Short changed: Japan’s Move Toward Responsible Investing Strains Stock-Lending

The fallout from Japan’s public pension fund’s decision to no longer allow overseas shares to be lent out from its ¥80tn ($733bn) global equity portfolio continues to divide opinion, with experts unsure the move will have its intended effect of negating short selling.

The Government Pension Investment Fund (GPIF) is the world’s largest single asset owner, holding more than $1.6trn, so when it talks, as it did in December 2019 in announcing the decision, the market listens.

The fund said stock lending “effectively creates a gap in the period in which the stock is held by GPIF, and can be considered to be inconsistent with the fulfilment of the stewardship responsibilities of a long-term investor.” It said the current stock lending scheme “lacks transparency in terms of who is the ultimate borrower and for what purpose they are borrowing the stock.”

Shares in its $370bn overseas equity portfolio were immediately impacted, and could bring significant disruption to global equity markets if others follow its lead. The move was taken as a strike against short-sellers, in part of efforts to establish the GPIF as an environmental, social and governance-focused leader.

In flagging stewardship concerns, the GPIF referenced long-running arguments over how asset managers are unable to exercise their voting rights on stocks which have been borrowed, and the limited transparency of the borrowers’ voting intentions.

Asset owners who lend the stock cannot be sure of how stock votes are being used, and whether they are being used in line with their views for example on climate change, the argument goes.

As a result, GPIF will no longer lend overseas stocks until lending schemes strengthen their processes and enable GPIF to ensure its investments reflect its responsible investment policies.

Traders in Tokyo said the threat the GPIF’s decision posed is that other asset managers may feel obliged to copy and label the practice of short selling as “non-ESG”, a theory which has been discussed at regulatory level.

At the end of 2019, the European Securities and Markets Authority (ESMA), which oversees securities trading regulation in the European Union, floated new rules to tackle “undue short-termism” in markets, on the basis that investment for environmental and social aims is tied to thinking about the more distant future.

Others believe the move is merely symbolic, and will have minimal impact on market fundamentals.

“It is important to dispel any myths that securities lending is somehow incompatible with ESG and good stewardship,” said Mick Chadwick, head of securities finance at Aviva Investors. “This is particularly significant given the importance of an orderly and efficient securities financing market as part of the broader sustainable capital markets agenda.”

There are currently several aspects of securities lending that can present issues for ESG-minded investors, such as when a stock is out on loan, the voting rights go with it, ensuring the asset owner cannot engage with its portfolio companies.

“This is a contentious point and is inextricably linked to your philosophical position on short selling,” said Jennifer Davidson, analyst at LCP financial advisers. “Many believe the existence of short-sellers is essential for accurate market pricing, to prevent overpricing caused by a market rush, and to aid liquidity. This would support the continued practice of stock lending.”

Tesla boss Elon Musk backed the GPIF in a tweet: “Bravo, right thing to do! Short selling should be illegal”. Baillie Gifford partner Charles Plowden also said it was a good idea, adding that share lending “recognizes little responsibility to society and accordingly contributes little to it”.

However, BNY Mellon’s Paul Solway said although the decision was a shock, it has not proved as seismic as some were predicting.

“We’ve not seen any measurable wider market impact from the GPIF suspension so far, which may suggest that beneficial owners agree with the ESMA conclusions that lending and long-term investment are entirely compatible,” he said. “That said, it is more important than ever to have a strong corporate governance policy underpinning lending activity.”