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Divi Chat Podcast and Blog
Divi Chat Podcast and Blog
Divi Chat Podcast and Blog
Divi Chat Podcast and Blog

THE GREENING OF SECURITIES FINANCE:

THE PATH FORWARD

To the Audit Committees of Securities Lenders:

Thomas Jefferson said that we are only stewards of the wealth of our generation, held in usufruct for the next.[1] In that spirit, we are pleased to report on the evolution of best practices for ESG compliance in the securities finance community. Sustainability must be a core morality in a market where each day tens of thousands of professionals work alongside their industry partners to reinvest the savings of more than $1.7 trillion held in trust for our dependents.

Securities finance, perhaps more than any other global industry, demands practices which are not just socially acceptable, but also contribute to a rigorous discipline for governance and environmental sustainability. For nowhere else is society more dependent on honesty and fair play than nearest the treasure chest.

Our metrics in this study will be auditable, made accessible by compiling the confidential data for securities financing transactions in a data trust under the control of trade-matched, unique transaction identifiers validated by an encrypted, blockchained journal and distributed ledger.

 

We welcome your questions and comments, either now or when we meet at the next industry conference.

Thank you for considering participation in our inaugural 2022 Annual ESG Report, “The Greening of Securities Finance: The Path Forward.” We welcome your questions and comments, either now or when we meet at the next industry conference.

I. PROXY METRICS: BALANCING THE VOTING – INCOME TRADEOFF

This phase of the study will update our 2010 examination of academic allegations of borrowed proxy abuse by responding to recent academic criticisms of negligent stewardship by asset managers in balancing the loan-proxy tradeoff. Using new data sources, mapping techniques, and database technologies, we will examine activity spike periods around proxy record dates for evidence of loan recall / substitution breakdowns in relation to the uninstructed voting capacities of broker-dealers in the context of their borrowing volumes. This study and confidential report is intended to be a control group for the data sources and a proof of concept for the algorithms and statistical methods we plan to employ for end-to-end mapping in Phase II.

GOVERNANCE BEST PRACTICES

a. Causes and significance of activity spikes near proxy record dates
b. Substitution dynamics for recalls by lending agents and prime brokers
c. Edge-to-edge reporting for securities lenders

Trades / Models

Trades / Models

Documents / Surveys

Documents / Surveys

Many factors are involved in recall dynamics. But if principals have enough relevant data to avoid contributing to market instabilities, they could reduce record-date potential for pricing volatility and short squeezes. For example, if the timelines and results of past recalls were better understood, e.g., ten working days lead-time, it  would be easier for lenders to comply with minimum recall  standards. At present, there are no specific metrics  available to guide lenders on the best way to optimize their proxy recall processes. Historical, industry-wide aggregates describing recall efficiency, relative to proxy significance,  specialness, and other factors, would be helpful.

Disclosure of aggregate, security-specific results by a neutral entity could also reduce the periodic confusion experienced by academics and regulators when considering the cause of spikes in lending activity around record dates.

II. CROSS BORDER COMPLIANCE: PREVENTING TAX AUDITS

By pooling policy documents and risk profiles with the datasets from Phase I, this study will examine cross-border securities lending transactions over dividend record dates, by mapping inter-market transactions on an end-to-end basis to elicit each borrower’s purpose. In doing so, transactions with benign purposes, including recalls, can be separated from indeterminate or potentially abusive purposes.We anticipate that parsing transactions in this manner could be useful to regulators and taxing authorities in the European Union, for example, who have been vexed by tax withholding reclaim schemes and searching for methods to detect them.

SOCIAL BEST PRACTICES

a. Causes and significance of activity spikes near dividend record dates
b. Regulatory outreach and tax compliance in cross-border finance
c. Hedge Funds as change agents, per the UN "Principles for Responsible Investing"
d. Systemic risk mitigation in clearing and settlement of cross-border securities loans

Trades / Models

Trades / Models

Documents / Surveys

Documents / Surveys

We believe it may now be possible, despite the fungibility of securities and the fluid accounting practices of prime brokers, to track many, and perhaps most securities loans through the use of encrypted, shared ledgers. We believe that an intermarket and cross-
border cryptographically-encrypted, append-only, shared ledger may be able to solve the modern problem of withholding tax fraud in the European markets, by virtue of its ability to validate a securities loan’s economic substance or the lender’s exempt status to the satisfaction of the taxing authorities. In addition, if institutional investors voluntarily support the ledger, it could also be reported as an ESG social benefit from the securities finance community to the global capital markets. And, if successfully developed, U.S. mutual funds and other institutional investors could be largely spared the burden of intrusive audits of their cross-border loans by the IRS and EU tax authorities.

III. DATA TRUSTS AND SHARED LEDGERS:
GIVING CONTROL BACK TO THE PRINCIPLES

By pooling policy documents and risk profiles with the datasets from Phase I, this study will examine cross-border securities lending transactions over dividend record dates, by mapping inter-market transactions on an end-to-end basis to elicit each borrower’s purpose. In doing so, transactions with benign purposes, including recalls, can be separated from indeterminate or potentially abusive purposes.We anticipate that parsing transactions in this manner could be useful to regulators and taxing authorities in the European Union, for example, who have been vexed by tax withholding reclaim schemes and searching for methods to detect them.

SUSTAINABILITY AND ENVIRONMENTAL BEST PRACTICES

a. ESG compliance as an evolving principle in RFP reviews of agent securities lenders
b. Sustainable and activist strategies at trusted hedge funds, by the numbers
c. Practical aspects of "green bonds" as segregated ESG collateral
d. Exclusive ESG lending arrangements at prime brokers

Trades / Models

Trades / Models

Documents / Surveys

Documents / Surveys

We believe it may now be possible, despite the fungibility of securities and the fluid accounting practices of prime brokers, to track many, and perhaps most securities loans through the use of encrypted, shared ledgers. We believe that an intermarket and cross-
border cryptographically-encrypted, append-only, shared ledger may be able to solve the modern problem of withholding tax fraud in the European markets, by virtue of its ability to validate a securities loan’s economic substance or the lender’s exempt status to the satisfaction of the taxing authorities. In addition, if institutional investors voluntarily support the ledger, it could also be reported as an ESG social benefit from the securities finance community to the global capital markets. And, if successfully developed, U.S. mutual funds and other institutional investors could be largely spared the burden of intrusive audits of their cross-border loans by the IRS and EU tax authorities.

AMICUS / REBUTTAL BIBLIOGRAPHY

Official Guidance and Standards

OFFICIAL GUIDANCE AND STANDARDS

INDUSTRY WHITEPAPERS AND STANDARDS

EUROPEAN UNION

RECENT PRESS