ESMA bats away claims of a link between securities lending and ‘short-termism’
18 December 2019 Paris
Image: Shutterstock
The European Securities and Markets Authority (ESMA) has dismissed concerns that securities lending and short selling are linked to anti-ESG practices in a new report.
The EU watchdog has concluded an investigation into “undue short-term pressures in securities markets”, and has now submitted a list of recommendations to the European Commission on next steps.
ESMA’s list includes disclosure of environmental, social and governance (ESG) factors such as amending the Non-Financial Reporting Directive (NFRD) and promoting a single set of international ESG disclosure standards.
The regulator also recommends a review of the white list under the Takeover Bids Directive, among other changes to rules around institutional investor-related activities.
However, despite multiple concerns raised by respondents to its public survey on unstainable trading practices that pointed the finger at securities lending, ESMA specifically stated that it “does not see a solid basis for additional policy recommendations at this stage”.
Moreover, in the Securities and Markets Stakeholders Group, which helps to facilitate consultations between ESMA, its board of supervisors and stakeholders, reinforced this stance.
In the report, the group acknowledged that securities lending, “if done in a controlled way, is an opportunity to add value for fund investors and compatible with long-term investment strategies, and contributes to market liquidity and price discovery”.
It went on to note that transparency is important to allow end investors to understand funds’ securities lending practices and to decide whether they want to invest in a fund that pursues such practices.
What were the complaints?
As part of the study, ESMA invited market participants to submit comments on what they saw as practices they considered to be promoting ‘short-termism’.
The focus on short-termism has grown in tandem with the rise of ESG practices and refers to a disproportionate emphasis on short-term gains over long-term sustainability.
Responses included calls for high-frequency trading to be banned from EU capital markets on the grounds that regulators incur significant costs supervising such activities and it has “no economic value but sends the signal to market participants that short-termism can be a regular source of profit”.
Elsewhere, three issuer associations stressed that the rise of shareholder activism in Europe may to a certain extent go against the promotion of long-term value creation, as such activity may force companies to become overly focused on short-term financial performance.
These respondents argued that activism may result in certain funds which are “driven by short-term profit motivations using speculative methods, including short-selling coupled with massive securities lending and borrowing”.
Finally, the survey garnered a warning from an investor association that securities lending can place “undue short-term pressure” on companies when long-term oriented investors lend securities to short sellers that use the securities for short-term purposes.
This respondent went on to request for strengthened disclosure/governance rules for asset managers towards their end investors regarding lending practices.
“The short-term performance pressures on companies can result in an excessive focus on immediate profit extraction hindering them in meeting sustainability goals,” said ESMA chair Steven Maijoor. “We need to ensure that firms move to a long-term approach towards more sustainable finance while factoring in the risk climate change carries.”
In its more comprehensive response to the survey, ESMA pointed out that “short-selling and securities lending are key for price discovery and market liquidity”.
ESMA added that it is not aware of concrete evidence pointing to a cause-effect connection between these practices and the existence of undue short-term market pressures.
Additionally, the regulator noted, that the Short Selling Regulation foresees the right of national competent authorities and ESMA to adopt emergency measures that may even restrict the capacity of market participants to sell short financial instruments temporarily where a threat to the financial stability or to market confidence may exist.
Comprehensive existing regulatory frameworks around UCITS funds and exchange-traded funds, as well as the Securities Financing Transactions Regulation, due to come into force in April 2020, were highlighted as being sufficient measures to appropriately oversee the market.
ESMA’s public backing of securities financing and short selling comes in the same week that the International Securities Lending Association revealed the formation of a Council for Sustainable Finance.
The council, which will sit for the first time in Q1 next year, aims to further cement the role of ESG in all aspects of the lending market and establish universal standards to ease challenges around different interpretations of what is considered ESG-friendly.
ESMA’s work on undue short-term pressures forms part of its work on sustainable finance and relates to the European Commission’s action plan on financing sustainable growth.
