Securities lending and stewardship: promoting effective shareholder engagement
07 December 2021
Active ownership implies a two-way dialogue between investors and corporate issuers — not simply micro-managing, but enabling effective shareholder communication and influence over corporate policy. Bob Currie reviews the implications for securities lenders
Image: stock.adobe.com/alphaspirit
Institutional investors have ratched up their focus on investment stewardship, ensuring that they have appropriate governance structures, along with the necessary data and tools, to ensure they act in stakeholders’ best interests in creating sustainable value.
The United Nations Principles for Responsible Investment (PRI) describe stewardship as a process where investors use their influence over current or potential investees and issuers, policy makers and service providers, often collaboratively, to maximise overall long-term value.
The PRI, established initially in 2005 under the office of former UN secretary general Kofi Annan, identify a range of financial, regulatory and sustainability motivations for asset owners and investment managers to undertake effective stewardship.
This includes regulatory incentives, such as those established under the EU Shareholder Rights Directive (particularly SRD II) which requires asset owners and asset managers to publish an engagement policy and to disclose annually how the key elements of their investment strategy contribute to the medium-to-long term performance of their assets. Among other provisions, SRD II gives companies the right to identify their shareholders and requires proxy advisers to disclose information illustrating how their voting recommendations are reliable and accurate.
Some jurisdictions, including the UK, have published stewardship codes providing guidance to asset owners regarding how they should fulfil their responsibilities as investors and shareholders. The UK Stewardship Code defines stewardship as the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society (p 4).
More broadly, pressure from pension and insurance scheme members, policy makers and wider public action (for example environmental campaigns, lobbying of companies, product blacklisting) has motivated institutional investors to reflect more deeply on stewardship as part of their fiduciary obligations to scheme members or ultimate beneficiaries.
David Crum, managing director and head of asset owner solutions at Minerva Analytics, notes that responsible investment (RI) considerations have been rising up the priority list for asset owners. As they apply RI and sustainability criteria to asset allocation and to provider selection, they are also turning their attention to their securities lending and other post-trade activities to ensure these are consistent with the standards they apply across the investment process.
For some pension funds, notes Crum, securities lending is seen as a marginal activity. Although this may provide a valuable source of revenue, these institutional investors do not view this as a core function and do not believe this should get in the way of their long-term stewardship responsibilities. This situation was illustrated in December 2019, for example, when Japan’s £300 billion Government Pension Investment Fund announced a widely-publicised termination of its securities lending activities, believing this to be inconsistent with the stewardship responsibilities of a long-term investor.
The recently formed Global Alliance of Securities Lending Associations has released a Best Practice Voting Guide as its first publication. As a general principle, this document advocates that a lender’s ability to fulfil their stewardship responsibilities over their underlying investments should not be impeded by their participation in securities lending (p 3).
More broadly, this global alliance promotes industry standard legal documentation, including the Global Master Securities Lending Agreement, which incorporates safeguards to ensure securities lending can be conducted as a complementary activity to a lender’s responsible investment strategies. This includes a commitment from borrowers that they do not enter into loan transactions for the primary purpose of exercising voting rights for those securities. This also protects a lender’s right to terminate a loan, providing that the lender provides adequate notice.
Some jurisdictions also operate regulations which define the conditions under which firms may engage in securities lending transactions. In North America, for example, Regulation T — which guides the conditions under which a US broker dealer may engage in a lending transaction — contains a “purpose test” limiting borrowing or lending of securities to situations involving short sales or fails coverage. Borrowing to vote a proxy is not a permitted purpose under Regulation T (GASLA, op.cit., p 4).
In this respect, GASLA encourages lenders to align with UN PRI principles, including guidance on when shares on loan should be recalled for voting purposes. In doing so, lenders should assess the materiality of the vote against the impact that recalling the securities will have on projected lending revenue. On balance, the UN PRI recommends that: ‘Recalling all shares is usually a rare approach, as this could cause clients or beneficiaries to incur financial losses greater than the negative impacts of not exercising voting rights — for example, when there are no controversial items on the agenda (UN PRI, Practical Guide to Active Ownership in Listed Equity, 2018, p 28).
