Our expert panel discusses sustainability challenges in the ETF industry, and looks at the case for harmonisation, as well as issues with the CSDR regime, thematics, and more. Chaired by Alex Rolandi.

Raymond Backreedy (Chief investment officer, Sparrows Capital)
Marie Dzanis (Head of asset management for EMEA Northern Trust Asset Management and chief executive officer for Northern Trust Global Investments)
Jason Guthrie (Head of capital markets and digital assets, WisdomTree)
Benoit Sorel (Head of products for iShares EMEA, BlackRock)
Keshava Shastry (Head of the Efama task force and head of capital markets, DWS)
Ismael Garcia Puente (Fund manager, Mapfre)
Valerio Schmitz-Esser (Head of index solutions, Credit Suisse Asset Management)

Funds Europe – There have been strong inflows into ESG-focused ETFs in recent times, but many do not meet sustainable development goal (SDG) requirements. What are the challenges issuers face when launching SDG-aligned ETFs? What can be done to make sure ESG-focused ETFs are up to sustainability standards?

Raymond Backreedy, Sparrows Capital – From a buyer’s perspective, we have seen a lot of customers asking us for ESG portfolios. The first thing one needs to understand is exactly what they want. We need to take a step back and look at the index providers and what kind of ratings they are using, the ratings agencies and how they are constructing the indices, and then in turn how the ETF is constructed.

Regarding the SDGs, most indices and ETFs across those indices are actually aligned to climate change and carbon-offsetting goals rather than anything else, so there are a lot of ETFs tracking climate change/environmental flavours, but there is a lack of ETFs in areas such as social justice.

It’s a data issue, it’s a metric issue, and of course it’s a taxonomy issue too. It’s a case of the nature of what one needs to capture with the index through its methodologies; it’s going to be very, very difficult to capture all 17 goals, especially when some of these things are hard to quantify, they’re more qualitative/subjective.

Marie Dzanis, Northern Trust – It’s an opportunity. Data shows that less than 30% of global ESG-focused issues align with SDGs.

When you look at it further, 90% of exclusion-only ETFs don’t align to SDGs at all. This is due to their narrow scope because there is a lack of structured data and standards for measuring. There’s also subjectivity in financial return measurement, and increased focus on specific angles, like climate and carbon, that leaves many of the SDGs underrepresented. Some is scooped up into impact investing.

Looking at the lack of breadth of public investments directly into companies that could align with SDGs, that could be a challenge. For example, in the US when we were creating products years ago, having a water ETF looking at the upstream or downstream consequences and what would be in that would dilute the actual outcome or the exposure to a water security.

Jason Guthrie, WisdomTree – What muddies the water even more is a lack of consensus from clients. It’s a very nuanced space and you could take a lot of very nuanced approaches. Even when we’re just talking about exclusion lists and the like, where do you draw the line on what this is meant to be? There are some very strict approaches to sustainability, and there are some very lax ones.

This plays out even more acutely when we get to the ‘G’ of ESG – governance – when it comes to voting on stocks, on board governance etc, this becomes very subjective, and it becomes difficult for some people to balance the social outcomes with the investing outcomes, because at the end of the day, that’s what we’re here for.

Benoit Sorel, BlackRock – Everyone agrees with the UN’s Sustainable Development Goals, but from an investment outcome perspective, they are narrow in terms of what they can achieve.

There are only a handful of investable SDGs, such as good health and wellbeing (SDG3), clean water and sanitation (SDG6) or sustainable cities and communities (SDG11). Each of these represents a narrow prism of thematic investing.

The reason why we have collectively gathered so many assets in sustainable strategies last year is because they come as a replacement for core holdings, both equity and fixed income. Broad sustainable indices allow investors to implement their sustainable strategies with a financial outcome in line with their historical allocation tools.

The SDG space is a market for thematic investing, with an even bigger room to play for non-indexing strategies like private markets where you do impact investing.

Keshava Shastry, DWS – Sustainable investing is still a relatively young practice. Rapid growth and progress is being seen at the global and European levels, but work needs to be done on implementing the framework and taxonomies to align the wide-ranging issues within the space. ESG is one of the many measures of sustainability, but there are plenty of different ways about it. While there is a significant overlap between the various metrics, products targeting the various gauges such as climate and other various angles are still being left out. Ultimately, we’re there to provide a financial instrument for people’s long-term goals, and long-term depends on how you define it.

Ismael Garcia Puente, Mapfre – The European Commission will take action on this matter in the next sustainable finance regulation discussion on March 10 in Rome. From a wealth management division point of view, that will help a lot for our retail investors or individual investors to align their goals when selecting ESG products. For ETFs in particular, two things are needed: more suitable benchmarks to replicate, and related to that, we need maybe not more data but better data in order to create better benchmarks to track.

Sorel – We also need more harmonisation. The fact that every country, every market, every regulator or industry group is going with their own local regulation is counterproductive because it leads to less clarity for the end investor.

The European Union took the lead on climate benchmarks, but on sustainability, we are witnessing the emergence of multiple local standards and labels. When you’re a product provider, either you’re going through fragmentation and have multiple product ranges designed for multiple countries, or you end up having a product suite that complies with every label and regulation but doesn’t mean anything from a financial or ESG outcome.

Valerio Schmitz-Esser, Credit Suisse – ESG is very much about making good investments with competitive returns, while generating environmental and social benefits. If you compare the performances of many ESG benchmarks, you find that they performed better than many standard benchmarks. SDGs are much more of a niche.

Take SDG2, the zero-hunger objective, for example. It will be challenging to develop an index that would promote the goal of zero hunger. Not all SDGs pose philosophical discussions, but some are very hard to operationalise for an index concept.

Guthrie – It’s not possible to hit all the social outcomes from an ETF or an indexing point of view. If you really want to put money towards that, there are activist investors out there that can go to work. That’s where you maybe want to put 10% or 15% of your pot so they can go and bully companies into achieving certain goals. That’s not the seat that we’re in, we are here for diversified low-cost efficient scale. Of course we want good practice, but there’s a limit.