Following Commerzbank's licensing, in early September, of Solactive's Global Ethical Low Volatility AR EUR Index, an underlying for a wide range of products including capital protected and more complex structures for retail and institutional investors, SRP spoke to the bank's equity derivatives team about: developing a suite of products with high environmental, social and governance (ESG) standards; what is driving ESG; and how to differentiate the offering in an increasingly crowded market.
Commerzbank has been looking at ESG indices for some time, with the aim of producing new structured products, according to Robert Roe (pictured), an equity and hybrid derivatives structurer at Commerzbank in London. "Our first foray was via the Dow Jones Sustainability indices (the DJSI Ethical Europe Low Vol Synthetic PR Index); we also looked at indices which had a smart beta angle, as this is what our clients are demanding," said Roe.
The bank decided to partner with Sustainalytics and Solactive to develop an ESG gauge, the Solactive Global Ethical Low Volatility AR EUR Index, as it "would enable us to respond to demand via an index that provides exposure to companies which adhere to the highest possible ethical standards, while remaining diversified geographically and reducing risk".
The number of providers developing ESG strategies has increased dramatically and it is difficult to find differentiating factors, which is why use of the new index is currently exclusive to Commerzbank, according to Varun Mahajan, European head of equity and hybrid structuring at the bank.
"One thing we noticed during the research and developmental stage is that there are many European ESG/smart beta indices already used in the structured products market, but we couldn't find any global indices which could provide global exposure to companies with high ethical standards along with smart beta filters," said Mahajan. "That's why we decided to create this ethical index, which would provide exposure to companies around the world."
The choice of research material was based on the value of the data used in the index. "Sustainalytics does not only have a comprehensive quantitative research in order to apply an ESG rating on the companies within the global benchmarks, but it has comprehensive qualitative research capabilities," said Roe. "It uses a rating system that makes it very easy to identify global stocks that meet the ESG criteria for inclusion in the index. Any company that has been subject to any rumour or is involved in any controversy surrounding ESG principles shows up in the monitoring system and are excluded from the Index. This brings transparency to the selection and shows how important the data is for building an index."
The bank reviewed all the index calculation agents and the ethical screenings available, according to Remi Collignon, another structurer at the equity & hybrid derivatives structuring team. "We discussed our initiative with the main index providers to see what kind of solutions they had and also to see what kind of ethical screenings they would offer as part of their service," said Colligon. "All the parties we approached had a very comprehensive ESG set up, but we decided to go with Solactive because it is a very innovative and flexible outfit."
Commerz has previously worked with MSCI and S&P, and is also starting to work more closely with Stoxx, "because they have a very interesting proposition with their range of structured products optimised indices," said Mahajan.
"The goal after licensing the index is to build a comprehensive range of solutions that can be delivered via different vehicles, depending on the needs of the investor," said Mahajan. "We have started with a Swedish krona-denominated structure, because we have seen a greater demand for this kind of product in Sweden and other Scandinavian countries. Germany is obviously a target market for this new range, but our salesforce covers the whole of Europe and we expect the new range will resonate in other markets as well."
This kind of product is typically bought by institutional investors and pension funds, but the bank is not limiting the offering to those investors. "We want to offer this to a wider investor base; we believe there may be appetite in the retail market for ESG-based solutions," said Mahajan. "Semi-institutional managers, such as independent asset managers and brokerage houses, are also potential users of the product, because professional investors understand ethical investing and its role in portfolio management."
This part of the market will become mainstream in the medium term on the back of its acceptance by retail, according to Mahajan. "We already see a large amount of ESG products being purchased by retail investors in some markets and we think this may trickle down to other markets," said Mahajan.
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