abrdn
Matthew Chessum, abrdn’s investment director for securities lending, collateral management and money markets, speaks to Bob Currie about plans to grow the fund manager’s lending programme, the fallout from GameStop and its steps to embrace sustainable development objectives
Standard Life Aberdeen’s decision to rebrand as abrdn in April 2021 raised a few eyebrows across the industry. Chief executive Stephen Bird explained that the new brand builds on the company’s heritage and is “modern, dynamic and, most importantly, engaging for all of our client and customer channels”.
For those born in the 1960s and ‘70s, this new branding may be hard on the eye, resembling a predictive text accident as much as an attempt to appeal to younger investors.
But over the years, Aberdeen Asset Management, from its 1980s formation in the eponymous Scottish oil town, through various mergers and acquisitions (M&A) — including its 2017 junction with Standard Life Investments (SLI) — has often been something of a frontrunner, prepared to do things slightly differently.
Its Aberdeen Technology unit trust, for example, was one of the most publicised collective investment vehicles offering economic exposure to the 1990s tech boom.
Around the same time, Aberdeen signed an investment operations outsourcing deal with Cogent, becoming one of the first UK fund managers to outsource middle-and back-office processes to a third-party asset servicing specialist. Many have taken this road subsequently — being ‘in house’ feels like a departure from the orthodoxy these days — but it was a bold and contrarian move when Aberdeen made this choice in 1997.
This eye on the future — and a willingness to reinvent itself — continues in its product strategy, its investment brand and in many parts of its approach to securities lending and liquidity management.
Scale with growth
With more than £530 billion in assets under management (AUM) and administration on behalf of investor clients — through organic growth and M&A activity — abrdn offers scale in the securities finance segment and an international asset gathering capability that continues to feed this hefty securities inventory.
Having had to moderate its growth ambitions for a time, following the Standard Life Investments merger and the huge transition project this engendered, the current focus for the securities lending and liquidity management team, according to Chessum, is on expanding its securities lending programmes across all fund ranges and mandates.
In the current low yield, low interest rate environment, securities lending is probably more important than it has ever been in terms of its contribution to the performance of abrdn funds.
This importance is likely to grow as abrdn extends its product range to offer a wider rack of indexed funds and exchange-traded products — alongside its established expertise in actively-managed funds — where revenue from securities lending will be key to driving performance and expansion.
This step comes in the wake of a period of corporate restructuring following its M&A activity over the past seven or eight years. This has brought on board a range of new funds, not all of which are yet supported within the lending programme.
When Aberdeen acquired Scottish Widows Investment Partnership (SWIP) in 2013, for example, SWIP’s securities lending activity was promptly integrated into Aberdeen’s lending strategy following the purchase.
In contrast, when SLI purchased Ignis Asset Management from Phoenix Asset Management in 2014, Ignis’ lending activity was discontinued when Ignis migrated into SLI.
With much of this post-merger transition work now completed, the lending team now has the opportunity to squeeze more out of this pot of assets. This will include integrating fund ranges that have not previously been migrated into the lending programme.
Two other factors have been particularly important during the first half of 2021 in shaping the focus and approach of the lending programme. One has been the fallout from GameStop and the rise in meme stock trading via retail brokerage platforms. A second has been the regulatory push behind sustainable investment and the requirement that investment processes, including securities lending, repo and collateral management, promote high environmental, social and governance (ESG) standards.
GameStop debrief
The turmoil created by the GameStop short squeeze caught the industry by surprise and prompted detailed re-evaluation of the role played by securities lending in financial markets.
This directed the spotlight internally on securities lending and collateral management to a degree not seen since the global financial crisis of 2008, notes Chessum.
abrdn’s lending strategy is structured by fund range, utilising discretionary and exclusive programmes to lock in opportunities for fee generation. The approach typically is to hold a small number of positions in large sizes — with controls in place to monitor and mitigate the associated risk across these transactions. “Trading in larger sizes, we are careful about the footprint that we have in the market and the impact that our lending activity may have on pricing and liquidity,” says Chessum. “By adding supply, there is inevitably a danger of forcing down the fee and, therefore, being poorly compensated for lending in larger volumes.”
The risk impact associated with GameStop was not well understood — and this has triggered a re-evaluation of the risk implications for asset owners lending securities into the market, should similar stress situations develop in the future.
