Reflections of the CEO

Sustainability | Transparency

In a BlackRock survey of 425 global investors published in 2020, poor quality and the availability of relevant data was seen as the single biggest barrier to sustainable investing. Anyone looking at the implementation of the Sustainable Finance Disclosure Regulation (SFDR) here in Europe would probably share similar sentiments, where lack of clarity around the scope of key elements of the regulation is causing confusion as market participants try to understand how the legislation may apply to their businesses. At a recent European Supervisory Authorities’ (ESAs) hearing on the draft Regulatory Technical Standards (RTS) for SFDR, the recurring issue of the lack of clear definitions for Article 8 products (those that promote environmental/social characteristics) and Article 9 products (those with a sustainable investment objective) was again highlighted. It was generally felt at this forum that this issue should be dealt with by the European Commission through Level I text amendments, rather than through the RTS process.

In the absence of clear guidance, we are all operating in something of a vacuum, which means that the industry-led initiatives to align securities lending within an ESG investment framework, become ever more important. In March of this year, we published our joint whitepaper with Allen & Overy, ‘Framing securities lending for the sustainability era’ which set out a clear agenda to tackle these important questions, including how to define securities lending from a ESG perspective. In this regard, I was also delighted to see PASLA and the RMA recently publish their framework for ESG and securities lending which provides important guidance to the institutional investor community.

One of the themes that was discussed in both our Allen & Overy white paper, as well as the recently published PASLA/RMA framework, is that of transparency. This is something of an intriguing topic that is often talked about in broad terms, but I feel is important to think about; firstly, what do we actually mean by transparency and furthermore, what questions or concerns are we are trying to address though transparency. It is widely acknowledged that securities lending plays an important role in the development and operation of a well-functioning and diverse capital markets eco-system, and to make that system work, institutional investors must make their securities available for lending. Quite rightly, some institutional investors have raised questions and concerns around the reasons why borrower’s seek to borrow securities. Whilst these questions are not essentially new, they do have a greater resonance when seen through an ESG lens.

The securities lending value chain is one that relies on transfer of title, where legal ownership temporarily passes to the borrower. Without this, it would be impossible for a borrower to, for example cover a short sale or an anticipated settlement failure, but does mean that there is some loss of immediate visibility as the security moves through the system. However, before we can judge if that apparent loss of visibility presents an unacceptable level of business or reputational risk, we need to examine the environment that borrowers operate in, particularly here in Europe. Typically, most if not all securities are borrowed by prudentially regulated entities that are subject to wide ranging and at times detailed regulatory scrutiny, with additional safeguards through personal conduct frameworks, such as the Senior Managers Regime in the UK. This means at both a personal and organisational level, the interests of borrowers and lenders are aligned in that they want to see orderly and responsible markets, and whilst individual trades may not be directly visible to a lender, they can take considerable comfort from the implied integrity required of the borrowing community. Other key initiatives such as the Bank of England Money Markets Code also foster a greater level of responsibility throughout the securities lending value chain.

More recently, the broader impact of the sustainability agenda is providing further market level scrutiny and behavioural transparency. Regulatory frameworks such as SFDR will lead to counterparty screening around ESG fundamentals, and again, this presents no real benefit to borrowers in promoting business to their clients that could undermine their implied ESG rating. Over time, poor ESG scoring could affect their ability to access trading counterparts, and their cost of capital could increase as investors potentially shun non-ESG friendly names.

Sitting above are at times very specific pieces of legislation and guidance such as SFTR, where in Europe the regulatory community can see and scrutinise every securities lending transaction, thereby providing very effective market level transparency. This is supported by complementary disclosures around short side positions, where the EU Short Selling Regulation sets mandatory transparency requirements with significant net short positions being reportable to the relevant National Competent Authority.

As we look at the array of legislation and regulation around our industry that drives greater transparency in all its forms, the accusation that there is insufficient transparency begins to look potentially unfounded.  It would be too easy to simply advocate for more transparency, but I feel that would be missing the point. We have to balance the needs of institutional investors with those of our borrowers, and come to common ground that allows the market to function efficiently and seamlessly. It is important that we all understand what questions we feel we need to answer through transparency, and how existing regulation and legislation may have the answers we are looking for.

Andrew Dyson, CEO

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