In early December 2019 the Japanese Government Pension Investment Fund announced that it had ‘decided to suspend stock lending until further notice’. This is one example of a growing number of asset owners evaluating their securities lending practices due to ESG concerns as long-term investors.
Concerns have been raised that short-sellers (borrowers) could potentially undermine long-term stewardship efforts by mispricing or not considering ESG characteristics.
The immediate impact of these events on the world’s lending supply was limited. For context, in June 2019 global on-loan balances were around $2.45 tn, representing a small proportion of the $18.47 tn available within lending programs, according to data from the International Securities Lending Association.
As the number of asset owners with ESG-related concerns grows, however, the lending supply may further decline. And between 2018 and 2019 the UN Principles for Responsible Investment (UNPRI) reported a 16 percent increase in the number of asset-owner signatories committed to ESG investing, bringing the total to more than 2,300 signatories with more than $86.3 tn in assets under management.
In this article, we attempt to form a perspective on the intersection of ESG investing and securities lending based on academic findings. After an extensive literature review, there are four main findings we cover:
- Empirical evidence supports foundational assumptions in financial theory, which suggest that short-selling, facilitated by securities lending, improves market efficiency and allows for the proper allocation of capital
- An increasing number of regulations and investor demands are driving the adoption of sustainable investment strategies
- Lenders have tried to integrate ESG but, given fewer borrowers with ESG investment philosophies, some lenders are concerned about the potential negative impacts on their long-term ESG stewardship efforts due to borrowers mispricing these characteristics
- While research indicates that short-selling does not destroy a company’s long-term value, the relationship between short-selling and material ESG performance is unclear.
What are the ESG concerns of long-term investors?
A growing number of asset owners and managers are voicing concerns that securities lending limits their ability to exercise proper stewardship on underlying investments, highlighting three key concerns:
- The transfer of stock-ownership rights. When stocks are on loan, the voting rights for those shares are also transferred. This is inconsistent with the wishes of asset owners that mandate that their asset managers need to conscientiously exercise voting rights on all their shares
- There is a transparency concern because owners do not have clarity on who borrows shares, nor the reasoning behind those decisions
- Underlying these points is the perception that short-sellers (borrowers) destroy long-term value due to a misalignment in the longerterm investment horizon of lenders (beneficial owners). This raises issues of short-termism, which CFA Institute defines as the ‘excessive focus on short-term results at the expense of long-term interests’.
Asset owners are not the first to direct concerns at short-sellers. Financial regulators have historically viewed short-selling with skepticism, especially during times of financial turmoil. For example, during the 2008 financial crisis, the SEC pointed to short-sellers as a reason behind the sharp decline in prices and banned short-selling on 799 financial stocks. The continued debate has attracted interest from academics, which we can turn to for a better understanding of short-sellers' role in capital markets.
This is an extract from an article that appeared in the Fall 2020 issue of IR Magazine. To continue reading, click here to open the full digital edition of IR Magazine
Bridget Realmuto LaPerla
