Money isn’t everything
04 August 2020
Lothian Pension Fund is a long-term lender that has now decided on an ESG-focused strategy that priorities principles over profits. And it thinks more beneficial owners will follow suit
Image: samott/stock.adobe.com
In many ways, the UK’s Lothian Pension Fund (LPF) represents the typical beneficial owner. It is Scotland’s second-largest pension scheme with more than £8 billion in assets under management and has engaged in securities lending for more than a decade. The fund’s management still sees the benefit in lending out a portion of its portfolio to generate what its chief investment officerBruce Miller recently described as the “significant fee income” that it brings, which boosts the fund’s long-term performance. According to its latest annual report, the fund earned £577,000 from “securities lending and sundries” in 2019/20 down 38.8 percent from the £577,000 recorded a year earlier. Part of the reason for this is that global lending revenue has dropped off in 2019 and so far in 2020, compared to the bumper year seen in 2018.
Figures from DataLend show that macro market uncertainty and skittish hedge funds resulted in securities lending revenue falling by 13 percent year-on-year for 2019. Global revenue hit $8.66 billion in 2019, representing a decline in revenue across all regions and in both the equity and fixed income markets.
Despite LPD following the global downward trend, a double-digit revenue loss might spur some lenders to re-evaluate their collateral profiles or seek new ways to return to form and become more attractive to borrowers. In reality, although the fund would undoubtedly welcome increased profits, it is among a growing demographic of beneficial owners that no longer measure the success of their securities lending programmes purely, or even primarily, by revenue.
As of June, LPF decided to prioritise its environmental, social and governance (ESG) principles above profits by installing an automatic-recall facility with its custodian, Northern Trust, that would allow it to leverage 100 percent of its shares during voting at annual general meetings (AGMs). “As a responsible investor, it’s vital that we use our votes to make the maximum impact we can on behalf of our stakeholders. If this means sacrificing fee income because it’s the right thing to do, then we’ll do that,” LPF’s CEO Doug Heron explained at the time.
“This is a progressive move by the investment team at LPF, but we believe that it will set the standard for the management of stock lending going forward.”
For beneficial owners, the relationship between ESG and securities lending can be complex as each lender explores, forms and refines what responsible investing means to them.
This has occasionally led to clashes of interests, mostly around an asset owner’s dislike of short selling, which securities lending facilitates. The most prominent example of this was seen in December 2019 when the world’s largest pension fund, based in Japan, withdrew its global equities from its lending programme due to poor visibility of the end borrower and a lack of control over their use of the assets.
More recently, UniSuper, one of Australia’s largest superannuation funds, suspended its securities lending programme to stifle supply to short sellers amid the coronavirus fuelled market sell-off in March. It is yet to re-engage its programme.
For LPF, however, the concerns were not around short sellers, but the need to do its duty in bringing its full voting powers to bear on ESG-related corporate actions. As beneficial owners begin to define what they require to appease their ESG principles we will likely see new features such as an automatic re-call service appear as the unlikely bedfellows of securities lending and ESG get comfortable.
To discuss the move in more detail and the possibility of a new emerging trend for beneficial owners, SLT spoke to David Hickey, who leads LPF’s ESG strategy, to find out how the fund arrived in this position and what is next.
How active was LPF in voting during AGMs in the past and what drove the demand for an automatic recall facility?
Until recently, we’ve always kept back 5 percent of our stock from our lending programme to ensure we could vote at every AGM. In the past two years, there has been a lot of focus on the volume of voting and it has been decided that the better standard is to vote with all your holding.
Until now, recalls were very manually intensive. They involved monitoring data services to be alerted to voting opportunities. We would then have to notify our custodian to recall the stock in time for that AGM. After the vote, we’d have to let them know that the stock was available to lend again.
A lot of local authority pension schemes are short of resources as it is and we certainly don’t have resources to go through hundreds of stocks and do manual recalls. So, we approached Northern Trust at the end of 2019 to see if there was a better way. At the time, Northern Trust didn’t have any form of automatic recall process so they went away and built one for us, which took several months.
Even with the facility in place, we will continue to hold back 5 percent of our stock just in case something goes wrong.
Securities lending is a buyer’s market and beneficial owners are often encouraged by agent lenders to make themselves as attractive to borrowers as possible by not doing exactly this sort of thing. Was this a concern for you?
