ESG and securities lending can co-exist
26 May 2020
Don D'Eramo, global head of securities finance, RBC Investor & Treasury Services looks at how lenders seek to strike the right balance between ESG principles and revenue optimisation
Image: Don D鈥橢ramo/RBC I&TS
The integration of environmental, social and governance (ESG) factors is an increasingly important part of investment strategies. Investors seek to exercise governance responsibilities by screening companies considered to be more responsible in their corporate behaviour, or focusing on those where voting rights can be used to exert influence.
ESG performance is also a growing consideration among beneficial owners as they endeavour to implement and adhere to guiding principles in harmony with the nuances of securities lending. This can also play into the timing and recall of loans. For example, when a security is out on loan, beneficial owners are required to close positions on loan in order to facilitate proxy voting as this entitlement transfers to the borrower.
The issue was recently brought to the forefront when Japan鈥檚 Government Pension Investment Fund (GPIF), which aims to be a market leader in ESG financing, paused its equity securities lending programme late in 2019, noting that it 鈥渃an be considered to be inconsistent with the fulfilment of the stewardship responsibilities of a long-term investor鈥�.
The International Securities Lending Association (ISLA) is also focused on ESG, including challenges around beneficial owners鈥� collateral as well as the industry鈥檚 association with short selling. In a recent blog post, ISLA鈥檚 CEO Andrew Dyson said the introduction of ESG principles into the securities finance market has created 鈥渁n interesting natural tension鈥� between the traditional rules-based approach and values or principles-driven strategies of sustainable finance.
鈥淩econciling these quite different worlds will present both organizational and cultural challenges across our markets and beyond,鈥� he wrote.
Fulfilling good governance
Regardless of the reasons GPIF had for stopping its securities lending programme, which went beyond proxy voting, lenders can still find ways to maintain their vote, says Donato D鈥橢ramo, and managing director and global head of securities finance at RBC Investor & Treasury Services (RBC I&TS), and president of the Canadian Securities Lending Association.
鈥淪ecurities lending can definitely co-exist with ESG governance given that one of the key tenets of securities lending programmes is their ability to meet clients鈥� requirements,鈥� D鈥橢ramo says. 鈥淔or example, if you want to vote your shares at every annual general meeting, or on only a potentially contentious issue, the ability to recall your securities to vote is there.鈥�
The solution, according to D鈥橢ramo, is for lenders to work directly with their agents to construct a securities lending program that fits their investment strategy and practices. Lenders should inform their agent ahead of the required voting date, so that lending positions can be returned. 鈥淚t鈥檚 all about the transfer of information and understanding what your client鈥檚 lending objectives are,鈥� says D鈥橢ramo.
The revenue consideration
Revenue is amongst some of the considerations for lenders when deciding whether to recall securities to vote, as it can limit earning potential 鈥� particularly with high intrinsic value loans. The decision to recall often comes down to giving up additional lending revenue to place the vote. 鈥淪ometimes there is a trade-off between revenue and governance objectives, said D鈥橢ramo. 鈥淓very lender will have varying degrees as to how they want to enhance their corporate governance policy,鈥� he adds.
In many cases, lenders have internal guidelines that help determine when to vote, such as on important events related to performance, or based on ESG principles. A lender may leave securities on loan if the voting matter is not considered material to their overall performance.
鈥淩BC I&TS takes a consultative approach with clients to determine the most suitable model of fulfilling their governance requirements 鈥� case-by-case or full mandate,鈥� according to D鈥橢ramo, 鈥渨hile also striking a balance on revenue鈥�.
Going beyond voting rights
The discussion regarding ESG and securities lending goes beyond voting rights and may include restricting certain types of securities based on internal governance policies or certain types of collateral depending on internal ESG views. For example, lenders may see short-selling as inconsistent with ESG investing, since sustainable investing is often seen as a long-term investment strategy.
However, various studies have countered that argument. D鈥橢ramo refers to a recent European Securities and Markets Authority (ESMA) report. 鈥淚n December 2019, ESMA published its findings on 鈥榩otential undue short-term pressures in securities markets鈥�. The report specifically noted that 鈥榮hort selling and securities lending are key for price discovery and market liquidity鈥�.鈥�
The agent鈥檚 role is to translate the lender鈥檚 mission and goals into a specific securities lending program, the same way it has for non-ESG issues. 鈥淲e have been balancing this practice with clients for many years,鈥� D鈥橢ramo says. 鈥淭his is not a new process, but the enhanced focus requires more consultative client discussions to find the best approach for all.鈥�
Bespoke securities lending
Securities lending is not a one-size-fits-all approach. Lenders are looking for programmes designed to meet their specific needs and goals, which increasingly includes ESG factors.
As ESG continues to play a role in investment strategies, lenders need to balance performance needs with their responsible investing principles. It may be a trade-off between revenue and how material the vote is to the lender.