Beneficial owners need to be confident that they can access their loan securities, particularly in conditions of market stress — and if they choose to sell securities that they have placed on loan, they must be clear how long it will take to recall those securities. With implementation of the settlement discipline regime component of the Central Securities Depository Regulation scheduled for February 2022, this will present a risk of being bought in if the borrower’s failure to return securities promptly leads to a failed settlement.
The industry is working together to understand the implications of this chain of events, in terms of financial costs (settlement fines, buy-in costs) and potential damage to future lending or trading relationships,
“During H1, we have done a lot of work within the organisation in reviewing the mechanics of securities lending, ensuring that the risks are well managed and explaining the relative benefits and risks of securities lending to senior decision makers,” says Chessum. “Traditionally, securities lending has rarely featured on the agenda at fund board level, but fall out from the meme stock turmoil has moved our business towards the front of management priorities.”
Specifically, this has provided opportunity to confirm to senior management that securities lending delivers valuable incremental revenue to the investment fund, managed within a tightly-controlled risk framework — based on careful counterparty selection and credit risk assessment, lending against high-quality, well-diversified collateral and, typically, with indemnification extended by the lending agent.
The industry’s experience during the recent COVID-19 crisis has illustrated the important work done by the agent lender and tri-party communities in managing efficient lending and collateral management during conditions of market instability, as well, as we have noted, in providing security to lenders through indemnification.
“Although indemnification does provide a final layer of risk defence, offering reassurance to the fund board and group risk management, we reinforce the point that with a well-tested risk management framework in place we should rarely, if ever, need to call on agent indemnification,” says Chessum.
Sustainable investment
Beyond the enduring drive to maximise risk-adjusted return, one that extends beyond the fund management teams to all the supporting functions, the asset management industry is also focused on promoting sustainable investment practices and a commitment to ESG principles expected by investors and a broader public.
At industry and company level, a primary focus for the first half of 2021 has been in adapting to the Sustainable Finance Disclosure Regulation (SFDR). This applies mandatory disclosure obligations for asset managers and other financial market participants, with substantive provisions becoming effective from 10 March 2021.
This regulation was implemented by the European Commission in parallel with the Taxonomy Regulation and Low Carbon Benchmarks Regulation as part of a package of legislation designed to give substance to the Commission’s Action Plan on Sustainable Finance.
SFDR requires asset managers, including those managing UCITS and Alternative Investment Fund Managers Directive (AIFMD)-compliant funds, to provide standardised disclosures indicating how ESG factors are integrated into their investment and post-trade processes at an organisational and product level. This typically applies to fund managers regardless of whether they have a declared ESG focus to their investment policies. The expectation is that buy-side firms and investment advisors provide sustainability-related information on their financial products and assess the impact of their investment process from a sustainability perspective.
This challenge is complicated by the fact that little has been written about securities lending in SFDR and this lack of codified guidance makes it difficult to prepare. It is still unclear on what terms asset managers should be including Article 8 or Article 9 funds (see box below) in their lending programmes — or whether other changes to lending and collateral management practices are needed to meet SFDR requirements.
As the regulation progresses, Chessum says it is important that the focus is not simply on collateral exclusion — which will reduce the range of eligible collateral that lenders are able to accept — but is more about encouraging, and applying pressure to, companies to become greener and more socially responsible.
Like many asset managers, abrdn’s approach, working through its lending agents, has been to apply an ESG overlay to its collateral eligibility parameters. For equity collateral, for example, it requires that equities accepted as collateral should fall within the MSCI ESG Index.
According to Chessum, agent lenders and tri-party agents have an essential role to play in helping asset managers and beneficial owners to fulfil these objectives in the longer term. This screening process requires sophisticated algorithms and collateral optimisers to work efficiently at scale and few buy-side firms have the in-house tools to do this without the support of third-party lending and collateral management specialists.
SFT asked how effectively the agent lender and tri-party communities are fulfilling this role currently.
“The industry is at a crossroads in terms of what we require”, responds Chessum. Buy-side and sell-side firms, agent lenders and beneficial owners are looking at each other for leadership and guidance. “It is difficult to establish a clear policy because we are trying to solve a problem, and to meet a regulatory commitment, that currently only exists in outline.”
This said, abrdn recognises that there are steps it can be taking in the meantime to ensure that it is compliant with the spirit of sustainable investment.
