SRP ESG Index Report 2023 by SRP & FOW

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ESG

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ESG in the structured products market The integration of environmental, social and governance (ESG) aspects in investment products is becoming mainstream in financial markets. This brings with it growing expectations for transparent ESG data requirements and the need for regulation aimed at improving ESG transparency and comparability. Despite the challenges for ESG investing in an environment dominated by the energy crisis and the war in Ukraine, the growth of sustainable investment funds aimed at ESG themes has the potential to significantly contribute to addressing climate change and other sustainable development goals (SDG) set out by the United Nations in 2015. Some regulations like EU based Taxonomy, SFDR disclosures and MIFID II ESG amendments are designed to collect at collecting data from investment firms and investors to monitor and identify their alignment with ESG values. The question however is how and how much of the ESG factors being integrated in products are meeting the client’s understanding of ESG and matching their investing preferences. This ESG report includes insights and opinions from executives of some of the most active index providers and manufacturers

of ESG products in the retail structured products market, an update on the most recent regulatory developments as well as a breakdown showing issuance and sales per region, type of strategy, decrement v non-decrement, geographical exposure and ESG sub-themes. The second part of the report includes a profile section with insights from a selection of the main providers of ESG indices and products to retail investors, according to SRP data. As we did in our first edition, we want to highlight that challenges remain to provide a complete picture on individual players and country-by-country analysis, especially in the context of nonpublic issuance and sales. This report will be integrated as one of the chapters of the next edition of SRP’s Index Report which will be delivered at the end of 2023.

All tables/charts are based on data from StructuredRetailProducts.com

Contents Executive Summary: Market evolution – steady growth

Profiles: Solactive

Putting a label to ESG: regulatory update

Profiles: Société Générale

Market overview: ESG adoption – slowly but surely

Profiles: BNP Paribas

Profiles: MSCI

Profiles: Cacib

Profiles: Euronext

Profiles: Natixis

Profiles: Qontigo

Profiles: Barclays

Profiles: S&PDJI

Regional Insight: ESG in the US

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Executive Summary: Market evolution – steady growth ESG has become one of the main drivers of underlying innovation in the structured products over the last five years

study released by PwC in October 2022 found that asset managers globally are expected to increase their ESG-related assets under management (AuM) to US$33.9 trillion by 2026, from US$18.4 trillion in 2021. A 2022 ESG survey by Morgan Stanley (Sustainable Signals Opportunities for Asset Managers to Meet Asset Owner Demands) found that 77% of all institutional investors have increased interest in sustainable investing since May 2020, and more than 80% already implement sustainable investing strategies in all or part of their portfolios—or plan to do so. The survey shows that sustainable investing remains an important focus area for institutional investors, especially in Emea, and that despite regional differences in both adoption and drivers, the market is primed for additional growth, particularly in Apac. This demand, however, is not limited to a niche group of investors as suggested by the growing number of retail investors considering ESG in their investment activities. ESG accounted for

65% of all flows into European ETFs in 2022, according to data from Morningstar - ESG ETFs recorded inflows of €51bn in 2022 out of total flows of €78.4bn for all ETFs in Europe. As demand for sustainability continues to penetrate the wealth management market and investors increasingly look to invest and support sustainability, issuance and sales of ESG structured products have also raised with the tide. Our first attempt to shed light on this area of the market covering the period 2013-2018 showed a steady and stable growth in the issuance and sales of ESG structured products sold across retail markets. Since 2019, the market has developed further year-onyear with two significant spikes in 2018-2019 and 2021-2022. In the structured products market, ESG has become one of the main drivers of underlying innovation with sales now accounting for US$12.7 billion, an increase of 22.1% compared to the US$10.4 billion sold in 2021, according to SRP data.

ESG indices: evolution 2019-2022

3,000

14,000 12,000

2,500

10,000

2,000

8,000

1,500 6,000

1,000

4,000

500

2,000

2019

www.structuredretailproducts.com

2020

2021

Sales US$m (LHS)

Issuance (RHS)

2022

5 Evolution of ESG-linked structured products 14,000

3,000

12,000

2,500

10,000

2,000

8,000 1,500 6,000 1,000

4,000

500

2,000 0

0 2013

2014

2015

2016

2017

Sales US$m (LHS)

Setting standards Regulatory uncertainty and lack of standardisations on ESG reporting have exposed ESG investment assets to greenwashing, resulting in falling confidence in the credibility of ESG products among investors. However, the structured products market has developed a functioning framework to deliver ESG investments in an increasingly competitive market with several issuers seeking to set new standards.

2018

2019

2020

2021

2022

Issuance (RHS)

three years,” says Isabelle Millat, head of sustainability, global markets, SG. “Seventy per cent of the transactions come from retail investors and we see a growing number of clients asking for ESG characteristics.” Others like Citi are newer in the space but actively seeking to close the gap. The US bank has made ESG offering a priority “to be one of the first banks to move on innovative ESG themes via third party indices”.

As a pioneer in ESG, Société Générale (SG) has invested in its capabilities “to be able to offer a competitive catalogue with new solutions around the three big main building blocks - bonds, indices and positive contributions”.

Some of Citi’s recent launches include the Morningstar France Positive Economy Select 30 with Positive Planet; Morningstar Gender Diversity Select Indices in partnership with Equileap; Climate Action Indices with the S&P Net Zero 2050 Paris-Aligned ESG Select index family launched in November 2021.

“The volume of products tracking our ESG indices in many different forms including structured products has quadrupled over

“Over the last few years, ESG indices have become new benchmarks for structured products in a growing number

70% of the transactions come from retail investors Isabelle Millat, head of sustainability, global markets, Société Générale

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Demand spans from wide ESG indices to more narrow exposures Arthur Dorbessan, global head of retail indexes, Citi Multi Asset Group

of markets – France, of course, as the leading market with a robust regulatory framework around those indices since 2018 but also more recently Germany, Spain, Italy or Eastern Europe,” says Arthur Dorbessan, global head of retail indexes, Citi Multi Asset Group. “This trend developed as new prescriptive frameworks/labels were put in place.” Barclays launched a green structured notes programme to offer institutional and retail investors a ‘differentiated green investment opportunity’ at the end of 2021. The UK bank launched the Barclays Solactive Climate Change Europe BTI index on an exclusive basis at the beginning of 2022 to be used as the underlying of new structured products – the index features across 20 live products worth US$37.6 million. S: to replace million with ‘m’ Morgan Stanley also increased its profile in the ESG space in late 2021 with the launch of the Solactive ISS ESG Future of Plastic Index which provides a benchmark comprised of companies addressing the plastic waste issue with new practices and solutions and has been deployed across 32 products worth an estimated US$58m marketed in Ireland, Germany & Austria and Sweden. S: Also, in 2021, Goldman Sachs developed a Goldman Sachs Sustainability Issuance Framework to use proceeds from structured products for social causes. ESG is also “core” at BNP Paribas, another tier-one manufacturer of structured products and a leading provider by issuance and sales of ESG structured products over the last few years. “[ESG] is at the highest level of the agenda of the group and permeates through all businesses,” says Youri Siegel, head of global market sustainable structuring, BNP Paribas CIB. “Every business in the bank, including the global markets division, are really trying hard to find all possible routes to foster positive impact as a bank; by evolving the product mix, supporting clients, and innovating on product thematics, etc.” Siegel believes that product manufacturers can maximise the

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impact of sustainable investing by “proactively designing and promoting solutions”. “We have significant resources in terms of data - carbon footprint, issuer rating, governance rating, diversity, people, digital tools etc to design investment and hedging solutions that can help our clients with various ESG goals,” he says. The bank has also put “a lot of effort” in its markets division and CIB globally to support this demand with the development of social and green bond programmes. “Our expectation is that the share of ESG structured products will continue to grow over the years ahead. Because we started early innovating ESG products - our first ESG index was launched in 2013, almost 10 years ago - we are a leader in the market, and we want to retain that position by bringing to the market cutting edge ESG investment solutions that meet robust standards.” One of the most “recent innovations” came to life in September 2022 after the bank launched a social bond framework, and a social index on Eurozone equities which was followed by new partnerships with social associations to combine donations with the investment to offer “a fully-fledged social offer”. Another French bank leading the ESG charge in the retail structured products market is Credit Agricole CIB (CACIB) which sees ESG growing as an investment theme “at a global level but also internally”. “We can distinguish two types of ESG activities. What we call dark green activities - green notes with the use of proceeds allocated to green products, on one hand, and the bank’s activity around responsible investing - which includes the creation of dedicated products and indices, on the other hand. Those two green activities can be implemented in the same product,” says Matthieu Monlun, head of domestic markets & CA group sales, equity solutions, CACIB. Monlun notes that ESG is now entering an “interesting phase” which could result in higher adoption because the current macro environment is pushing the market away from autocalls and towards capital guaranteed and fixed income products, which traditionally have not been offered in the ESG structured products realm.

