We asked two European pension investors how they reconcile their securities lending and short-selling activities with their responsible-investment policies
Responsible investment takes precedence
As investors, we engage in what we characterise as responsible stock lending, as set out in our stewardship policy. However, the decision over whether to lend stock is determined by our clients.
We went live with our securities lending programme at the end of 2020. All net revenues derived from stock lending, including dividends and coupons from securities loaned out, are for the benefits of clients in the relevant sub-portfolios.
Brunel itself does not undertake any short-selling. We do, however, have one manager, a mandate within one of our sub-funds, that does undertake some short-selling, but only quantitatively, based on valuations.
Stock lending has liquidity advantages for good market functioning, and we do focus on the need to maximise our client revenues in line with their own long-term aims. We are seeking to maximise these benefits while minimising the potential for issues. We appointed Minerva Analytics to provide support to our stock-lending programme to enable us to take action, such as recalling stock.
Thus far, our prudential action on stock lending has been forward-thinking, rather than reactive. We have only recently begun our securities-lending programme but our policy position is quite clear. If there is any misalignment between the economic benefits of stock lending and fulfilling our responsible investment commitments, then the latter will take precedence.
Specifically, it is written into our stock-lending policy that, where there is a perceived trade-off between the economic benefit of stock lending, and Brunel’s ability to discharge its obligations as a responsible long-term investor, the latter will have precedence.
The positives outweigh the negatives
PGGM’s pension fund clients do not engage in short-selling activities. However, the company offers its pension clients the possibility of engaging in stock lending. It is up to the individual clients to decide whether securities lending is an instrument they want to use. At the moment, five equity and three fixed-income portfolios totalling around €90bn in assets lend out via the PGGM securities-lending programme.
At PGGM we take our role as a responsible investor very seriously. Therefore, we constantly ask ourselves whether stock lending is an activity that should be carried out by a responsible investor.
Securities lending does conflict with certain activities in which a responsible investor normally engages.
When good responsible-investment policies are in place, securities lending and responsible investments would not seem to be mutually exclusive activities. But, as with everything, a certain amount of knowledge and prudence is required to run a responsible securities-lending programme. It is also important to be aware that securities lending may not be reconcilable with certain funds or portfolios.
When it comes to index-tracking funds, there seems to be no reason against stock lending. In fact, the earnings from stock lending could be an important contributor to the outperformance of the fund.
When, on the other hand, a fund invests in a handful of names chosen for their quality and ESG excellence, stock lending might lead to uncomfortable situations.
This, of course, does not mean that the fund manager should ignore short-term information on the companies he or she invests in or never engage in lending. It could just mean choosing a ‘no lending unless’ stance instead of a stance that could be summarised as ‘lending always allowed, unless’.
In 2009, the UK’s financial regulator, then known as the Financial Services Authority, published an influential discussion paper on short-selling. We believe the conclusions still hold true today. The paper argued that short-selling can generally be expected to increase market efficiency but can have negative impacts. It highlighted the cases when the risk of a negative impact is heightened, for instance a time of extreme market turbulence or for firms engaged in rights issues.
In the paper, the authority also noted that restrictions on short-selling could be targeted towards affected sectors. This practice was taking place at the time with regard to UK financial sector companies, which were particularly hit by the credit crunch. But the FSA said that for most of the time the positive benefits of short-selling outweigh the negative impacts.
In PGGM’s experience, so far, stock lending has not created responsible investment issues. If that were the case, we agree that responsibility always takes precedence over the benefits of stock lending.
PGGM has a securities-lending policy in place in which the rules of engagement are clearly set out. PGGM also has a voting, tax and collateral policy to ensure that there can be no ambiguity when it comes to securities lending and responsible investing.
Interviews by Carlo Svaluto Moreolo