Balancing sustainability with profitability: ESG and Securities Lending

Sunil Daswani Head of Agency Securities Lending at Standard Chartered Bank

Environmental, social and governance (ESG) issues are fast-emerging as important priorities for institutional investors. Research published in November 2020 covering 600 investors in 6 key markets reveals that 87%I already actively invest in companies that have reduced their near-term return on capital (such as reduced dividends, share buybacks etc.) in order to reallocate capital to ESG initiatives.

Ninety-one percent (91%) expect their firms to rank ESG more highly post-COVID, and 88%II believe that the companies in which they invest will do so. While investors’ ESG motivations will vary, 91%III believe that companies with strong ESG performance are more resilient in a crisis. From a securities lending perspective, the increased institutional focus on ESG is an extremely positive development and reflects strongly Standard Chartered’s own values and strategic priorities. The challenge is therefore how to support clients’ specific ESG priorities into our client solutions, whilst also supporting their wider investment objectives.

ESG obstacles in securities lending

Despite the trend towards principle-based investing, there remain some challenges in translating ESG objectives into securities lending. For example, some asset managersIV have claimed that securities lending programmes for exchange-traded funds (ETFs) that track ESG indices are not financially viable, given that restrictive collateral parameters and regular recalls erode the potential revenue from lending. These issues are worth exploring in more detail:

Collateral

It is reasonable that lenders would apply the same ESG criteria to their collateral as they would to stock selection. Where cash or some fixed income securities are posted as collateral, this may not be a significant issue. However, where equities are used for collateral, it has been difficult in the past to assess compliance with a lender’s ESG requirements in a consistent way, or to monitor this over time.

Recalls

Given that an investor cannot participate in shareholder votes (typically via proxy), when they have lent a security, they may decide to recall a security to allow them to do so. This issue resonates specifically for ESG-driven investment, where institutional shareholders may play an important role in defining a company’s ESG strategy. Stock lenders take different approaches to this: some instruct the custodian to remove all securities to enable proxy voting, irrespective of the issues on which voting is taking place. Some do so opportunistically, according to the market or the materiality or topic of the vote, and some remove particular names or maintain “buffers” i.e. hold back a portion of the holding for voting purposes. There are three challenges here, particularly when working with traditional pooled securities lending programmes:

i) Recording and automating compliance with the specific terms of an investor’s ESG strategy without compromising operational efficiency.
ii) Limiting the period for which a stock is removed from a lending programme to minimise the financial impact.
iii) Providing meaningful data to lenders to enable them to make informed decisions on whether the materiality and potential impact of the vote compensates for the loss of income.

Overcoming challenges

To address these issues requires an operationally efficient way to balance ESG compliance and financial performance, and a consistent way of measuring and comparing fund performance at an industry level. By resolving these challenges, bringing together securities lending and ESG becomes more achievable. A variety of ways to overcome these issues are emerging, both at an individual securities lending programme level, and at a wider industry level.

Defining industry wide ESG principles

The draft principles are now in the final stages of consultation, but broadly cover nine key areas: Sustainable finance alignment, Inclusion and diversity, Transparency, Collateral, Short Selling, Tax, Voting, Innovation and digitisation and Feedback. These principles are supported through a programme of events and a mentoring programme to maintain industry engagement, dialogue, and co-operation on an ongoing basis. At Standard Chartered, we are highly supportive of initiatives such as Global PSSL that aim to develop standards that build industry confidence and consensus, build industry confidence and consensus, resolve fragmentation, and improve transparency at an industry level. This industry-wide collaboration will become increasingly important as industry stakeholders develop their ESG policies. For example, clients are starting to ask more questions around climate or employment controversies, which then need to be built into ESG parameters, and reflected in global monitoring standards.