The share of ESG structured products will continue to grow in the years ahead Youri Siegel, head of global market sustainable structuring, BNP Paribas CIB

Space for innovation As the number of investors interested in sustainable investing increases, customisation has also become a trademark of ESG structured products - this shift is driving collaboration between data and index providers as well as investment banks and wealth managers. Despite remaining question marks around the performance of ESG structured products and the limited size of this segment within the wider structured products market, improvements around ESG data have been a catalyst for new tailor-made underlyings that cover a variety of ESG themes. The demand spans from wide ESG indices to more narrow exposures such as ESG indices aligned with United Nation Sustainable Development Goals like climate action, water, biodiversity or gender equality more recently, according to Citi’s Dorbesan. “We saw particularly a large demand on Paris Aligned indices in France last year as a widely adopted climate index standard,” he says. Access to more granular data and new metrics is also helping to measure the impact achieved by green bond and

positive impact programmes. BNP Paribas’ Siegel notes that as demand for custom strategies increases and the market evolves. “Regulators are engaging too, so the market is becoming fully aligned. With performance still a concern for investors and issuers alike, the liquidity of the new ESG customised underlyings which sometimes include synthetic dividend (decrement) and risk/ volatility control features, has forced manufacturers to fine tune their risk management systems to address the increasing use of illiquid underlyings. “The market still faces the same challenges in terms of liquidity and still relies on proxies to hedge volatility. This is not new on the day-to-day risk management and hedging of the trading book but still brings challenges even so more now in regards of decrement indices with rates going up,” says Mahdi Bouayad, head of ESG & index solutions, CACIB. Bouayad believes that in the current environment of increasing interest rates these features could fall out of favour as investors may be willing to remove the decrement feature from indices and return to structures that use price return indices. “That [would] lead to more difficulties on the sell side in terms

ESG is now entering an “interesting phase” which could result in higher adoption Matthieu Monlun, head of domestic markets & CA group sales, equity solutions, CACIB

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Products [embedding a positive contribution] have a practical narrative involving real life considerations Kristell Herbault, product engineer, Société Générale

of pricing and modelling because they now need to take into account the dividend risk that was basically removed with decrement indices. We are working together with our trading desk in order to model the dividend risk and be able to provide ESG solutions without the decrement,” says Bouayad. Isabelle Millat, Head of sustainability for Global Markets, SG, notes that from a risk management perspective, there are specific risks around products that are not linked to major benchmarks and are less diversified, but this is no different to any other structured product “where the same control for risk variables like volatility and dividends applies”. “ESG products are no different. It is challenging because ESG can involve biases, but this is no different from any other trend or theme we have seen in the market. We have proven ESG products can offer competitive prices and be consistent with the bank’s risk guidelines,” she says. Stephane Mattattia, managing director, head of index products for Europe, Middle East and Africa and global thematic index products at MSCI, also points that investment banks have certain liquidity requirements which must be met anyway. “We don’t see any issues with new custom indices,” he says, adding that most of these underlyigs end up in the sweet spot of number of stocks which is between 30 for the narrowest to 75 for the broadest. “These are pretty liquid levels.” The problem with lack of liquidity, according to Mattattia, is that it can impact scalability. “But banks are managing the risks and we are also very careful not to license the same topic to everyone to avoid concentration. If this were the case, we would ensure that everyone licensing a specific custom strategy is aware so that the risks are handled appropriately,” Mattattia says. Positive outlook Kristell Herbault, product engineer at SG, notes that at a structuring level, one of the most interesting and challenging aspects of structuring sustainable and positive solutions is around embedding the positive contribution in the product. “These products have a practical narrative involving real life considerations.”, she says.

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On a more generic note, Millat adds: “Our ESG offering is where quantitative financial expertise and real-life ESG awareness meet, and that makes it special,” she says. “We expect investors to increase their exposure to ESG assets as we work to increase their knowledge and awareness.” For products embedding a positive contribution, in order to channel the positive contributions embedded in products, manufacturers and distributors have established new partnerships with non-profit organisations. BNP Paribas’ Siegler provides examples of some recent developments in this area – the French bank has partnered with Tara Ocean to help fund a polar station project and has also collaborated with social partner organisations such as Habitat & Humanisme, Sport dans la Ville, Article 1 and the Rescue & Recover Fund with RedCross, Doctors without Borders, and Care. Other manufacturers have launched their own partnerships like Morgan Stanley with the National Geographic Societey; SG with PUR Projet which works with several thousand local farmers and small producers in some fifty countries to plant or replant millions of trees; and Goldman Sachs with the National Urban League, a civil rights organisation in Harlem. All in all, the scope for growth of the ESG segment of the retail structured products market remains high as most market players believe ESG products across Europe are only scrapping the surface. The outlook is that the US and several Apac markets will follow suit. “France to a certain extent has led the way when it comes to distribution via retail distribution networks, private banks, retail banks, insurance companies, and there is no reason to believe this cannot be somehow replicated in other markets despite the different degrees of adoption on a country basis,” says Millat. “Structured Products investments provide just one more way to engage in a dialogue with end investors about ESG. We think this creates awareness - it is an essential driver to continue developing our offer. The outlook for ESG products is positive because there are still themes to explore and to deploy better.”

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Putting a label on ESG: regulatory update The European Structured Investment Products Association (Eusipa) is not advocating for a particular approach but is urging its members to “be careful with their approach to the ESG score”.

Eusipa is not going to recommend one approach over another

he structured products industry has been working on ESG disclosure standards since early 2020 after the three European Supervisory Authorities (ESAs - Eba, Eiopa and Esma) announced new guidelines on proposed environmental, social and governance (ESG) disclosure standards for financial market participants, advisers and products. “Under the new rules, product firms have to change their approach on product design and marketing,” says Thomas Wulf, general secretary of the European Structured Investment Products Association (Eusipa). The Mifid II ESG Delegated Act (DA) regulation states that EU investment managers and advisors have to collect and incorporate their client’s ESG ‘suitability preferences’ in the product target market assessment. This applies to existing and new clients. In practice, the Mifid II ESG DA in that sense requires quantification of the extent to which a product is in line with EU taxonomy and/or Sustainable Finance Disclosure Regulation (SFDR) Art 8 & 9 Funds and SFDR Principal Adverse Impact (PAI). The changing ESG regulatory landscape triggered by the new guidelines will require a significant overhaul to align products with ESG factors and outcomes. The new rules around transparency in the disclosure of sustainability features is

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aimed at reducing the mis-selling risk and avoid greenwashing, as well as greenbleaching – when product manufacturers refrain from claiming that a product is sustainable to avoid data problems arising from the disclosure obligations. According to Wulf, for the moment, the usage of Article 8 and Article 9 categories is somewhat side-lined by the qualification requirements under Mifid, which are fully applicable as of November 2022. Different approaches “In essence, the Mifid rules require distributors to ask investors how ‘green’ their product needs to be, and reversely oblige the distributor to show how green their products actually are,” he says. Under the new guidelines, there are three relevant ways to evaluate a structured product for its ESG contribution, based on the categories offered in the legal text. Some are based on how issuance proceeds are used, which may relate to general funding or the allocation of proceeds to a pool-based asset structure,” says Wulf. In addition to determining the values under the Mifid ESG categories, one approach is to use the delta of the derivative embedded in the product to quantify economic exposure to the underlying provided by the product, which could under certain conditions be coupled with the Green Asset Ratio (GAR) of the financing component.

