An evolving environment 

As environmental, social and governance (ESG) continues to top the agenda for many firms, we look at how this has impacted the securities finance industry during 2022.    

ESG has been a hot topic within the securities finance industry for some time, with various initiatives introduced to ensure firms are meeting their clients’ expectations for sustainable and transparent trading.

As Darren Crowther, general manager securities finance and collateral management at Broadridge puts it, right across the industry participants are striving to find the right balance between responsible ESG voting practices and maximising securities lending revenue.

“We are helping clients to create a more efficient share recall process around proxy voting, which enables firms to gain the intelligence they need to make informed decisions around shares on loan and to optimise the recalls process,” he says.

Collateral availability has become something tangible that firms are implementing into collateral calculations on trades. “The ability to consider ESG impact on trading decisions has now reached a point of clarity and firms should plan to implement this as part of their roadmap,” adds Crowther. “This will provide them with the ability to clearly identify ESG collateral availability.”

Simon Lee, managing director, head of business development for the EMEA and APAC regions at eSecLending explains that his company’s role as an agent lender is to support its client requirements in the ESG space, which increasingly looks to address criteria pertaining to the collateral it holds on their behalf and the counterparties it lends to, in addition to the more familiar topic of proxy voting.

Standardised offerings

Given that every beneficial owner will view the subject through their own unique corporate lens, the challenge for the industry is to provide client-centric solutions that can be accommodated within the confines of agent lending programmes that by their nature have been designed to standardise their service offering as much as possible.“As a third party agent, all our client lending programmes are managed on a fully segregated basis, which historically has provided clients with a significant degree of control over the extent to which their programmes can be tailored to a highly customised set of parameters,” says Lee.

This functionality has become increasingly applicable in an ESG context, with each client being able to structure their programmes to meet their ESG criteria without hindrance. An example of this relates to non-cash collateral where each client maintains their own tailored collateral schedules, with individual screening for non-compliant securities which can be dynamically adjusted with minimal notice.

All of this is made possible thanks to holding each client’s collateral in fully segregated accounts, held in their name.

“Concerning proxy voting, as we noted previously the topic has long been a key component of how we support our clients’ ESG requirements,” says Lee. “A decade ago we launched ProxyValue in partnership with Institutional Shareholder Services (ISS). This product applies securities lending performance information to proxy voting management to provide a customised report at a transaction level to help institutional investors, boards and auditors ensure proxy voting fiduciary duties are met despite participation in a lending programme.”

Changing landscape

As the ESG landscape continues to evolve in the securities lending space and proxy voting remains at the fore, eSecLending has further developed this product – which now incorporates ESG metrics to each upcoming meeting, providing clients with additional data points to help them meet their requirements.

Lee notes that industry associations are also working hard to provide best practice direction to allow beneficial owners to manage their ESG requirements in harmony with their securities lending programmes.

“The Pan Asia Securities Lending Association led the way on this with the Global Framework for ESG and Securities Lending, which it partnered to produce with the Risk Management Association and was endorsed by the International Securities Lending Association,” he adds. “These associations have formed the Global Alliance of Securities Lending Associations, with ESG being one of the key areas in which they will seek to promote global best practice.”

Supporting clients managing risk, liquidity and ESG criteria in securities finance and collateral management is a key objective for Clearstream notes the firm’s vice president collateral management, Marc Poinsignon.

“Governance - the ‘G’ in ESG – has taken centre stage with a particular focus on investor stewardship and transparency,” he says. “This extends to securities finance and collateral management where leading industry standards and best practices have developed over time. These are at the heart of our services and continue to be monitored closely.”

Screening options

Enabling ESG collateral screening is important, whether it is from a risk mitigation angle or for an investor to comply with their ESG policies. Clearstream already offers solutions to clients to manage collateral inclusion and exclusions to meet their ESG criteria and is working closely with ESG metrics experts to further enrich the criteria available and facilitate the whole process for agent-lenders, investors, and borrowers.

“Additionally, we want to play our role in supporting liquidity in growing ESG bond segments with the successful launch last year of ESG bond identifiers that include green, social, sustainability and sustainability-linked bonds,” adds Poinsignon.

These identifiers leverage international standards, principles and guidelines that are available in the market and can be used alongside any liquidity and risk criteria already available in the firm’s programme to support ESG bond securities finance trades.

Poinsignon observes that ultimately, the transition in capital markets to more sustainable finance may require a phased approach with achievable, scalable and standardised parameters as well as different shades of transitional efforts in different regions and economies.

“We are looking to support our clients in navigating this transition with robust methodologies whilst keeping a flexible approach,” he says.

State Street believes that a well-managed securities lending programme can be a valuable portfolio management tool and enable funds to receive an additional source of income that can add incremental risk- adjusted returns to a fund’s overall investment return objective.

“Some of the key ESG elements that are relevant to beneficial owners include improved transparency in the lending chain, determining whether to recall securities to exercise ownership rights such as voting, and managing ESG risks associated with collateral reinvestments,” explains Jia Xinting, ESG investment strategist APAC at State Street.