Matthew Chessum, investment director for securities lending, collateral management and money markets at abrdn, observes that securities lending activities have become more prominent in the fund manager appointment process. Asset management firms are now receiving more detailed evaluation in the request-for-proposal (RFP) questionnaire asking about collateral requirements, about procedures for recalling stock, in some cases about the percentages of stock from a fund portfolio that has been recalled for voting purposes. Institutional investors (and their consultants) are also requesting additional information on an asset manager’s internal risk controls, how it applies technology and the tools that it uses for analysing and reporting performance.
The key, notes Chessum, is to ensure that the stewardship, governance and sustainability principles established for the fund are applied across all parts of the investment process, from investment decision-making through to trading and post-trade functions. This requires that all securities lending and collateral management activities must align with the standards established at fund level — whether this relates to voting and recalling stock, the application of ESG screening to received collateral, or ensuring that the securities lending strategy aligns with the risk parameters agreed by the fund board on behalf of investors.
Oversight is a key part in meeting these fiduciary responsibilities. “This requires that lending performance is effectively benchmarked and aligns with our specified risk budget and return targets,” says Chessum. This also, among other responsibilities, involves oversight of agent lenders and all other outsourced services. “With this in mind, we must be holding agent lenders and other service partners to account, ensuring that we are asking the right questions and that we draw an appropriate level of detail and transparency from our periodic performance reviews,” he says.
In line with this principle, GASLA advises that asset owners should engage with their lending agent(s) — if they use one — to establish an effective and efficient operational structure that aligns with their governance and responsible investment policies (p 3).
The key takeaway for asset owners, notes Minerva’s David Crum, is to understand what is going on within their lending programme and how they are exposed to lending activity — whether in their own lending programme, or via a pooled structure if they invest via exchange-traded funds (ETFs) and collective investments. This information is not always easy to access and for pooled funds this may require looking deep into the fund documentation.
Crum indicates that it is also advisable for asset owners to clarify, and to specify clearly in their shareholder engagement principles, what their position is on short selling. “I have engaged with trustees that say they are opposed in principle to short selling, but they have given little consideration to whether they are inadvertently supporting this activity by lending assets from the pension scheme,” he comments.
Stephen Merry, head of advisory and analytics at Thomas Murray, notes that while the supplier selection conversation with institutional clients has historically centred heavily around opportunities for generating lending revenue, asset owners increasingly recognise the importance of drilling down deeply into the risks — credit risk, collateral risk, operational risk — associated with lending activities. This, he says, is fundamental to Thomas Murray’s approach as a provider of supplier and infrastructure risk analysis in capital markets.
While most lenders receive indemnification from their lending agent, for example, in practice the language employed in the indemnification agreement and the coverage this provides can vary dramatically from one agent lender to another. It is essential to evaluate this indemnification in detail, understanding clearly how it operates and the strength of the lending agents’ risk management framework beyond the indemnification.
To provide independent verification of data provided via RFP responses, Thomas Murray has been working closely with a securities lending specialist [which it chooses not to name at this time], particularly to validate revenue estimates and to assess how this will vary with changes in lending strategy, the composition of the inventory of lendable assets, and the lender’s tolerance for risk.
In profile
For Minerva’s David Crum, voting is coming back into profile as a mechanism through which institutional investors can influence company policy regarding environmental, social and governance issues. Investors recognise this as a way of getting things done. To fulfil their policy on diversity and inclusion or on climate change, for example, their foremost step may be to research publicly-listed companies in their investment portfolio and look to define management policy through shareholder engagement. This, he says, all comes back to good stewardship.