“Our approach is guided by the question,’What does the investor expect from a sustainability perspective when investing in a fund?’”, says Chessum. “This defines our ESG strategy across the fund transaction lifecycle, embracing investment decisions, securities lending and collateral management, cash management, corporate actions processing and all other relevant functions.”
Community dialogue
At industry level, the International Securities Lending Association (ISLA) established a beneficial owner working group in early 2021. This was created to give asset owners a stronger voice in defining the future direction of the industry.
In controlling the supply side of the market, beneficial owners have always had a central position in the securities lending value chain. However, this has not always been fully reflected in their opportunities to shape market practice and policy making.
“Financial intermediaries, particularly the agent lending and tri-party community, have done a fine job in representing beneficial owner interests, but it is important that beneficial owners also have a direct voice within ISLA and other industry associations,” says Chessum, who serves as ISLA board member and co-chair of the beneficial owner working group.
This year, representatives from the securities lending community, including buy-side firms, have also had detailed input into the review of the Bank of England’s UK Money Markets Code of Conduct, which guides best practice in unsecured, repo and securities lending markets, as well as adding important provisions around ESG, diversity and inclusion and remote working among other factors. The central bank has also been taking on board the views of the industry through its Securities Lending Committee, which meets quarterly.
In planning ahead, the focus at abrdn is all about expansion of its lending programme, not just in the UK and Europe, but also in the Asia-Pacific and Australia.
Chessum notes that Asia is an important area of focus for the company and, therefore, it is a natural point of focus for the securities lending programme. “Fees have generally been higher in Asia over the past few years, so it is important that we keep a close eye on any developments with regards to new fund launches, increased AUM and any new markets,” he says. “Making securities lending a core function and part of the “day one” process when a new fund is launched in all regions is an important step towards growing the programme and returns for our investors.”
In terms of agent selection, abrdn continues to focus on best-of-breed and how to draw best value from its programme through discretionary and exclusive lending. As the discipline matures, peer-to-peer lending may also play a more active part in its lending strategy in times ahead.
One focus for improvement from a lender perspective, Chessum notes, is the need for greater pricing transparency and access to near real-time pricing information.
“As a lender, we monitor fees paid to us by the agent, but we only see one side of the trade. We have no sight of the pricing paid by a hedge fund or prime broker, for example, when they borrow those securities.”
Alongside better price benchmarking for the borrower side of the market, there is demand to move market pricing closer to real-time. “For too long, it has been necessary to make lending decisions based on stale data and there is a clear appetite across the market for data vendors and agent lenders to reduce this time lag,” says Chessum. “Few other investment functions beyond securities lending are working with pricing data that can often be up to 48 hours old.”
With economies opening up, the world finding its feet again after COVID-19 and economic growth at levels not seen for 75 years, Chessum finds that business confidence is growing and companies are re-positioning to remain competitive. These events, he believes, offer hope for a period more akin to “business as usual” for securities lending.
“Brexit is behind us, hopefully, and companies are spending reserves built up through the pandemic,” he says. “This growth and spending power provides opportunities for end users to deploy a broad range of strategies, whether long-short, arbitrage or corporate-activity related, with a growing degree of confidence.” This, in turn, drives fees upwards and will increase opportunities for beneficial owners to deliver meaningful incremental returns through their lending strategies.
[Box out] Article 8 and Article 9 funds under SFDR
According to the draft regulatory technical standards on the Sustainable Finance Disclosure Regulation, published by the European Supervisory Authorities on 4 February 2021, an Article 8 fund (‘Light Green funds’) under SFDR is a fund which “promotes environmental or social characteristics” as part of its approach to investment and where the companies in which the investments are made follow good governance processes.
An Article 9 Fund under SFDR is “a fund that has sustainable investment or a reduction in carbon emissions as its objective.” An Article 9 fund is required to incorporate good governance into its investment strategy, including assessment of sound management structures, employee relations, remuneration and tax for the underlying investments. It is required to evaluate the fund portfolio against the principle of “do no significant harm” by considering Principal Adverse Sustainable Impact statements (PASIs) and integrating considerations of the minimum social safeguards detailed in the Taxonomy Regulation.
In the draft RTS, an Article 9 fund with a carbon reduction objective must refer to an EU Climate Transition Benchmark or an EU Paris-aligned benchmark.
These draft RTS are intended to supplement SFDR and, if approved, will come into force on 1 January 2022.
