Securities lending programmes do not generate enough income to be worth doing for exchange-traded funds (ETFs) that track environmental, social and governance (ESG) indexes, according to German asset manager DWS.
The need for restrictive collateral parameters and regular recalls creates “a number of other challenges and alters the economics of the securities lending function to the extent that it effectively erodes much of the potential revenue from lending,” says DWS passive product specialist structurer Zeb Saeed.
DWS, which is majority-owned by Deutsche Bank, recently pulled the plug on the lending programme for one of its ETFs as part of its switch from tracking a traditional FTSE index to an ESG-friendly one.
The UCITS ETF, with $37 million in assets under management, has swapped the FTSE All-Share index for the MSCI UK IMI Low Carbon SRI Leaders Select index which tracks small and mid-cap UK entities with high ESG scores.
DWS tells SFT that 11 of its 250 UCITS ETFs are now tracking ESG indexes but the latest one was the first to be switched over and therefore the only fund so far to close a lending programme.
The asset manager also has 33 Xtrackers listed, of which eight are ESG focused.
The other ESG ETFs were either purpose built or did not lend assets before transitioning to an ESG index.
A spokesperson for DWS adds that the asset manager is “very focused on expanding our ESG ETF range”.
Beyond the operational challenges of juggling ESG compliance and a lending programme, the fragmented nature of the sustainable financing sector makes it difficult to compare funds’ performance, relative to standardised and more crowded indexes.
As a result, the less competitive environment means funds do not have to seek out additional incremental returns offered by securities lending programmes and other financing strategies.
Saeed notes that lending agents are capable of constructing bespoke ESG-friendly programmes with collateral rules and automatic recall facilities but concedes that this would make the assets unpopular with borrowers.
“It all adds up to those wanting to borrow stocks being incentivised to borrow from funds tracking non-ESG benchmarks. These reasons, amongst others, lead providers to therefore not engage in securities lending on ESG ETFs,” explains Saeed.
Meanwhile, DWS also suggests there is an ethical dimension to consider as investors seeking an ESG investment may have an issue with securities lending as it facilitates short selling.
DWS stresses it doesn't take a view on the ethics of the matter and only seeks to respond to specific investor demand.