Some local government pension funds have been doing this for several decades — either directly reading company accounts and annual reports and formulating their voting policy on the basis of whether management directives warrant support at an AGM or EGM, or using the services of a proxy voting research company to help with the heavy lifting of the analysis of resolutions. However, the practice is now becoming more universal, with more pension funds thinking about having their own bespoke voting policies to implement their ESG or RI policies or beliefs.
Fund managers are also recognising the importance of applying sound governance and stewardship principles across actively managed and passive strategies.
Frankfurt-headquartered international asset manager DWS explains that, for its active portfolios, it meets regularly with the management of portfolio companies and discusses ESG and associated topics, especially in cases of green or sustainable bonds. Its focus on active ownership also extends to its passive investments where, according to DWS, “it is even more important to engage in terms of governance and encourage positive change through voting.” Without the possibility to make active investment decisions, it says, “we are effectively ‘permanently’ invested and thus, have a fiduciary duty to foster changes designed to increase shareholder value in the longer-term.”
DWS uses the services of two proxy advisory service providers: Institutional Shareholder Services Europe and IVOX Glass Lewis. “Both service providers analyse general meetings and their agendas based on our proprietary voting policy and provide us with voting recommendations and their rationale,” says a DWS spokesperson. The voting follows a four-eye principle approach, whereby investment professionals and members of the DWS Corporate Governance Center put forward voting proposals and the members of the Corporate Governance Center [on behalf of DWS Investment GmbH] provide the final approval for the votes to be instructed.
Minerva has worked with clients over a number of years in developing bespoke voting policies. It has also developed a sustainable securities lending solution. In providing this service, Minerva takes in data feeds from the custodian, typically on a daily basis, detailing client assets that are out on loan. It then screens these against the issuer ratings maintained in its research database. Investor clients have flexibility to set bespoke trigger levels which flag up contentious issues that may require a loan recall. This information, including the ability to instruct a share recall, is available to asset owners via the client portal — and this screening process can be applied to the received collateral, as well as invested assets that they hold in portfolio.
“In developing our stewardship services, we continue to push for greater transparency across the chain of shareholder communication, from issuer to investor, to ensure that all votes cast are truly counted — and that when stock is recalled, it is returned in time for it to be voted as intended,” says Crum. Although this was a priority in the second Shareholder Rights Directive, it is unclear whether this has delivered the intended advances in shareholder communication and voting efficiency. “We continue to press for custodians to share information so we can benchmark performance in this area,” adds Crum.
Voting policy is commonly at the forefront of discussions between asset owner and agent lender, notes Thomas Murray chief executive Ross Whitehill. Typically, the lending agent will wish to know at an early stage what the investor’s policy will be with regard to shareholder communication. Does it intend to vote all eligible stock? To vote certain types of stock? What will its requirement be in terms of share recalls?
This discussion is important, Whitehill notes, in defining the terms of the lending relationship and the list of eligible counterparties. “If the lender expects to recall stock regularly, this is likely to be reflected in the lending fee. This is also relevant as asset owners apply ESG screening to collateral that they will accept. If the collateral receiver applies highly-restrictive collateral eligibility criteria — whether based on credit quality or ESG criteria — this is also likely to be reflected in the lending fee.”
With this in mind, there are some within the industry that believe that sector-based exclusions are simply unsustainable, providing a blunt instrument for screening eligible collateral that will ultimately result in collateral shortages (at least for certain collateral types) and a rise in the cost of collateralisation.
To this point, DWS says it has deliberately decided against implementing top-down sector-based exclusions and has introduced enhanced level due diligence when there is evidence that issuers face excessive climate and transition risks or severe and confirmed violations of international norms (DWS, Active Ownership: Engagement and Proxy-voting Report, 2021, p 16).
Data and performance metrics
In helping asset owners to fulfil these commitments, Thomas Murray’s Merry identifies high-levels of investment by leading custodian-lenders and triparty agents in their securities lending and collateral optimisation platforms. These are now offering a wide range of performance and risk metrics associated with the lending programme and the ability to align a lending programme with a lender’s individual ESG parameters objectives is paramount.
