now loading...
Wealth Asia Connect Middle East Treasury & Capital Markets Europe ESG Forum TechTalk
ESG Investing / Understanding ESG / Asset Management / Wealth Management
Climate goals spur ETFs based on net zero indices
Demand grows for benchmarks that guide investors in aligning portfolios with efforts to achieve carbon neutrality
Bayani S. Cruz 6 Dec 2021

As the need to shift investments towards fighting climate change becomes more urgent, demand for net-zero indices to benchmark investment portfolios has been increasing rapidly.

What is not widely known is that exchange-traded funds (ETFs) based on net-zero indices have entered the market, quietly accumulating billions of dollars in assets. However, there are not that many net-zero indices in the market yet.

“We have seen a huge uptick in demand for indices that are net-zero-aligned. We already have a suite of current ESG indices but none of these has been designed to be net-zero-aligned,” Jaspreet Duhra, global head of ESG indices at S&P Dow Jones Indices, tells The Asset in an interview.

In response to this trend, S&P DJI launched the Paris-Aligned & Climate Transition (PACT) indices in June 2020. As the name implies, these indices track the performance of eligible equity securities, selected and weighted to be collectively compatible with a 1.5ºC global warming climate scenario set by the Paris Climate Agreement adopted globally in 2015. The PACT index series was recently renamed to S&P Net Zero 2050 Climate Transition ESG Index Series and S&P Net Zero 2050 Paris-Aligned ESG Index Series.

The PACT indices were designed in accordance with standards for net-zero indices set by the European Union (EU) as well as standards from the Task Force on Climate-related Financial Disclosure (TCFD).

“The EU has put out guidances for what a low climate benchmark should look like or specifically a benchmark that’s claiming to be net-zero-aligned. That really helped us because that was the foundation of the indices that we have designed. So we’ve made sure we have met all their rules. We also aligned the indices with the TCFD, a really popular framework that’s been taken up by regulators, by companies, by investors to report against,” Duhra says.

ETFs

The PACT indices were well-received by ETF providers and a total of seven ETFs have been launched based on these indices with total assets amounting to over US$5 billion.

These include:

*Franklin S&P 500 Paris Aligned Climate ETF launched on July 7 2020 with US$80.16 million in AUM as of December 1 2021; 

* iShares S&P 500 Paris-Aligned Climate ETF launched on April 22 2021 with US$4.5 million AUM as of December 1 2021;

* Lyxor Net Zero 2050 S&P 500 Climate UCITS ETF launched on July 15 2020 with US$457.3 million as of October 29 2021; 

* Lyxor Net Zero 2050 S&P Europe Climate UCITS ETF launched on September 16 2020 with US$75.6 million as of October 29 2021;

* Lyxor Net Zero 2050 S&P Eurozone Climate UCITS ETF launched on July 6 2020 with US$1.02 billion in AUM as of October 29 2021;

* Lyxor Net Zero 2050 S&P World Climate UCITS ETF launched on September 16 2020 with US$161.41 million in AUM as of October 29 2021;

* Lyxor Net Zero 2050 S&P Europe Climate ETF (Germany) launched in September 16 2020 with 75 million euros in AUM as of October 29 2021. 

In addition to the ETFs, massive segregated mandates from institutional investors have also been launched based on the PACT indices or methodology. For example, the Federal Government of Germany mandated S&P DJI to develop the S&P ESG Eurozone 60 Bund-SV Index, a customized index using a methodology based on the PACT, which will serve as a performance benchmark for four of the government’s federal special pension funds.

“And we’re seeing more interest in net-zero indices. When we’re talking to clients, say, in Europe, 70% of the meetings are about net-zero-aligned indices. So it’s definitely an area where we see a lot of momentum, a lot of active conversations,” Duhra says.

Structured products

Interest in net-zero indices is so strong that on November 22 2021, S&P DJI launched a version of the PACT indices that is designed for structured products providers.

