Until now, the growth of the listed ESG derivatives market has centred on futures and options that reference indices with an applied exclusionary methodology.
This made sense for exchanges as it would appeal to the broadest possible range of investors. An ESG derivative that references a popular index, such as the Euro Stoxx 50 or S&P 500, will be easier for an investor to integrate into their infrastructure.
But as ESG continues to grow quickly as an asset class, investors are applying increasingly sophisticated strategies and are finding exclusion to be too blunt a methodology.
On Wednesday, Eurex announced that it would launch ESG futures and options on the DAX 50 and Euro Stoxx 50 indices.
The DAX 50 ESG index contracts will carry a standardised Sustainalytics screening and exclude companies involved in controversial weapons, military contracting, tobacco production, thermal coal and nuclear power.
The Euro Stoxx 50 index will also apply a Sustainalytics-created screening methodology. But it will also apply ESG scores to companies in the index and replace the bottom scoring 10% with companies from the same industries that have higher scores.
The ESG scoring methodology is more suited to investors who believe that ESG focused companies outperform their peers because their aims give them a superior business model.
“The Euro Stoxx 50 ESG Index and the DAX 50 ESG Index both represent highly liquid solutions for asset owners who are looking for cost-effective ways to integrate sustainable factors in the core of their investments,” said Rodolphe Bocquet, global head of sustainable investment at Qontigo.
“These indices are well suited for derivatives and are an important part of the comprehensive Qontigo sustainable investment ecosystem.”
Innovation is taking hold and accelerating in ESG derivatives, with new products being pumped out in the listed and over the counter markets.
In recent comments, International Swaps and Derivatives Association chief executive Scott O’Malia acknowledged that standardisation would soon be needed in this growing product line.
“First and foremost, the derivatives market will be the means by which participants are able to hedge their exposure to ESG assets, but its role extends further. Derivatives play an important role in facilitating price discovery and fostering greater market transparency. They contribute to the establishment of a market price and thereby enable better assessments of risk.
“Alongside the development of ESG derivatives products, work will be needed to promote standardisation across jurisdictions and market segments in order to ensure efficiency while reducing risk and cost, and also supporting digitisation,” he said.
“ISDA documentation and definitions are already being used to document ESG transactions,” added O’Malia. “For example, swaps that are linked to a client’s performance against a set of sustainability targets have been documented under the 2006 ISDA Definitions. We have also started to expand the range of ISDA templates for environmental trading to include renewable energy certificates.”
