Eye of the tiger
28 May 2019
While many investors are incorporating ESG into securities lending programmes, it’s not on everybody’s agenda, so the industry must keep the risks of inaction in sharp focus
Image: Shutterstock
Environmental, social and governance (ESG) has become a hot topic in the financial services industry but ESG investing should not be looked at as the ‘latest trend’ because, according to industry experts, it is here to stay. Currently, the planet’s oceans are being disrupted, the forests are being destroyed, and devastating changes are happening to the climate. We’re also facing a global poaching crisis but WWF found that wild tiger numbers are on the up for the first time in conservation history, and China has committed to banning all trade in ivory. This offers a gleam of hope—we still have time to act.
Christian Nolting, CIO of Deutsche Bank Wealth Management, points out in his ‘CIO Insights Reflections,’ that the risks of inaction are substantial. Inaction has negative consequences for the world we live in and comes with concrete economic and social costs.
Nolting noted: “Environmental negligence can destroy our living space, without attention to social matters we sacrifice human capital and hence productivity, and, finallsy, lack of governance creates wrong incentives. It’s no secret that wrong incentives tend to have a negative impact on the environment, but what all too often goes unnoticed is that they can have a deleterious impact on long-term financial performance as well.”
Andy Dyson, CEO of the International Securities Lending Association, explains that ESG investing refers to a class of investing that is also known as ‘sustainable investing’.
He cited: “This is an umbrella term for investments that seek positive returns and long-term impact on society, environment and the performance of the business. Sustainable finance includes a strong green finance component that aims to support economic growth, whilst reducing pressures on the environment, addressing greenhouse gas emissions, tackling pollution, minimising waste and improving efficiency in the use of natural resources. In light of the growing political and social focus on issues associated with climate change more broadly, investors are increasingly looking to align their investment strategies with these greener credentials.”
A natural step in the securities lending landscape
Recently, NN Investment Partners (NN IP) analysed every aspect of securities lending and ESG, and discovered the areas that overlap. Xavier Bouthors, senior portfolio manager, securities lending, NN IP, explained: “We adapted these areas to be compatible with our ambition to be a leader in responsible investing. We see this as a natural step in the evolution of the securities lending landscape.”
Also from NN IP, Martin Aasly, senior portfolio manager, commented: “The first thing to highlight is that our responsible investing team cannot engage with companies if the voting rights have been passed on to someone else. So, every security needs to be available for voting, which may sound simple and obvious, but it requires a solid process of monitoring record dates and issuing recalls when necessary.”
Bouthors affirmed: “Another area that we see impacted by ESG in recent times is the exclusion of securities that do not fit our ESG requirements for investment. These also need to apply to collateral received under securities lending. These ‘exclusion lists’ were once tricky to incorporate but are now adopted by tri-party collateral agents as part of a push from beneficial owners.”
He continued: “Asset managers have also had to evaluate their approach to the potential issues arising from differences in fiscal status between assets and fund domiciles. Asset managers should conduct their securities lending activity in a way that complies with local tax rules, and seek to avoid entering into securities lending transactions for the purpose of improving their tax position. At NN IP we have measures in place to prevent the facilitation of such trades.”
Aasly added: “Finally, a common perception of securities lending is that it facilitates shorting and that shorting is bad because it undermines the value of long-only portfolios. However, the notion that securities lending is incompatible with ESG because it facilitates short selling is a misconception. We believe in efficient markets in which short selling plays a crucial role. This is well established and documented.”
Dyson highlighted that in keeping with a responsible investing approach, institutions are able to tailor their lending programmes to adhere to specific stewardship codes of conduct, as well as the Shareholders Rights Directive and the Principles for Responsible Investment.
He said: “We are also seeing some institutions screening their counterparties to ensure that they also comply with broad ESG criteria. At a more granular level, individual ESG funds may not be able to lend currently as they are only able to accept collateral which complies with the parameters of the fund. This may not always be readily available.”
“Institutional investors or shareholders, although one step removed from the day to day governance of a company, do have a responsibility to scrutinise the activities of the management of the company around this and other related ESG factors. Exercise of that responsibility can come through ensuring that they vote at important shareholder meetings, etc. In the context of securities lending, it is important that any investor has a clear policy around governance and in particular recalling securities to vote at Annual General Meetings (AGM) and Extraordinary General Meetings.”
Dyson also noted that through the development of best practice and operating protocols, it is possible for an institutional investor to still discharge its governance obligations while capturing securities lending revenues as appropriate.
