Don D'Eramo, global head of securities finance, RBC Investor & Treasury Services looks at how lenders seek to strike the right balance between ESG principles and revenue optimisation
The integration of environmental, social and governance (ESG) factors is an increasingly important part of investment strategies. Investors seek to exercise governance responsibilities by screening companies considered to be more responsible in their corporate behaviour, or focusing on those where voting rights can be used to exert influence.
ESG performance is also a growing consideration among beneficial owners as they endeavour to implement and adhere to guiding principles in harmony with the nuances of securities lending. This can also play into the timing and recall of loans. For example, when a security is out on loan, beneficial owners are required to close positions on loan in order to facilitate proxy voting as this entitlement transfers to the borrower.
The issue was recently brought to the forefront when Japan’s Government Pension Investment Fund (GPIF), which aims to be a market leader in ESG financing, paused its equity securities lending programme late in 2019, noting that it “can be considered to be inconsistent with the fulfilment of the stewardship responsibilities of a long-term investor”.
The International Securities Lending Association (ISLA) is also focused on ESG, including challenges around beneficial owners’ collateral as well as the industry’s association with short selling. In a recent blog post, ISLA’s CEO Andrew Dyson said the introduction of ESG principles into the securities finance market has created “an interesting natural tension” between the traditional rules-based approach and values or principles-driven strategies of sustainable finance.
“Reconciling these quite different worlds will present both organizational and cultural challenges across our markets and beyond,” he wrote.
Fulfilling good governance
Regardless of the reasons GPIF had for stopping its securities lending programme, which went beyond proxy voting, lenders can still find ways to maintain their vote, says Donato D’Eramo, and managing director and global head of securities finance at RBC Investor & Treasury Services (RBC I&TS), and president of the Canadian Securities Lending Association.
“Securities lending can definitely co-exist with ESG governance given that one of the key tenets of securities lending programmes is their ability to meet clients’ requirements,” D’Eramo says. “For example, if you want to vote your shares at every annual general meeting, or on only a potentially contentious issue, the ability to recall your securities to vote is there.”
The solution, according to D’Eramo, is for lenders to work directly with their agents to construct a securities lending program that fits their investment strategy and practices. Lenders should inform their agent ahead of the required voting date, so that lending positions can be returned. “It’s all about the transfer of information and understanding what your client’s lending objectives are,” says D’Eramo.
The revenue consideration
Revenue is amongst some of the considerations for lenders when deciding whether to recall securities to vote, as it can limit earning potential – particularly with high intrinsic value loans. The decision to recall often comes down to giving up additional lending revenue to place the vote. “Sometimes there is a trade-off between revenue and governance objectives, said D’Eramo. “Every lender will have varying degrees as to how they want to enhance their corporate governance policy,” he adds.
In many cases, lenders have internal guidelines that help determine when to vote, such as on important events related to performance, or based on ESG principles. A lender may leave securities on loan if the voting matter is not considered material to their overall performance.
“RBC I&TS takes a consultative approach with clients to determine the most suitable model of fulfilling their governance requirements – case-by-case or full mandate,” according to D’Eramo, “while also striking a balance on revenue”.
Going beyond voting rights
The discussion regarding ESG and securities lending goes beyond voting rights and may include restricting certain types of securities based on internal governance policies or certain types of collateral depending on internal ESG views. For example, lenders may see short-selling as inconsistent with ESG investing, since sustainable investing is often seen as a long-term investment strategy.
However, various studies have countered that argument. D’Eramo refers to a recent European Securities and Markets Authority (ESMA) report. “In December 2019, ESMA published its findings on ‘potential undue short-term pressures in securities markets’. The report specifically noted that ‘short selling and securities lending are key for price discovery and market liquidity’.”
The agent’s role is to translate the lender’s mission and goals into a specific securities lending program, the same way it has for non-ESG issues. “We have been balancing this practice with clients for many years,” D’Eramo says. “This is not a new process, but the enhanced focus requires more consultative client discussions to find the best approach for all.”
Bespoke securities lending
Securities lending is not a one-size-fits-all approach. Lenders are looking for programmes designed to meet their specific needs and goals, which increasingly includes ESG factors.
As ESG continues to play a role in investment strategies, lenders need to balance performance needs with their responsible investing principles. It may be a trade-off between revenue and how material the vote is to the lender.
According to D’Eramo, it is possible to balance ESG-inspired lending approaches with the right strategies. “ESG is an increasing focal point in the investment industry at large, with downstream considerations for securities lending,” D’Eramo says.
He recommends lenders find a “bespoke, well-thought-out securities lending program” to ensure their investing needs are properly met.
