Session Summaries from the 2021 PASLA/RMA Update on Asian Securities Lending

The recent PASLA/RMA Update on Asian Securities Lending brought together leaders in the securities lending industry in the APAC region for two great days of panel discussions from industry leaders. Discussion topics included:

• Environmental, Social, and Governance
• The Future of Securities Lending in the Asia-Pacific Region
• Fintech and Emerging Technologies
• The Hong Kong/China Relationship
• Developing Market Opportunities
• Key Figures in the Industry

Session: ESG and Securities Lending

Moderator: Paul Solway, Head of Securities Finance, Asia Pacific, BNY Mellon

Panelists: Stefan Kaiser, Managing Director, BlackRock; Leslie Lin, Head of Stock Loan Trading, Morgan Stanley; Kate Saulenas, Portfolio Analyst, Sunsuper Pty Ltd

The ESG market is soaring globally, more than doubling in size in just the last five years and accelerating last year with the pandemic. Many asset owners have integrated ESG decisions across the spectrum of investments. With this growth comes regulatory change, with more disclosure regulation around sustainability. This scrutiny will naturally extend to securities lending. There are regulations governing short selling in Asia, but few that address ESG. The industry needs to be proactive in putting forth these frameworks and best practices before regulators tackle them. The key challenge as an industry is ensuring investors’ investment objectives are not jeopardized, while at the same time retaining scalability in securities lending so clients can continue to earn revenues.

PASLA has developed some technical guidelines which encourage lenders to take responsibility for ESG factors in securities lending programs. The guidelines set out options and key considerations for lenders as they establish their programs. The working group initially focused on six factors, in order of importance as perceived by participants in PASLA’s recent survey/consultation: voting rights, transparency in the lending chain, noncash collateral eligibility and cash reinvestment restrictions, rehypothecation of noncash collateral, different tax obligations, and participating in the short side of the market. We discuss the first three here.

Voting rights is one of the most prevalent issues when looking at ESG and securities lending. Most would agree there needs to be good governance and accountability around voting. Options to address this issue include never recall loaned securities ahead of investee companies’ elective events, recall loaned securities ahead of elective results by proxy voting policy, or always recall loaned securities ahead of elective results. In an extreme world where all lenders recall for proxies, the overall supply would be challenged at certain times of the year. Having a known but clear policy/framework that ensures certainty of useable supply (versus any required recall/restriction) would be optimal.

Transparency of the lending chain was deemed the second most important factor in the survey. Lenders have several options when addressing this issue, including no monitoring of the lending chain, entrusting its monitoring to the discretion of agent lenders or borrowers, or participating in industry initiatives that apply technology to achieving greater transparency in the securities lending chain. Beneficial owners believe efforts to increase transparency down the lending chain are helpful, as having more data leads to the ability to make better decisions. In the short term, given primary counterparty restrictions that are controllable today, full chain transparency is not always technically possible. The second option seems to be preferable. Review your counterparties regularly, is what borrowers and agent lenders are suggesting. Maintain an open dialogue to understand borrowers’ comfort level with ESG investments.

The issue of noncash collateral eligibility and cash reinvestment restrictions is a “seemingly complex beast,” especially with the introduction of products such as special purpose acquisition companies. Options here include no restrictions to noncash collateral eligibility or the reinvestment of cash, restrictions by classification, or restrictions by identifier or single issue. When looking at noncash collateral and collateral reinvestment, beneficial owners, for example, might want to maintain liquidity and minimize any duration mismatch, as well as retain credit quality and the institution’s ESG guidelines and principles. The exposure management function and responsible investment team should work together to make sure the securities lending function and collateral are in line with ESG guidelines. As one beneficial owner said, “It wouldn’t be in our investment portfolio if we didn’t want it as collateral. If it is excluded in our regular ESG policy, it could be based on a sector like tobacco, and we do not have any debt in that collateral. This approach goes beyond what is excluded to what we consider as ESG hot topics, or things that are on our list of engagement.” 

It is apparent from the discussions that ESG is here to stay. There may be other items to review within the ESG framework specifically related to securities finance transactions. It is important to get those issues out front so they are part of formulating ESG guidelines. Review your investment beliefs about ESG and prioritize your ESG policy and compliance. ESG considerations have become the standard in investment portfolios and could present risks that must be addressed from a securities lending (and borrowing) perspective.

Some queries were raised during the discussion related to how ESG factors could impact yields and pricing.  While pricing would ultimately be down to market supply versus demand, we would foresee that any restrictions placed on portfolios would lead to a more limited return to a lender that would reflect both the limits to the opportunities available and the additional monitoring that may be required.

We would anticipate that any of the guideline factors could be applied to all funds, not just “ESG funds.”