SFT asked abrdn’s Matthew Chessum whether his securities lending, collateral management and money markets team is making use of a wider range of data vendors and metrics to help them meet their stewardship responsibilities.
“This is certainly the case at fund level,” he replied. “As an investment manager, we employ feeds from a range of data vendors to help us to analyse an issuer’s carbon footprint, for example.” Beyond this, abrdn has not recently extended its use of data vendors and ESG metrics specifically to support its securities lending activity. “In accordance with my earlier point, the key is to ensure we are aligned with the standards applied at fund and company level. This must be consistent across the organisation.”
“In evaluating our fiduciary standards, the overarching question is typically “What does the investor expect when they invest in an abrdn fund? And, would they invest after completing thorough due diligence on the company and its fund products?”, adds Chessum.
Pooled funds service
In February, the fund manager DWS, in partnership with the Asset Management Exchange (AMX), Minerva Analytics and Northern Trust, released an investment solution that enables pension schemes to express their stewardship preferences through voting in pooled funds.
This service aggregates investor preferences and seeks to execute votes in alignment with the distribution of preferences across the fund’s unit (or share) holders. Where aggregate investor preferences conflict within a pooled fund, voting instructions can be split accordingly.
Commenting on this service, the service partners note in a joint statement that institutional investors in pooled funds have historically relied on the investment manager to execute a voting policy for the pooled fund. However, when investor preferences have diverged from the manager’s policy, they have been forced to accept the votes placed by the manager.
Shalin Bhagwan, DWS head of Pensions Advisory and EMEA Consultants, says: “We identified a need to advance stewardship practices in the context of pooled funds to align more closely with investor responsibility and preferences with proxy voting. This move to democratise the process fits with a changing political and social context that increasingly views responsible stewardship as an important part of asset ownership.”
Bhagwan describes how DWS worked closely with its development partners to put in place a solution whereby each partner could leverage their areas of expertise. “For DWS, that means our decades-long experience of efficient index tracking and portfolio management,” he says. “This year we have focused on rolling out the concept and educating the market on why this is needed. We hope to be launching the first fund early next year.”
Minerva founder and chief executive Sarah Wilson notes that pooled funds index strategies are a highly cost-effective proposition for long-term investors. “For too long, however, that has meant compromising on stewardship and voting issues,” she says. “We have always believed that the application of smart technology can offer investors the best of both worlds: cost effective asset management with active ownership.”
“Previously, there has been little to stop collective investment fund managers splitting their votes in this way,” adds Minerva’s David Crum. “It is disappointing that it has taken until this year to develop a workable solution and to see fund managers’ voting shares held in pooled funds in accordance with the stewardship preferences of their investors.”
Since DWS has adopted this strategy, BlackRock has also declared a commitment to making voting choice options available to institutional clients invested in index strategies through segregated accounts or certain pooled funds. This will apply for approximately 40 per cent of the US$4.8 trillion index equity assets that BlackRock manages on behalf of clients in the US and UK.
Beginning in 2022, BlackRock says that it is taking the first in a series of steps to expand the opportunity for clients to participate in proxy voting decisions where legally and operationally viable. To do this, BlackRock has been developing new technology and working with industry partners over the past few years to enable a significant expansion in proxy voting choices for more clients.
Notwithstanding, BlackRock notes that in certain markets proxy voting involves logistical issues which can affect its ability to vote proxies and the desirability of doing so.
Consequently, BlackRock votes proxies on a “best-efforts” basis. In some circumstances, BlackRock Investment Stewardship may determine that it is in the best interests of BlackRock’s clients not to vote proxies if the costs (including, but not limited to, opportunity costs associated with share-blocking constraints) associated with exercising a vote are expected to outweigh the benefit the client would derive by voting on the proposal (BlackRock Investment Stewardship: Global Principals, effective Jan 2021, p 12).