Easing the path to a solution
Discussing potential cost barriers, Dyson argued that the mobilisation of so-called ESG assets within lending programmes should not necessarily attract additional costs. However, Dyson attained that the absence of any meaningful non-cash collateral, ESG compliant collateral buckets is a clear barrier at the moment.
He added: “While recognising that this is not necessarily a simple fix to a complicated problem, we are keen to explore market-wide solutions around establishing best practice and industry standards which may ease the path to a solution here.”
Ross Bowman, client management, BNP Paribas Securities Services, observed: “Both data and costs of technology were the top two barriers to ESG integration cited under the 2018 BNP Paribas Global ESG survey of 347 respondents from 16 countries within the global investment community.”
“As a result, there is a growing opportunity for global banking groups to provide data and technology solutions to investors that utilise the vast array of available data while leveraging technology platforms to benefit from economies of scale.”
Faryda Lindeman, senior responsible investment specialist, NN IP, stated that ESG integration represents an opportunity to modernise the investment management industry but is a process with hindrances as well as, “a lack of standards for measuring ESG performance; lack of ESG performance data reported by companies; concerns about the underperformance of ESG investments; lack of ESG data from other sources; and costs associated with ESG integration”.
Lindeman remarked: “We contest that there is a lack of ESG data from sources other than the companies. This may have been an issue in the earlier days of responsible investing, but nowadays there is a proliferation of ESG data, both in the ‘traditional’ as well as in the alternative data domain.”
“The challenge is more to focus on those data points that are relevant for the business model and financial value creation. There may be concerns around the cost associated with ESG integration, particularly if investment managers feel they need to have access to a multitude of ESG data providers and the extra people to analyse / interpret that, but NN IP analysis shows that responsible investing does not have to cost returns. It may even improve financial returns.”
Incorporating ESG
Incorporating ESG into securities lending programmes won’t be smooth sailing. Bouthors commented: “There are substantial challenges involved in adapting a securities lending programme to ESG parameters, and it requires both knowledge and expertise in both lending and sustainable finance.”
Aasly explained that NN IP monitors the record dates and annual general meetings so that securities are back well in time to vote. He advised that lenders should seek to automate this as much as possible.
Bouthors stated that a key step in incorporating ESG factors is the protection of voting rights. He explained: “So we maintain the right to recall and restrict our securities at any time to engage in shareholder meetings. This is embedded in the securities lending process where our Responsible Investing team, who oversees governance responsibilities, monitors securities for voting.”
“We then recall the securities and restrict them from lending until voting is concluded. This ensures NN IP can always exercise its voting rights and prevents ‘empty voting’.”
Aasly noted that just as their approach to responsible investing excludes certain types of business activities for investments, the same principles apply to collateral received. He commented: “NN IP applies dynamically adjusted exclusion-lists of both equity and fixed income securities with triparty collateral agents to ensure only eligible securities are used in any trade with NN IP.”
Bowman added: “Ensuring strong programme governance, providing a high degree of flexibility on what securities are accepted as collateral, tailoring cash collateral investments and providing lenders with an ‘ESG related score’ to facilitate the benchmarking of borrowers from a sustainability perspective, are tenets that are fast becoming key focus areas for lenders.”
Increasingly important
While ESG is becoming increasingly important for investors, the demand for further education in this area has heightened. Recently, Chartered Financial Analyst UK launched a new qualification in ESG investing, which will be available to investment professionals later this year. The Certificate will be the first formal qualification on ESG investing available sector-wide investment professionals in the UK.
This increasing interest to engage and educate investment professionals on ESG investing stirs some cause for optimism.
Bowman suggested that institutional investors are making investment decisions based on the long-term sustainability of a company, and not just its financial performance. He added that such decisions, reflect on the values of that investing company.
He added: “Lenders are beginning to reshape their securities lending programmes in line with the ESG tenets they are adopting more broadly across their business and investment practices.”
Meanwhile, highlighting further cause for optimism, at NN IP, Lindeman observed the opportunities of ESG and found a strong link between the longer-term positive impact of ESG integration and improved risk-adjusted returns, in addition to its effects on the well-being of both society and the environment.
She outlined: “Aside from that, we are convinced of the benefits of integrating ESG information into the investment process for our equity, fixed income and multi-asset strategies. ESG is relevant because it relates to both corporate competitiveness and the strategic choices companies make.”
“Focusing on ESG factors enables our analysts to unlock potential value by identifying the associated opportunities and/or risks, which fund managers then use as the basis for their investment decisions. Focusing on ESG also ensures that we live up to our values, and demonstrate good corporate citizenship. It helps us better align our core business with the broader expectations of society.”
