Investors are getting serious about sustainable and responsible investment as people around the world wake up to increasingly complex Environmental, Social and Governance (ESG) challenges and the need to comply with the recent wave of regulations on greater transparency. Is our securities lending business compatible with SRI goals? The answer from CACEIS is yes, provided that we set some rules of conduct.
ESG has moved to the mainstream. Environmental, social and governance concerns are an economic reality – an imperative that market participants must get to grips with now, sooner rather than later.
Investors increasingly want to invest in sustainable products and to be reassured on the investments they are considering.
The concept of sustainability for investment products is measured according to the “double materiality” principle, which can be defined as follows:
- The product has a positive impact on one of the extra-financial criteria
- And does not have a negative impact on other extra-financial criteria
Securities lending gives investors the opportunity to increase the returns they earn on the assets in their portfolio. It is widely accepted that the practice provides liquidity to financial markets and can also meet both lenders’ and borrowers’ specific ESG criteria with a set of good conduct rules.
With our Asset Servicing expertise and our thorough knowledge of current regulations, CACEIS has a long history of securities lending programmes tailored to our clients’ needs. We consistently help and advise clients to address market challenges.
“We've been having discussions with all market participants and participating to many roundtables in order to help the industry establishing a strong set of sustainability principles for securities lending”, explains Dan Copin, Group Head of Securities Finance and Repo at CACEIS.
These principles can be grouped into 5 pillars:
- Transparency and ethics
- Selecting service providers
- Selecting borrowers
- Collateral selection
- Voting rights and attending general meetings
Securities lending is an important component for the smooth functioning of financial markets. It enables to settle failing trades or cover short sales where permitted, and also to structure indices or hedging products for investors. However beneficial for the future, it’s clear that responsible management strategies cannot have the effect of disrupting the markets by drying up stocks of securities to lend.
That being said, as securities lending is an OTC activity for which the available market data is provided by the participants, it’s important that investors have access to all the information for their programme: securities lent, collateral received, corporate action reporting, etc.
The process of selecting the service provider responsible for initiating securities lending is an integral part of clients’ ESG policy. They will choose providers who are involved in a positive and practical approach regarding ESG challenges and have environmental, social and governance policies in place.
In the Agent model offered by CACEIS (which acts as the intermediary in securities lending transactions), the client chooses the counterparties to which it is willing to lend its securities, so it is important that the selection of the borrower is based on the right ESG criteria. These indicators are generally the same as those applied to selecting providers, with the addition of counterparty default risk.
The lender, in accordance with his ESG policy, must have the capacity to exclude the securities identified as non-compliant (specific isin, country, etc..). It is important to make sure that the system and/or the agent selected for the management is able to ban from the collateral the securities according to specific criteria.
As a committed investor, the lender should be able to exercise voting rights on the securities at general shareholders meetings. But ownership transfers when securities are lent and the voting right passes to the borrower if they hold the securities on the date of record for the AGM.
So, in order to be assured to exercise its right to vote at the corporate meeting, the lender must be able to recall, or to restrict, the lending on any selected names during a specific period.
There are different approaches: recalling all the endable positon, limiting to scope to the sensitive votes, or fixing a significant percentage to avoid lending over the period.
The debate is vigorous because many market players are reluctant to recall the shares. Indeed, there is a concern about the erosion of liquidity during the “ freezing” periods which would be really damaging for the proper functioning of the financial markets.
Solutions for our clients
“We have a range of solutions for our clients to meet the requirements of these five pillars, ensuring they can steer their sustainable investment policy while also benefiting from an active securities lending programme,” says Donia Rouigueb, Head of Sales – Securities Finance and Repo at CACEIS.
CACEIS is fully committed to sustainable finance as an asset servicer and our Corporate Social Responsibility (CSR) policy is kept under constant review. Our policy and actions are assessed by EcoVadis and have been since 2014. In 2020, CACEIS earned Platinum sustainability recognition, with a score of 77/100, joining the top 1% of all rated companies in our sector.
We are fully transparent throughout the securities lending process, providing dedicated activity reports (positions, collateral received, etc.), benchmark reporting, analysis of the liquidity vs. risk approach to securities lending, and more.
For borrower selection, we have a strict counterparty approval policy based on quantitative (e.g. financial data) and qualitative criteria. When it comes to selecting collateral, lending clients have the option to exclude securities that do not fit with their ESG policy, or a type of securities (stocks, bonds, etc.), or specific ISINs.
Finally, on the delicate question of recalling securities during AGM periods, we offer the option of recalls at any time so lenders can vote on resolutions. Another possibility is to set up a quota system of stocks to be recalled also known as "buffers".
“It is important to note that introducing ESG policy principles reduce the benefits of the securities lending programme and as a consequence the revenues from this activity. This impact will be seen in the performance reports provided in compliance with “best execution" requirements. As ESG restrictions are not taken into account in the construction of these reports, yet there is the potential for distorting the assessment of the securities lending programme’s profitability," points out Dan Copin.
These pillars should be seen as indicative. ESG is a hotly debated subject and it is the lender’s responsibility to accept these principles and to define to what extent it wishes to apply them.
In conclusion, securities lending, which both guarantees market liquidity and generates income for securities portfolios, can now be fully embedded in a responsible investment strategy. Securities lending is compatible with ESG imperatives, providing the parameters are clearly defined early in the process and can be adjusted quickly as the market, regulations and clients’ internal policies change and evolve. As a leading securities lending provider, we at CACEIS continually adapt to our clients’ needs through a tailor-made programme and a flexible and robust IT system.
“We’re here for our clients across the entire Front-to-Back chain and are actively engaged in market discussions. Our aim is to capitalise on our ESG expertise in temporary securities transfers providing clients with the reassurance they need that this activity is aligned with their investment goals. CACEIS has the tools and expertise to put together the right programme for you, based on the securities you hold and in line with your ESG policy,” concludes Donia Rouigueb.