“Much like asset allocation and portfolio construction, where some clients take an active role while others outsource these decisions to us, more of our clients are interested in having a say in how their index holdings are voted,” says a BlackRock spokesperson.
The United Nations Principles for Responsible Investment (PRI) describe stewardship as a process where investors use their influence over current or potential investees and issuers, policy makers and service providers, often collaboratively, to maximise overall long-term value.
The PRI, established initially in 2005 under the office of former UN secretary general Kofi Annan, identify a range of financial, regulatory and sustainability motivations for asset owners and investment managers to undertake effective stewardship.
This includes regulatory incentives, such as those established under the EU Shareholder Rights Directive (particularly SRD II) which requires asset owners and asset managers to publish an engagement policy and to disclose annually how the key elements of their investment strategy contribute to the medium-to-long term performance of their assets. Among other provisions, SRD II gives companies the right to identify their shareholders and requires proxy advisers to disclose information illustrating how their voting recommendations are reliable and accurate.
Some jurisdictions, including the UK, have published stewardship codes providing guidance to asset owners regarding how they should fulfil their responsibilities as investors and shareholders. The UK Stewardship Code defines stewardship as the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society (p 4).
More broadly, pressure from pension and insurance scheme members, policy makers and wider public action (for example environmental campaigns, lobbying of companies, product blacklisting) has motivated institutional investors to reflect more deeply on stewardship as part of their fiduciary obligations to scheme members or ultimate beneficiaries.
David Crum, managing director and head of asset owner solutions at Minerva Analytics, notes that responsible investment (RI) considerations have been rising up the priority list for asset owners. As they apply RI and sustainability criteria to asset allocation and to provider selection, they are also turning their attention to their securities lending and other post-trade activities to ensure these are consistent with the standards they apply across the investment process.
For some pension funds, notes Crum, securities lending is seen as a marginal activity. Although this may provide a valuable source of revenue, these institutional investors do not view this as a core function and do not believe this should get in the way of their long-term stewardship responsibilities. This situation was illustrated in December 2019, for example, when Japan’s £300 billion Government Pension Investment Fund announced a widely-publicised termination of its securities lending activities, believing this to be inconsistent with the stewardship responsibilities of a long-term investor.
The recently formed Global Alliance of Securities Lending Associations has released a Best Practice Voting Guide as its first publication. As a general principle, this document advocates that a lender’s ability to fulfil their stewardship responsibilities over their underlying investments should not be impeded by their participation in securities lending (p 3).
More broadly, this global alliance promotes industry standard legal documentation, including the Global Master Securities Lending Agreement, which incorporates safeguards to ensure securities lending can be conducted as a complementary activity to a lender’s responsible investment strategies. This includes a commitment from borrowers that they do not enter into loan transactions for the primary purpose of exercising voting rights for those securities. This also protects a lender’s right to terminate a loan, providing that the lender provides adequate notice.
Some jurisdictions also operate regulations which define the conditions under which firms may engage in securities lending transactions. In North America, for example, Regulation T — which guides the conditions under which a US broker dealer may engage in a lending transaction — contains a “purpose test” limiting borrowing or lending of securities to situations involving short sales or fails coverage. Borrowing to vote a proxy is not a permitted purpose under Regulation T (GASLA, op.cit., p 4).
In this respect, GASLA encourages lenders to align with UN PRI principles, including guidance on when shares on loan should be recalled for voting purposes. In doing so, lenders should assess the materiality of the vote against the impact that recalling the securities will have on projected lending revenue. On balance, the UN PRI recommends that: ‘Recalling all shares is usually a rare approach, as this could cause clients or beneficiaries to incur financial losses greater than the negative impacts of not exercising voting rights — for example, when there are no controversial items on the agenda (UN PRI, Practical Guide to Active Ownership in Listed Equity, 2018, p 28).