11 “Another alternative is a balance sheet-only approach, which, rather than falling back on the derivative component, assesses the issuer’s general balance sheet on the basis that issuance proceeds flow here first,” says Wulf. There are two variations to this methodology. One would assess the ESG quality of an asset pool held on the balance sheet of the issuer, while the alternative is to look at the balance sheet’s green asset ratio rather than the GAR of the asset pool. A third variation for structuring ESG structured products uses the reference to Principal Adverse Impact (PAI) indicators as defined in the SFDR, which does not yet trigger a need to quantify the ESG effects as the other methodologies do. Industry position Eusipa is not going to recommend one approach over another, while supporting the notion that product providers must be careful with their approach to the ESG score as they will be required to show how compliant a product is in percentage points as defined in Mifid, according to Wulf. “In defining the relevant ESG investment levels manufacturers will rely on the corporate information provided as of 2023, while the GAR of financial institutions (important for the balance sheet-related approach outside specific asset pools) is going

to be officially announced only as of 2024,” he says. In addition, to the new requirements around the taxonomy there still is a high level of uncertainty, around how, if at all, any product level ESG disclosure will be incorporated in the Priips KID, an item that may potentially be addressed in the EU Commission’s Retail Investment Strategy which is expected to be released on 3 May. “It is already foreseeable that it will be tremendously difficult to include all Mifid ESG/ SFDR and taxonomy related elements in the currently limited KID space of three pages, especially if they are quantitative in nature and need further explanation,” says Wulf. “As the debate around the best way to meet the new regulatory guidelines evolves, the main pitfall is the apparent complexity of the ESG value proposition, which could prove a major deterrent to retail investment.” Additionally, the regulatory framework for ESG value propositions is becoming more stringent and tighter by the day. “Increasingly narrowly regulated ESG products may help reassure the investor from an outside perspective, but they do not necessarily help the investor understand the many shades of green there are in practice,” concludes Wulf.

ESG DISCLOSURE OBLIGATION IN THE EU RELEVANT FOR INSTITUTIONS FSB-TCFD RECOMMENDATIONS

EU Taxonomy and transparency: Key pillars to support the European Green Deal

TAXONOMY DISCLOSURES (TAXONOMY REGULATION)

NON FINANCIAL STATEMENT (NFRD)

EBA PRUDENTIAL DISCLOSURES (CRR/IFR)

DISCLOSURE REGULATION (SFDR)

WHAT

Defines environmentally sustainable activities (Paris aligned) WHO

WHAT

Corporates’ ESG and diversity information WHO

NFRD Corporates

ESG risks and risk mitigating actions WHO

Public-interest companies (more than 500 employees)

Large listed banks (CRR) and investment firms (IFR)

WHAT

Investment products and financial advice WHO

Financial firms selling investment products and financial advisers

EBA MANDATES TAXONOMY REGULATION Advice to Commission on KPIs

CRR ITS Pillar 3 disclosures on ESG risks

SFDR ESAs’ Joint Committee

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ESG – slowly but surely Sales volumes for products linked to ESG-indices keep on rising, with Europe leading the way, as more index providers enter the mix and issuers continue to increase their offering. ESG indices: single index notional (US$m)

ESG indices: market share index providers by notional 600

14,000 12,000

400

8,000 300 6,000 200

4,000

80% Americas & APAC

EMEA

90%

500

10,000

100

2,000 -

100%

2019

2021

2022

Americas (Right)

Apac (Right)

2020

EMEA (Left axis)

70% 60% 50% 40% 30% 20% 10% 0%

MSCI

2019 Euronext

2020 Qontigo

2021

S&P Dow Jones

SGX

2022 Refinitiv

Solactive

Other

Sales volumes for products linked to a single ESG index have increased by 145% in the past four years – from an estimated US$5.2 billion in 2019 (from 480 products) to US$12.8 billion in 2022 (from 2,250 products). Emea (Europe, Middle East & Africa) continues to lead the way with almost 98% of all volumes invested in products issued in the region, predominately in Europe. Whereas Emea has seen a constant increase in volumes, especially since 2020, the Americas and Apac paint a different picture.

between the regions, especially when it comes to Apac and Emea, with estimated volumes of US$51m and US$59m, respectively, for 2022.

The former saw estimated ESG-linked volumes of US$161m in 2022, and although this represents a six-fold increase since 2019, sales were actually down 20% on the previous year (2019: US$199m). In Apac, sales were the highest in 2019, when US$487m was linked to structures on a single ESG index. Since then, volumes drastically reduced in 2020 and 2021 before slightly recovering last year.

MSCI, which held a market share of just four percent in 2019, has steadily seen its influence grow to become one of the main providers for ESG indices. In 2022, it claimed 33% of the market with the MSCI World Climate Change ESG Select 4.5% Decrement EUR Index alone collecting an estimated US$2 billion from more than 1,000 products issued by Deka Bank in Germany.

Products tied to a basket of ESG indices are far less frequently issued. However, here there is less difference

Euronext held 25% of the market, down from 45% in 2019. It utilized 20 different indices in 2022, that were used in 52

ESG notional per region - single index (US$m)

ESG notional per region - index basket (US$m)

ESG INDEX PROVIDERS Products linked to ESG indices from MSCI, Euronext, Qontigo and S&P Dow Jones Indices (S&P DJI) captured 85% of all volumes in 2022.

Region

2019

2020

2021

2022

Region

2019

Americas

199

161

Americas

Apac

487

117

Apac

Emea

4,679

4,992

10,240

12,480

Emea

Total

5,189

5,036

10,481

12,758

Total

2020

2021

2022

120

136

111

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14 ESG indices: market share index providers by issuance

ESG indices: issuers - market share by notional

100%

90%

80%

70%

60%

40% 30% 20% 10%

MSCI

Landesbank BW Crédit Mutuel Arkéa Citi

60%

50%

Other

2019 Qontigo

2020 Euronext

2021

S&P Dow Jones

Solactive

2022 SGX

Refinitiv

Credit Agricole CIB

40%

BNP Paribas

30%

Amundi

20%

Natixis

10%

Deka Bank

0% Other

products, including 42 aimed at investors in the French retail market. Of these, the Euronext France Social Decrement 3.75% Index was among the most popular, with estimated sales of US$300m.

Goldman Sachs

50%

Société Générale

2019

2020

2021

2022

60 ESG Index was utilised by TD Securities in 46 products issued in Canada (since the beginning of 2021). Other index providers with a presence in 2022 included SGX, Refinitiv, Solactive, Morningstar and FTSE Russell.

Qontigo has seen its market share shrink significantly in recent years: from 47% in 2019 to 14% last year. However, this is more to do with increased competition than anything else as its estimated ESG-index linked sales volumes for 2022, at US$1.9 billion, were higher than those for 2020 and 2021. Its iStoxx France ESG 40 Decrement 50 Index and Euro Stoxx 50 ESG Index, for example, were both frequently used in 2022, as was the idDAX 50 ESG NR Decrement 4% PR EUR Index.

ESG INDICES - ISSUERS French financial institutions are dominating the issuers table – with four out of the top five issuers in 2022 domiciled in France. Société Générale was the main issuer, with a 20% market share in ESG index-linked products, while Natixis (11%), Amundi (nine percent) and BNP Paribas (eight percent) also made the top five.

The one provider which really turned its offering upside down was S&P DJI. In 2019 its indices barely registered in the ESG segment, with sales of below US$10m. Fast forward three years, and it is a completely different story with approximately US$1.6 billion collected – the equivalent of a 13% share of the ESG market. One of its flagship indices, the S&P Transatlantic 100 ESG Select Equal Weight 50 Point Decrement Index, was exclusively used in 23 products (since the end of 2021) by BNP Paribas – predominately in France but also in Finland – while the S&P/TSX

Deka Bank, in second with a 16% market share, was the only non-French entity. The German provider of asset management and capital market solutions has made huge inroads in the last few years. In 2019 it was virtually non-existent in the ESG sphere with a 0.4% market share, but since then it has significantly expanded its ESG coverage mainly driven by products linked to three MSCI indices:

ESG indices: index provider market share with top 5 issuers 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

2019

2020

2021

2022

2019

Societe Generale

2020

2021

2022

DekaBank MSCI

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Euronext

2019

2020

2021

2022

2019

2020

Natixis Qontigo

S&P Dow Jones

2021

2022

2019

Amundi SGX

Refinitiv

Solactive

2020

2021

BNP Paribas Other

2022

15 ESG indices: decrement vs non-decrement (US$m)

ESG indices with a volatility target - notional (US$m)

14,000

400

12,000

350

10,000

300

8,000

250

6,000

200 150

4,000

100

2,000 0

2019

2020 Decrement index

2021

2022

Non-decrement index

MSCI World Climate Change ESG Select 4.5% Decrement EUR Index, MSCI Germany Climate Change ESG Select 4% Index and MSCI EMU Climate Change ESG Select 4% Decrement Index.

