ESG was firmly in the spotlight well before COVID-19 ran a coach and horses through global economies.
Despite the coronavirus pandemic disrupting the world’s economies and altering society in a colossal way, there are silver linings breaking through the clouds. One of them is that the presence of environmental, social and governance (ESG) in securities finance looks set to cast off any lingering accusations of faddishness and assume its place in the centre of discussions on how the market will move forward.
ESG and securities lending have endured a rocky relationship thus far, as asset owners have explored their feelings on what is, or isn’t, an acceptable and ethical financing strategy. Most of the concerns beneficial owners have raised so far are centred on securities lending’s role in facilitating short selling, which some feel runs contrary to their governance responsibilities. This has led to some prominent beneficial owners to withdraw their assets from the market, but, the over-saturated pool of assets available to lend has so far absorbed these losses without difficulty.
Despite the occasional compliance headache and awkward questions during client meetings, agent lenders and industry bodies are determined to square the circle of lending assets while maintaining a well-developed ESG policy in order to mitigate the concerns of beneficial owners. The International Securities Lending Association (ISLA) appointed Radek Stech, an expert in environmental law at Exeter University to chair its semi-autonomous Council for Sustainable Finance (ICSF), while major banks created new, ESG-focused roles to apply a lens of sustainable financing to all aspects of their operations.
Research by BlackRock Asset Management shows that ESG issues can impact company fundamentals if ignored, while those that do recognise the importance of these factors and manage them well are becoming increasingly attractive to investors.
According to Matthew Chessum, investment director at Aberdeen Standard Investments: “ESG is unavoidable. It has to be addressed and is set to increase in importance further in the next few years. Financial gain is not part of the conversation here.”
“Good stewardship is vital to ensure that companies and investors remain a positive driving force in the economy,” he adds. “I think that you will find that this issue is already within the top three of any financial institution globally. There is both headline and reputation risk involved in not taking sustainability seriously.”
Chessum goes on to explain that investors have access to more information than ever and want to know how and to what standards their money is being managed. “Strong governance has existed within most securities lending programmes for many years, the only real change is the implementation of the social and environmental standards,” he explains.
“Finally, the introduction or enhancement of any ESG standards makes a securities lending programme stronger. Better governance, a broader appreciation of social and environmental impacts will future proof any programme protecting revenues for the medium to long term,” Chessum concludes.
Along came COVID
When the pandemic hit, companies were forced to tap into credit sources, slash dividends and lay off huge swathes of their workforce. Industry observers initially speculated whether firms’ ESG convictions would be forgotten in the struggle to simply survive. It was questioned whether issues of ethics and sustainability would be put on the backburner until stability returned. But, several months on, ESG appears to still be high on the priority list for beneficial owners and the rest of the market. Part of this is helped by initial data showing that, far from being a burden, ESG-focused funds fared better than their peers.
According to data from Morningstar Direct, ESG funds have outperformed so far in the market slump, with 60 percent of European ESG exchange-traded funds beating the MSCI Europe Index. This has allowed ESG to not only be maintained during the crisis seen in Q1 but to actually be viewed as a piece of the puzzle in how to get global economies back on track.
Amid the current pandemic, the ICSF published a paper called ‘Making Sense of Sustainable Securities Lending & Short Selling During the COVID-19 Crisis’, which argues that securities lending and short selling are positive mechanisms as long as they conform with the council’s Principle of Sustainable Securities Lending (PSSL) framework.
Stech explains that the debate around short selling and market liquidity prompted ICSF to publish a position paper on regulatory divergence. “We see the role of sustainable securities lending helping us on the road to recovery,” he explains. “This pandemic has forced us to organise our thoughts and resolve more quickly than we had originally planned. We need to think more about ESG, because ESG is at the core of what we do. It will help with market recovery and reinforce the overall sustainable finance agenda.”
David Lewis, senior director at FIS Astec Analytics in London, highlights that COVID-19 has brought about a re-evaluation of many aspects of society’s values, such as community responsibility and appreciation for the NHS in the UK. There is huge pressure for change in racial discrimination and its association with corporate responsibility – behavioural change in corporations which can also be seen in the community credentials touted by major multi-nationals including supermarkets supporting food banks and prioritising essential workers with access to resources.
He explains that “the movement toward ethical investment seems to me to be very much in line with this direction of travel and to expect greater responsibility from our investment managers is not out of step with changing expectations toward any other service provider”.
Lewis adds: “Certain funds are replacing financial performance metrics second to ethical investments, understanding that divesting themselves of fossil fuel producers in favour of renewable energy projects may cost them in the near term, but is clearly a better long term bet.”
The pandemic has seen 23 percent of investors accelerate their focus on ESG credentials, according to a survey from BNP Paribas Asset Management, which found social consideration to become “extremely or very important” going forward. The survey that was published earlier this month in conjunction with Greenwich Associates found 81 percent of respondents are already employing ESG in all parts of their portfolios. After a rocky start to the year the future is looking bright for ESG and all involved.
