ISLA takes aim at ESG stumbling blocks
18 March 2021 UK
Image: marcin_jucha/adobe.stock.com
The International Securities Lending Association (ISLA) has fired the starting gun on its new campaign to lay environmental, social and governance (ESG) best practices over the market with a five-step plan for progress.
Central to ISLA’s ESG ambitions is regaining control of the narrative of the growth of sustainable financing in the context of securities lending, which still suffers from woolly terminology and a lack of broad consensus on what role the market should play in the adoption and promotion of ESG.
ISLA CEO Andy Dyson has repeatedly warned against letting securities lending “become the story” in the ESG debate as it distracts from first principles of the role financing plays in facilitating overall capital market liquidity.
In the context of the EU’s newly-installed Sustainable Finance Disclosure Regulation (SFDR), ISLA is also guiding its members away from overstating the ESG credentials of products that are largely neutral in their impact on sustainability in order to avoid a potential quagmire of complex reporting requirements or other disclosure rules that are expected in the near and medium term.
In a new white paper, written in partnership with law firm Allen & Overy and unveiled at the trade body’s post-trade event this week, ISLA states that securities lending can play an important role, both with the functioning of capital markets more broadly but also in assisting with individual ESG investment strategies.
The paper, 'Framing securities lending for the sustainability era’ outlines five steps ISLA, through its ESG steering group, will take to enhance clarity around the sustainability debate and bring members and other stakeholders together to align activities and strategies across the board.
The steps get to the heart of concerns that buy-side members are voicing around facilitating short selling and the juggling of a lending programme with governance responsibilities surrounding voting and avoiding non-ESG assets that might appear in collateral baskets.
The plan
Action I
ISLA will work with members and industry stakeholders towards the development of a best
practice standard on creating a common understanding of ESG objectives in the context of securities lending arrangements.
This action aims to address the lack of universal consensus on what an ESG objective is, especially in the specific context of securities lending. ISLA notes that the EU’s SFDR and Taxonomies may shed light on the regulator’s view in due course but this will still not solve the problem on an international level, where different and potentially conflicting standards are emerging.
Action II
ISLA intends to work with the membership to update current best practices for recalling securities and to create industry standards around voting in line with good governance principles.
Here, ISLA hopes to dispel reservations that are increasingly prevalent among the buy-side community that securities lending undermines an asset manager's stewardship responsibility around exercising voting rights.
Under standard securities lending agreements (both title transfer and pledge), the voting rights for loaned securities transfer to the borrower, which has led to the charge that securities lending is not compatible with active shareholder engagement. This need not be the case, ISLA writes.
Action III
ISLA intends to adapt current transparency best practices for regulators around shareholder disclosure and identification, keeping in line with the regulatory requirements of the second Shareholder Rights Directive (SRD II).
The association notes that a key concern of sceptical lenders is the purpose for which their securities are being borrowed — for instance, borrowing a share to be able to vote according to a short-termist or non-ESG aligned strategy.
To address this, ISLA aims to couch ESG in the context of the EU and UK’s broader corporate governance and transparency agendas and other related rules frameworks.
Action IV
ISLA will work with members and industry stakeholder groups to engage in a feasibility study on how current market practices could be optimised to increase transparency.
This step will instigate a market review of how to promote visibility of counterparties throughout the transaction chain and prepare for expected ESG-related due diligence requirements.
Action V
ISLA intends to work with its Collateral Management steering group, with a mandate from ISLA’s Beneficial Owner steering group, to develop high-level standards for collateral selection and to ensure the approach to cash reinvestment aligns with the lender’s ESG objectives.
“The most prominent and potentially radical impact on our markets is the increasing number of institutional clients who are adopting ESG objectives within their investment process,” ISLA explains. “Determining whether securities collateral is equivalent to the loaned securities, and whether cash is reinvested consistently with these ESG objectives, will present an important challenge.”
ISLA observes that the scale of the task of creating and actively managing bespoke collateral schedules based on ESG ratings will likely require significant involvement from third party vendors.
