Green finance rules are driving huge changes in ETF indexing but have not disrupted index providers - firms that the FCA is now monitoring, writes Peter Taberner.
Since March last year, several ETF providers have switched benchmarks in their ETFs, moving from traditional indices to ones that employ sustainability criteria in their composition.
One recent example is Ossiam, a Paris-based ETF provider with around €6 billion of assets under management. In January, it moved one of its ETFs from the Stoxx Europe 600 Equal Weighted Index to an ESG version of the same index as part of a wider programme of conversion.
As a result, the newly named Ossiam Stoxx Europe 600 ESG Equal Weight ETF saw a 20% reduction in the number of stocks the ETF could invest in.
Paul Lacroix, head of structuring at Ossiam, says the ESG index also slightly changed sector and country allocations as a result of exclusions.
“The index selects the top-ranking securities in each of the ICB Industries [a sector classification system] until the number of selected securities reaches 80% of the number of securities in the investment universe. Finally, the remaining eligible companies are equally weighted in the ETF,” says Lacroix.
The move by Ossiam and other ETF providers is chiefly a reaction to pressure created by the EU’s Sustainable Finance Disclosure Regulation (SFDR), which aims to make funds in general more transparent about sustainable investments.
There are 1,945 ETFs in Europe with $51.45 billion (€47.6 billion) of assets, according to ETFGI figures.
The SFDR sets out sustainability disclosure requirements with the aim of increasing the transparency of funds and increasing the comparability of disclosures for end investors.
ETFs and other in-scope funds that do not employ any kind of sustainability into their investment process will be known as ‘Article 6’ funds.
Under the SFDR, to be described as an ‘Article 8’ fund, a fund must “promote” investments with social and environmental characteristics. To be considered an ‘Article 9’ fund, a fund must promote sustainable investments.
Asked if he was concerned that the SFDR change might affect the Stoxx 600 ETF performance, Lacroix said Ossiam does not see ESG as a source of return for the equal-weighted strategy, “but rather as a long-term risk-reduction element”.
However, underlining the importance of SFDR to fund inflows, Lacroix did say that the rules – which were meant to be only a disclosure regulation originally – have come to form something like a fund ratings system.
Amundi, another Paris-headquartered asset manager, responded to the SFDR by launching an expanded ESG range in May last year. This included new launches and some existing fixed income ETFs moving from ‘vanilla’ indices to ESG indices.
The firm says its responsible investing range comprises more than 80 products that are classified under SFDR Article 8 or 9.
Examples of ETFs that Amundi has converted include a product tracking the S&P 500 and which is now called the S&P 500 ESG Ucits ETF DR. The ETF has around €2.57 billion of assets under management (AuM).
The firm recently switched ETFs focused on climate change so that they track Paris-aligned benchmarks (PAB). Overall, these ETFs account for more than €12 billion of AuM and track the MSCI SRI Filtered PAB indices.
BlackRock, which operates the iShares ETF brand, has developed a “comprehensive suite of Article 8 and Article 9 strategies” across asset classes including cash and private assets, a spokesperson says.
In the firm’s sustainability update report last year, BlackRock said that 72% of its fund launches and updates to existing funds in Europe adhered to Article 8 or Article 9. This was ahead of the of the original 70% target and includes wider funds than ETFs.
German asset manager DWS, which operates the Xtrackers ETF brand, has converted 31 original ETFs to products that now use ESG methodologies in their index composition.
Michael Mohr, head of passive products at the firm, says the ETFs are now labelled either Article 8 or 9. “All in all, there are 54 Xtrackers ETFs – of which 36 are individual sub-funds – which are SFDR-compliant; 48 products are attached to Article 8, and six products to Article 9,” he adds.
The firm’s largest product is the Xtrackers MSCI USA ESG Ucits ETF, which has £3.98 billion (€4.7 billion) of assets under management and was launched as an ESG product from the beginning. Performance has steadily increased in the 12-month period from March 31, 2021. In US dollars, the return was 16.37 %.
Part of this conversion took place in September last year when DWS completed the conversion of nine existing European equity Xtrackers ETFs that track different sectors. These now track the same sectors, but using ESG-screened MSCI indices.
This overhaul of benchmarks could have disrupted the index market – yet the above evidence suggests mainstream traditional index providers such as MSCI have managed to keep their fund management clients by offering them ESG versions of traditional benchmark products.
Alternative index providers – for example, Solactive – have been competing with the likes of MSCI, and in recent months the UK’s Financial Conduct Authority has increased its scrutiny of the index market, suspecting it to be uncompetitive, with high prices and difficulties for asset managers who want to change providers.
BlackRock said its clients used multiple ESG data sources and providers, and the firm was expecting continued innovation in this space from institutions looking for customised indices.
At DWS, Mohr says for every new Xtrackers ESG ETF (whether a conversion or a brand-new launch), all relevant index providers are considered “as we want to find the best solution for our clients and our product offering”.
SFDR has led to index switches – but it has not disrupted the market to the extent that alternative index providers have gained more ground. It is, however, impacting the gigantic passive investment market.
The Amundi spokeperson says: “We believe that ETFs have a critical role to play in driving the transition to a low carbon economy,” and that responsible investing is “driving huge change” in the ETF industry, as well as beyond.
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