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Magazine Issues » December 2020

Securities finance roundtable: Time for the tin hats?

Funds Europe – What are the key issues for the securities lending and financing community in driving ESG integration across the transaction value chain? What obstacles exist to advancing this agenda?

Chessum – The ESG conversation has continued to gather momentum this year and a lot of work is being invested in this area, particularly around diversity and inclusion. This momentum will continue into 2021 and this will be positive for the financial services industry.

Bouthors – ESG issues have been high on our agenda at NN IP for a number of years and these are heavily integrated into our securities lending and financing programmes. This centres on establishing a clear securities lending strategy in consultation with asset owner clients, providing guidance on how ESG screening will apply to loan securities and collateral and how voting requirements will be managed for stock in the lending programme. We also apply screening to the counterparties we do business with. The industry has embraced this challenge and it is rapidly developing its procedures for applying ESG screening. 

We have been able to manage the challenge of voting loan stock effectively with our lending agent. But not all lending agents are the same. We have also spoken to other lending agents that take the view: ‘Voting on loan stock is not our problem. If you want to vote stock in your securities lending programme, find yourself a way of dealing with it.’

Meaden – We have used an ESG filter within our securities lending and financing division for around 18 months, applying this to securities on loan and to the collateral. From a voting perspective, it is important to have regular communication with the ESG team, identifying in advance when meetings are imminent and minimising any complications this may create for stock held in the lending programme. This dialogue can reduce the need for loan recalls around annual and special meetings.

Dyson – There is still work to do in extending flexibility around collateral use that is ESG-compliant. We are liaising with tri-party agents to ensure that there is more product and a wider choice of solutions for the collateral-taker. Applying ESG filters to collateral eligibility cannot simply mean having a long list of exclusions.

Rouigueb – The ESG agenda has important implications for promoting diversity, inclusion and positive environment outcomes, but this is also likely to impact lending revenues. Particularly for equities, it will become more complex to handle loan transactions.

For the investor, one of the top priorities is typically around voting and meeting attendance. As a lending agent, it will be necessary to develop powerful tools to recall stocks across the many different countries in which our clients have lending activity – recognising that jurisdictions apply different rules regarding how stock is voted and how a loan transaction is structured legally. These challenges present a threat to the profitability of equity lending as an asset class.

Moreover, as a service provider, there can be considerable risk associated with managing voting on loan stock. It is only through investing in technology, and having good communication with clients and counterparties, that we can mitigate this risk.

Dyson – ESG is front and centre of the regulatory and policy agenda in Europe. In the UK, this will be prominent as the UK government hosts the COP26 UN Climate Change Summit in Glasgow – and it may potentially be used by UK policymakers to reinforce the appeal of the UK market after Brexit.

We have touched on voting issues. It appears, at times, that the securities industry attracts blame for impairing asset owners’ ability to vote stocks they hold in portfolio. Looking at the percentage of FTSE 100 company stock that was voted at general meetings during 2019, this was little above 70%. Given that the average percentage of FTSE 100 stock on loan is typically 6-7%, it is probably too simplistic to blame ‘lost votes’ just on stock being out on loan.

Inevitably, much attention has been directed to the impact of short-selling bans and whether short selling is compatible with the long-term stewardship obligations that asset managers bear on behalf of their investors. This is a wider debate that is not limited purely to securities lending and financing considerations, but there is a strong case that short selling plays an important role in price discovery and in protecting liquidity within financial markets. Isla’s position is that short selling is compatible with these buy-side stewardship obligations.

Chessum – There has been a commitment to ESG within securities lending for many years. This has come to the forefront in recent times because it is integral to the investment strategy of many investment funds. But it is not a recent development. At ASI, we have procedures in place to ensure we know exactly what and why we are lending, how this will impact liquidity and how this will affect pricing. This is all about good corporate governance and good programme governance. Nothing has changed because ESG has come into the spotlight. We have always lived and breathed these principles.

Meaden – I agree. Within our organisation, this has been a priority for several decades as part of our commitment to delivering high standards of corporate governance.

Dyson – The ESG agenda has reinforced the need for asset owners to engage more fully with their lending programmes and to have a better understanding of this activity. There are certain types of lending construct where this will be harder than others – and when you are a lending agent servicing an investor that employs multiple asset managers, this can be challenging. Clients need to be educated to make informed decisions in this area. This centres on having a well-designed governance structure which can then be applied over your lending programme.

At a time when investors are struggling to generate revenue, securities lending provides an important contribution. Asset managers in some jurisdictions are charging near-zero fees to attract the investor, but then compensating themselves through the revenue they generate through securities lending. This can make fee structures for Ucits look uncompetitive.

Rouigueb – There is a cultural difference in how asset managers approach securities lending. For some European funds, there is a view that if they can generate an income from lending, that is a cherry on top. In other jurisdictions, securities lending revenue is viewed as a fundamental, perhaps indispensable, contributor to a fund’s profitability.

Dyson – This is an important educational issue that needs to be discussed further. In Europe, we are seeing a cultural shift in how retail investors view the investment process. From Isla’s perspective, we view this as an exciting opportunity to help the industry move forwards, to remain competitive globally and to integrate ESG principles more fully into the investment process.

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