Having received ESMA’s recommendations, the commission which will decide whether to initiate legislative changes to address the report and monitor the effectiveness of certain legislative acts to assess whether there is a need for further action.
The EU watchdog has concluded an investigation into “undue short-term pressures in securities markets”, and has now submitted a list of recommendations to the European Commission on next steps.
ESMA’s list includes disclosure of environmental, social and governance (ESG) factors such as amending the Non-Financial Reporting Directive (NFRD) and promoting a single set of international ESG disclosure standards.
The regulator also recommends a review of the white list under the Takeover Bids Directive, among other changes to rules around institutional investor-related activities.
However, despite multiple concerns raised by respondents to its public survey on unstainable trading practices that pointed the finger at securities lending, ESMA specifically stated that it “does not see a solid basis for additional policy recommendations at this stage”.
Moreover, in the Securities and Markets Stakeholders Group, which helps to facilitate consultations between ESMA, its board of supervisors and stakeholders, reinforced this stance.
In the report, the group acknowledged that securities lending, “if done in a controlled way, is an opportunity to add value for fund investors and compatible with long-term investment strategies, and contributes to market liquidity and price discovery”.
It went on to note that transparency is important to allow end investors to understand funds’ securities lending practices and to decide whether they want to invest in a fund that pursues such practices.
What were the complaints?
As part of the study, ESMA invited market participants to submit comments on what they saw as practices they considered to be promoting ‘short-termism’.
The focus on short-termism has grown in tandem with the rise of ESG practices and refers to a disproportionate emphasis on short-term gains over long-term sustainability.
Responses included calls for high-frequency trading to be banned from EU capital markets on the grounds that regulators incur significant costs supervising such activities and it has “no economic value but sends the signal to market participants that short-termism can be a regular source of profit”.
Elsewhere, three issuer associations stressed that the rise of shareholder activism in Europe may to a certain extent go against the promotion of long-term value creation, as such activity may force companies to become overly focused on short-term financial performance.
These respondents argued that activism may result in certain funds which are “driven by short-term profit motivations using speculative methods, including short-selling coupled with massive securities lending and borrowing”.
Finally, the survey garnered a warning from an investor association that securities lending can place “undue short-term pressure” on companies when long-term oriented investors lend securities to short sellers that use the securities for short-term purposes.
This respondent went on to request for strengthened disclosure/governance rules for asset managers towards their end investors regarding lending practices.
“The short-term performance pressures on companies can result in an excessive focus on immediate profit extraction hindering them in meeting sustainability goals,” said ESMA chair Steven Maijoor. “We need to ensure that firms move to a long-term approach towards more sustainable finance while factoring in the risk climate change carries.”
In its more comprehensive response to the survey, ESMA pointed out that “short-selling and securities lending are key for price discovery and market liquidity”.
ESMA added that it is not aware of concrete evidence pointing to a cause-effect connection between these practices and the existence of undue short-term market pressures.
Additionally, the regulator noted, that the Short Selling Regulation foresees the right of national competent authorities and ESMA to adopt emergency measures that may even restrict the capacity of market participants to sell short financial instruments temporarily where a threat to the financial stability or to market confidence may exist.
Comprehensive existing regulatory frameworks around UCITS funds and exchange-traded funds, as well as the Securities Financing Transactions Regulation, due to come into force in April 2020, were highlighted as being sufficient measures to appropriately oversee the market.
ESMA’s public backing of securities financing and short selling comes in the same week that the International Securities Lending Association revealed the formation of a Council for Sustainable Finance.
The council, which will sit for the first time in Q1 next year, aims to further cement the role of ESG in all aspects of the lending market and establish universal standards to ease challenges around different interpretations of what is considered ESG-friendly.
ESMA’s work on undue short-term pressures forms part of its work on sustainable finance and relates to the European Commission’s action plan on financing sustainable growth.
Having received ESMA’s recommendations, the commission which will decide whether to initiate legislative changes to address the report and monitor the effectiveness of certain legislative acts to assess whether there is a need for further action.
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