2019

2020

2021

2022

5% Index – which was seen in 31 products worth US$2.7 billion in 2019-2021 – to a more diverse offering in 2022 when, apart from Euronext ESG indices it also used indices from SGX (iEdge ESG Transatlantic EW 50 Decrement 50 Points GTR Index, iEdge ESG Transatlantic Water EW 50 Decrement 5% NTR Index, among others) and MSCI (MSCI World Health Care Select ESG Top 50 5% Decrement Index).

Just outside the top five we find Crédit Agricole CIB, which like Deka Bank, barely registered in 2019 but since then steadily increased its market share, collecting almost US$1 billion in 2022.

Amundi’s offering included indices from Qontigo (Euro iStoxx 50 Carbon Adaptation GR Decrement 5% Index), Euronext (Euronext CDP Environment France EW Decrement 5% Index), MSCI (MSCI Europe Select Green 50 5% Decrement Index) and S&P DJI (S&P Eurozone 50 Paris-Aligned Climate Select Index).

Société Générale offered access to 37 ESG indices between 2019-2022, including indices from Solactive, Qontigo and MSCI. However, the bulk of SocGen’s ESG index-linked volumes has come from Euronext indices such as the SBF Top 50 ESG EW Decrement 50 Points and Euronext Euro 50 ESG EW Decrement 50 Points Index, which it has used since 2019. Deka Bank, which in 2019 had solely used Qontigo’s Stoxx Europe ESG Leaders Select 30 EUR Index shifted its focus a year later to MSCI indices, including the afore mentioned MSCI World Climate Change ESG Select 4.5% Decrement EUR Index. Natixis also moved from using almost exclusively Euronext indices such as the Euronext Climate Objective 50 Euro EW Decrement

BNP Paribas issued products on 41 different ESG indices between 2019-2022. BNP too collected healthy volumes throughout the period from products linked to Euronext indices such as the Euronext Transatlantic ESG Leaders 60 EW Decrement 5% and Euronext Eurozone ESG Leaders 40 EW Decrement 5% Index, but in 2022 it also issued 20 products linked to the S&P Transatlantic 100 ESG Select Equal Weight 50 Point Decrement Index.

ESG indices: thematics by issuer Societe Generale Natixis Intesa Sanpaolo Goldman Sachs DekaBank Credit Suisse Credit Agricole CIB Financial Solutions BNP Paribas Amundi 0% Climate

Climate Paris Aligned

10% Broad ESG Index

20%

30%

ESG leaders

40% Environment

50%

60%

Low carbon

Clean water

70%

80%

ESG Momentum

90%

100%

Circular economy

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16 ESG indices: geographic exposure (US$m)

ESG indices: geographic exposure by region 100%

14,000

90%

12,000

80% 70%

10,000

60%

8,000

50% 40%

6,000

30% 20%

4,000

10%

2,000 0 Europe

2019 World

2020 France

US & Europe

2021 Germany

US & Canada

China

Other

Issuers such as Société Générale, Intesa Sanpaolo, Crédit Agricole CIB and Credit Suisse focused on the use of broad ESG indices (60% and more of total output) but others, such as Goldman Sachs, BNP Paribas and Amundi, offered a more diverse palette. Goldman offered access to thematics such as climate Paris aligned, ESG leaders, the environment and ESG momentum. Amundi offered much of those too but also added low carbon while BNP Paribas, whose main thematic was ESG leaders, also offered products linked to themes such as clean water and the circular economy. ESG DECREMENT INDICES After 2019, there has been a significant increase in the use of ESG-themed decrement indices. In 2022, more than 88% of all sales came from products linked to a single-decrement index compared to 52% in 2019. For 2020 and 2021 this figure stood at 79% and 90%, respectively. Examples of ESG decrement indices include the MSCI World Climate Change ESG Select 4.5% Decrement EUR Index which is based on the MSCI World Climate Change ESG Select Index and includes large and mid-cap segments across 23 Developed Markets (DM) countries. The index applies a constant markdown (synthetic dividend) of 4.5% on an annual basis, expressed as a percentage of performance. It has been used as the underlying for nearly 2,000 structured products targeted mainly at investors in Germany Other examples included the SBF Top 50 ESG EW Decrement 50 Points, with estimated sales of US$3 billion from 200 products, the Euronext Climate Objective 50 Euro EW Decrement 5% Index (US$2.4 billion from 34 products) and Stoxx Global ESG Leaders Select 50 EUR Index (€1.8 billion from 217 products). The last three indices were mainly used in the French market. Target volatility ESG indices with a target volatility collected an estimated US$325m in 2022, down six percent YoY, but a 6.7-fold increase compared to 2019 when these indices gathered less than US$50m. An example is the Morningstar Exponential Technologies ESG Screened Target Volatility 7% Index, which in 2022 has been used by HSBC as the underlying in 28 structured deposits aimed at retail investors in China.

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2019

2020

2021

2022

Americas

2022

American stocks

European stocks

2019

2020

2021

2022

Apac Global stocks

2019

2020

2021

2022

Emea Apac stocks

EU & US stocks (Transatlantic)

ESG INDICES BY GEOGRAPHIC EXPOSURE Traditionally, geographic exposure has focused on Europe, World, and France, however, since 2020, transatlantic indices (Europe & US) have gained traction. The former three were responsible for 97% of all sales in 2019, but last year this figure had shrunk to 79% with transatlantic indices capturing 17% of sales volumes – up six percent year-on-year. Most index providers offer indices with ‘transatlantic’ exposure these days which is reflected on the SRP database with iStoxx Transatlantic ESG 100 EW Decrement Index, iEdge ESG Transatlantic Water EW 50 Decrement 5% NTR Index, Euronext Transatlantic ESG Leaders 60 EW Decrement 5%, S&P Transatlantic 100 ESG Select Equal Weight 50 Point Decrement Index and MSCI Transatlantic Select Green 50 5% Decrement Gross Index all frequently used. If we look at geographic exposure by region, we see a clear preference for ‘local’ stocks, with investors in the Americas preferring American shares, those in Emea preferring European stocks with only Apac investors having a more global outlook. In the Americas, 49% of sales in 2022 came from products linked to indices with exposure to American stocks, a figure which was as high as 100% in 2020. More than 60% of 2022 volumes in Emea was tied to products on indices with European exposure – this was the lowest figure in the last four years with a high of 75% reached in 2020. There was also a consistent demand for global stocks in the region (fouryear average of 23%) while indices with transatlantic exposure gathered pace in 2021 and 2022, responsible for 11% and 17% of ESG-linked sales, respectively. In Apac, exposure varied very much per year. In 2019, 94% of sales came from products linked to indices with European exposure, however, by 2022 this figure had been reduced to zero, with investors instead looking for global (75%) or Apac exposure (24%). ESG INDICES: THEMATICS Broad ESG-screened- and climate indices have been the main thematic in recent years, and, except for 2019, have made up at least 50% of ESG-linked sales volumes. By 2022 they had

17 ESG indices: thematics (US$m)

ESG indices: single index notional (US$m) by country

14,000

Other* Alternative energies

12,000

Green technologies Healthcare

10,000

ESG leaders ESG Momentum

8,000

SRI SDG

6,000

Clean water Low carbon

4,000

Circular economy Social & Governance

2,000

Environment Climate Paris Aligned

Climate

2019

2020

2021

Broad ESG-screened Index

2022

2019 France

*Other includes biodiversity, waste management, future consumers, megatrends and quality

a combined market share of 56%, with 38% tied into products linked to Broad ESG-screened indices and a further 18% tied in climate indices. A relatively new thematic is climate Paris-aligned, which was first seen in 2021 but really took off in 2022 when it claimed eight percent of sales volumes. Of these, the MSCI Euro Climate Select 50 Paris Aligned 5% Decrement Net Index was one of the most successful, with an estimated US$320m collected from six products that were issued in France on the paper of Crédit Agricole CIB Financial Solutions. The S and G of ESG are also fast becoming a topic favoured by investors. It barely registered in 2019 but has since steadily increased its market share.

