The industry is increasingly factoring climate financial risk and other sustainability risk considerations into collateral selection. However, any new ESG criteria applicable to collateral selection must not result in a collateral set which is too narrow as this could disrupt financial stability and liquidity as well as the ultimate goal of an orderly transition process to a sustainable economy.
The paper submits the primary role of collateral is as a risk management tool for the market. It therefore remains vital to ensure adequate diversification of collateral guidelines. Accordingly, the risk analysis for collateral acceptability should continue to take into account all relevant risks, including, but not limited to, sustainability and ESG risks.
The securities lending industry is in a transition phase. Instead of implementing exclusion policies or narrow lists of favoured collateral assets with potentially adverse impacts on risk management and market stability, ISLA considers that appropriate, achievable guidance from regulators and central banks in relation to securities lending and collateral would help to accelerate market participants to the next stage of the path to net zero.
The paper therefore concludes by noting that ISLA considers that the following confirmation/guidance from regulators and central banks in relation to securities lending and collateral would be useful:
- as an investment tool, securities lending transactions (including any associated collateral) do not constitute sustainable investments in their own right, even though they can successfully integrate the sustainability preferences of the lender/asset owner;
- collateral, as a risk management tool, does not need to integrate the same level of ESG screening as the long portfolio of the fund. Eligible collateral guidelines should intentionally constitute broader and more liquid parameters, in order to effectively manage risk; and
- recommended best practice (ideally endorsing industry-led recommendations), as to how businesses that engage in securities lending can convey their incorporation of sustainability factors into collateral eligibility criteria.