Euronext: risk of fragmentation in ESG products is counterproductive

There is no doubt that sustainable finance and ESG products are becoming increasingly important to policy makers and financial participants around the world, according to panellists of Derivatives market and ESG indices: the quest for the right approach, an online webinar organised by Euronext on 1 December.

“Passive instruments and the derivatives market have a key role to play in the transition to a sustainable economy and in the recovery from the coronavirus pandemic,” said Martina Macpherson, SVP, strategic partnerships & engagement, at Moody’s. “Both issuers and investors will be looking to the derivatives market to hedge their exposures.”

We even start to see hedge funds investigating the ESG journey - Neven Graillat

Neven Graillat (pictured), chief sustainability product officer at BNP Paribas, said that sustainability is a long journey where the whole bank is committed to delivering for all its clients.

“The biggest trend we see today is that ESG is part of the discussion that we have with all our types of clients. At first, it was mainly issuers and institutional clients. Now we see that for retail investors it is a fundamental issue for them too,” he said. “We even start to see hedge funds investigating the ESG journey, trying to understand how it will impact the performance of the fund, and how they need to incorporate and integrate ESG into their asset allocation.”

According to Fabrice Rahmouni (right), head of indices at Euronext, sustainable finance is part of the exchange’s DNA. “The first low carbon index ever created in Europe was created by Euronext in 2008, 10 years before COP 21,” he said, adding that in 2019, more than 50% of ESG structured products sold in Europe were based on Euronext ESG indices.

SRP data confirms that last year 107 structured products worth a combined US$2.5 billion were linked to Euronext ESG indices, of which the Euronext Climate Objective 50 Euro EW Decrement 5% Index – seen in seven products issued on the paper of Natixis – collected combined sales of US$967m.

In 2020 to date, there have been 148 products with estimated sales of US$2.1 billion that were tied to indices developed by the exchange. The Euronext Climate Objective 50 Euro EW Decrement 5% Index was once again the best performing with sales of US$989m from 18 products, again exclusively issued via Natixis.

Biodiversity and oceans, another important topic, according to Graillat, is also captured by Euronext in its Water and Ocean Europe 40 Equal Weight Decrement 5% and 4% indices.

“We work with Euronext on new solutions to deploy thematic strategies and a critical issue to tackle are oceans,” he said.

But Building an ESG index for derivatives is not an easy exercise. “E, S and G criteria are sometimes very different. The position of the index should be clear, how you combine them and how you prioritise them,” he added.

Understanding the end-investor is of utmost importance, according to Derk Lutgert (right), head of corporate strategy at Optiver.

“If the end-investor has a need for ESG derivatives to meet their portfolio goals there is also a need for issuers and exchanges to launch these products,” he said. “For this green transition to really succeed, investor trust in ESG products is really key. Trust that these products will offer the return that they are looking for, and trust that these products could also replace traditional benchmarks in the future.”

Given the amount of money that is deployed and shifting to ESG, it is starting to be perceived as a risk, and especially when it comes to climate change, as a risk that needs to be managed. “In the beginning the question was more ‘how can I get a positive impact from my investment’ and now the new storyline that we see is ‘how do I manage my climate risk’,” he said.

Optiver is not blindly supporting all ESG launches.

“We believe that the risk of fragmentation in ESG products will actually be counterproductive, because in a fragmented market trading costs will increase, and by launching ESG products with limited investor demand or commitment from the exchanges we just run the risk of overcomplicating the space creating confusion, and worst case, for investors to lose trust in the ESG segment,” Lutgert said.

There are 302 live structured products linked to Euronext ESG indices listed on the SRP database. The majority of those (221 products with sales of more than US$5.5 billion) are targeted at investors in the French market.