2020 Germany

Italy

2021 Belgium

2022 Finland

Ireland

Investors in the Americas have a clear preference for broad ESGscreened indices, which made up 81% of all volumes in 2022, while those in Apac are keen too, but also show an interest in green technology with products linked to the latter capturing 45% of all ESG sales volumes. In Emea, and Europe specifically, broad ESG-screened indices were also the dominant force, although here there was a much wider spectrum of thematics on offer than in the other regions, with climate, Paris-aligned, low carbon, the circular economy and others all vying for a share of the structured products market. ESG INDICES BY MARKET In the French market, an estimated US$9.3 billion was collected by structured products linked to ESG-indices in 2022 – the equivalent of 75% of global ESG-linked sales. Germany accounted for approximately 21% of all sales with a further two percent gathered in Italy.

The circular economy, clean water, healthcare and green technologies were all themes that entered the structured products space for the first time in 2022.

ESG indices: theme by region 100%

Other ESG

90%

Circular economy Future consumers

80%

Quality select Green technologies

70%

Healthcare Alternative energies

60%

ESG Momentum

50%

Social & Governance

40%

Low carbon

Clean water Environment

30%

Sustainability SDG

20%

SRI

ESG leaders

10% 0%

Climate Paris Aligned Climate

2019

2020 2021 Americas

2022

2019

2020

2021 Apac

2022

2019

2020

2021 EMEA

2022

Broad ESG Index

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18 ESG ETFs: single versus basket - market share

ESG ETFs: notional per region

100%

600

90%

500

80% 70%

400

60%

300

50% 40%

200

30% 20%

100

10% 0

2020

2021 Single ETF

2022

2020

2021 Americas

ETF basket

In Belgium, which had captured almost 10% of global ESG-linked sales in 2019, the market share was down to 0.6% in 2022, partly driven by a recommendation from the FSMA that issuers and distributors of structured products should consider the complexity of the underlying assets when determining the target market and distribution strategy. Products linked to ESG exchange-traded funds (ETF) were mostly linked to single ETFs although there has been a gradual shift towards ETF baskets. Looking at sales volumes, ESG ETF-linked structures had their best year in 2021, when more than US$500m was invested in products linked to single ETFs with a further US$85m invested in ETF baskets. However, sales in both 2020 and 2022 were far less prominent with a combined US$75m invested in 2021 and US$60m last year.

Apac

2022 EMEA

The highest volumes, by some distance, were recorded in the Americas, and specifically the US. In 2021, US$420m was collected from 142 products including almost US$400m that was invested in products linked to the iShares Global Clean Energy ETF. Other funds frequently used in the US market were the Invesco Solar ETF and the ARK Innovation ETF. In Emea, apart from the aforementioned iShares Global Clean Energy ETF, the Deka MSCI World Climate Change ESG UCITS ETF was the most used. Thematics for ESG ETF-linked products have seen much change over the years. Whereas the focus in 2020 was on Social & Governance and sustainability, the following year was dominated by alternative energies while in 2022 solar/clean energy baskets were the most in demand.

ESG ETFs: notional by thematics

2022

2021

2020

20% Solar/clean energy basket

40% Sustainability

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Climate

Alternative energies

60% Clean energy

80% Electric vehicles

Social & Governance

100% Other

MSCI: more than 50% of our indexes in Europe are ESG The index provider is the fastest growing provider of ESG underlyings to the retail structured products market over the last four years.

Investors are increasingly aware of climate and ESG issues and want to do their part MSCI has seen its market share in the structured products market growing significantly since 2019 on the back of strong growth from market-cap and ESG indices as reported in the last quarter of 2022, as well as new additions to its offering such as the launch of the first sentiment-based rotation thematic index, the launch of a digital assets index suite, and a taxonomy framework with Goldman Sachs to provide investors, service providers, developers, and researchers a way to help monitor market trends, analyse portfolio risk and returns, review portfolio performance and reporting, and help build new products across the global digital-assets ecosystem. According to Stephane Mattatia (pictured), global head of thematic indexes and derivatives licensing at MSCI, ESG has become an area of innovation where the industry is helping to set up standards. “The industry is moving quickly because of the market dynamics. Ultimately all these initiatives will converge – the industry is helping to create a common language for ESG and standards that everybody understands and can follow,” says Mattatia. “The debate around ESG ratings has been left behind and the whole industry is seeking to progress towards a common language and a common understanding of what ESG means. This is also positive because it means that it allows us to evolve towards a common framework for ESG.”

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From a geographical and product development perspective, the European market continues to front run most of the developments and innovations in the space. “The Emea region has become the first source of ESG index creation for the structured products market for many reasons,” says Mattatia. “Investors are increasingly aware of climate and ESG issues and want to do their part. You can see this by looking at where they are investing.” According to Mattatia, more than 50% of the indexes delivered by MSCI in structured products market are now ESG. “It has become a must have in Europe,” he says, adding that 2022 was a very strong vintage for structured products at MSCI. “Our growth in Europe continues. I only expect a continuation of this trend for the coming years, because ESG is here to stay in Europe and there is a lot of work to do with regulators to make these products accessible for everyone that wants to contribute.” When it comes to ESG related thematics, Mattatia points at water, clean energy and biodiversity as “the most popular” sub-themes. “We think this trend will continue very strongly in Europe,” he says. In Europe, France and Germany remain at the forefront of developments and activity but other markets are catching up.

21 “There is scope to grow in Apac and the Americas, but they are at different stages of ESG development,” says Mattatia. “There needs to be a green angle in public policy to support ESG activities. “We think investors in America and APAC will increasingly tackle their ESG concerns by investing in ESG products via thematics that resonate with them – water, clean energy, electric vehicles, future mobility, and so on.” What makes a product E-S-G? Stephane Mattatia: It’s difficult to answer, but you clearly see two ways of expressing ESG. One is via the issuer rating and the second is implementing those ESG views from a positive investment perspective as you look through the ESG lens. Historically, the E pillar has been the main driver of activity, but as the market evolves, we see a shift towards the ‘S’ in ESG which started in 2022. We have developed a social index and licensed it to two banks which are looking to launch products covering this aspect of ESG. It is part of the ESG evolution – investors now want to come into ESG and look with more precision, make specific selections and carefully pick which angle they want to take. This is positive because it shows more ownership of the ESG matter from the client perspective and that pushes the market to create high quality products. Has the data deployed in ESG strategies improved over the last few years? Stephane Mattatia: A few years ago, ESG was just a box ticking

Top MSCI underlyings 2019

USDm

Issuance

Market share

MSCI Europe Countries ESG Select 50 Points Decrement Index

120.17

MSCI World ESG Yield Select Variance Price Index

30.20

MSCI Europe ESG Leaders Select Top 50 Dividend

exercise, but this is no longer the case – it is not about exclusions anymore, but about providing ESG exposure in a meaningful manner with conviction. We are now able to look into the market and provide more granularity in the exposures we can offer. When we started trading our first ESG indexes 10 years ago, it was more of a tilting allocation. People now want more granularity and looking at things like diversity and social angles as well, which pushes us to look for other sources of data that would allow us to go more precisely on whichever aspect of ESG the client wants exposure to. This is where the market is going. Investors want to have more ownership and more impact with their investments. They want to choose and customise their exposures and this is also good for us because it challenges us to come up with solutions and new ideas to access these investment ideas. Can structured products help to increase ESG adoption? What are the main challenges to grow this part of the market? Stephane Mattatia: I do not think that there is a specific hurdle for ESG adoption. Everyone is pushing in the same direction and with the support of public policies, ESG is becoming relevant across the world. Regulation is needed and must aim at making sure that everyone speaks the same language to avoid greenwashing. We think it is a process - as the mentalities of people evolve there will be more adoption. There is a whole generation of younger investors clearly aware and keen on going for ESG and sustainable investing. For the more mature investors it will take some time, but it takes time because it is also something ambitious.

