While environmental, social and governance (ESG) practices have been in the background of securities lending for many years, Covid-19 has led many asset owners and managers to incorporate them into the business.
“Two things happened with stock lending. One is ESG-related and the other relates to the benefits that asset owners and managers now attribute to stock lending and stock financing. These are the trends that accelerated the most during Covid, ”said Mark Snowdon, Head of Capital Markets, Asia Pacific at Northern Trust.
In securities lending, an asset owner / institutional investor lends his units to another institutional investor through a securities lending broker, which is usually a custodian, in order to generate additional income from the units. In this scenario, the asset owner wants to get the shares back in case he has to use them for proxy voting.
The most obvious concern for asset owners who want to tie their ESG policies into their stock lending program is that if a stock is loaned, they will lose their voting rights.
“On the surface it may seem inconsistent with ESG principles, but securities lenders have been successfully balancing securities lending returns with good governance demands for many years,” says Snowdon.
The pandemic has highlighted the importance of sustainability in the economy while also pushing investors to get additional returns on their stocks.
The key here is to be able to run the loan program efficiently without foregoing the implementation of ESG guidelines. This depends heavily on good communication between the asset owner and the lender.
“ESG and stock lending can definitely co-exist efficiently and effectively, but it takes care and communication to ensure that these two seemingly diametrical elements of the investment strategy can work together. But as long as the benefits are customer-centric, it can work as a coordinated strategy, ”says Snowdon.
In reality, ensuring that an asset owner who lends their securities can meet their ESG obligations is often an important factor in the relationship between that owner and the stocklending intermediary. The stock lending agent must be able to handle it.
For the ESG and stocklending to work together effectively, the asset owner and the stocklending agent must agree on the following: First, what securities or assets are available for lending; Second, what collateral the asset owner / lender will accept in exchange for lending its securities and how that collateral will affect its ESG policies; and third, asset owners / managers need to make a careful decision-making process regarding their investments and their impact through their ESG policies and stock lending requirements.
“In reality, collateral considerations are more of a terminal risk, as a customer can only be directly exposed to this collateral if the borrower defaults and this collateral cannot be liquidated and has to be transferred to the customer. While the risk of this happening in the broader system is relatively small, it’s still important to address it, ”says Snowdon. “Working with a supportive, customer-centric stocklending agent, the right balance is achievable and results from an agreed approach between the agent and the asset owner.”
A typical stocklending agreement covers items that require voting on securities; what types of voting are important; whether the vote on a percentage of the shares is acceptable or whether a vote must be taken on all the shares; whether all markets are equally important in the vote; and what revenue will investors be willing to give up by recalling credit to ensure voting.
“Sustainability is a core element of ESG investing, and stock lending is important as it brings greater liquidity to capital markets in general and higher returns to lending investors. It is therefore important for all parties to understand how companies can integrate their credit programs and their approach to ESG, ”says Snowdon.