Since Feb. 10, investors can trade futures on the STOXX® USA 500 ESG-X Index, a benchmark for US equities that incorporates standard responsible exclusions based on feedback from European asset owners. The contracts mark the internationalization of Eurex’s ESG derivatives offering, which includes the widely traded STOXX® Europe 600 ESG-X Index (FSEG) futures.
Pulse Online caught up with Magnus Linder, Head of Derivatives at Swedbank Robur, to find out how a comprehensive suite of ESG derivatives helps a money manager with an established tradition of responsible investing.
Swedbank Robur, one of Scandinavia’s largest asset managers, has more than 140 billion euros under management,1 all of which are subject to the company’s responsible investment policy, risk assessments and exclusion on ethical and sustainability grounds.
Magnus, how do ESG derivatives help Swedbank Robur’s investment strategy?
“Swedbank Robur´s vision is to be a world leader in sustainable value creation, and we have been working with ESG issues for nearly 25 years. Sustainability principles are not only embedded in our philosophy, they are also integrated in the way we work and do business. Specifically, for example, Swedbank Robur has a proscription on the use of non-sustainable financial products, including derivatives. Until only very recently, this created important tactical problems. In managing ESG portfolios, one would run into liquidity constraints and tracking-error problems. That changed with the introduction of derivatives that also observe responsible principles. In that sense, we welcome the introduction of new futures covering the US market.”
Can you explain what those problems and issues were, and how they are resolved?
“If you are managing an ESG portfolio, you need to handle daily flows. Let’s say 5% of the portfolio must be in liquid positions to manage redemptions. Before the introduction of ESG derivatives, you had two options: one was to hold 95% in an ESG basket and 5% in cash to manage those flows. In this case one would comply with the ESG mandate but would be underinvested by 5% and that meant not tracking the benchmark. Alternatively, one could be fully invested by having 95% in an ESG basket and 5% in benchmark futures, for example on the EURO STOXX 50® Index. But that 5% breaches your ESG mandate because you would be holding a small portion in undesired companies and sectors.
With ESG futures you can be ‘fully ESG and fully invested,’ by holding 95% in an ESG basket and 5% in ESG futures. It is the best of both worlds. Plus, you can also achieve important cost savings.”
How do those savings come around?
“The derivatives are not only a solution in terms of mandate and compliance. The futures also result in significant savings relative to trading an ESG basket of stocks. Investing in a basket of stocks that meet sustainability standards can cost multiple times more than buying futures on the STOXX Europe 600 ESG-X or the STOXX USA 500 ESG-X indices because of the accumulation of fixed fees and holding costs for every stock purchased. Even if you optimized the basket and bought only 150 or 50 stocks, you would still pay much more than if you bought the derivatives.
When you compare costs for different assets, the things you normally look at are liquidity and spreads. But after the front job is done and the trade goes down to the operations side, there is a huge difference between trading a basket with several hundred stocks against just booking down one futures trade. These costs, accumulated over one year, will have a significant impact on performance.”
Swedbank was involved in the creation of the ESG-X indices and the derivatives. How did that help adoption?
“Our ambition is to play an active role in the development of more sustainable financial instruments. For us it was very interesting that the policies of asset owners were directly taken into account in the development of the STOXX ESG-X Indices through a consultation process. This guaranteed that the indices and the derivatives were of easy adoption and ensured vast interest from people in the market. In that sense, we are not surprised that the STOXX 600 ESG-X futures have gotten so much traction in only one year.”
You were also among the first to trade the futures on the STOXX Europe 600 ESG-X Index on Eurex.
“Yes. We were looking for tradeable benchmark indices that were compliant with our responsible investment policy. For investors who already trade on Eurex and are familiar with the STOXX methodologies, it is an easy move. Our overall view on STOXX ESG products is that they are proving to be the easiest and cheapest way to get sustainable exposure. Liquidity is most important. Trading in STOXX Europe 600 ESG-X futures amounted to a notional value of more than 5 billion euros in December only. These days, large trading blocs of the ESG-X futures have spread costs that are only a little bit wider than those on benchmark STOXX Europe 600 Index futures.”
What do the new USA 500 ESG-X contracts add to the ESG derivatives offering?
“We are excited we can expand that same liquid ESG exposure to the US, a market that gets an important part of our clients’ asset allocation. What’s also of particular interest is that the STOXX USA 500 ESG-X includes a negative screen for thermal-coal mining and coal-fired power plants, which is unique and meets our requirements.”2
What role do these ESG restrictions play in an investor’s mandate?
“For us, the focus on ESG issues is driven by our own beliefs as a company but also by our customers’ needs. We assume responsibility by taking action on sustainability and corporate governance issues on behalf of our unit holders and investors. It is vital for us to understand and secure that the companies we invest in maintain a positive direction aligned with responsible and sustainable principles. We work only with credible counterparties such as STOXX and Eurex where we can rely on rigorous screening methodologies and the best corporate data when trading ESG derivatives.”
The trend is that ESG will become even more entrenched among European investors, and I have no doubt that the pool of assets will grow. It is important that the market for financial products grows alongside, pushing the boundaries in innovation and access.”
1 AUM data as of 2019. Source: Swedbank 2019 Annual and Sustainability Report.
2 The ESG-X indices also implement product-involvement exclusions for controversial weapons and tobacco, as well as a norm-based screening for United Nations Global Compact principles. Controversial weapons comprise anti-personnel mines, biological and chemical weapons, cluster weapons, depleted uranium, nuclear weapons and white phosphorus weapons.