Top MSCI underlyings 2020

USDm

Issuance

Market share

MSCI Europe Select Green 50 5% Decrement Index

398.98

MSCI World Climate Change ESG Select 4.5% Decrement EUR Index

128.64

147

22.85

MSCI EMU SRI Select 30 Decrement 3.5% Index

29.34

MSCI Europe Select Green 50 5% Decrement Index

12.86

MSCI France Select ESG 30 5% Decrement Net Index

21.73

MSCI EMU SRI Select 30 Decrement 3.5% Index

12.46

MSCI Global Diversified Megatrends 5% Decrement Index

8.86

Top MSCI underlyings 2021

USDm

Issuance

Market share

Top MSCI underlyings 2022

USDm

Issuance

Market share

MSCI World Climate Change ESG Select 4.5% Decrement EUR Index

1305.21

864

12%

MSCI World Climate Change ESG Select 4.5% Decrement EUR Index

1715.56

948

13%

MSCI Germany Climate Change ESG Select 4% Index

443.94

300

MSCI France Select ESG 30 5% Decrement Net Index

630.90

MSCI Europe Select Green 50 5% Decrement Index

250.31

MSCI EMU Circular Economy Sustainable Impact Select 50 Points Decrement Index

445.57

MSCI EMU Climate Change ESG Select 4% Decrement Index

239.22

168

MSCI World Health Care Select ESG Top 50 5% Decrement Index

301.13

MSCI EMU SRI Select 30 Decrement 3.5% Index

191.22

152

MSCI Euro Climate Select 50 Paris Aligned 5% Decrement Net Index

290.41

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Euronext: the biggest part by far of what our clients request Euronext has capitalised on demand for ESG underlyings in Europe, particularly in France, to retain a significant market share as one of the top providers of ESG underlyings to the structured products market with about 25% of the products issued featuring an index developed by the index provider. The most recent development came in the form of a gender equality based index – the Euronext Equileap Gender Equality France 40 Index, launched in partnership Equileap in December 2022, but the European index provider was also behind the second highest selling ESG index in the structured products market last year. The SBF Top 50 ESG EW Decrement 50 Points Index sold US$1.3 billion across 103 products in 2022 and was only beaten by the MSCI World Climate Change ESG Select 4.5% Decrement index which was linked to over 1,000 products and raised US$1.9 billion during the same period – The SBF Top 50 ESG EW Decrement 50 Points is now the third highest selling ESG strategy from Euronext in the structured products market. “ESG is an important trend for our index business and the biggest part by far of what our clients request - more than 80% of the indices that we have created in 2022 include ESG features in one way or another,” says Fabrice Rahmouni, head of Index Business at Euronext. From an index provider stand-point, looking back provides perspective to observe how the market has evolved from applying broad ESG considerations into one single index to using different environmental and social pillars in indices and more recently sub-pillars with specific themes - biodiversity, education, hydrogen and other sub-themes. “This is possible thanks to new data providers that do not have a broad approach to ESG but are experts on very specific metrics and this is pushing everybody to partner with specialist data partners big and small to develop new strategies covering very specific themes such as climate, hydrogen, biodiversity indices but as well social indices that grow quite rapidly in 2022 as education and employment for instance,” says Ramouni. A few years ago, the ESG story was difficult to explain, according to Ramouni, because the different E, S and G considerations were not clearly defined. “The financial world is sometimes blamed for many kinds of things, but when it comes to ESG it is playing a leading role to create market standards,” he says. “The industry has learned by working on the granularity of the data to make the message clearer. We see it as a natural evolution – as everything starts with data. The more we learn the quicker we will be to respond to demand.”

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Decrement has been a feature of ESG underlyings over the last couple of years. Can the increase in interest rates fade the focus on the dividend risk? Fabrice Rahmouni: The increase in interest rates could have an impact on demand for decrement indices because decrement by definition is linked to the market levels, and we are in a change of cycle currently. Here, we have a very pragmatic approach and open to accommodate the new needs of issuers of structured products as we did with decrement and then continue to serve their new approaches in this context (providing for instance new high yield low vol approaches) From an index provider point of view, we think there is room for further innovation around the methodology itself, the data used as well as in the ways to calculate and measure market performance. The structured products market is clearly driven by innovation, and we are always open to new creative solutions. Of course, we have high due diligence requirements and responsibilities under the BMR regulation, so we must be 100% sure that our indices are built accordingly. How can index providers help bring clarity around ESG and the different components of an investment product –bond component, underlying, use of proceeds? Fabrice Rahmouni: All the components are important, and some investors have their preferences but the composition of the portfolio itself is what will make the difference from an index provider point of view. Our focus is on improving the methodologies we deploy on our ESG indices and being more cautious on exclusions and the data we use to build our indices. On the top of this, as the regulation (and labels) are also a key factor for our client we naturally consider this into the construction process of our indices, e.g. the methodology of the CAC ESG has been constructed to comply with the spirit of the French ISR Label. We want to contribute to the growth of ESG with quality underlyings that meet ESG requirements and deliver value to investors. What makes Euronext indices from the offering of other providers? Do you think open architecture can add an edge when curating ESG data to build indices? Fabrice Rahmouni: On the top of our brand, our main strengths include providing expertise and advise to clients

23 on ESG side (data, label, regulation) and our ability to interact and create customized solutions. We also have a competitive pricing model and a collaborative approach with a large range of ESG data providers. Indeed, here we are different from main other index providers in that we have an open architecture set up when it comes to ESG.

make things clear for market participants across Europe. The market recognizes the need for standards, but this takes time and requires time and resources (reporting). However, without clear rules we run the risk of greenwashing and misleading investors - it is important to have a solid set of rules that apply to the whole market.

We have more than 10 partnerships with different boutiques and data providers which gives us access to new sources to develop indices and specific expertise when it comes to ESG that clients want to take advantage of.

Where is the focus at Euronext for 2023?

Can regulation slow down ESG adoption and limit investor choice? Fabrice Rahmouni: The lack of standards and the cost to meet new regulations is a challenge but we think the market is moving in the right direction. Five years ago, there were almost no ESG rules whereas now, at least in Europe, regulators are moving to create a framework to bring clarity. The current set up is not ideal yet because the different players must meet different national / international guidelines and it adds a layer of complexity into the methodology of indices. However, we think the new rules provide a chance to move forward and

Fabrice Rahmouni: From a thematic point of view, there is opportunity around the S of ESG, and clients are demanding new solutions that can be delivered in different products to cover and support social aspects. Investors are concerned about the social impact of the recent pandemic and the state of the economy. As such, we think there is going to be a push from ESG on the social side as Gender equality, education and employment for instance, that are themes gaining traction among investors. We think this will also help increase awareness and expand the pool of ESG investors. From a geographical point of view, France remains our top market for ESG indices, but we have seen increased activity in Italy and Nordic Countries over the last year. We expect other European markets to follow this trend.

Top Euronext underlyings 2019

USDm

Issuance

Market share

Euronext Climate Objective 50 Euro EW Decrement 5% Index

798.65

15%

Euronext Eurozone ESG Leaders 40 EW Decrement 5% Index

501.87

10%

Euronext Euro 50 ESG EW Decrement 50 Points Index

456.36

SBF Top 50 ESG EW Decrement 50 Points

415.32

Euronext Eurozone 100 ESG Decrement 5% Index

59.48

Top Euronext underlyings 2020

USDm

Issuance

Market share

Euronext Climate Objective 50 Euro EW Decrement 5% Index

839.96

17%

SBF Top 50 ESG EW Decrement 50 Points

546.82

11%

Euronext Eurozone ESG Leaders 40 EW Decrement 5% Index

225.86

Euronext Euro 50 ESG EW Decrement 50 Points Index

203.65

Euronext CDP Environment France EW Decrement 5% Index

146.96

Top Euronext underlyings 2021

USDm

Issuance

Market share

Euronext Euro 50 ESG EW Decrement 50 Points Index

988.74

Euronext Climate Objective 50 Euro EW Decrement 5% Index

680.97

Euronext Core Euro & Global Climate Change EW Decrement 5% Index

445.19

SBF Top 50 ESG EW Decrement 50 Points

437.69

Euronext Transatlantic ESG Leaders 60 EW Decrement 5%

392.06

Top Euronext underlyings 2022

USDm

Issuance

Market share

SBF Top 50 ESG EW Decrement 50 Points

1564.80

12%

Euronext France Social Decrement 3.75% Index

286.74

Euronext CDP Environment France EW Decrement 5% Index

235.34

Euronext CDP Environment Eurozone EW Decrement 3.75% Index

227.32

Euronext Eurozone Diversity & Governance 40 EW Decrement 5% Index

165.24

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YOUR INDEX ISN’T THAT TRENDY? CHOOSE A THEMATIC INDE THAT WILL KEEP YOU ON TODAY’S MEGATRENDS Learn more about STOXX thematic indices on qontigo.com/thematics

Indices by Qontigo

Qontigo: The trend towards customisation is playing on our strengths Armelle Loeb, Qontigo, head of index sales Emea and member of the STOXX management board, sees the trend towards customisation as an opportunity to leverage the index provider’s open architecture and bespoke approach.

