SRP spoke to Ulrich Stoof, Emea product manager, derivatives licensing, and Christine Chardonnens, executive director and product manager for environmental, social and governance (ESG) indices at MSCI about ESG. In the first of two articles, Stoof and Chardonnens talk about the creation of ESG indices and the appreciable increase in interest from structured product providers in these underlyings this year.
The amount of investment that MSCI has dedicated to the development of research and indices that based around all elements of the environment and social and corporate governance has led to the creation of benchmarks that reflect the markets they cover, rather than single, bespoke indices that are tailored to work within the constraints of specific investment products, according to Ulrich Stoof (pictured), Emea product manager, derivatives licensing at MSCI.
"Some providers of indices have worked with external ESG research houses to create underlyings for a specific structured product or pay-off in mind. These indices function well for this purpose but are often less representative for the whole ESG market, in the sense of a benchmark," said Stoof.
MSCI starts from the basis of research. "We are an integrated analytics, index and ESG research provider," said Stoof. "In contrast to other index providers, we are also ESG research providers. Our ESG research team has grown organically and parts of the ESG business, before they came to MSCI, have been in existence for about 40 years: KLD, for example, which was acquired by MSCI, has done ESG research for a long time. "In our ESG research team, we have 160 analysts who just do company, bond, fund and sovereign ESG ratings, covering 6,000 companies, 9,000 issuers, 350,000 bonds and over 20,000 funds," said Stoof. "We sell this research to asset owners, consultants, asset managers and banks, in differentiated products which provide different granularity in respect to ESG rating and descriptor data. And we also use this research to create ESG indexes."
"We have seen significantly more interest in environmental and ESG indices this year than in previous years," said Stoof. "We had conversations with financial product providers last year and years before, but really this year the level of interest and engagement in ESG as a general theme is not comparable to the years before. That's more for the structured products providers, not asset managers and owners, who have been invested and using ESG research for far longer. Why are they interested? It depends on their client base, but all are more interested, particularly as a result of increased of several UN initiatives like the COP 21, regulatory pressure and overall investor awareness."
When it comes to creating structured products, "you need to ask what is the purpose of using the index: to serve as a benchmark, an underlying for a passive investment or ETF, or an underlying for a tracker or structured products," said Stoof. "What are the characteristics an index has to have to be appealing to this audience? Some are more driven by the product design.
"Structured products offer a relatively flexible instrument with an interesting payoff, which enables people who would not have access to this strategy," he said. "Then you have to look at, as an underlying, what do you need for an interesting structured product. These products should be tactical in what someone tries to achieve, because the payoff is good or it does something you can't do or don't want to do with another investment instrument.
"We do a lot in customising indexes for structured products, indices are used and designed differently compared to say an ESG benchmark for an asset owner said Stoof.
"The Nordic countries have been in the forefront of ESG integration and use of ESG Indices, so has France, to some extent due to regulations, and Europe overall," he said. "It's coming in other regions, but not quite where it is in Europe yet. The Asian markets so far have seen less use of ESG data in the investment processes.
"We differentiate between three distinct approaches to ESG investing," said Stoof. "A value-based ESG approach, where the investor seeks to avoid conflict with his values by excluding specific securities, an impact-based, which focuses on the impact a company potentially has generally measured by revenue percentage linked to a particular theme, eg. products and services related to pollution prevention, and then there is an integrated or risk-focused ESG approach, which is more about mitigating risks related to issues which traditionally were seen as non-financial or not material but are now considered relevant particularly on a medium and long-term horizon. Our indices are aligned with these different purposes, such as implementing ESG criteria to mitigate risk or any kind of substantial misalignment from values.
"Within the MSCI Sustainable Impact Index, for example, securities are included which align with the United Nations Sustainable Development goals, which can be environmental, addressing issues with natural capital and climate change, but are also social, which can be social empowerment and covering basic needs," he said.
According to Christine Chardonnens, executive director and product manager for environmental, social and governance (ESG) indices at MSCI, "value-related exclusions can be related to companies which are generating revenues from the businesses like tobacco, weapons, nuclear power. They tend to be quite specific to some investors, and vary from one country to another, by client segment, although some are quite common across the board, like controversial weapons. Although people are quite split on whether nuclear is good or bad.
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