We predict having this re-call service will cost us roughly 16 percent of our annual revenue but ESG comes before the income from securities lending. Responsible investing and voting have become so important now with the Shareholders Rights Directive and the other ESG-related codes LPF has signed up to, which includes being a member of Climate Action 100+. All this puts pressure on us to act responsibly and disclose how we’re acting as an asset owner and doubly-so as a public asset owner.
The benefits of the automatic recall facility far outweigh the negatives. In some ways, through the automatic recall facility, we are able to have our cake and eat it now with only a small knock to our revenue. We are able to maintain a securities lending programme and discharge 100 percent of our voting obligations. While we had to sacrifice an element of our returns, we could have lost all of it if we had to withdraw from securities lending entirely, which was a possibility.
Although new facilities like ours will undoubtedly cause more work for agent lenders, it may also lead to more beneficial owners entering the lending market as these tools will allow them to juggle their ESG responsibilities and lending, much like it allows us to do.
Other than these initatives you have signed up to, where does the pressure to lean into ESG come from?
Most of the pressure we receive is from lobbying groups that have very strong views on what public pension funds should or shouldn’t be investing in. There are pressure groups for lots of areas and there’s a risk that you can say “yes” to everything and risk being left with literally nothing to invest it. We’ve taken the stance that there are certain areas that are now commonly understood as being not acceptable and we’ve created our ESG policy along those lines.
In order to be more clear in what our standards are, we have recently published a Statement of Responsible Investment Principles. This highlights our ambition to vote 100 percent of our shares; to measure the carbon intensity of 100 percent of our assets by 2022; to cease any primary investment in companies that aren’t aligned with the goals of the Paris agreement; and to continue engaging with non-Paris aligned companies until 2025 with any companies making little progress towards the goals likely being divested at this point.
With the recall facility and your investment principles clearly defined, do you feel you’ve reached an optimal place in your ESG strategy?
I was brought on as a European equities manager and my role has evolved to take on more of the fund’s ESG strategy. Now I look back at what we were doing five years ago I think that wasn’t optimal. Hopefully, when we look back five years from now we will say the same because that means we’ve continued to evolve and improve. There’s no such thing as perfect.
For the recall facility specifically, going forward we will have to monitor it because it hasn’t really been tested yet. I’m sure there will be issues that will need to be addressed but that’s what you get when you’re an early adopter.
How do you rank LPF’s ESG development against its peers?
I see us being the Leeds United of ESG. We are towards the top of the Championship, but we’re not in the Premiership yet. When I look at the funds that are front runners in ESG, I think of Brunel Pension Partnership, the Church of England’s funds and USS.
We are not resourced to keep up with those entities but we do the best we can and try to be strategic to be as effective as possible. We do a lot of collaborative work and I founded a group that brings together Scottish pension funds to discuss issues and help each other.
Figures from DataLend show that macro market uncertainty and skittish hedge funds resulted in securities lending revenue falling by 13 percent year-on-year for 2019. Global revenue hit $8.66 billion in 2019, representing a decline in revenue across all regions and in both the equity and fixed income markets.
Despite LPD following the global downward trend, a double-digit revenue loss might spur some lenders to re-evaluate their collateral profiles or seek new ways to return to form and become more attractive to borrowers. In reality, although the fund would undoubtedly welcome increased profits, it is among a growing demographic of beneficial owners that no longer measure the success of their securities lending programmes purely, or even primarily, by revenue.
As of June, LPF decided to prioritise its environmental, social and governance (ESG) principles above profits by installing an automatic-recall facility with its custodian, Northern Trust, that would allow it to leverage 100 percent of its shares during voting at annual general meetings (AGMs). “As a responsible investor, it’s vital that we use our votes to make the maximum impact we can on behalf of our stakeholders. If this means sacrificing fee income because it’s the right thing to do, then we’ll do that,” LPF’s CEO Doug Heron explained at the time.
“This is a progressive move by the investment team at LPF, but we believe that it will set the standard for the management of stock lending going forward.”
For beneficial owners, the relationship between ESG and securities lending can be complex as each lender explores, forms and refines what responsible investing means to them.
This has occasionally led to clashes of interests, mostly around an asset owner’s dislike of short selling, which securities lending facilitates. The most prominent example of this was seen in December 2019 when the world’s largest pension fund, based in Japan, withdrew its global equities from its lending programme due to poor visibility of the end borrower and a lack of control over their use of the assets.
More recently, UniSuper, one of Australia’s largest superannuation funds, suspended its securities lending programme to stifle supply to short sellers amid the coronavirus fuelled market sell-off in March. It is yet to re-engage its programme.