There is an appetite from investors for new ESG themes How would you describe activity around ESG structured products? For the past two to three years, almost 100% of the iSTOXX indices - these are custom indices we design for clients like structured products issuers - have had some element of ESG tilt. However, as we develop new iSTOXX indices with issuers of structured products, we can see that there is a shift from basic exclusions towards a more best-in-class approach. But we are faced with different regulatory requirements at a national level – France, Belgium, and other countries - which still provide challenges for the development of the most advanced ESG index solutions for retail structured products, such as PAB or Net Zero, which are by nature relatively complex methodologies. What are the main challenges around ESG adoption – regulation, lack of standards? This is something we ask ourselves all the time. First of all, there is no real regulatory framework you can apply across markets. There have been some efforts at a country level to provide some clarity and standards as we have seen with the German associations and their ESG Code of Sustainability, but this approach is different from the French market, for instance. Besides the different regulatory frameworks, there is also a shift towards customization driven by issuers and distributors themselves, who want their products to incorporate their own ESG, climate and biodiversity convictions. This is a trend we see in structured products but also in ETFs as well as the traditional

asset management industry. This makes it harder to come up with standardised methodologies. What is your outlook for this part of the market? The war in Ukraine and the energy crisis could delay the transition towards a green economy, but the main drivers to increase adoption remain regulation and education. We think the introduction of the different regulatory guidelines such as the MiFID 2 requirements will help to increase awareness as distributors are now required to ask investors about their sustainability preferences. Once given the option and more transparency, we think investors will want their investments to have a positive impact on sustainable goals whether it is on climate or on social issues, but this does not necessarily mean that they are willing to give up performance. The challenge is to create indices and products that deliver a similar performance and have a positive ESG contribution. How do you view the issue of “greenwashing”? This is an issue which we think regulation will help to address, but the industry needs further clarification from regulators. The new MiFID 2 requirements and ESG taxonomy will limit the risk of greenwashing and drive the market towards a natural standardisation of offerings. Under the new MiFID 2 rules, distributors must be able to classify products according to different sustainability objectives: a

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26 percentage of sustainable investments as per the EU Taxonomy, a percentage of sustainable investment as per the SFDR’s SI or a consideration of Principal Adverse Impact indicators. The SFDR’s SI indicator, in particular, is getting a lot of attention from distributors who are putting pressure on issuers to have a consistent SI framework, and the issuers are putting pressure on index providers to come up with such a framework and develop strategies with high SI, good performance and with suitable pricing for structured products. We think the introduction of the different regulatory pillars will help differentiate ESG and non-ESG products and increase investor awareness. How do ESG requirements impact performance? ESG exclusions or climate optimisation can have a negative impact on the performance of some sectors and markets, but this isn’t always the case. However, I would not pitch ESG as a way to outperform a benchmark but as a way to support green and ethical causes without sacrificing too much performance. What new themes are you exploring with clients? The number of new sub-themes within the sustainability space, such as biodiversity, clean energy, ocean care, green infrastructure and

other commodity-related themes has increased over the past years, and this is also helping to move this segment of the market forward. There is an appetite from end investors to include these new themes in their investments and we must respond to that demand with indices that capture these segments with a financial optimisation overlay such as decrement or risk control, so that these indices price well for structured products. Do you see structured products as an opportunity to grow your ESG index business? Our index business is based on an open architecture approach which allows us to work with some of the best data providers across the globe to develop new investment themes. In terms of thematic and ESG investing, the trend towards customisation is thus playing on one of our strengths. The STOXX index business, now part of Qontigo, was also one of the first to develop a range of indices optimised for structured products, such as decrement indices, low volatility and high dividend indices, or risk control indices. This is helping us to partner with market players to meet the need of investors. Customisation is in our DNA, and we are well positioned to capitalise on the current trends.

Top Qontigo underlyings 2019

USDm

Issuance

Market share

Stoxx Global ESG Leaders Select 50 EUR Index

1249.69

24%

Stoxx Europe ESG Leaders Select 30 EUR Index

762.07

169

15%

Euro iStoxx ESG Leaders 50 NR Decrement 5%

165.00

iStoxx Europe ESG Climate Awareness Select 50

153.14

iStoxx Transatlantic ESG 100 EW Decrement Index

50.07

Top Qontigo underlyings 2020

USDm

Issuance

Market share

Stoxx Global ESG Leaders Select 50 EUR Index

453.13

134

iStoxx Transatlantic ESG 100 EW Decrement Index

378.07

iStoxx Europe 600 ESG-X NR Decrement 4.75% Index

254.70

Euro iStoxx 50 Carbon Adaptation GR Decrement 5% Index

213.33

Stoxx Europe ESG Leaders Select 30 EUR Index

124.74

114

Top Qontigo underlyings 2021

USDm

Issuance

Market share

Euro iStoxx 50 Carbon Adaptation GR Decrement 5% Index

474.03

iStoxx Europe 600 ESG-X NR Decrement 4.75% Index

283.71

iStoxx Transatlantic ESG 100 EW Decrement Index

275.89

Euro Stoxx 50 ESG-X Index

176.22

Euro iStoxx ESG Choice 50 EW NR Decrement 4% Index

85.12

Top Qontigo underlyings 2022

USDm

Issuance

Market share

Euro Stoxx 50 ESG-X Index

521.69

Euro iStoxx 50 Carbon Adaptation GR Decrement 5% Index

309.44

iStoxx France ESG 40 Decrement 50 Index

243.98

idDAX 50 ESG NR Decrement 4% PR EUR Index

198.58

131

iStoxx Europe 600 ESG-X NR Decrement 4.75% Index

125.93

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S&PDJI: structured products, a growth area for ESG indices S&P Dow Jones Indices has seen its footprint in the ESG structured products market increase since 2020 and has become the second fastest growing provider in this space.

ESG sophistication within European structured finance has potentially lagged other asset classes The index provider saw sales linked to its ESG underlyings growing two-fold in 2022 jumping into contention to dispute the third spot in the 2022 ESG index provider league table with a 10% market share, alongside Qontigo. The two bestselling S&PPDJI ESG indices in 2022 – the S&P Transatlantic 100 ESG Select Equal Weight 50 Point Decrement Index and S&P Eurozone 50 Net Zero 2050 Paris-Aligned ESG Select 50 Point Decrement Index, were deployed in the French market across 20 products worth US$403.10m and 18 products with a value of US$216.26m, respectively. In South Africa, the S&P/TSX 60 ESG Index was featured across 32 products/US$100.90m while the flagship S&P 500 ESG was

Index

the underlying reference for 12 products worth US$3.12m in 2022 – the S&P 500 ESG index is linked to 125 live products worth an estimated US$45.5m, according to SRP data. “Although initially ESG adoption in structured products was arguably slower than for example ESG in equities, that is not to say the demand hasn’t been there,” says Stephanie Rowton, head of ESG indices, Emea, S&P Dow Jones Indices, adding that demand for S&PDJI general ESG indices, like the S&P 500 ESG, “continues to be incredibly popular as market participants look to use a broad-based index that incorporate ESG metrics”. According to Rowton, ESG sophistication within European

Issuance

Sales Volume

S&P Transatlantic 100 ESG Select Equal Weight 50 Point Decrement

416.71 (USDm)

S&P Eurozone 30 ESG-Momentum Select EW 50 Point Decrement

252.89 (USDm)

S&P Eurozone 50 Net Zero 2050 Paris-Aligned ESG Select 50 Point Decrement

219.52 (USDm)

S&P Transatlantic 100 Net Zero 2050 Paris-Aligned ESG Select 50 Decrement

131.51 (USDm)

S&P/TSX 60 ESG

116.28 (USDm)

S&P Eurozone 30 ESG-Momentum EW 50 Point Decrement TR

109.94 (USDm)

S&P 500 ESG

125

45.55 (USDm)

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29 structured finance has potentially lagged other asset classes where the ability to utilise and integrate highly sophisticated data such as forward-looking climate data, “is readily available”.