Recall decisions

The decision on whether to recall a security for voting will usually depend on whether a particular vote would have a material impact on the fund, and whether the benefit of voting would outweigh the forgoing of lending income.

“To answer these questions, sometimes it requires the beneficiary owners or lenders to form judgements about events or outcomes that might be difficult to quantify,” accepts Xinting. “It requires expertise and extensive experience in order to make such a call.”

Another aspect to consider is managing ESG risks associated with collateral reinvestments. To support beneficiary owners and to ensure ESG standards are met in their collateral reinvestments, in 2021 the agency lending team of State Street Global Markets partnered with State Street Global Advisors to provide securities lending clients with a commingled cash collateral reinvestment strategy that follows short term investment guidelines while considering R-factor - a proprietary ESG scoring system as a component in making its investment decisions to the extent consistent with applicable law.

Having started out very broadly, the industry has now narrowed the focus of its ESG lens on a few key areas – namely voting, collateral and transparency suggests Dimitri Orlando, head of EquiLend data & analytics EMEA & APAC.

“Arguably, the most obvious impact of ESG on securities lending is recalling shares for voting purposes,” he says. “ESG-friendly lending programmes make it easy for beneficial owners to recall shares to vote on key topics at AGMs.”

Collateral questions

On collateral, the discussion has centred on the ability of the collateral received for a loan (and for cash collateral, the underlying investments) to meet the beneficial owner’s ESG parameters.

In response to a clear industry need for greater transparency and higher quality ESG evaluation options - particularly in securities finance - EquiLend has launched an environmental, social and governance data analysis and validation service for securities finance market participants.

“This service enables firms to submit ESG- related data to our specialist data analytics team, who will then perform an independent analysis and validation,” explains Orlando.

Knowing that determining the ideal mix of ESG options is essential for any successful securities lending programme, BNY Mellon offers clients an ESG-compatible securities lending programme across several key parameters.

“We know that ESG will continue to be an important topic for Asian clients, and we will continue to develop our ESG offering as the current fragmented and early evolutionary ESG landscape evolves,” says John Moran, head of securities finance business development at BNY Mellon.

He explains that the bank has several ESG subject matter experts who sit on the boards of leading industry associations. In addition, it continues to review ways to optimise a securities lending program that meets clients’ requirements.

“Recognising that transparency is key, we give clients increased visibility through our ESG collateral dashboard with market- leading ESG data from MSCI ESG Research,” adds Moran. “In our roadmap, we will look to provide greater transparency and enhanced information to allow clients to generate revenue while strategically applying their ESG principles. Interestingly, we have seen an Asian sovereign wealth fund looking to revisit securities lending after previously suspending part of its programme due to ESG concerns.”

According to Simon Kellaway, Greater China and North Asia head of the financing & securities services team at Standard Chartered, ESG is not always front and centre of the securities financing conversation in Asia.

Growing focus

 However, he notes that on the investor front it has grown as a focus area and as an increasing priority in Asia over the last 12 months as the trend for ESG investing has swept from west to east. This will naturally impact the securities finance industry as investors build sustainability ambitions and ESG KPIs into their overall asset allocation and investment strategies.

“This focus on ESG can be seen in the changing regulatory landscape across the region,” says Kellaway. “For example, China has made some strong moves to drive its ESG agenda, particularly focusing on the transparency of data and the ability to recognise ownership throughout the transaction chain.”

In June 2021, the China Security Regulatory Commission (CSRC) revised format standards for annual reports and semi-annual reports of listed companies, which separated relevant provisions reporting on environmental and social responsibility to make them more easily identifiable.

“We are seeing an expansion in the number of regulators that mandate or give guidance to ESG related reporting for financial institutions,” adds Kellaway. “For example, Singapore is expected to mandate disclosure based on the Task Force of Climate-Related Financial Disclosures recommendations from 2023 for some industries and all issuers will be required to provide climate reporting on a ‘comply or explain’ basis and set a board diversity policy from end of 2022.”

Elsewhere in the region the central bank of Malaysia has identified climate risk among its top five priorities for its work to 2026 with plans for mandatory climate related disclosures, a climate stress test and a pledge to consider to factor capital requirements into climate risks.

These markets are home to some of the largest and most complex lending clients, whose programmes can be expected to develop in line with the growing ESG trends.  

Data dependencies

Kellaway notes that while the issues of transparency and consistent data are very relevant in the securities finance industry, greater focus will be dependent on how much data becomes available and how standardised it can become.

“Examples of efforts to knowledge share and help market participants navigate the complexity of the different standards can be seen throughout the industry,” he says. One such example is where the ASEAN exchanges environmental, social and governance working group published a comparable table of sustainability reporting regimes to help investors understand the different reporting requirements across the region.

On the topic of initiatives market participants have implemented to address client demands for transparency and access to data, Kellaway observes that ensuring beneficial owners who lend out their securities can meet their ESG obligations is often going to be a key driver of the relationship between that beneficial owner and the securities lending agent.

