Custodians are playing a greater role in bringing transparency to asset owners around the effectiveness of their sustainable investment strategies.
High-profile investor lawsuits such as the US$3 billion Petrobras corruption class action, have increased the focus of asset owners on corporate governance accountability. For custodians and other asset servicing providers, this has coincided with a broad-based increase in demand for more ESG-related data and analysis from their institutional clients.
Custodians have a significant role to play in facilitating ESG investment strategies and are being asked to do more by their asset owning clients, says Véra Delvoye, Asset Owners Segment Strategy Lead at BNP Paribas Securities Services. “We are expected to bring more transparency on core custody services and tools for effective corporate governance.”
To ensure maximum protection over their holdings, she adds, asset owners want custodians to cover the whole value chain, from investment through to custody.
“Specifically, some asset owners that choose several investment managers will ask us to control and report on every breach an asset manager makes against their investment guidelines.”
In a global ESG survey of asset owners and managers, BNP Paribas identified three particular custodian services that support an ESG strategy: ESG-specific benchmarking; analytics and risk monitoring; and ESG reporting. All three areas are data intensive. Custodians are racing to evolve their ESG reporting capabilities, adding big data analytics, artificial intelligence and machine-learning tools to their reporting solutions, the report noted. By consolidating and benchmarking various data sources, the custodian plays a central role in helping institutional investors to integrate ESG into their investment decision-making process.
Roberto Pecora, chief executive officer of Société Générale Securities Services for Italy, recently wrote that ESG assessments are “at the heart of our clients’ strategic choices”. The role of the securities services provider is to contribute value-added services on reporting, rating, allocation choices, portfolio analysis, touching both pre- and post-trade processes, he added. “Risk and performance analysis are also closely related to sustainability assessments.” The very nature of custody and safe-keeping, he wrote, gives service providers the centrality from which derives the task and opportunity to provide comprehensive support to asset managers and asset owners with a vertical cut across the entire value chain for the integration of ESG assessments.
The data challenge
One of the most significant challenges for asset owners is the sheer volume of ESG data. Almost two years ago, BNY Mellon identified a number of “unmet needs” around ESG data analytics, says Corinne Neale, Global Head of Business Applications, BNY Mellon Data & Analytics Solutions.
Some of these unmet needs – such as clearer definitions around sustainability – are gradually being filled, helping “institutions and asset owners to define their own set of ESG priorities”, says Neale.
Once an asset owner has set its priorities, it needs to track against them, apply those to products and portfolios and determine if they are reflected in their investments. In parallel, it is valuable for the entire community of asset owners to gain an understanding of accepted sustainability investment practices, Neale adds, to gain clarity about peers’ practices and data use.
To help clients meet these needs, the custodian created ESG Data Analytics, a cloud-based, data agnostic application that ‘mass-customises’ investment portfolios to clients’ individual ESG factor preferences. The application’s data governance and peer behaviour feedback loops (which Neale likens to crowd sourcing) help users to select ESG factors to construct custom investment portfolios.
ESG analytics and reporting services are now commonplace among custodians. In July 2020, HSBC launched an ESG reporting service for asset owners and managers. It is designed to provide independent reporting on the ESG profile of asset owners’ investments, enabling them to discuss the ESG aspects of positions in their funds with asset managers. In turn, asset managers with an in-house ESG capability can use the tool to compare with their own research.
In March this year, BNP Paribas Securities Services partnered with Clarity AI, a data science and technology company. Under the partnership, users of the French custodian’s Manaos platform have access to Clarity AI’s sustainability data and insights, which cover more than 30,000 companies, 400 public administrations and 200,000 investment funds.
A month later, Citi announced it had incorporated ESG scores into its securities services data platform Citi Velocity Clarity. The platform enables clients to analyse the sustainability of their holdings at both a portfolio and security level. The update includes new visualisation and algorithmic tools supplied by global data provider Arabesque S-Ray to help analyse multiple sustainability measures on a daily basis.
While there is much talk about the need for standards in terms of ESG data inputs, Neale points out that it is “highly likely” that investors will continue to have their own combination of preferences and priorities. Therefore, the bigger issue is to make the data more comparable. “While for most investors there are certain common priorities such as carbon reduction, the combination of priorities will depend on personal circumstances and what the asset owner organisation stands for. Standards will help but they will never accommodate all of the different flavours of humanity.”
