ESG: The buy-side perspective
17 March 2020
Can lenders strike the right balance between ESG investing and facilitating sustainable principles in their lending programmes?
Image: Shutterstock
The concept of investing sustainably has moved from the sidelines to mainstream across financial markets in recent years, with environmental, social and corporate governance (ESG) principles now being integrated into many securities lending programmes.
As a result, agent lenders that until now only had to manage scheduled corporate actions and a handful of collateral parameters within their client’s lending programmes are now facing demands for much more bespoke services that are tailored to individual lender’s ESG requirements.
Efforts to create standardisation of what is or isn’t ESG friendly with lending programmes are already underway but the securities finance industry is also facing a much bigger challenge from those that argue the entire industry falls foul of responsible investment standards.
Despite the positive endorsements from the likes of the European Securities and Markets Authority, which produced a report late last year that dismissed concerns that securities lending and short selling are linked to anti-ESG practices and “short-termism”, the buy side is yet to agree on how to harmonise their investment strategies and ethical responsibilities.
To some extent, regulators in the EU and elsewhere are taking the matter out of investors’ hands by taking an increasingly proactive stance on handing down rules and guidance on what it considers to be ESG friendly investments or not.
“The authorities are focusing more deeply on ’strategic steering‘ and general business model analysis,” explains Michael Huertas, co-head of the Europe financial institutions regulatory group at Dentons. “Not only will supervised institutions need to focus on compliance and governance requirements, but they will need to be prepared to explain and defend their decision-making and how they arrived at a particular decision.”
Peter Paul van de Wijs, chief external affairs officer at the Global Reporting Initiative (GRI), which help businesses and governments manage their ESG-related strategies, says that, for a majority of investors, “ESG data is hugely important for decision making on their investment strategies. Clients of asset owners increasingly want their money sustainably and responsibly invested,” he explains.
“The demand for comprehensive ESG data is one of the drivers GRI is seeing that is pushing the growth in ESG disclosure by businesses”, says Wijs.
“To put in context, 93 percent of the world’s largest 250 companies report their sustainability performance – of which three quarters use GRI,” he adds.
The increased scrutiny of firm’s governance and investment decisions has garnered a wide range of responses due to the subjective nature of the process. One of the more radical consequences came from Japan where the country’s $1.6 trillion Government Pension Investment Fund (GPIF) partially suspended its securities lending programme in an effort to meet its perceived stewardship responsibilities to maintain control of the stocks in its portfolio.
In December 2019, GPIF announced that while shares were lent, the original stockholder does not continuously have full shareholder rights, and therefore cannot be a good steward when it comes to ESG shareholder activism. Nothing was said about short-selling in their original statement but subsequent statements by the fund’s chief investment officer, Hiro Mizuno, strongly implied that a dislike of the practice was central to the decision.
Despite some initial shock and fretting from market participants about the risk of a domino effect by other lenders, none are yet to follow suit in foregoing the revenue from lending due to concerns around governance responsibilities.
However, Andrew Dyson, CEO of International Securities Lending Association (ISLA), admits that the move “raised important questions around ESG” and that the link between short sellers and long-term investors is being put under increased scrutiny.
Luckily, for the industry, many buy-side participants see the introduction of ESG as the natural evolution of the existing rules-based framework that the industry is built on. Mick Chadwick, head of securities finance at Aviva Investors, explains: “Our belief is that there’s no innate contradiction between securities lending and good stewardship. Indeed, we’ve long recognised that an orderly securities lending market is an essential component of an orderly, liquid and sustainable capital market more broadly.”
Chadwick says that ESG principles underpin all aspects of Aviva’s investment decision-making process and that securities lending is no exception.
Elsewhere, Matthew Chessum, investment director at Aberdeen Standard Investments, reinforces this point, arguing that “ESG investing and active engagement are all key considerations that are strongly embedded within the investment management process within Aberdeen Standard Investments”. He also agrees that ESG in particular underpins all of the investment activities, including securities lending.