“The securities lending agent must have the ability to deal with this in a flexible and transparent way that also enables risk mitigation,” he says. “The balance that clients look for is the ability for a provider to offer a well-executed lending programme that can also incorporate a client’s - often bespoke - ESG policies. Transparency and flexibility are key, as well as good communication between the beneficial owner and the agent lender.”

This is something that is much easier to set up in an individualised, tailored programme than a pooled arrangement with other beneficial owners. The tailored, auction driven programmes Standard Chartered sees in the market now naturally combine high returns with low risk, but also facilitate a growing client demand for transparency and customisation - where it is easier to track portfolio usage and give access to enriched data about loans, collateral, borrowers, and voting-related activity.

Information availability

Access to data is a topic that is being addressed across the post-trade space, but when it comes to ESG data all players continue to struggle with a lack of standardisation and in emerging markets, limited availability of data.

“ESG data is primarily driven by company disclosures and as more regulations are introduced across Asia we expect to see a better level of data becoming available,” says Kellaway.

In Singapore, SGX intends to mandate that climate and board diversity disclosures be made based on Task Force of Climate-Related Financial Disclosures recommendations from 2023 for some industries, and all issuers will be required to provide climate reporting on a comply or explain basis and set a board diversity policy from the end of this year.

In December 2020, Hong Kong’s Green and Sustainable Finance Cross-Agency Steering Group announced plans for aligned climate- related disclosures to become mandatory by 2025, while in Taiwan the FSX has mandated ESG related data disclosure from 2022 by size and industry of company.

Standard Chartered is an opening signatory to the Global Principles for Sustainable Securities Lending (PSSL) which seeks to embed ESG standards into securities lending activity and promote the transparency of relevant data.

The PSSL consists of nine principles that signatories must commit to and encourages the adoption of transparency and accountability in securities lending programmes by providing accurate information about the sustainable securities lending approaches and activities conducted by agent lenders and borrowers.

“Finally, some lenders have taken the decision to uncouple their securities lending programmes from their custodians,” explains Kellaway. “This ensures they can take full advantage of best-in-breed lenders who will maximise returns and deliver flexible reporting in a low risk programme, while simultaneously enabling them to pursue bespoke ESG-led programmes.” 

Increased returns

He says these options can materially increase returns by lending lower amounts of targeted securities via an auction process, while simultaneously minimising operational risk through highly automated electronic links between the custodian and lender. They also benefit investors by providing rich data and flexible ESG-oriented options for recall governance and collateral alignment.

So how are beneficial owners collaborating with agent lenders and borrowers to ensure that ESG standards are met? According to Kellaway, beneficial owners and borrowers in Asia are still defining their ESG standards and working to understand the regulatory requirements in reporting required of financial institutions, as well as the ESG data that is available.

“As such, the best option available will be a flexible/individualised programme which beneficial owners can adapt to their own ESG standards, or which can promote confidence in meeting their own ESG policies,” he says.

In integrating ESG policies, the steps do not differ significantly from a standard lending arrangement where the details would need to be agreed between the beneficial owners and agent lenders, except that the integration of ESG standards must be clearly understood and acknowledged by all parties in terms of:

• What securities or assets are available for loan

• What collateral the beneficial owner will accept in return for lending and how this collateral needs to comply with the beneficial owners ESG policies

• Asset owners/asset managers must undertake a conscious decision-making process about how their investments, their ESG policies and their bespoke securities lending requirements will interoperate

Programmes that are flexible and client- specific (i.e. non-pooled) are ideal as they naturally allow for such specific and tailored requirements.

“In incorporating ESG policies into their lending programmes, beneficial owners tend to focus on two key areas initially – the collateral that is accepted from borrowers, and the ability to recall securities for proxy votes,” says Kellaway. “Further collaboration will be needed to establish the material ESG standards for each lending portfolio and agree the data to monitor these standards.”

Visibility vital

The lack of standardisation or harmonisation of ESG data is a conundrum that is being experienced across the banking industry. The ability for a beneficial owner to have clear visibility on where their portfolio is, who it has been lent to and what collateral is being held against it will be an important first step to monitoring ESG standards.

ESG securities lending programmes will need to have the flexibility to allow beneficial owners to recall securities for proxy votes where this aligns with their ESG policies and to monitor where an upcoming vote may have impact, even when that security is on loan.

Transparency of data and a view of securities that are on loan is essential to ensure that the beneficial owner understands which securities need to be voted on  consistent with their ESG policies;  which  types  of votes  are   important;   whether   voting   on a percentage of shares is acceptable, or whether all shares need to be voted on; whether all markets are of equal importance when it comes to voting; and what revenue the beneficial owner is prepared to give up by recalling loans to ensure voting.

“In turn, the lending agent will need to ensure the availability of timely data to allow the beneficial owner to make this assessment, along with enough flexibility within their programme to allow for recalls where necessary, either through an auto recall or manual recall process, whilst seeking to minimise the commercial impact to the lender,” concludes Kellaway. 

This article is part of the Global Investor Asia Pacific Securities Finance Guide 2022, and if you want to download the full guide click here.