Matthew Chessum, investment director for securities lending, collateral management and money markets at abrdn, observes that securities lending activities have become more prominent in the fund manager appointment process. Asset management firms are now receiving more detailed evaluation in the request-for-proposal (RFP) questionnaire asking about collateral requirements, about procedures for recalling stock, in some cases about the percentages of stock from a fund portfolio that has been recalled for voting purposes. Institutional investors (and their consultants) are also requesting additional information on an asset manager’s internal risk controls, how it applies technology and the tools that it uses for analysing and reporting performance.
The key, notes Chessum, is to ensure that the stewardship, governance and sustainability principles established for the fund are applied across all parts of the investment process, from investment decision-making through to trading and post-trade functions. This requires that all securities lending and collateral management activities must align with the standards established at fund level — whether this relates to voting and recalling stock, the application of ESG screening to received collateral, or ensuring that the securities lending strategy aligns with the risk parameters agreed by the fund board on behalf of investors.
Oversight is a key part in meeting these fiduciary responsibilities. “This requires that lending performance is effectively benchmarked and aligns with our specified risk budget and return targets,” says Chessum. This also, among other responsibilities, involves oversight of agent lenders and all other outsourced services. “With this in mind, we must be holding agent lenders and other service partners to account, ensuring that we are asking the right questions and that we draw an appropriate level of detail and transparency from our periodic performance reviews,” he says.
In line with this principle, GASLA advises that asset owners should engage with their lending agent(s) — if they use one — to establish an effective and efficient operational structure that aligns with their governance and responsible investment policies (p 3).
The key takeaway for asset owners, notes Minerva’s David Crum, is to understand what is going on within their lending programme and how they are exposed to lending activity — whether in their own lending programme, or via a pooled structure if they invest via exchange-traded funds (ETFs) and collective investments. This information is not always easy to access and for pooled funds this may require looking deep into the fund documentation.
Crum indicates that it is also advisable for asset owners to clarify, and to specify clearly in their shareholder engagement principles, what their position is on short selling. “I have engaged with trustees that say they are opposed in principle to short selling, but they have given little consideration to whether they are inadvertently supporting this activity by lending assets from the pension scheme,” he comments.
Stephen Merry, head of advisory and analytics at Thomas Murray, notes that while the supplier selection conversation with institutional clients has historically centred heavily around opportunities for generating lending revenue, asset owners increasingly recognise the importance of drilling down deeply into the risks — credit risk, collateral risk, operational risk — associated with lending activities. This, he says, is fundamental to Thomas Murray’s approach as a provider of supplier and infrastructure risk analysis in capital markets.
While most lenders receive indemnification from their lending agent, for example, in practice the language employed in the indemnification agreement and the coverage this provides can vary dramatically from one agent lender to another. It is essential to evaluate this indemnification in detail, understanding clearly how it operates and the strength of the lending agents’ risk management framework beyond the indemnification.
To provide independent verification of data provided via RFP responses, Thomas Murray has been working closely with a securities lending specialist [which it chooses not to name at this time], particularly to validate revenue estimates and to assess how this will vary with changes in lending strategy, the composition of the inventory of lendable assets, and the lender’s tolerance for risk.
In profile
For Minerva’s David Crum, voting is coming back into profile as a mechanism through which institutional investors can influence company policy regarding environmental, social and governance issues. Investors recognise this as a way of getting things done. To fulfil their policy on diversity and inclusion or on climate change, for example, their foremost step may be to research publicly-listed companies in their investment portfolio and look to define management policy through shareholder engagement. This, he says, all comes back to good stewardship.
Some local government pension funds have been doing this for several decades — either directly reading company accounts and annual reports and formulating their voting policy on the basis of whether management directives warrant support at an AGM or EGM, or using the services of a proxy voting research company to help with the heavy lifting of the analysis of resolutions. However, the practice is now becoming more universal, with more pension funds thinking about having their own bespoke voting policies to implement their ESG or RI policies or beliefs.