Going forward with a sense of optimism, the risks of inaction must be kept in sharp focus. As Sir David Attenborough recently pointed out: “It may sound frightening, but the scientific evidence is that if we have not taken dramatic action within the next decade, we could face irreversible damage to the natural world and the collapse of our societies.”
Christian Nolting, CIO of Deutsche Bank Wealth Management, points out in his ‘CIO Insights Reflections,’ that the risks of inaction are substantial. Inaction has negative consequences for the world we live in and comes with concrete economic and social costs.
Nolting noted: “Environmental negligence can destroy our living space, without attention to social matters we sacrifice human capital and hence productivity, and, finallsy, lack of governance creates wrong incentives. It’s no secret that wrong incentives tend to have a negative impact on the environment, but what all too often goes unnoticed is that they can have a deleterious impact on long-term financial performance as well.”
Andy Dyson, CEO of the International Securities Lending Association, explains that ESG investing refers to a class of investing that is also known as ‘sustainable investing’.
He cited: “This is an umbrella term for investments that seek positive returns and long-term impact on society, environment and the performance of the business. Sustainable finance includes a strong green finance component that aims to support economic growth, whilst reducing pressures on the environment, addressing greenhouse gas emissions, tackling pollution, minimising waste and improving efficiency in the use of natural resources. In light of the growing political and social focus on issues associated with climate change more broadly, investors are increasingly looking to align their investment strategies with these greener credentials.”
A natural step in the securities lending landscape
Recently, NN Investment Partners (NN IP) analysed every aspect of securities lending and ESG, and discovered the areas that overlap. Xavier Bouthors, senior portfolio manager, securities lending, NN IP, explained: “We adapted these areas to be compatible with our ambition to be a leader in responsible investing. We see this as a natural step in the evolution of the securities lending landscape.”
Also from NN IP, Martin Aasly, senior portfolio manager, commented: “The first thing to highlight is that our responsible investing team cannot engage with companies if the voting rights have been passed on to someone else. So, every security needs to be available for voting, which may sound simple and obvious, but it requires a solid process of monitoring record dates and issuing recalls when necessary.”
Bouthors affirmed: “Another area that we see impacted by ESG in recent times is the exclusion of securities that do not fit our ESG requirements for investment. These also need to apply to collateral received under securities lending. These ‘exclusion lists’ were once tricky to incorporate but are now adopted by tri-party collateral agents as part of a push from beneficial owners.”
He continued: “Asset managers have also had to evaluate their approach to the potential issues arising from differences in fiscal status between assets and fund domiciles. Asset managers should conduct their securities lending activity in a way that complies with local tax rules, and seek to avoid entering into securities lending transactions for the purpose of improving their tax position. At NN IP we have measures in place to prevent the facilitation of such trades.”
Aasly added: “Finally, a common perception of securities lending is that it facilitates shorting and that shorting is bad because it undermines the value of long-only portfolios. However, the notion that securities lending is incompatible with ESG because it facilitates short selling is a misconception. We believe in efficient markets in which short selling plays a crucial role. This is well established and documented.”
Dyson highlighted that in keeping with a responsible investing approach, institutions are able to tailor their lending programmes to adhere to specific stewardship codes of conduct, as well as the Shareholders Rights Directive and the Principles for Responsible Investment.
He said: “We are also seeing some institutions screening their counterparties to ensure that they also comply with broad ESG criteria. At a more granular level, individual ESG funds may not be able to lend currently as they are only able to accept collateral which complies with the parameters of the fund. This may not always be readily available.”
“Institutional investors or shareholders, although one step removed from the day to day governance of a company, do have a responsibility to scrutinise the activities of the management of the company around this and other related ESG factors. Exercise of that responsibility can come through ensuring that they vote at important shareholder meetings, etc. In the context of securities lending, it is important that any investor has a clear policy around governance and in particular recalling securities to vote at Annual General Meetings (AGM) and Extraordinary General Meetings.”
Dyson also noted that through the development of best practice and operating protocols, it is possible for an institutional investor to still discharge its governance obligations while capturing securities lending revenues as appropriate.
Easing the path to a solution
Discussing potential cost barriers, Dyson argued that the mobilisation of so-called ESG assets within lending programmes should not necessarily attract additional costs. However, Dyson attained that the absence of any meaningful non-cash collateral, ESG compliant collateral buckets is a clear barrier at the moment.
He added: “While recognising that this is not necessarily a simple fix to a complicated problem, we are keen to explore market-wide solutions around establishing best practice and industry standards which may ease the path to a solution here.”