For LPF, however, the concerns were not around short sellers, but the need to do its duty in bringing its full voting powers to bear on ESG-related corporate actions. As beneficial owners begin to define what they require to appease their ESG principles we will likely see new features such as an automatic re-call service appear as the unlikely bedfellows of securities lending and ESG get comfortable.
To discuss the move in more detail and the possibility of a new emerging trend for beneficial owners, SLT spoke to David Hickey, who leads LPF’s ESG strategy, to find out how the fund arrived in this position and what is next.
How active was LPF in voting during AGMs in the past and what drove the demand for an automatic recall facility?
Until recently, we’ve always kept back 5 percent of our stock from our lending programme to ensure we could vote at every AGM. In the past two years, there has been a lot of focus on the volume of voting and it has been decided that the better standard is to vote with all your holding.
Until now, recalls were very manually intensive. They involved monitoring data services to be alerted to voting opportunities. We would then have to notify our custodian to recall the stock in time for that AGM. After the vote, we’d have to let them know that the stock was available to lend again.
A lot of local authority pension schemes are short of resources as it is and we certainly don’t have resources to go through hundreds of stocks and do manual recalls. So, we approached Northern Trust at the end of 2019 to see if there was a better way. At the time, Northern Trust didn’t have any form of automatic recall process so they went away and built one for us, which took several months.
Even with the facility in place, we will continue to hold back 5 percent of our stock just in case something goes wrong.
Securities lending is a buyer’s market and beneficial owners are often encouraged by agent lenders to make themselves as attractive to borrowers as possible by not doing exactly this sort of thing. Was this a concern for you?
We predict having this re-call service will cost us roughly 16 percent of our annual revenue but ESG comes before the income from securities lending. Responsible investing and voting have become so important now with the Shareholders Rights Directive and the other ESG-related codes LPF has signed up to, which includes being a member of Climate Action 100+. All this puts pressure on us to act responsibly and disclose how we’re acting as an asset owner and doubly-so as a public asset owner.
The benefits of the automatic recall facility far outweigh the negatives. In some ways, through the automatic recall facility, we are able to have our cake and eat it now with only a small knock to our revenue. We are able to maintain a securities lending programme and discharge 100 percent of our voting obligations. While we had to sacrifice an element of our returns, we could have lost all of it if we had to withdraw from securities lending entirely, which was a possibility.
Although new facilities like ours will undoubtedly cause more work for agent lenders, it may also lead to more beneficial owners entering the lending market as these tools will allow them to juggle their ESG responsibilities and lending, much like it allows us to do.
Other than these initatives you have signed up to, where does the pressure to lean into ESG come from?
Most of the pressure we receive is from lobbying groups that have very strong views on what public pension funds should or shouldn’t be investing in. There are pressure groups for lots of areas and there’s a risk that you can say “yes” to everything and risk being left with literally nothing to invest it. We’ve taken the stance that there are certain areas that are now commonly understood as being not acceptable and we’ve created our ESG policy along those lines.
In order to be more clear in what our standards are, we have recently published a Statement of Responsible Investment Principles. This highlights our ambition to vote 100 percent of our shares; to measure the carbon intensity of 100 percent of our assets by 2022; to cease any primary investment in companies that aren’t aligned with the goals of the Paris agreement; and to continue engaging with non-Paris aligned companies until 2025 with any companies making little progress towards the goals likely being divested at this point.
With the recall facility and your investment principles clearly defined, do you feel you’ve reached an optimal place in your ESG strategy?
I was brought on as a European equities manager and my role has evolved to take on more of the fund’s ESG strategy. Now I look back at what we were doing five years ago I think that wasn’t optimal. Hopefully, when we look back five years from now we will say the same because that means we’ve continued to evolve and improve. There’s no such thing as perfect.
For the recall facility specifically, going forward we will have to monitor it because it hasn’t really been tested yet. I’m sure there will be issues that will need to be addressed but that’s what you get when you’re an early adopter.
How do you rank LPF’s ESG development against its peers?
I see us being the Leeds United of ESG. We are towards the top of the Championship, but we’re not in the Premiership yet. When I look at the funds that are front runners in ESG, I think of Brunel Pension Partnership, the Church of England’s funds and USS.
We are not resourced to keep up with those entities but we do the best we can and try to be strategic to be as effective as possible. We do a lot of collaborative work and I founded a group that brings together Scottish pension funds to discuss issues and help each other.
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