“Whilst it may not be feasible to achieve standardisation of outcome, consistency of process could be achieved by agreeing principles as to how a security or investment is determined to meet the lender’s ESG objectives,” ISLA adds.
Central to ISLA’s ESG ambitions is regaining control of the narrative of the growth of sustainable financing in the context of securities lending, which still suffers from woolly terminology and a lack of broad consensus on what role the market should play in the adoption and promotion of ESG.
ISLA CEO Andy Dyson has repeatedly warned against letting securities lending “become the story” in the ESG debate as it distracts from first principles of the role financing plays in facilitating overall capital market liquidity.
In the context of the EU’s newly-installed Sustainable Finance Disclosure Regulation (SFDR), ISLA is also guiding its members away from overstating the ESG credentials of products that are largely neutral in their impact on sustainability in order to avoid a potential quagmire of complex reporting requirements or other disclosure rules that are expected in the near and medium term.
In a new white paper, written in partnership with law firm Allen & Overy and unveiled at the trade body’s post-trade event this week, ISLA states that securities lending can play an important role, both with the functioning of capital markets more broadly but also in assisting with individual ESG investment strategies.
The paper, 'Framing securities lending for the sustainability era’ outlines five steps ISLA, through its ESG steering group, will take to enhance clarity around the sustainability debate and bring members and other stakeholders together to align activities and strategies across the board.
The steps get to the heart of concerns that buy-side members are voicing around facilitating short selling and the juggling of a lending programme with governance responsibilities surrounding voting and avoiding non-ESG assets that might appear in collateral baskets.
The plan
Action I
ISLA will work with members and industry stakeholders towards the development of a best
practice standard on creating a common understanding of ESG objectives in the context of securities lending arrangements.
This action aims to address the lack of universal consensus on what an ESG objective is, especially in the specific context of securities lending. ISLA notes that the EU’s SFDR and Taxonomies may shed light on the regulator’s view in due course but this will still not solve the problem on an international level, where different and potentially conflicting standards are emerging.
Action II
ISLA intends to work with the membership to update current best practices for recalling securities and to create industry standards around voting in line with good governance principles.
Here, ISLA hopes to dispel reservations that are increasingly prevalent among the buy-side community that securities lending undermines an asset manager's stewardship responsibility around exercising voting rights.
Under standard securities lending agreements (both title transfer and pledge), the voting rights for loaned securities transfer to the borrower, which has led to the charge that securities lending is not compatible with active shareholder engagement. This need not be the case, ISLA writes.
Action III
ISLA intends to adapt current transparency best practices for regulators around shareholder disclosure and identification, keeping in line with the regulatory requirements of the second Shareholder Rights Directive (SRD II).
The association notes that a key concern of sceptical lenders is the purpose for which their securities are being borrowed — for instance, borrowing a share to be able to vote according to a short-termist or non-ESG aligned strategy.
To address this, ISLA aims to couch ESG in the context of the EU and UK’s broader corporate governance and transparency agendas and other related rules frameworks.
Action IV
ISLA will work with members and industry stakeholder groups to engage in a feasibility study on how current market practices could be optimised to increase transparency.
This step will instigate a market review of how to promote visibility of counterparties throughout the transaction chain and prepare for expected ESG-related due diligence requirements.
Action V
ISLA intends to work with its Collateral Management steering group, with a mandate from ISLA’s Beneficial Owner steering group, to develop high-level standards for collateral selection and to ensure the approach to cash reinvestment aligns with the lender’s ESG objectives.
“The most prominent and potentially radical impact on our markets is the increasing number of institutional clients who are adopting ESG objectives within their investment process,” ISLA explains. “Determining whether securities collateral is equivalent to the loaned securities, and whether cash is reinvested consistently with these ESG objectives, will present an important challenge.”
ISLA observes that the scale of the task of creating and actively managing bespoke collateral schedules based on ESG ratings will likely require significant involvement from third party vendors.
“Whilst it may not be feasible to achieve standardisation of outcome, consistency of process could be achieved by agreeing principles as to how a security or investment is determined to meet the lender’s ESG objectives,” ISLA adds.
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