Fund managers are also recognising the importance of applying sound governance and stewardship principles across actively managed and passive strategies.
Frankfurt-headquartered international asset manager DWS explains that, for its active portfolios, it meets regularly with the management of portfolio companies and discusses ESG and associated topics, especially in cases of green or sustainable bonds. Its focus on active ownership also extends to its passive investments where, according to DWS, “it is even more important to engage in terms of governance and encourage positive change through voting.” Without the possibility to make active investment decisions, it says, “we are effectively ‘permanently’ invested and thus, have a fiduciary duty to foster changes designed to increase shareholder value in the longer-term.”
DWS uses the services of two proxy advisory service providers: Institutional Shareholder Services Europe and IVOX Glass Lewis. “Both service providers analyse general meetings and their agendas based on our proprietary voting policy and provide us with voting recommendations and their rationale,” says a DWS spokesperson. The voting follows a four-eye principle approach, whereby investment professionals and members of the DWS Corporate Governance Center put forward voting proposals and the members of the Corporate Governance Center [on behalf of DWS Investment GmbH] provide the final approval for the votes to be instructed.
Minerva has worked with clients over a number of years in developing bespoke voting policies. It has also developed a sustainable securities lending solution. In providing this service, Minerva takes in data feeds from the custodian, typically on a daily basis, detailing client assets that are out on loan. It then screens these against the issuer ratings maintained in its research database. Investor clients have flexibility to set bespoke trigger levels which flag up contentious issues that may require a loan recall. This information, including the ability to instruct a share recall, is available to asset owners via the client portal — and this screening process can be applied to the received collateral, as well as invested assets that they hold in portfolio.
“In developing our stewardship services, we continue to push for greater transparency across the chain of shareholder communication, from issuer to investor, to ensure that all votes cast are truly counted — and that when stock is recalled, it is returned in time for it to be voted as intended,” says Crum. Although this was a priority in the second Shareholder Rights Directive, it is unclear whether this has delivered the intended advances in shareholder communication and voting efficiency. “We continue to press for custodians to share information so we can benchmark performance in this area,” adds Crum.
Voting policy is commonly at the forefront of discussions between asset owner and agent lender, notes Thomas Murray chief executive Ross Whitehill. Typically, the lending agent will wish to know at an early stage what the investor’s policy will be with regard to shareholder communication. Does it intend to vote all eligible stock? To vote certain types of stock? What will its requirement be in terms of share recalls?
This discussion is important, Whitehill notes, in defining the terms of the lending relationship and the list of eligible counterparties. “If the lender expects to recall stock regularly, this is likely to be reflected in the lending fee. This is also relevant as asset owners apply ESG screening to collateral that they will accept. If the collateral receiver applies highly-restrictive collateral eligibility criteria — whether based on credit quality or ESG criteria — this is also likely to be reflected in the lending fee.”
With this in mind, there are some within the industry that believe that sector-based exclusions are simply unsustainable, providing a blunt instrument for screening eligible collateral that will ultimately result in collateral shortages (at least for certain collateral types) and a rise in the cost of collateralisation.
To this point, DWS says it has deliberately decided against implementing top-down sector-based exclusions and has introduced enhanced level due diligence when there is evidence that issuers face excessive climate and transition risks or severe and confirmed violations of international norms (DWS, Active Ownership: Engagement and Proxy-voting Report, 2021, p 16).
Data and performance metrics
In helping asset owners to fulfil these commitments, Thomas Murray’s Merry identifies high-levels of investment by leading custodian-lenders and triparty agents in their securities lending and collateral optimisation platforms. These are now offering a wide range of performance and risk metrics associated with the lending programme and the ability to align a lending programme with a lender’s individual ESG parameters objectives is paramount.
SFT asked abrdn’s Matthew Chessum whether his securities lending, collateral management and money markets team is making use of a wider range of data vendors and metrics to help them meet their stewardship responsibilities.