Ross Bowman, client management, BNP Paribas Securities Services, observed: “Both data and costs of technology were the top two barriers to ESG integration cited under the 2018 BNP Paribas Global ESG survey of 347 respondents from 16 countries within the global investment community.”
“As a result, there is a growing opportunity for global banking groups to provide data and technology solutions to investors that utilise the vast array of available data while leveraging technology platforms to benefit from economies of scale.”
Faryda Lindeman, senior responsible investment specialist, NN IP, stated that ESG integration represents an opportunity to modernise the investment management industry but is a process with hindrances as well as, “a lack of standards for measuring ESG performance; lack of ESG performance data reported by companies; concerns about the underperformance of ESG investments; lack of ESG data from other sources; and costs associated with ESG integration”.
Lindeman remarked: “We contest that there is a lack of ESG data from sources other than the companies. This may have been an issue in the earlier days of responsible investing, but nowadays there is a proliferation of ESG data, both in the ‘traditional’ as well as in the alternative data domain.”
“The challenge is more to focus on those data points that are relevant for the business model and financial value creation. There may be concerns around the cost associated with ESG integration, particularly if investment managers feel they need to have access to a multitude of ESG data providers and the extra people to analyse / interpret that, but NN IP analysis shows that responsible investing does not have to cost returns. It may even improve financial returns.”
Incorporating ESG
Incorporating ESG into securities lending programmes won’t be smooth sailing. Bouthors commented: “There are substantial challenges involved in adapting a securities lending programme to ESG parameters, and it requires both knowledge and expertise in both lending and sustainable finance.”
Aasly explained that NN IP monitors the record dates and annual general meetings so that securities are back well in time to vote. He advised that lenders should seek to automate this as much as possible.
Bouthors stated that a key step in incorporating ESG factors is the protection of voting rights. He explained: “So we maintain the right to recall and restrict our securities at any time to engage in shareholder meetings. This is embedded in the securities lending process where our Responsible Investing team, who oversees governance responsibilities, monitors securities for voting.”
“We then recall the securities and restrict them from lending until voting is concluded. This ensures NN IP can always exercise its voting rights and prevents ‘empty voting’.”
Aasly noted that just as their approach to responsible investing excludes certain types of business activities for investments, the same principles apply to collateral received. He commented: “NN IP applies dynamically adjusted exclusion-lists of both equity and fixed income securities with triparty collateral agents to ensure only eligible securities are used in any trade with NN IP.”
Bowman added: “Ensuring strong programme governance, providing a high degree of flexibility on what securities are accepted as collateral, tailoring cash collateral investments and providing lenders with an ‘ESG related score’ to facilitate the benchmarking of borrowers from a sustainability perspective, are tenets that are fast becoming key focus areas for lenders.”
Increasingly important
While ESG is becoming increasingly important for investors, the demand for further education in this area has heightened. Recently, Chartered Financial Analyst UK launched a new qualification in ESG investing, which will be available to investment professionals later this year. The Certificate will be the first formal qualification on ESG investing available sector-wide investment professionals in the UK.
This increasing interest to engage and educate investment professionals on ESG investing stirs some cause for optimism.
Bowman suggested that institutional investors are making investment decisions based on the long-term sustainability of a company, and not just its financial performance. He added that such decisions, reflect on the values of that investing company.
He added: “Lenders are beginning to reshape their securities lending programmes in line with the ESG tenets they are adopting more broadly across their business and investment practices.”
Meanwhile, highlighting further cause for optimism, at NN IP, Lindeman observed the opportunities of ESG and found a strong link between the longer-term positive impact of ESG integration and improved risk-adjusted returns, in addition to its effects on the well-being of both society and the environment.
She outlined: “Aside from that, we are convinced of the benefits of integrating ESG information into the investment process for our equity, fixed income and multi-asset strategies. ESG is relevant because it relates to both corporate competitiveness and the strategic choices companies make.”
“Focusing on ESG factors enables our analysts to unlock potential value by identifying the associated opportunities and/or risks, which fund managers then use as the basis for their investment decisions. Focusing on ESG also ensures that we live up to our values, and demonstrate good corporate citizenship. It helps us better align our core business with the broader expectations of society.”
Going forward with a sense of optimism, the risks of inaction must be kept in sharp focus. As Sir David Attenborough recently pointed out: “It may sound frightening, but the scientific evidence is that if we have not taken dramatic action within the next decade, we could face irreversible damage to the natural world and the collapse of our societies.”
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