Ethical investments and structured products I: £1.7bn AUM and counting

Socially responsible investments started as a niche market in the early 2000s and over the years have been incorporated by pension funds and asset managers to their mandates. The concept is not new in the structured products market with UBS issuing the first leverage certificate (Open-End Zertifikat) linked to the FTSE4Good Europe 50 in 2001, which was followed by another 29 products featuring FTSE4Good indices brought to market in different European jurisdictions in the run up to the 2008 crisis.

Although ‘ethical investments’ became part of the theme-based investment trend prior to the financial crisis which saw sports-, catastrophe-, and infrastructure-linked structured bonds, the use of indices covering environmental management, human and labour rights, supply chain labour standards, countering bribery, corporate governance, and climate change mitigation never became mainstream and have remained on the side-lines.

At the end of 2013, however, at the request of BNP Paribas, Solactive - in cooperation with Vigeo and Forum Ethibel – launched the Ethical Europe Equity index a socially responsible investment (SRI) benchmark comprising 30 liquid European shares which has raised €1.36bn across 59 products since then, of which 37 were marketed by BNP Paribas. The French bank was also behind the first World Bank green bond linked to an equity index which was launched in September 2014 and also licensed in October 2014 the new Solactive Ethical US Equity Index, in a move to expand its range of sustainable structured investment solutions.

Investor’s awareness has increased and providers can now leverage their knowledge and capabilities to shift gear and build a range of structured products covering the SRI segment, according to Jean Eric Pacini, head of equity derivatives sales EMEA, at BNP Paribas.

“For a number of years, there was a lot of talk about SRI investments but with few solutions reaching the market,” says Pacini. “Last year, we saw an inflexion point, with investor demand for these products growing fast. We have seen it with our range of products linked to the Solactive Ethic Equity index, which has now sold over €2bn. We believe this theme has finally taken off and responds to the needs of investors.”

The World Bank green bond, says Steffen Scheuble, chief executive at Solactive, has opened new opportunities for similar products and underlying indices, but also increased the scope and popularity of the SRI concept. “This is a very important area for us, not only because it has a positive effect on our reputation as an index provider, but because we’re part of a success story,” says Scheuble.

SRI investing has been part of the culture for a long time in the Benelux and Nordics, and these countries will continue to be drivers, according to Scheuble. “But we see increasing interest in other markets, such as the UK, France, Germany and Switzerland, and the US is also picking up on the trend,” he says. “We see SRI investments as a fast-growing niche.”

Heike Reichelt, head of investor relations and new products at the World Bank, also believes there has been a shift in the mindset of investors seeking to connect more with social and environmental purposes. “We see that our green bonds are speeding up that trend in the fixed-income market and catalysing the interest from investors to know where their money is going and the positive impact these bonds have for society,” she says. “One of the reasons we are putting so much effort and focus on green bonds is to create awareness for the need to finance these sort of activities. But for all investors - including individual investors - issuers need to make sure the risk-return is appropriate. The financial aspect of these products must also to be appropriate.”

Education
According to Pacini, as the backer of the World Bank index-linked green bond, BNP Paribas has a role to play in education. “After the launch of the first equity index-linked green bond, we engaged with investors in a series of roadshows to introduce and explain the product, and the wider theme,” he says. “We have two roadshows planned in Switzerland and France to promote this new tranche, and we involve representatives of the World Bank in Washington quite frequently.”

Scheuble agrees that education will always be needed to increase awareness. “There are obviously challenges as some countries out there are far behind any SRI approach and there’s a lot of work to do before this theme gets any interest,” he says. “This will change over time.”

BNP Paribas launched the World Bank equity-linked green bond in the Asia-Pacific region back in February and it’s developing a number of products, says Pacini. “The collaboration with the World Bank is not exclusive and we are looking at ways of diversifying our offering in the SRI market with other themes that resonate with investors,” he says. “We are also working with other supranational issuers to develop ideas, and are in constant dialogue with end investors to develop our SRI range to cater for those investors.”

According to Pacini, developing an ethical product range which responds to investors’ demand is not particularly easy. “The definition of SRI varies across clients, we need to find interest from a supranational issuer… and make sure every angle is covered as these are high profile transactions and everything has to fall in place,” he says. “The average time we spend with this kind of products is about four months and that will also influence the frequency of the products.”

This is not the first equity-linked product issued by the World Bank, which was involved in the launch of index-linked uridashi notes in Japan and other countries, but it’s the first index-linked green bonds, says Richtel, pointing at the need to have significant reach to make the investment available to as many investors as possible. “We have the expertise in house to issue structured bonds,” she says. “But BNP Paribas has the expertise to develop this kind of product and the distribution network to reach a wide investor base.”

Target market
Ethical structured products can offer an interesting alternative to investors as low interest rates have created a difficult environment for bond investors who are looking for ways to get a pick-up in yield, says Scheuble, who also points at the increasing demand as an opportunity to develop further underlyings.

Our aim is to bring indices to the market that are used by more than one party,” says Scheuble. “Green bonds have a natural fit within the ESG theme, but when you design an index you have to build the option and the underlying index in a way that the option is cheap. To achieve that, we included a built-in volatility filter and a dividend filter.”

The demand for SRI investments has traditionally come from institutional investors but with initiatives such as the index-linked green bond he believes this theme will resonate with retail investors, according to Scheuble. “[Retail investors] are also looking for yield and are also interested in investing in high quality bonds,” he says. “We believe the combination of good credit ratings and yield/upside will catch the attention of retail investors.”

BNPP has developed variations for private banking and wealth management clients. “Depending on the target market, the product features may vary,” he says. “The idea is to be able to have these index-linked green bonds in all the markets BNP Paribas covers, as it has become a core investment theme that reflects the broader mind set of the bank.

“It’s early days and at the moment we are leveraging our existing sales and structuring capabilities to cover this segment, because we are effectively tapping into the same client base as with any of our other structured solutions,” says Pacini.