“As the securities lending programme is closely aligned to the overall investment strategy within a fund all securities lending activity has been designed to work in tandem with the funds ESG principles,” he adds.
The original G
So far, ESG in securities lending has predominantly, focused on the ability to recall on-loan stocks in order to participate in votes and other corporate actions, along with creating collateral profiles that exclude exposure to controversial sectors, such as arms dealing. This makes sense as it builds upon existing infrastructure in any major lending programme.
“Historically, much of the focus on ESG within securities lending has been on the ‘G’ component. It’s important that securities lending market participants have a voting policy in place in order to reconcile any potential conflicts that may arise between lending and voting securities” Chadwick states.
Chessum also explains: “Active engagement and our stewardship responsibilities have always been very important factors in the fund management process and these have always been supported through a funds ability to recall on loan positions at any point in time.”
Meanwhile, for collateral, ESG demands are driving a shift away from omnibus account structures to segregated ones that allow for more effective management.
Chadwick warns against taking a one-size-fits-all approach to managing collateral and says that Aviva’s collateral is managed on a fully segregated basis.
Embracing change
According to Chadwick, the growth of ESG in securities lending programmes is only going to increase in the years to come. However, industry participants can play a guiding role in ensuring the integration is a smooth one; and that means standardisation is essential.
Aviva Investors is among the founding members of ISLA’s Council for Sustainable Finance (ICSF), which came together for the first time earlier this year. The council’s aim is to develop a set of Principles for Sustainable Securities Lending (PSSL) that can be used as a universally accepted template for incorporating ESG into lending. Currently, a significant portion of buy-side members do not have a defined ESG policy and therefore the production of such a resource at this pivotal moment could help avoid a lot of debate and uncertainty in the future.
“I would encourage all beneficial owners to refer to the Principles for Sustainable Securities Lending (PSSL) that the ICSF has just released and I would also encourage them to join in the more broader ESG conversation where lending is concerned and become members of this movement,” says Chessum. “Beneficial owners need to remain on the front foot if they are to continue to offer real ESG products to their underlying investors.”
As a result, agent lenders that until now only had to manage scheduled corporate actions and a handful of collateral parameters within their client’s lending programmes are now facing demands for much more bespoke services that are tailored to individual lender’s ESG requirements.
Efforts to create standardisation of what is or isn’t ESG friendly with lending programmes are already underway but the securities finance industry is also facing a much bigger challenge from those that argue the entire industry falls foul of responsible investment standards.
Despite the positive endorsements from the likes of the European Securities and Markets Authority, which produced a report late last year that dismissed concerns that securities lending and short selling are linked to anti-ESG practices and “short-termism”, the buy side is yet to agree on how to harmonise their investment strategies and ethical responsibilities.
To some extent, regulators in the EU and elsewhere are taking the matter out of investors’ hands by taking an increasingly proactive stance on handing down rules and guidance on what it considers to be ESG friendly investments or not.
“The authorities are focusing more deeply on ’strategic steering‘ and general business model analysis,” explains Michael Huertas, co-head of the Europe financial institutions regulatory group at Dentons. “Not only will supervised institutions need to focus on compliance and governance requirements, but they will need to be prepared to explain and defend their decision-making and how they arrived at a particular decision.”
Peter Paul van de Wijs, chief external affairs officer at the Global Reporting Initiative (GRI), which help businesses and governments manage their ESG-related strategies, says that, for a majority of investors, “ESG data is hugely important for decision making on their investment strategies. Clients of asset owners increasingly want their money sustainably and responsibly invested,” he explains.
“The demand for comprehensive ESG data is one of the drivers GRI is seeing that is pushing the growth in ESG disclosure by businesses”, says Wijs.
“To put in context, 93 percent of the world’s largest 250 companies report their sustainability performance – of which three quarters use GRI,” he adds.
