ESG – Leaving a Mark on Structured Products
This is the fourth article in a series covering STOXX’s Innovate2Invest annual conference, held in London on May 21.
Institutional and retail client demand is making environmental, social and governance (ESG) strategies a common feature and requirement in the structured-products business, according to a panel of industry professionals at the Innovate2Invest conference.
“From the kind of requests we get from clients in terms of new index creation, I would say for European countries, 80% of the indices have some kind of ESG criteria attached,” said Johannes Ingerfurth, Equity Derivatives Structurer at J.P. Morgan, speaking at the panel.
Ingerfurth mentioned a recent survey where 60% of hedge funds said their clients ask for ESG investments. That contrasts with a share of 21% of hedge funds that are able to offer some sort of ESG, he said. “There is still some flow to come also from the hedge-fund industry.”
Europe’s south catching up
Cultural dissimilarities with regards to ESG exclusions and local regulations set differences in issuance among European countries, said Isabelle Millat, Head of Sustainable Investment Solutions at Societe Generale Corporate and Investment Banking. She added that while northern European investors have been, and remain, ESG pioneers, other countries are catching up.
“To this date, northern European countries are still leaders,” Millat said during the debate. “To give an example, for institutional clients in Belgium my sales force tells me it is not even worth coming to them with a structured investment idea if it doesn’t entail some sort of sustainable feature. However, I see ESG adoption going south, in the good sense of the term.”
Armelle Loeb-Darcagne, Managing Director and Head of European Sales at STOXX, as well as moderator in the debate, asked how deeply embedded ESG strategies had become within structured products.
Ingerfurth at J.P. Morgan said Europe remains the most advanced region in this sense, with the Nordic markets still leading, while countries such as Spain and Italy are embracing them at a growing pace.
“I started in this industry in 2015 and I remember back in the day, in Europe there was not so much investment in ESG but a lot of people asking questions about it,” he said. “I think in the US we are at this stage now. In Asia, there are some trades in Japan but we are still at a quite early stage.”
The role of regulators
Regulation of ESG structured products was a recurring topic during this discussion, as it was during other panels throughout the event. A previous article reported on experts’ views on rules governing ESG strategies.
Michael Herly, Vice President for Equity Derivatives Structuring at Credit Suisse, mentioned the example of the Belgian regulator, which has set, according to him, “very strict rules” as to what constitutes an ESG index or structured product. This has impeded indices that were branded as ESG but whose responsible selection was light, he said.
Millat of Societe Generale agreed that new rules can be “a help or also a hurdle.’ As an example of the former, she mentioned the case of the French regulator, which she said recently led a consultation that resulted in a common set of standards for ESG indices sold in the retail structured-products industry.
“That was good practice both in terms of the process and in terms of the content,” she said. “The process was very collaborative. In terms of the content, the objective was not to define very rigid, strict standards as to what an ESG index was or was not. It was more about designing rules and standards for filters or transparency.”
“With these standards you don’t hinder future innovation or new themes, and you can still address different client demands” she said. “It is flexible enough.”
ESG and products’ pricing terms
Credit Suisse’s Herly highlighted the need for issuers to make use of good pricing terms for their products, and indicated that regulators’ work can sometimes complicate the process.
“For structured products especially, one of the main questions is about pricing efficiency,” said Herly. “When we think about an index or a strategy that should be the underlying for a structured product, usually we face some pricing considerations. There are some regulators that are preventing the design of complex indices and that is to some extent jeopardizing the potential for having indices that do work for traditional structured products.”
Where the ESG benchmarks will come from
As ESG carves its way into the world of passive investing, the panel discussed what it would take for an index to become an ESG benchmark.
For J.P. Morgan’s Ingerfurth, a key point to consider in the search for a benchmark is the value of tradable assets linked to it. He said it was very promising that Eurex had launched its first futures on STOXX ESG indices, which could create the liquidity and ease of trade that investors need to adopt a benchmark.
“It is always a little bit of a chicken-and-egg kind of thing,” said Ingerfurth. “Because you need to have the liquidity to be the benchmark and the other way around. So Eurex and STOXX have somehow laid the egg now, let’s see if the chicken is going to follow.”
Herly said that the constitution of a benchmark will be shaped by national and ideological idiosyncrasies. He mentioned the example of nuclear power, which is excluded by many responsible investors in some countries yet considered positive by others as an alternative to fossil-fuel energy.
Finally, all three participants said that the adoption of responsible criteria isn’t limited to their offered products but is also being embraced by their employers for the broader benefit of client relationships.
Millat wrapped up by mentioning three points she says are key to foster bigger penetration of structured products in portfolios: product innovation, clarification of the offering, and education.
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