Published on Tue, 12/15/2020 - 16:02
Securities Lending, an activity compatible with a CSR policy
At first glance, the Corporate Social Responsibility (CSR) approach leads to a certain number of constraints, which do not go in the direction of the securities lending activity. However, by further digging the subject this activity can have a positive impact as part of a CSR approach for the following reasons.
First, we should not forget that securities lending contributes to the market liquidity, that is why this activity should not be banned. Indeed, securities lending is essential for market efficiency, as it provides liquidity by exchanging assets (efficient trade settlement, financing, trading volume). It also leads to fairer pricing by reducing trading costs (tightening the bid/ask spread). This fact is well established and documented. As reaffirmed in the report of the International Securities Lending Association (ISLA) of August 20201.
On negative point, a common perception of securities lending is that it facilitates short selling, which may affect the long-term value of portfolios.
However, there is no evidence of that affirmation. In a December 2019 report, Undue short-term pressure on corporations, the European Securities and Markets Authority (ESMA)2 stated that it “is not aware of concrete evidence pointing to a cause-effect connection between short selling and securities lending and the existence of undue short-term market pressures. It instead reiterated short selling and securities lending's contribution to market liquidity and price discovery”.
There are other examples given in April 2020, by BlackRock in Securities Lending Viewed through the Sustainability Lens3 : “The Federal Reserve has found that short sales improve market stability. Their research has shown that short selling does not systematically drive down asset prices, and that restricting short selling could actually lead to reduced liquidity and higher transaction costs for investors. Similarly, in the European Systemic Risk Board’s (ESRB) January 2018 working paper on ‘Short-selling bans and bank stability’, the authors concluded that contrary to intention, stocks with short selling bans experienced greater probability of default and volatility, leading to higher risk to end investors.”
Thus, except in specific circumstances, short selling and hence securities lending have a positive impact on market stability and liquidity.
See other several recent studies on this question :
- The International Securities Lending Association (ISLA) Council for Sustainable Finance4 reminds in February 2020 that one of the principles for Sustainable Securities Lending is short selling: “Covering short selling is beneficial to financial markets. It is part of the essential market mechanism that facilitates price discovery and liquidity. It also reduces the asymmetry in a market participant’s ability to express an opinion on the value of assets.”
- Brown Brothers Harriman published the December 17th 2019 an article regarding Securities Lending or ESG Investing? Both5. It states “Without securities lending, the ability to sell short and cover trade fails disappears - meaning there is no market making, hedging, or true price discovery, all leading to less efficient and more volatile markets. This is why securities lending is referred to as the oil upon which the engines of financial markets rely, and why many investors decide to lend securities. Without it, markets would splutter and eventually seize. Not only do many firms feel securities lending fulfills their responsibility to optimize returns for their investors; they’ve also been vocal that it contributes to sustainable capital markets.”
More important certain positive aspects can be highlighted :
First, securities lending allows the investors (such as asset managers or insurers) to access to more market information. Indeed, being present on these markets allows to have more « color » (Do a lot of counterparts look after this stock, are the levels tightening, why, what are the news on this stock, …).
Second, securities lending enables investors and funds to benefit from additional returns on their investments. Indeed, all of the (net, excluding transaction fees) income from the securities lending activity is transferred to the funds, thus contributing to their performance. This outperformance brought by the activity eventually allows funds to "differentiate" from their competitors and therefore to highlight funds/companies according to CSR criteria. Moreover, this contributes to fund performance, thus encouraging them to invest in these funds and therefore contributes to highlighting CSR funds.
Third, unless there is a specific operation, all securities lending are callable (that is to say, stocks can be recalled at any time within 24 ou 48 hours). Especially, this makes it possible to recall and restrict any operation to ensure that the investor can vote during the shareholder meetings, in order to prevent any speculative approach.
This approach is aligned with the Principles for Responsible Investment (PRI) and the International Corporate Governance Network’s Guidance on Securities Lending6, as well as the European Fund and Asset Management Association’s (EFAMA) Stewardship Code and Principles7.”
Finally, they are more and more studies to apply some CSR criteria’s on stocks received in collateral.
Conclusion : Studies clearly demonstrate the compatibility of securities lending transactions with a CSR approach. This is more according to the organizational arrangements put in place at Natixis TradEx Solutions.
Securities Lending at Natixis TradEx Solutions
Natixis TradEx Solutions is a significant actor in the market of securities lending. This activity relies in particular on solid relationships with counterparties. The goal is to optimize the positions of stocks (bonds and equities) held in the portfolios of Natixis TradEx Solutions’ clients and to generate an additional source of performance thanks to the income generated by operations while considering the associated risks. Like some of our clients which apply an SRI policy, the securities lending activity at Natixis TradEx Solutions also follows a CSR policy. The key principles are the following :
1. The securities lending trades by themselves :
- Transparency towards clients :
- Information and visibility by the investor of stock of lent securities (what level, what is the Markit level,…).
- Industrial organization and automatic alerts when a decision of selling is taken.
- Possibility to systematic recall for the votes during the shareholder meetings period.
- Stocks received in collateral :
Triparty mode→ Independent organization that manages the securities received in collateral according to a matrix defined by Natixis TradEx Solutions, validated by the risks of its clients and integrating the CSR criteria (for the moment some names are already excluded, for example: stocks linked to issuers of the coal industry, cluster bombs and anti-personnel mines or worst offender). This matrix is the same for all funds (equities, bonds, diversified, etc.) and all counterparties signed in Triparty.
- Application of a strict tax policy :
Natixis TradEx Solutions has tax monitoring and applies a strict tax policy.
- Follow-up of the lendable stocks in a clearly identified base :
- Lending of 50% max of the client’s portfolio.
- The scope of lendable securities is defined and validated by the clients.
- Possibility to temporarily or definitively exclude some securities from the lendable stocks.
- Recall at any time of the trades.
2. At Natixis TradEx Solutions’ organization level :
- Recognized “human capital” within Natixis TradEx Solutions’ Securities Lending team :
- Expertise/know-how of traders and their experience
- Gender equality in the team
- Set up of guidelines for this activity through :
- A counterparty selection process + an annual rating
- Procedures regularly updated
- Legal framework of the activity (GMRA or GMSLA)
- A selection and execution policy
- The ban on borrowing securities and therefore no short selling
- CSR annual survey sent to our counterparts :
Even if at this stage, the issue of the CSR is not yet dealt with by the entire markets chain, Natixis TradEx Solutions has decided to send a CSR questionnaire to counterparts and brokers and to take their responses into account in the annual vote of brokers.
By Marion Lepoivre
Securities Lending and Repo Trader at Natixis TradEx Solutions
1 https://www.isla.co.uk/assets/smart-pdfs/isla-securities-lending-market-report-august-2020/#p=17 In particularP16 to 23
2 Rapport ESMA Undue short-term pressure on corporations ESMA30-22-762 | 18 Décembre 2019 https://www.esma.europa.eu/sites/default/files/library/esma30-22-62_report_on_undue_short-term_pressure_on_corporations_from_the_financial_sector.pdf
6https://www.unpri.org/download?ac=4151 - Engagement and voting practices
7 EFAMA Stewardship Code - Principles for asset managers’ monitoring of, voting in, engagement with investee companies. In particular principles 1, 5 and 6.
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