Agent Lenders Must Compete on ESG Integration

Risk Management Association outlines best practices for matching sustainable investment principles with securities lending processes.

Rather than being rated on ‘ESG-compliance’, securities lending programmes should be evaluated based on how well they support asset owners’ sustainable investment objectives, according to the Risk Management Association (RMA). This emerging market reality will provide an opportunity for agent lenders to distinguish their offerings from those of their peers, but also presents a risk for those who do not adapt, the Association warned, in its new guide to best practice.

“Sustainable investing is increasingly influencing how asset owners and managers are making investment-related decisions, and it is important to align on how to integrate ESG data into lending programmes,” said Nick Delikaris, Co-Chair of the RMA’s Financial Technology and Automation Committee.

The Committee commissioned State Street Associates to examine best practices in the evolving ESG and securities lending landscape. The research has been published in a white paper, ‘Integrating ESG Considerations into Securities Lending’, which provides an overview of data sources and methodologies available to asset owners. While the ESG data landscape has been difficult to understand, said Delikaris, “taking a data-centric approach is the only way to implement a customised ESG-framework in a securities lending programme”.

Securities lending, whereby an asset owner loans stock or other assets to another investor or firm and the borrower in return posts collateral, generated more than US$7.5 billion in revenue in 2020, said the white paper. The practice “serves as a useful collateral management solution for asset managers”, and is also a “critical component of market efficiency, providing liquidity and promoting price discovery”. For these reasons, the authors regard it as crucial that securities lending aligns with the increased importance placed by investors on ESG factors.

The transfer of shareholder rights and the type of collateral used in a securities lending transaction are two areas that have challenged ESG integration efforts.

Best practices outlined

The white paper highlights a number of best practices, including the facilitation of shareholder activism in a securities lending programme. Agent lenders must be able to facilitate security-level recalls for asset owners to vote for sustainable changes that align with their ESG objectives. There is, however, minimal regulatory guidance around what asset owners should best consider as a proper threshold to balance revenue versus proxy vote materiality. As a result, asset owners may have differing views on when to recall for a proxy vote.

The complexity associated with voting is related to another best practice cited in the report: agent lenders helping asset owners to balance trade-offs between the materiality of proxy votes and the revenue they earn from lending stock. Because sustainability objectives differ across asset owners, the proxy votes that each owner considers material will also differ.

Lending programmes that work towards sustainable best practices can attract clients, concluded the white paper, while the programmes that are late in adopting them may risk “harming partnerships”.

Best practice guidance has also been highlighted in the recent launch of a framework for institutional investors to align their securities lending activities with their ESG policies and principles. The Global Framework for ESG and Securities Lending has been designed by the RMA and the Pan Asia Securities Lending Association to address a growing need among asset managers and owners for securities lending activities do not compromise their ability to use their proxy votes at investee companies AGMs.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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