Comprehensive access to ESG data is still a challenge, particularly when trying to cover the entire investment universe of a client, says Delvoye. “Clients tell us they want a solution to get all of their investor portfolio covered with qualitative and consistent ESG data across asset classes. If they have decided to invest in a small or medium-sized company, they often highlight that they do not have enough data from their data vendors which results in in-house ESG risk assessment. It can be a very paper-based process at times.”
The selection of a data vendor will depend on the level of maturity of the asset owner, she adds. “Central banks, for example, are very keen to integrate climate-related risks. They want full transparency on methodologies used and are extremely cautious about how they source data.” In this scenario, publicly available sources of data would be the most appropriate, but such data is scarce.
Delvoye says the European Union’s Sustainable Finance Disclosure Regulation (SFDR) is the first milestone that stipulates indicators and the way they have to be reported. “It is a big step towards enabling asset owners to be clear that they are investing in a sustainable way.”
As they focus increasingly on long-term sustainability issues, asset owners are increasingly fighting against short-termism among their portfolio companies and engaging more with them, with implications for voting practices of owners and managers. “Typically, an asset owner will ask their asset manager to ensure they are able to exercise their votes and these votes are in line with asset owner’s sustainable investment policy,” says Delvoye. As a custodian, BNP Paribas Securities Services provides transparency around all voting. The more sophisticated asset owners will engage with asset managers on specific ESG-related reports and resolutions, and will expect their custodian to consolidate ESG reporting at all levels through the entire investment hierarchy.
ESG-aware securities lending
In line with their increasingly proactive approach to stewardship, asset owners are increasingly adopting securities lending arrangements that allow for a recall of stock in order to vote at AGMs, particularly on ESG topics. In its recently published stewardship statement, the UK’s National Employees Savings Trust (NEST), for example, states: “Before we appoint our equity fund managers, we ask about their policy on stock lending and whether stock is recalled in order to cast votes on those shares. We encourage our fund managers to recall stock where appropriate. Not all of our fund managers carry out stock lending. However, where they do so, it is monitored by NEST to ensure they act within the pre-defined guidelines and risk parameters set out in the contract.”
Asset manager Invesco says responsibility for its voting decisions lies with its portfolio managers and analysts with input and support from its Global ESG team and Proxy Operations functions, incorporating a number of factors and inputs including the unique circumstances affecting companies, public disclosures, regional best practices, third-party research and any dialogue it has had with portfolio companies. Its proprietary proxy voting platform, PROXYintel, facilitates implementation of voting decisions and rationales across global investment teams. “For securities on loan as part of a securities lending program, the relevant portfolio manager will make the determination whether to recall shares so that we will be entitled to vote,” the firm states.
Roy Zimmerhansl, Practice Lead at Pierpoint Alpha Community, a membership organisation for securities finance professionals, says the challenge in voting when it comes to securities lending is that a borrower of a security will not have an economic stake in the company – the investment company should be making any decisions regarding a vote. “However, every owner of assets in a securities lending transaction has the right to ask for their shares back at any time,” he says.
Realistically, he adds, it is reasonable for every investor to weight the value of voting versus the revenue received from lending. What is important is that a clear governance policy is in place as to whether the asset owner will exercise their rights.
ESG factors are also important when it comes to the collateral used in a securities lending transaction, he says. “ESG-aware investors go to the trouble of buying shares that satisfy certain criteria but when they lend those shares out to make extra revenue they don’t necessarily assess the collateral the borrower puts up to ensure it is in alignment with ESG policies.” This is an area of growing importance and one that should be examined, says Zimmerhansl.
A non-profit organisation, the Global Principles for Sustainable Securities Lending (Global PSSL), aims to further the cause of sustainable securities lending. The initiative provides a hub for all key stakeholders to co-create, maintain and progress sustainable securities lending. It is focused on creating a global market standard and to contribute to the broader sustainable finance agenda including sustainable development goals, market liquidity, active ownership and stewardship and the community interest. In March 2021 it launched a voluntary ESG Standard on Short Activism.