Paul Solway, Director and Communications Officer at the Pan Asia Securities Lending Association (PASLA), explains the pragmatic approach behind the Global Framework for ESG and Securities Lending.
I would be the first to admit that lending and borrowing stocks and bonds can seem somewhat distant from the ideals of the UN Sustainable Development Goals (SDGs). After all, our industry does not allocate or manage capital. Securities lending is a value-added product of portfolio management. It mobilises investors’ assets on a temporary basis to provide liquidity, enables risk management and supports price discovery – as well as generating returns for the lender.
But the reality is that ESG integration for institutional investors cannot be complete without thinking about how these principles can be applied to activities inherently linked to portfolio management. For example, it would not make sense for an investor to observe a certain principle of responsible investing, such as not holding armaments or tobacco stocks, only for the same investor to accept stocks from these sectors as collateral when it lends out securities.
That means there is a link between our market and the SDGs – and that is why the Pan Asia Securities Lending Association and Risk Management Association (RMA) are partnering to launch the first industry initiative to provide practical guidance on how ESG principles can be aligned with securities lending.
The Global Framework for ESG and Securities Lending (GFESL) addresses the six main touchpoints that we have identified between securities finance and ESG. These include exercising voting rights, transparency in the lending chain and lending over dividend record dates. The GFESL provides standardised options, essential background and key considerations for lenders, as well as offering suggestions on best practice for each touchpoint.
Two basic truths
In over a year of research, consultation and discussion, securities lending industry associations have discovered two basic truths about the relationship between ESG principles and our market. First, that ESG and securities lending are complementary, not conflicting. This is not simply wishful thinking on the part of agent lenders and prime brokers: the RMA surveyed 44 institutional investors last November and 95% of them said ESG investing and securities lending can co-exist.
The other basic truth is that this relationship is complex. Institutional investors have different approaches to ESG when it comes to portfolio management, so it should be no surprise that interpretations can vary widely when it comes to securities lending. For example, should an institutional investor recall loaned securities so it can exercise its right to vote in every portfolio company’s annual or extraordinary general meeting, every time? That could disrupt supply in the market and reduce the returns that the institution generates from lending stock, which amounted to US$7.66 billion last year. Should it just recall the stock – or not make new loans – under certain circumstances? If so, which ones?
It would be counterproductive to adopt a rigid approach to nuanced questions like these. One size would not fit all. But we do think it is vital that institutions engaged in lending securities have a common decision-making framework that helps them apply their organisational ESG policies to this activity. Without such a framework, the evidence suggests that many of these institutions are simply not clear about how to proceed: the RMA survey found that only 18% of respondents always apply ESG principles to their securities lending programmes.
Practical, pragmatic goals
This first edition of the GFESL has pragmatic, practical goals. It offers technical guidance to institutional investors in particular – lenders or beneficial owners within securities finance – on how to make a start with integrating ESG factors into securities lending programmes.
Returning to the voting rights example, the GFESL is not prescriptive. It provides a choice of three standardised options for lenders, ranging from the most laissez-faire (never recall loaned securities or restrict lending ahead of investee companies’ elective events) to the most interventionist (always recall and restrict) with a middle ground in between (adopt a targeted recall or restriction policy that balances ESG objectives against lending opportunity costs).
Above all, the GFESL encourages the institutional investor or lender to take responsibility for this decision and to adopt a clear approach. For example, it suggests they assess or develop a recall policy based on ESG considerations in their proxy voting framework – and that they identify the types of resolutions on which they want to vote, by company and by issue. These requirements can then be factored into their lending commercial terms and conditions.
We are confident that a framework of this nature will be welcomed by institutional investors. In the fourth quarter of last year, PASLA conducted a consultation across Asia Pacific involving 150 senior industry professionals that included a survey as well as interviews with selected lenders.
It was clear in this process that institutional investors want to take responsibility for managing ESG factors as they lend out their securities – and the insights provided helped us to develop the GFESL. Survey respondents said that exercising an investor’s right to vote in AGMs and EGMs was the most important ESG factor that related to securities lending, followed by the need to better understand the parties involved in borrowing their securities.
Eighty-five per cent of asset owners and managers surveyed also said some controls should be in place to ensure the compatibility of ESG principles with securities lending, with the greatest number of respondents saying that ESG best practice would require thought around lending securities in which the beneficial owner has a significant market shareholding.
With this feedback in mind, the GFESL provides guidance on transparency in the lending chain, collateral and cash reinvestment, lending over dividend record dates, rehypothecation and facilitating participation in the short side of the market – as well as exercising voting rights. You can read it here.
We are proud to have made a start in this process, but believe that the GFESL must be refined in future so that it reflects evolving views about best practices and takes into account new research and insights. These efforts matter: there is a link between securities lending and the SDGs and – as an industry – we are determined that we should contribute towards a more sustainable financial system.