According to D鈥橢ramo, it is possible to balance ESG-inspired lending approaches with the right strategies. 鈥淓SG is an increasing focal point in the investment industry at large, with downstream considerations for securities lending,鈥� D鈥橢ramo says.
He recommends lenders find a 鈥渂espoke, well-thought-out securities lending program鈥� to ensure their investing needs are properly met.
ESG performance is also a growing consideration among beneficial owners as they endeavour to implement and adhere to guiding principles in harmony with the nuances of securities lending. This can also play into the timing and recall of loans. For example, when a security is out on loan, beneficial owners are required to close positions on loan in order to facilitate proxy voting as this entitlement transfers to the borrower.
The issue was recently brought to the forefront when Japan鈥檚 Government Pension Investment Fund (GPIF), which aims to be a market leader in ESG financing, paused its equity securities lending programme late in 2019, noting that it 鈥渃an be considered to be inconsistent with the fulfilment of the stewardship responsibilities of a long-term investor鈥�.
The International Securities Lending Association (ISLA) is also focused on ESG, including challenges around beneficial owners鈥� collateral as well as the industry鈥檚 association with short selling. In a recent blog post, ISLA鈥檚 CEO Andrew Dyson said the introduction of ESG principles into the securities finance market has created 鈥渁n interesting natural tension鈥� between the traditional rules-based approach and values or principles-driven strategies of sustainable finance.
鈥淩econciling these quite different worlds will present both organizational and cultural challenges across our markets and beyond,鈥� he wrote.
Fulfilling good governance
Regardless of the reasons GPIF had for stopping its securities lending programme, which went beyond proxy voting, lenders can still find ways to maintain their vote, says Donato D鈥橢ramo, and managing director and global head of securities finance at RBC Investor & Treasury Services (RBC I&TS), and president of the Canadian Securities Lending Association.
鈥淪ecurities lending can definitely co-exist with ESG governance given that one of the key tenets of securities lending programmes is their ability to meet clients鈥� requirements,鈥� D鈥橢ramo says. 鈥淔or example, if you want to vote your shares at every annual general meeting, or on only a potentially contentious issue, the ability to recall your securities to vote is there.鈥�
The solution, according to D鈥橢ramo, is for lenders to work directly with their agents to construct a securities lending program that fits their investment strategy and practices. Lenders should inform their agent ahead of the required voting date, so that lending positions can be returned. 鈥淚t鈥檚 all about the transfer of information and understanding what your client鈥檚 lending objectives are,鈥� says D鈥橢ramo.
The revenue consideration
Revenue is amongst some of the considerations for lenders when deciding whether to recall securities to vote, as it can limit earning potential 鈥� particularly with high intrinsic value loans. The decision to recall often comes down to giving up additional lending revenue to place the vote. 鈥淪ometimes there is a trade-off between revenue and governance objectives, said D鈥橢ramo. 鈥淓very lender will have varying degrees as to how they want to enhance their corporate governance policy,鈥� he adds.
In many cases, lenders have internal guidelines that help determine when to vote, such as on important events related to performance, or based on ESG principles. A lender may leave securities on loan if the voting matter is not considered material to their overall performance.
鈥淩BC I&TS takes a consultative approach with clients to determine the most suitable model of fulfilling their governance requirements 鈥� case-by-case or full mandate,鈥� according to D鈥橢ramo, 鈥渨hile also striking a balance on revenue鈥�.
Going beyond voting rights
The discussion regarding ESG and securities lending goes beyond voting rights and may include restricting certain types of securities based on internal governance policies or certain types of collateral depending on internal ESG views. For example, lenders may see short-selling as inconsistent with ESG investing, since sustainable investing is often seen as a long-term investment strategy.
However, various studies have countered that argument. D鈥橢ramo refers to a recent European Securities and Markets Authority (ESMA) report. 鈥淚n December 2019, ESMA published its findings on 鈥榩otential undue short-term pressures in securities markets鈥�. The report specifically noted that 鈥榮hort selling and securities lending are key for price discovery and market liquidity鈥�.鈥�
The agent鈥檚 role is to translate the lender鈥檚 mission and goals into a specific securities lending program, the same way it has for non-ESG issues. 鈥淲e have been balancing this practice with clients for many years,鈥� D鈥橢ramo says. 鈥淭his is not a new process, but the enhanced focus requires more consultative client discussions to find the best approach for all.鈥�
Bespoke securities lending
Securities lending is not a one-size-fits-all approach. Lenders are looking for programmes designed to meet their specific needs and goals, which increasingly includes ESG factors.
As ESG continues to play a role in investment strategies, lenders need to balance performance needs with their responsible investing principles. It may be a trade-off between revenue and how material the vote is to the lender.
According to D鈥橢ramo, it is possible to balance ESG-inspired lending approaches with the right strategies. 鈥淓SG is an increasing focal point in the investment industry at large, with downstream considerations for securities lending,鈥� D鈥橢ramo says.
He recommends lenders find a 鈥渂espoke, well-thought-out securities lending program鈥� to ensure their investing needs are properly met.
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