Page 17 - ISLA_SLReport_Feb2020_spreads

New Standards of Measurement Applying ESG-like principles to investing might appear to they would not be used for short selling exposes the real
have continued to lend its assets if it could guarantee
be a relatively simple process to undertake. Restricting
investments in tobacco companies or weapons manu- underlying reason for this decision – the belief that such
2020 marks the start of a new year and a decade. Much previously driven by the active funds. Neither are attrac- facturers, for example, is a binary decision once a fund actions can drive prices of assets downward. For such
has changed and more is due to change both economi- tive outcomes, and the former would arguably drive more has determined its investment principles. However, the an argument to be true goes against most fundamental
cally and politically as the new year gets under way. hedge fund activity as funds seek over valued shares to physical lack of eligible securities to invest in could lead to asset pricing principles, not to mention ignoring the exist-
short, driving demand in the securities lending world. crowding and the resultant over inflation of asset prices. ence of many alternative mechanisms through which an
One of the most significant changes specific to the secu- This outcome might be positive for securities lending If this does occur, it could become a serious issue that, in investor can profit from a falling asset price. What it does
rities finance industry, the Securities Finance Transaction but could represent a fall in overall market efficiency fact, fuels additional short selling activities. It is telling highlight is the almost sentimental view that it is some-
Regulation (SFTR), representing the first implementa- and transparency. that the $1.4 trillion GPIF fund states that $28 billion how distasteful to profit from an asset falling in value.
tion of the Financial Stability Boards (FSB) Transparency is invested in ESG compliant funds: just 2 percent of its
Directive, commences in April. Few would argue that However, as many of these new zero fee funds join the total portfolio. This fact lays bare the conflict between the On that measure, the GPIF has likely erred in its logic.
there isn’t still a great deal of work to do before then to securities lending supply, some notable funds are leav- demand for lower cost fund management and ESG princi- Having a 100-year investment time horizon makes the
get the market live and compliant with the new era of ing and leaving very publicly. The Government Pension ples. Most passive funds are index trackers and main indi- value of an asset from one day, week or month to the
transparency, but this is just one of the many changes Investment Fund (GPIF) of Japan, reputed to be the ces contain the most profitable and valuable companies. next almost completely irrelevant to its long-term strat-
that will be impacting our industry in the coming months world’s largest pension fund managing $1.4 trillion The most profitable and valuable companies in the world egy. Refusing the available securities lending revenue
and years. of assets, mostly through outsourced fund managers, are, at least currently, fossil fuel extractors and processors. is, therefore, arguably a fiduciary mistake but only if the
announced recently that it had decided to cease lending Investing in a passive fund may well get a piece of Apple, measure of success of the fund is no longer accounted for
However, there are other changes afoot reflecting trends its foreign equity assets. Debt instruments will continue Google and Facebook, but will also undoubtedly include in terms of overall financial provision for the pensioners
in the wider financial markets. These may well be a little to be lent and domestic Japanese equities remain una- ExxonMobil and Chevron. it serves, but instead includes a measurement of compli-
less tangible than SFTR but are nonetheless important. vailable to borrowers. The decision to abandon around ance with ESG principles.
In fact, the convergence of certain, sometimes conflict- $115 million of annual revenue (averaged over 2015 to The International Securities Lending Association (ISLA)
ing, market influences are potentially creating negative 2018) attributed to this activity was considered a price launched the ISLA Council for Sustainable Finance (ICSF) Few can claim to have not noticed the general shift in
impacts to the very markets that they are, at least indi- worth paying to support their environmental, social and last December. The announcement indicated that this investment funds on offer today, including the rise in
vidually, supposed to be improving. governance (ESG) objectives. launch had been the culmination of some 16 months of ESG-style funds and responsible investing as a new
preparation work, suggesting that this was not a knee age mantra. For some, the simple financial returns of an
Passive investment levels have risen dramatically over Explaining the decision to curtail lending, the executive jerk reaction, but the recognition of forthcoming changes investable asset are not the sole, or perhaps even key,
recent years. In 2017, according to the FCA, passive managing director and chief investment officer of GPIF, in the market. The stated objective of this council of determinant in the decision to invest. Balancing the activ-
investment funds in the EU accounted for 30 percent Hiro Mizuno, cited a lack of transparency with regard to experts is the promotion of “sustainable securities lend- ities of the securities finance industry with ESG principles
of total investment, up from 15 percent in 2007. In the who is borrowing shares and for what purpose as a sig- ing” through the promotion of new and relevant princi- will not be an easy task, but the opening of ideas for fund
US, as of 2018, passive funds control 43 percent of the nificant factor. ples that will assist the adoption of ESG principles into performance beyond the traditional basis point returns is
total investment market. The UK has seen passive funds securities lending practices. likely part of the solution.
rise from 6 percent in 2006 to 16 percent in 2016. Part Further, with an investment time horizon of 100 years, the
of the driver for this is the pressure to reduce fees; many GPIF has made it clear that focusing on short-term gains It will be interesting to see how this works in practice
large investment managers now provide zero fee invest- and strategies conflict with meeting its overall investment and how such principles can be implemented, particu-
ment funds and others zero fee brokerages. To achieve objectives, including ESG considerations. With such a larly when many consider there to be a potential conflict
this, cheaper to run passive funds are promoted, along bold move, just as other funds and fund managers are between a fund managers fiduciary responsibility to its
with securities lending vehicles to raise cost offsetting increasing their involvement in securities lending to boost clients to make the best returns possible and some of the
additional revenues. revenues, it begs the market to question whether there new ESG objectives.
has been a fundamental shift away from simply measur-
In a zero-sum game, rising passive investment must ing the financial returns of a fund in basis points. Meeting The GPIF has stated that transparency was a key issue David Lewis
replace actively invested funds. This process, in short, ESG objectives and expectations of responsible investing for it, and specifically the impact of not knowing whether Senior Director
crowds index equities while removing analysis and may well replace the simple financial results by which its assets were being borrowed to facilitate short sell- FIS Global
research bandwidth from the wider investment market, funds are measured. ing activities. Given the implication that the GPIF may

16 17