“This is certainly the case at fund level,” he replied. “As an investment manager, we employ feeds from a range of data vendors to help us to analyse an issuer’s carbon footprint, for example.” Beyond this, abrdn has not recently extended its use of data vendors and ESG metrics specifically to support its securities lending activity. “In accordance with my earlier point, the key is to ensure we are aligned with the standards applied at fund and company level. This must be consistent across the organisation.”
“In evaluating our fiduciary standards, the overarching question is typically “What does the investor expect when they invest in an abrdn fund? And, would they invest after completing thorough due diligence on the company and its fund products?”, adds Chessum.
Pooled funds service
In February, the fund manager DWS, in partnership with the Asset Management Exchange (AMX), Minerva Analytics and Northern Trust, released an investment solution that enables pension schemes to express their stewardship preferences through voting in pooled funds.
This service aggregates investor preferences and seeks to execute votes in alignment with the distribution of preferences across the fund’s unit (or share) holders. Where aggregate investor preferences conflict within a pooled fund, voting instructions can be split accordingly.
Commenting on this service, the service partners note in a joint statement that institutional investors in pooled funds have historically relied on the investment manager to execute a voting policy for the pooled fund. However, when investor preferences have diverged from the manager’s policy, they have been forced to accept the votes placed by the manager.
Shalin Bhagwan, DWS head of Pensions Advisory and EMEA Consultants, says: “We identified a need to advance stewardship practices in the context of pooled funds to align more closely with investor responsibility and preferences with proxy voting. This move to democratise the process fits with a changing political and social context that increasingly views responsible stewardship as an important part of asset ownership.”
Bhagwan describes how DWS worked closely with its development partners to put in place a solution whereby each partner could leverage their areas of expertise. “For DWS, that means our decades-long experience of efficient index tracking and portfolio management,” he says. “This year we have focused on rolling out the concept and educating the market on why this is needed. We hope to be launching the first fund early next year.”
Minerva founder and chief executive Sarah Wilson notes that pooled funds index strategies are a highly cost-effective proposition for long-term investors. “For too long, however, that has meant compromising on stewardship and voting issues,” she says. “We have always believed that the application of smart technology can offer investors the best of both worlds: cost effective asset management with active ownership.”
“Previously, there has been little to stop collective investment fund managers splitting their votes in this way,” adds Minerva’s David Crum. “It is disappointing that it has taken until this year to develop a workable solution and to see fund managers’ voting shares held in pooled funds in accordance with the stewardship preferences of their investors.”
Since DWS has adopted this strategy, BlackRock has also declared a commitment to making voting choice options available to institutional clients invested in index strategies through segregated accounts or certain pooled funds. This will apply for approximately 40 per cent of the US$4.8 trillion index equity assets that BlackRock manages on behalf of clients in the US and UK.
Beginning in 2022, BlackRock says that it is taking the first in a series of steps to expand the opportunity for clients to participate in proxy voting decisions where legally and operationally viable. To do this, BlackRock has been developing new technology and working with industry partners over the past few years to enable a significant expansion in proxy voting choices for more clients.
Notwithstanding, BlackRock notes that in certain markets proxy voting involves logistical issues which can affect its ability to vote proxies and the desirability of doing so.
Consequently, BlackRock votes proxies on a “best-efforts” basis. In some circumstances, BlackRock Investment Stewardship may determine that it is in the best interests of BlackRock’s clients not to vote proxies if the costs (including, but not limited to, opportunity costs associated with share-blocking constraints) associated with exercising a vote are expected to outweigh the benefit the client would derive by voting on the proposal (BlackRock Investment Stewardship: Global Principals, effective Jan 2021, p 12).
“Much like asset allocation and portfolio construction, where some clients take an active role while others outsource these decisions to us, more of our clients are interested in having a say in how their index holdings are voted,” says a BlackRock spokesperson.
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