion of a new survey from the Risk Management Association (RMA), involving nine leading institutional investors and 44 firms.
Published in October, it showed that 95% of respondents think that ESG investors are well-placed to lend securities without conflict, yet only 18% are taking the next step to ensure their securities lending programmes align with their ESG values.
Concerns
Securities lending is a good business, generating $8.7 billion of revenues for lenders last year, according to DataLend.
It is, however, riven with perceived conflicts, such as voting rights transferring to the borrower while securities are out on loan, or borrowers using their holdings to advocate short-term interests through short selling.
Securities lending oversight [teams] should try to be more coordinated with ESG colleagues
Fran Garritt, the Risk Management Association
“Many of those concerns could be alleviated with greater communication within asset managers as well as between asset managers and their lending agents,” says Fran Garritt, the RMA’s director of securities lending and market risk.
“Our survey also shows that, as a matter of best practice, teams responsible for securities lending oversight should try to be more coordinated with their ESG colleagues.”
With regards to proxy voting, 63% of the RMA’s survey respondents confirmed that their ESG policy includes parameters and principles on loan recalls and proxy voting.
Marney McCabe, co-head of global securities lending at Brown Brothers Harriman (BBH), says her firm’s clients only lend on average around 5% of their securities.
“Among corporate governance teams, there can be a misconception that much more is being lent out, but our client base, who are registered funds and global asset managers, tend to have a risk-adjusted approach. They’re already able to vote on the 95% of securities they have.”
Recall process
However, for the assets that would be relevant to voting, there are ways that agent lenders can help ensure that the recall process is easier for ESG investors, says McCabe, such as providing clients with the right information to allow them to make a balanced decision as to whether it is more beneficial to receive the lending revenue of shares or to vote.
There can be a misconception that much more is being lent out
Marney McCabe, Brown Brothers Harriman
That also requires better data on securities lending revenue.
“We have some clients who prefer automated solutions, so that they can set out their threshold for securities lending, the materiality of their vote, and when certain criteria are met. Then we make sure the shares are not out on loan,” says McCabe.
“Alternatively, we have clients who want to maintain control by consuming the relevant securities lending data and make the decision to restrict certain shares from loan.”
Some 43% of respondents to the RMA’s survey listed that greater transparency from companies around voting dates would also be useful when managing their securities lending programmes.
Minimal risk
Typically, however, there is minimal risk of investors being able to recall their securities for voting. There is lower lending liquidity around a record date that is deemed material, which is illustrative of lenders recalling their securities, says McCabe, adding that clients are given a lot of notice ahead of voting periods so that they can recall securities.
“The markets are also highly efficient,” she says.
Thomas Poppey, co-head of global securities lending at BBH, adds: “It is also important to have a thoughtful trading strategy when entering into a loan to avoid illiquidity rather than simply relying on the recall process.”
The RMA’s report highlights the practice of one European institution that maintains a priority list of companies targeted for engagement. Some of these are excluded from lending, while others on the list are subject to closer review for lending opportunities.
It’s important to have a thoughtful trading strategy when entering into a loan
Thomas Poppey, Brown Brothers Harriman
With regards to short selling, the RMA’s Garritt says: “The survey revealed that asset managers are more informed in regards to the benefits of securities lending. At this stage, the market understands that short selling is important for enabling price discovery, providing liquidity, facilitating hedging and bringing fraud to light.”
The report also points out that short selling could also be used as part of an ESG strategy, stating: “Many ESG-oriented investors follow an exclusionary approach by not investing in companies whose businesses they perceive as conflicting with their ESG principles: for example, those in the tobacco, nuclear, or coal sectors.”
Garritt adds: “These ESG principles can also apply to exclusion filters that an institutional investor can apply to the non-cash collateral that they will accept in a securities lending transaction. And they can apply to how cash collateral is reinvested.”
Ultimately, each investor has to determine its own comfort level with securities lending.
BBH’s Poppey says European investors are more comfortable and are ahead of the rest of the world in terms of connecting ESG to securities lending.
“Typically for firms that see ESG as central, there will be a well-developed securities lending programme that incorporates ESG principles,” he says.
Poppey reiterates that greater communication is still needed.
“Best practice for asset managers is to make sure there is a dialogue between those overseeing the deployment of an ESG strategy and those overseeing securities lending programmes,” he concludes.
