Reflections of the CEO

Sustainability | Voting

As many of us return to our desks after the Easter break, we continue to see how destructive and deadly COVID-19 can be, as countries grapple with further waves of the pandemic. Even in countries such as the UK, who appear in a better position than most, life is only just returning to some sort of normality, albeit very slowly. Consequently, striking the right balance between our collective desire to meet friends, family and colleagues face to face, with an obligation to ‘do the right thing’ in terms of wider public health concerns, is at times problematic. Something as straight forward as returning to the office is now a complex series of decisions, with the previous assumption that we would all work in an office setting for most of our working lives, no longer valid. Enforced remote working has bought with it unexpected benefits, such as a greater appreciation of the importance of a work-life balance as well as facilitating greater inclusion; hopefully these will not be lost as we return to pre-pandemic times.

The crisis has also created something of a mood for change across investment markets, as investment managers have reacted to the changing demands and sentiments of their investors. Much of this desire for change has centered around sustainability and the transition to net zero. In a recent report published earlier this year by JP Morgan (ESG Investing: Momentum Moves Mainstream), it highlighted how the growth of ESG funds is accelerating, with the ESG fund universe estimated at $7.2 trillion as at the end of 2020, compared to circa $3 trillion twelve months earlier. The pace of this change was also underlined more recently by the launch of the new BlackRock US Carbon Transition Readiness ETF on 8 April. At $1.25 billion, it was the single largest ETF launch in history.

I have discussed before how important it is that securities lending plays a full and meaningful role in that transition towards net zero. In our recent white paper produced jointly with Allen & Overy, Framing securities lending for the sustainability era, we outlined a clear roadmap to allow institutional investors to align their securities lending programmes within an ESG investment framework. As we begin to review the detail of next steps identified within that paper, I wanted to use this platform to explore some of the salient points that were covered, starting with active shareholder engagement, or in securities lending terms, the often-vexed issue of voting.

Although appearing now more prominently under an ESG banner, voting and more specifically proxy voting are nothing new to the debate. It is worth considering the implications for our market however, in a different context. Securities lending has often been seen by some as a barrier to effective shareholder engagement, and whilst it is true that any securities left on-loan ahead of an important company vote could dilute key decisions, the development of clear operational guidelines with an agent or other provider will easily negate this risk and ensure securities are recalled ahead of important corporate events.

In looking at this issue in more detail, it is important to recognise that the proportion of a company’s market cap that is routinely on-loan, is only at negligible levels. Data provided by IHS Markit suggests that in 2019, on average less than 1% of the market cap of the FTSE 100 was on-loan at any one time during the year, and although this expectedly increases to 1.7% when considering FTSE 250 names, both represent exceptionally low levels of borrowing. In contrast, a report published by KPMG/Makinson Cowell in January 2020 suggested that some 25% of the shares in issue for FTSE 100 companies, and 23% for FTSE 250 names were not voted on at Annual General Meetings in 2019.

If the data that we have for the FTSE indices is typical, then the issue of shareholder engagement and voting appears more complex than focusing solely on securities lending. We have advocated for some time that the most crucial element to this debate is not the role of securities lending around voting, but is that institutional investors need to have a well-developed engagement strategy that will include their stance on key areas such as voting. The data from KPMG/Makinson Cowell tends to support that view.

Once a full engagement/voting strategy has been established, it can be communicated to the institutional investor’s lending provider who will be able to calibrate their programme to ensure that the lending client has relevant securities back in their custody accounts ahead of important company meetings and votes. This is largely what happens today, where active stewardship has become an important part of our markets, and to an extent market best practice already reflects these essential elements of shareholder engagement.

There has already been clear recognition from governments that the transition to net zero cannot be accomplished by relying on public funding alone. As financial markets increasingly coalesce around these critical issues, it will be important that they are allowed to function efficiently and support this transition. Securities lending has an important part to play in that process and the development of best practice around areas such as voting will increasingly align securities lending with the sustainability agenda.

Andrew Dyson, CEO

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