STOXX has licensed the EURO iSTOXX® 50 Low Carbon NR Decrement 3.75% Index to Banca IMI to underly the first1 structured products distributed in Italy tracking a low-carbon strategy.
The low-carbon version of the flagship EURO STOXX 50® Index offers a tradable standardized solution to significantly decarbonize portfolios and address long-term climate risks, while keeping a similar return and equal stock constituency to the benchmark. The EURO iSTOXX 50 Low Carbon NR Decrement 3.75% Index uses estimated and reported carbon intensity scores provided by STOXX’s research partners CDP and ISS ESG.
Low-carbon strategies are part of a broader move from asset owners and money managers to incorporate environmental, social and governance (ESG) parameters into portfolios to better manage risk and observe responsible principles. They are also fueled by new regulation as governments work to limit climate change and meet goals set up under the 2015 Paris Agreement.
As part of its action plan on climate change, the European Commission has set up a list of proposals to govern financial markets with the aim of reorienting capital flows towards sustainable investment, manage financial risks stemming from climate change, and foster long-termism in financial activity. Among the proposals is a motion to introduce mandatory disclosures for institutional investors and asset managers on how they integrate ESG factors in their risk processes.
“Investors are increasingly aware of the long-term risks posed to their investments by climate change,” said Valeria Giovanna Zorzi, Head of Product Development, Global Market Securities – Global Market Sales from Banca IMI. Global efforts to decrease carbon emissions present “an opportunity for our investors to play a role in the transition towards a greener economy.”
Banca IMI is the investment-bank arm of Intesa Sanpaolo, one of Italy’s largest lenders.
The EURO iSTOXX 50 Low Carbon NR Decrement 3.75% Index is weighted according to each constituent’s free-float market capitalization multiplied by its carbon intensity factor. This tilt results in an overweight of stocks with a lower carbon footprint and vice versa.
Carbon information considered for the index comprises Scope 1 data (all direct greenhouse gas emissions) and Scope 2 data (indirect greenhouse gas emissions from consumption of purchased electricity, heat or steam).
The data sources are:
- Reported data (from CDP: companies voluntarily report on annual basis, among others, Scope 1 and Scope 2 emissions). This can be verified or not.
- Estimated data (from ISS-ESG, which uses, among others, CDP data to estimate greenhouse gas emissions with a model for companies that do not report to CDP).
Should neither data be available for a given company, the security will be excluded from the universe. STOXX Low Carbon indices’ exclusion rules and use of unverified and estimated data can be a force of engagement with corporate managements for investors.
The EURO iSTOXX 50 Low Carbon NR Decrement 3.75% Index replicates the net-return performance of the EURO STOXX® 50 Low Carbon Index with a constant 3.75% dividend markdown per annum. In other words, it is an alternative to the price performance (ex-dividends) of the EURO STOXX 50 Low Carbon Index that replaces the uncertainty of future dividends with a fixed component.
Decrement indices have emerged as an enhanced source of ‘optionality’ — or offer terms — for issuers of structured products, who need to present an interesting proposition to investors. The dividend yield of an underlying index, one of the variables to price options, has traditionally been used to increase the returns and capital protection terms offered in the products. But yields are unstable and unpredictable, and when they come down, they erode the optionality and appeal of structured products.
Decrements work as a synthetic and predictable alternative to dividends. The dividend markdown amount is used for the benefit of the client in the form of better terms: higher participation, higher protection or improved payoff.
A futures market for low-carbon European portfolios
For issuers of products on the EURO STOXX 50 Low Carbon Index and its variants, there is another benefit: since February, futures contracts on the index are available on Eurex. The futures are crucial for banks to hedge, foster liquidity and manage flows into low-carbon equity portfolios.
The roles in the path to a cleaner world
ESG and low-carbon strategies are moving to the core of European portfolios, and all participants in financial markets are reacting to facilitate this transition. While innovation from intermediaries such as STOXX and Banca IMI is creating ways to help out investors with their sustainable mandates, the real beneficiaries of ESG growth will be the broader society in its entirety.
1 According to SRP data.