As ESG grows, liquidity could wither, warns State Street
29 April 2020 London
Image: Wollertz/Shutterstock.com
A growing number of asset owners and managers are voicing concerns that securities lending undermines their ability to exercise proper stewardship on underlying investments, finds a new State Street research paper.
The paper, which reviews the growing incorporation of environmental, social and governance (ESG) practices by asset owners and managers, analyse the key concerns that lenders have highlighted regarding the appropriateness of their lending practices.
These include a lack of transparency, a lack of control over lent assets and the perception that facilitating short selling runs counter to asset owners’ long-term investment strategy.
The paper’s authors, Bridget Realmuto LaPerla, head of ESG research, and Travis Whitmore, part of the securities finance research team at State Street Associates, highlight the decision of Japan’s Government Pension Investment Fund (GPIF) to partially suspend its lending programme in 2019 suggests that “as the number of asset owners with these ESG-related concerns grows the lending supply may further decline”.
The United Nation Principles for Responsible Investment reported a 16 percent increase in the number of asset owner signatories committed to ESG investing, bringing the number of signatories to over 2,300, with more than $86.3 trillion in assets under management.
The example of GPIF and other pension funds that have recently taken a public stance against lending shows that increasing numbers of asset owners that are embracing ESG principles are using the opportunity to re-evaluate their participation in securities lending.
According to the paper, asset owners have three primary concerns when it comes to securities lending co-existing with their new ESG-friendly stance.
First, the loss of voting right during the on-loan period. The paper explains that lenders see this as being “inconsistent with the wishes of asset owners who mandate that their asset managers need to conscientiously exercise voting rights on all their shares”.
Second, there are transparency concerns, around the fact that lenders often do not have visibility on who the end borrower is or for what purpose they are borrowing the assets.
Finally, despite numerous attempts by the likes of the International Securities Lending Association (ISLA) and even the European Securities and Markets Authority to debunk the link between short selling and “short-termism”, the view persists among lenders that increased short selling of short damage its value long term.
The paper presents a wealth of research which systematically debunks each of these issues and ultimately concludes that “short selling is important for efficient capital markets and when viewed holistically, suggests that short selling is not detrimental to long-term value”.
Moreover, it notes that short selling, facilitated by securities lending, improves market efficiency and market liquidity.
The evidence cited includes research papers by the European Systemic Risk Board, the Sustainability Accounting Standards Board, and the Journal of Banking and Finance, among many others.
The global securities lending market has a long history of being oversaturated with a supply of assets available to lend compared to borrow demand, and even the withdrawal of GPIF, ostensibly the world’s biggest pension fund, did little to change that equation.
ISLA’s latest market report put the value of assets available to lend at around €21 trillion as of 2019 year-end. By comparison, total on-loan balances at the same time hovered around €2.3 trillion. The association has been very proactive in countering this trend of securities lending clashing with the rise of ESG. This includes forming a Council for Sustainable Finance that aims to further promote the findings of similar research referenced by State Street.
Despite this mountain of evidence, the recent economic disruption of the COVID-19 pandemic caused several prominent EU markets to impose controversial short selling bans as a way to alleviate downward pressure on markets. This would imply that the work of ISLA and others is far from over.
The paper, which reviews the growing incorporation of environmental, social and governance (ESG) practices by asset owners and managers, analyse the key concerns that lenders have highlighted regarding the appropriateness of their lending practices.
These include a lack of transparency, a lack of control over lent assets and the perception that facilitating short selling runs counter to asset owners’ long-term investment strategy.
The paper’s authors, Bridget Realmuto LaPerla, head of ESG research, and Travis Whitmore, part of the securities finance research team at State Street Associates, highlight the decision of Japan’s Government Pension Investment Fund (GPIF) to partially suspend its lending programme in 2019 suggests that “as the number of asset owners with these ESG-related concerns grows the lending supply may further decline”.
The United Nation Principles for Responsible Investment reported a 16 percent increase in the number of asset owner signatories committed to ESG investing, bringing the number of signatories to over 2,300, with more than $86.3 trillion in assets under management.
The example of GPIF and other pension funds that have recently taken a public stance against lending shows that increasing numbers of asset owners that are embracing ESG principles are using the opportunity to re-evaluate their participation in securities lending.
According to the paper, asset owners have three primary concerns when it comes to securities lending co-existing with their new ESG-friendly stance.
First, the loss of voting right during the on-loan period. The paper explains that lenders see this as being “inconsistent with the wishes of asset owners who mandate that their asset managers need to conscientiously exercise voting rights on all their shares”.
Second, there are transparency concerns, around the fact that lenders often do not have visibility on who the end borrower is or for what purpose they are borrowing the assets.
Finally, despite numerous attempts by the likes of the International Securities Lending Association (ISLA) and even the European Securities and Markets Authority to debunk the link between short selling and “short-termism”, the view persists among lenders that increased short selling of short damage its value long term.
The paper presents a wealth of research which systematically debunks each of these issues and ultimately concludes that “short selling is important for efficient capital markets and when viewed holistically, suggests that short selling is not detrimental to long-term value”.
Moreover, it notes that short selling, facilitated by securities lending, improves market efficiency and market liquidity.
The evidence cited includes research papers by the European Systemic Risk Board, the Sustainability Accounting Standards Board, and the Journal of Banking and Finance, among many others.
The global securities lending market has a long history of being oversaturated with a supply of assets available to lend compared to borrow demand, and even the withdrawal of GPIF, ostensibly the world’s biggest pension fund, did little to change that equation.
ISLA’s latest market report put the value of assets available to lend at around €21 trillion as of 2019 year-end. By comparison, total on-loan balances at the same time hovered around €2.3 trillion. The association has been very proactive in countering this trend of securities lending clashing with the rise of ESG. This includes forming a Council for Sustainable Finance that aims to further promote the findings of similar research referenced by State Street.
Despite this mountain of evidence, the recent economic disruption of the COVID-19 pandemic caused several prominent EU markets to impose controversial short selling bans as a way to alleviate downward pressure on markets. This would imply that the work of ISLA and others is far from over.
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