The increased scrutiny of firm’s governance and investment decisions has garnered a wide range of responses due to the subjective nature of the process. One of the more radical consequences came from Japan where the country’s $1.6 trillion Government Pension Investment Fund (GPIF) partially suspended its securities lending programme in an effort to meet its perceived stewardship responsibilities to maintain control of the stocks in its portfolio.
In December 2019, GPIF announced that while shares were lent, the original stockholder does not continuously have full shareholder rights, and therefore cannot be a good steward when it comes to ESG shareholder activism. Nothing was said about short-selling in their original statement but subsequent statements by the fund’s chief investment officer, Hiro Mizuno, strongly implied that a dislike of the practice was central to the decision.
Despite some initial shock and fretting from market participants about the risk of a domino effect by other lenders, none are yet to follow suit in foregoing the revenue from lending due to concerns around governance responsibilities.
However, Andrew Dyson, CEO of International Securities Lending Association (ISLA), admits that the move “raised important questions around ESG” and that the link between short sellers and long-term investors is being put under increased scrutiny.
Luckily, for the industry, many buy-side participants see the introduction of ESG as the natural evolution of the existing rules-based framework that the industry is built on. Mick Chadwick, head of securities finance at Aviva Investors, explains: “Our belief is that there’s no innate contradiction between securities lending and good stewardship. Indeed, we’ve long recognised that an orderly securities lending market is an essential component of an orderly, liquid and sustainable capital market more broadly.”
Chadwick says that ESG principles underpin all aspects of Aviva’s investment decision-making process and that securities lending is no exception.
Elsewhere, Matthew Chessum, investment director at Aberdeen Standard Investments, reinforces this point, arguing that “ESG investing and active engagement are all key considerations that are strongly embedded within the investment management process within Aberdeen Standard Investments”. He also agrees that ESG in particular underpins all of the investment activities, including securities lending.
“As the securities lending programme is closely aligned to the overall investment strategy within a fund all securities lending activity has been designed to work in tandem with the funds ESG principles,” he adds.
The original G
So far, ESG in securities lending has predominantly, focused on the ability to recall on-loan stocks in order to participate in votes and other corporate actions, along with creating collateral profiles that exclude exposure to controversial sectors, such as arms dealing. This makes sense as it builds upon existing infrastructure in any major lending programme.
“Historically, much of the focus on ESG within securities lending has been on the ‘G’ component. It’s important that securities lending market participants have a voting policy in place in order to reconcile any potential conflicts that may arise between lending and voting securities” Chadwick states.
Chessum also explains: “Active engagement and our stewardship responsibilities have always been very important factors in the fund management process and these have always been supported through a funds ability to recall on loan positions at any point in time.”
Meanwhile, for collateral, ESG demands are driving a shift away from omnibus account structures to segregated ones that allow for more effective management.
Chadwick warns against taking a one-size-fits-all approach to managing collateral and says that Aviva’s collateral is managed on a fully segregated basis.
Embracing change
According to Chadwick, the growth of ESG in securities lending programmes is only going to increase in the years to come. However, industry participants can play a guiding role in ensuring the integration is a smooth one; and that means standardisation is essential.
Aviva Investors is among the founding members of ISLA’s Council for Sustainable Finance (ICSF), which came together for the first time earlier this year. The council’s aim is to develop a set of Principles for Sustainable Securities Lending (PSSL) that can be used as a universally accepted template for incorporating ESG into lending. Currently, a significant portion of buy-side members do not have a defined ESG policy and therefore the production of such a resource at this pivotal moment could help avoid a lot of debate and uncertainty in the future.
“I would encourage all beneficial owners to refer to the Principles for Sustainable Securities Lending (PSSL) that the ICSF has just released and I would also encourage them to join in the more broader ESG conversation where lending is concerned and become members of this movement,” says Chessum. “Beneficial owners need to remain on the front foot if they are to continue to offer real ESG products to their underlying investors.”
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