Sunil Daswani, Global Head of Securities Lending, Standard Chartered
Environmental, social and governance (ESG) issues are fast-emerging as important priorities for institutional investors. Research published in November 2020 covering 600 investors in 6 key markets reveals that 87%1 already actively invest in companies that have reduced their near-term return on capital (such as reduced dividends, share buybacks etc.) in order to reallocate capital to ESG initiatives. Ninety-one percent (91%) expect their firms to rank ESG more highly post-COVID, and 88%2 believe that the companies in which they invest will do so. While investors’ ESG motivations will vary, 91%3 believe that companies with strong ESG performance are more resilient in a crisis.
From a securities lending perspective, the increased institutional focus on ESG is an extremely positive development, and reflects strongly Standard Chartered’s own values and strategic priorities. The challenge is therefore how to support clients’ specific ESG priorities into our client solutions, whilst also supporting their wider investment objectives.
ESG obstacles in securities lending
Despite the trend towards principle-based investing, there remain some challenges in translating ESG objectives into securities lending. For example, some asset managers4 have claimed that securities lending programmes for exchange-traded funds (ETFs) that track ESG indices are not financially viable, given that restrictive collateral parameters and regular recalls erode the potential revenue from lending. These issues are worth exploring in more detail:
It is reasonable that lenders would apply the same ESG criteria to their collateral as they would to stock selection. Where cash or some fixed income securities are posted as collateral, this may not be a significant issue. However, where equities are used for collateral, it has been difficult in the past to assess compliance with a lender’s ESG requirements in a consistent way, or to monitor this over time.
Given that an investor cannot participate in shareholder votes (typically via proxy), when they have lent a security, they may decide to recall a security to allow them to do so. This issue resonates specifically for ESG-driven investment, where institutional shareholders may play an important role in defining a company’s ESG strategy. Stock lenders take different approaches to this: some instruct the custodian to remove all securities to enable proxy voting, irrespective of the issues on which voting is taking place. Some do so opportunistically, according to the market or the materiality or topic of the vote, and some remove particular names or maintain “buffers” i.e. hold back a portion of the holding for voting purposes.
There are three challenges here, particularly when working with traditional pooled securities lending programmes:
- Recording and automating compliance with the specific terms of an investor’s ESG strategy without compromising operational efficiency;
- Limiting the period for which a stock is removed from a lending programme to minimise the financial impact;
- Providing meaningful data to lenders to enable them to make informed decisions on whether the materiality and potential impact of the vote compensates for the loss of income.
To address these issues requires an operationally efficient way to balance ESG compliance and financial performance, and a consistent way of measuring and comparing fund performance at an industry level. By resolving these challenges, bringing together securities lending and ESG becomes more achievable.
A variety of ways to overcome these issues are emerging, both at an individual securities lending programme level, and at a wider industry level.
Defining industry-wide ESG principles
Dr Radek Stech, founder and CEO of the Global Principles for Sustainable Securities Lending (Global PSSL5) comments,
“One of the challenges of sustainable finance today is that the definitions can be vague, and are not consistently applied across the industry, particularly in more niche but vital areas such as securities lending. Secondly, as global agendas evolve, these definitions, and the measures that support them, need to be co-created and adaptable.”
This was the background behind Dr Stech’s proposal at a 2018 European Securities Lending Forum, that a set of industry-wide environmental, social and governance (ESG) principles for securities lending could be drafted and universally adopted based on consultation with key stakeholders, including investment banks, beneficial owners, regulators and legislators in key countries. The Global PSSL is the realisation of this ambition, with the aim of creating a global ESG market standard for owners, lenders, borrowers and impact creators, such as Standard Chartered.
The draft principles are now in the final stages of consultation, but broadly cover nine key areas:
- Sustainable finance alignment
- Inclusion and diversity
- Short Selling
- Innovation and digitisation
These principles are supported through a programme of events and a mentoring programme to maintain industry engagement, dialogue and co-operation on an ongoing basis.
Balancing operations, principles and financial returns
One of the reasons that balancing financial returns with ESG priorities has been so difficult in the past is the lack of reliable and consistent data to trigger automated processes, enable informed decision-making and reduce financial impact. For example, the record date of AGMs – and particularly EGMs - at which key issues may be voted on – are not necessarily known in advance. Therefore, lenders have traditionally been obliged to track AGM dates themselves, which is prone to error without detailed historic data. As an alternative, many simply recall securities from lending programmes as a matter of course across a ‘window’ of time that often includes a wide margin for error. This creates significant opportunity cost through lost income.
Through Standard Chartered’s agency securities lending partnership with eSecLending, this challenge no longer applies. Our highly configurable, automated share recall service is becoming increasingly important as a tool to help support clients’ ESG and financial objectives. This solution uses rich data provided by ISS, to predict record dates with a high degree of confidence. It then combines this with economic data to enable clients to make informed decisions on whether to recall securities or leave them on loan. Consequently, the opportunity cost is reduced by limiting the frequency of recall, and the time period for which securities are removed from the lending programme. Furthermore, the ISS data set includes detailed ancillary data, such as on M&A or proxy contests, which is extremely valuable to drive informed decisions on stock recalls, but difficult for the lender to track independently.
Likewise, our collateral filtering and ongoing monitoring service gives lenders the assurance that their ESG priorities are reflected from end to end through the securities lending process.
Our clients are now raising ESG in almost every conversation, but their ESG agendas vary considerably, and continue to evolve over time. At Standard Chartered, we are highly supportive of initiatives such as Global PSSL that aim to develop standards that build industry confidence and consensus, resolve fragmentation and improve transparency at an industry level. This industry-wide collaboration will become increasingly important as industry stakeholders develop their ESG policies. For example, clients are starting to ask more questions around climate or employment controversies, which then need to be built into ESG parameters, and reflected in global monitoring standards.
Aligned with this, we see enormous opportunities for a highly differentiated agency securities lending service across both traditional and emerging markets. Our partnership with eSecLending means we can deliver securities lending solutions that are entirely segregated by client, and tailored to individual ESG priorities, whilst achieving higher risk-adjusted returns and greater transparency than traditional, pool-based lending programmes.
1 https://www.edelman.com/sites/g/files/aatuss191/files/2020-11/Edelman%202020%20Institutional%20Investor%20Trust_FINAL.pdf. Slide 7
2 Ibid. Slide 12
3 Ibid. Slide 11
5 More information on Global PSSL, including forthcoming events and mentoring programme can be found at https://gpssl.org