Investments in companies that contribute to the best interests of our planet provide hope for a more sustainable future, while also producing long-term returns for investors. Asset managers are attracted, since they are under both direct risk from climate-related disasters impacting commodities and global economies and indirect risk such as changing consumer preferences and increasing scrutiny and pressure by governments and regulators.
Those investors interested in putting their money where their values are can now find such investments available from brokerage firms and mutual fund companies that have begun to offer exchange-traded funds (ETFs) and other financial products that follow environmental, social, and governance (ESG) criteria, which are a set of operating standards that concerned investors can use to evaluate and choose between potential investments.
- Environmental criteria examine how a company advocates for the preservation and conservation of the planet and a champion of nature.
- Social criteria focus on the quality of a company’s relationships with employees, suppliers, customers, and their community.
- Governance evaluates a company’s leadership, executive pay, performance on audits, quality of internal controls, and protection of shareholder rights.
ESG criteria also helps investors avoid investing in companies that might pose greater financial risk due to their environmental or other practices and the potential for disastrous incidents resulting from them.
The EU Leads the Way
The European Union has introduced a broad selection of legislation designed to promote ESG issues, including the EU Sustainable Finance Action Plan, The EU Taxonomy Regulation, the EU Sustainable Finance Disclosure Regulation (SFDR), the EU Low-Carbon Benchmarks Regulation, the Task Force for Climate-related Financial Disclosures (TCFD), the EU Non-Financial Reporting Directive (NFRD), and the EU Shareholder Rights Directive (SDR II).
While this is all EU legislation, many US companies will be impacted depending upon the products and services they provide, and where they market them.
In general, the legislation serves to promote six environmental priorities:
- Climate change mitigation
- Climate change adaptation
- Sustainable use and protection of water and marine resources
- Pollution prevention and control
- Protection of healthy ecosystems
- Transition to a circular economy
This last indicates a shift from production that ultimately generates waste to an economy in which everything returns to the ecology to produce more benefit.
Defining and Promoting Sustainable Activities
All the EU legislative activity demonstrates their recognition of the importance of having everyone contribute to a sustainable future, including corporations and investors.
Defining sustainable activities provides clarity on what is conducive to environmental improvements and deserving of financing and what is harmful and in need of improvement or retirement.
Defining sustainable activities also provides an all-important bridge between environmental and financial performance. This can be a useful and highly valid decision-making tool in determining which companies, activities, or projects should be financed when the investor wishes to be ‘environmentally sustainable’. The SFDR and Taxonomy Regulation definitions also help combat so-called ‘greenwashing’ where marketeers attempt to pass off certain activities as ESG qualifying, when objectively they are not.
Aligned activities can expect more financing and should thus experience stronger and more consistent growth. Green bonds, loans or mortgages are considered aligned if the funds are invested in creating compliant activities and resources.
The universal benefit comes from the driving of capital into sustainable products and services for the foreseeable future.
Index License Management Impacts ESG Investing
If you agree that lax oversight, weak operational standards, and lacking commitment all contribute to the potential for difficult or irrecoverable disasters, as well as benefiting from the growth in renewable industries, you will agree that ESG strategies are valuable to investors. Equity and fixed income ESG indexes are used by institutional investors for index-based investment products, risk and return analysis, and to ensure compliance with ESG mandates. Indeed, in the EU it is now a legal requirement to ensure funds promoted as ESG meet the criteria set down under Articles 8 and 9 of the SFDR.
While all index providers have been trending upward, a recent study noted that the biggest increases were seen among ESG indices, which saw revenues soar by 31.3% in 2019, highlighting the commercial opportunity of ESG.
Index License Management (ILM) helps asset managers keep track of their licensing of relevant indices for use in their various portfolio products and services. As investors seek to incorporate ESG factors into their investment decision making processes they face two key priorities, remaining compliant with internal, governmental, and provider contractual obligations for the use of their indices, and control over their index spend.
At Calero-MDSL, our ILM system was originally designed to help document and managed index license expenses for market data managers. It has since been evolved to help firms meet these regulatory obligations by providing a management tool that tracks benchmark usage serving as a repository for all license agreements, indexes and families, and catalogs from third party index aggregators. These features allow firms to reconcile their inventory of index licenses onto their range of index linked portfolios, funds, structured products, user licenses, and more. We believe this could now also include maintaining the ESG compliance properties of your index inventory.
Help Us Protect the World
ESG represents an unprecedented opportunity to align the return requirements of investors with assets, resources, activities, and companies that are committed to improving life on our planet. Talk to us about how you can use ILM to ensure your ESG investment products are accurately licensed and documented.