Known as the “S&P Net Zero 2050 Paris-Aligned Select Index Series” (PACT Select), these indices are specifically designed as underlying indices for the structured product market which has been increasingly incorporating ESG principles.

The PACT Select indices measure the performance of a targeted number of the largest float-adjusted market capitalization companies designed to be collectively compatible with a 1.5ºC global warming scenario. Companies that are involved in controversial weapons and tobacco business activities, and ESG controversies, or are non-compliant with the United Nations Global Compact (UNGC) principles are excluded.

“Our S&P Net Zero 2050 ESG index offering includes indices that bring greater transparency in measuring climate-related risks and that have been designed to cater to the structured product market. S&P DJI is committed to helping our customers and market participants address climate change and achieve their goals in the path to net zero by 2050,” Duhra says.

Index and ratings teams

S&P DJI ESG Indices works closely with its sister firm S&P Global Sustainable 1, a data provider that at its core has an ESG ratings business acquired from RobecoSAM in January 2020. The acquisition included the widely followed SAM Corporate Sustainability Assessment (CSA), an annual evaluation of companies’ sustainability practices which is recognized as one of the most advanced ESG scoring methodologies with a 20-year track record.

“We’re independent companies. They will do the ratings on the companies and then, in the index team, we construct the indices. So we decide what rules are going to be for an ESG index or climate change index. We use data from multiple sources and one of those sources is the SAM team which is now part of S&P Global,” Duhra explains.

The way it works is that S&P DJI’s ESG index team provides feedback to the S&P Global ESG ratings team on what type of data they need for the index team’s coverage and the ESG ratings team takes this feedback into account in their data generation. Likewise, when the ESG ratings team has new data areas that needs to be filled, they work closely with the ESG index team.

Although the ESG index team does not necessarily have to used data provided by S&P Global, Duhra says: “We prefer to use our own in-house data (i.e., SAM) because we have a say in moulding that and we think our in-house data is superior when it comes to ESG ratings and climate. But where we might have a data gap, we’re free to source that data from elsewhere.”

ESG scoring systems

What can be confusing to an outsider is that the S&P DJI group has two ESG scoring systems for companies that are similar but not exactly the same.

The ESG index team has its own ESG scoring system, the S&P DJI ESG Scores, which is used for index construction, while the ESG ratings team has its own scoring system, the S&P Global ESG Scores, which is used for rating individual companies.

They are similar in the sense that the S&P DJI ESG Scores is based on the S&P Global ESG Scores, but they are different in the sense that the ESG index team tweaks the latter to achieve a normalized score across an industry group.

“Also, we’re not so harsh on companies not disclosing on what we call non-mandatory criteria whereas with the S&P Global Scores, they would immediately get zero. We’re trying to give companies a chance that might not participate in what we call the CSA, the corporate sustainability assessment, which is the proactive research that S&P Global does with companies, that sends them surveys, that asks for in-house information,” Duhra says.

On the issue of the same company getting two different ESG scores from the same group, Duhra explains that what’s important is that the company engages with the scoring entities. In the case of S&P DJI and S&P Global, this is participating in the CSA process.

“Generally, if you’re participating in that process, you’re getting a better score because you’re engaged in sending documentation through. So we make a couple of adjustments. So we do have our own scores but the foundation of them is the S&P Global ESG Scores,” Duhra says.

Conversation
Jenn Hui Tan
Jenn Hui Tan
global head of stewardship and sustainable investing
Fidelity International
- JOINED THE EVENT -
4th ESG Summit Webinar Series - Part 1
Paving the way toward net zero
View Highlights
Conversation
Danielle Welsh-Rose
Danielle Welsh-Rose
head of the Sustainability Institute, APAC, and ESG investment director, Asia Pacific
abrdn
- JOINED THE EVENT -
Webinar
APAC Climate Change Progress & Obstacles in 2022
View Highlights