“Issuers of structured products are increasingly starting to think about how their offerings align with the new guidelines and how to develop that more broadly,” she says.

“Our focus is to understand the needs of our clients [and the market], and then develop indices to meet those needs,” she says. “The demand for ESG products in the wider market remains high, and especially in the structured products’ market we see increasing demand.”

“We will continue to have an open dialogue with clients and market participants to better understand the implications of this evolving regulatory framework.”

Rowton points at EU regulation, including the EU Taxonomy, as a topic of interest among the index provider’s clients and although it has varying degrees of impact across issuers, “is viewed as the gold standard and therefore our clients’ end investors are calling for greater alignment with”. Side by side According to Rowton, indexing has evolved alongside ESG with index providers tapping into new opportunities to grow their ESG business and leverage their range of index-based solutions, research, and data. “We are closely monitoring all developments on data disclosure and standardisation. Arguably data is the most important element and our top priority when designing an index. The quality of the data is the foundation of a strong index [as] it creates credibility,” she says. Looking back at 2022, Rowton notes the ESG agenda was “the focus for many European market participants” seeking to align with the European taxonomy and regulation more broadly.

At a product development level, the ESG theme entered a new phase with new sub-themes like low carbon and water gaining traction as well as indices that focus on specific ESG areas such as diversity, inclusion, and the gender gap in companies. “There are several metrics from the E and the S of ESG that product providers are focusing on to design new products,” she says. “We expect that trend to continue as well as the demand for customised screens. We also expect climate indices to remain popular and we continue to receive requests for specific themes such as net zero indices.” From a geographic standpoint, France continues to drive most of the ESG activity in the structured products market, although Rowton points at Germany, the Nordics and the UK as markets where there is “additional interest”. “Our view of the structured products market is that it is a growth area for our ESG indices. There is often a need for customisation as clients look for exclusivity, new products and a team who they can work closely with to create a specific product,” says Rowton.

Top S&P Dow Jones underlyings 2019

USDm

Issuance

Market share

S&P EuroUSA 50 ESG Select Equal Weight 50 Point Decrement Index

55.08

S&P Eurozone 30 ESG-Momentum Select EW 50 Point Decrement Index

32.99

S&P 500 ESG

13.60

S&P Eurozone 30 ESG-Momentum EW 50 Point Decrement TR Index

1.50

Top S&P Dow Jones underlyings 2020

USDm

Issuance

Market share

S&P EuroUSA 50 Low Carbon ESG Select Equal Weight 50 Point Decrement Index

150.21

S&P Eurozone 30 ESG-Momentum Select EW 50 Point Decrement Index

142.24

S&P Eurozone 30 ESG-Momentum EW 50 Point Decrement TR Index

86.60

S&P EuroUSA 50 ESG Select Equal Weight 50 Point Decrement Index

75.11

S&P Global Clean Energy 3.5% Decrement Index

56.00

Top S&P Dow Jones underlyings 2021

USDm

Issuance

Market share

S&P Transatlantic 100 ESG Select Equal Weight 50 Point Decrement Index

436.32

S&P Eurozone 50 Net Zero 2050 Paris-Aligned ESG Select 50 Point Decrement Index

204.29

S&P Transatlantic 50 Net Zero 2050 Paris-Aligned Select 5% Decrement Index

150.21

S&P Eurozone 30 ESG-Momentum Select EW 50 Point Decrement Index

140.20

S&P Transatlantic 100 Net Zero 2050 Paris-Aligned ESG Select 50 Decrement Index

107.15

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Solactive: performance remains a potential pitfall The Frankfurt based index provider sees the ESG as an opportunity to develop new quality underlyings that respond to the increasing demand from investors for sustainable products.

ESG is now at the core of pretty much everything done in the asset management world Solactive is an active provider of ESG underlyings to the structured products market and part of the group of tier 2 ESG index providers comprising SGX – which has an exclusive agreement as a supplier of custom indices to Natixis, and Refinitiv. The German firm started 2023 with the launch of a partnership with Société Générale and Iceberg Data Lab to develop a range of biodiversity screened index strategies targeted at investors seeking to consider the impact of companies on biodiversity into their investments. The new indices - Solactive Transatlantic Biodiversity Screened 100 RW Index, Solactive Transatlantic Biodiversity Screened 150 CW Index and Solactive Transatlantic Biodiversity Screened Index - have been licensed to the French bank for the issuance of structured products. SRP spoke to Solactive’s chief markets officer Timo Pfeiffer (pictured) about the latest dynamics around ESG and indexing, and the company’s plans to continue serving the structured products market with new ESG underlyings. “It is fair to say ESG has picked up and continues to gain momentum,” says Pfeiffer. “A few years ago, ESG was more labelled as just another theme but that has changed. ESG is now at the core of pretty much everything done in the asset management world. You hardly have an index discussion that does not have an ESG element and that is a big change from two or three years ago.” Drivers Pfeiffer believes that the dominant piece - the environment, has been the key driver behind the development of new underlyings.

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“We have seen many new strategies around climate, climate change, climate transition, carbon reduction, net zero exposures… Zooming more closely on structured products, they remain a viable vehicle to deliver these strategies because of their flexibility which allows you to play with different sub themes across ESG - green energy, clean energy, hydrogen baskets,” says Pfeiffer. “Investors are also voting with their feet as suggested by the trading activity – one of our indices used by Morgan Stanley in Germany was the most traded structured product in Germany. We also developed an active climate transition index with Barclays that sold well across Europe, just to name two.” The social and governance sides of ESG are also gaining visibility and attention with Pfeiffer pointing a the collaboration with Equileap to launch a gender equality/ diversity index targeted at the structured products market “to respond to this demand for new ESG exposures”. As the industry moves towards a standard definition of ESG and how to disclose this information in products, Pfeiffer notes that the first questions when developing a strategy for a client “must be what the goal is and what the client wants to achieve”, and then look at “what are the most suitable data points to get to this goal”. “My personal view is the more elements – bond, underlying, positive impact - the better. I would not exclude one or the other, but we cannot be dogmatic and limit investor choice because of very strict requirements,” he says. Fragmentation According to Pfeiffer, it is going to take some time to move the

31 ‘S’ and ‘G’ parts of ESG if we consider that there are still large discrepancies withing the E part which is where there is the highest quantity of factual data available, and many ESG products out there use diverging ESG data. “There are still inconsistency issues around data points and definitions when it comes to the different parts of ESG,” he says. “There is quite granular data on some areas like gender equality but there is a long way to go on other aspects like social justice before we can rely on consistent data points to define that space. “Governance is even more opaque. Surely, there is some basics annual reports on time, etc. but it is a very difficult area to provide the right metrics to construct robust indices.” The lack of consistency and standards is slowing down development and adoption. Pfeiffer points at the French and German markets as good examples of the core discrepancies. “[The two countries] have fundamentally a disagreement on nuclear energy. This is not a structured products or financial topic but a fundamental disagreement on what ESG, sustainability, is and what is not,” says Pfeiffer, adding that although 100% alignment will not happen, the industry must find ways to go in the right direction with acceptable ESG definitions that can translate into more granular ESG data points. “That is one of the biggest issues we face, and regulation alone is not going to solve it.” Increased momentum ESG is now present in most conversations between index providers, issuers and distributors.

Top Solactive underlyings 2019

USDm

Issuance

Market share

Solactive Climate & Energy Transition Index

71.98

Solactive Sustainable Development Goals World RC 8 EUR Index

30.76

Solactive Sustainable Development Goals Impact Index

“Two years ago, probably around 10- 20% of our indices had an ESG element whereas nowadays it is for sure north of 50%,” says Pfeiffer. “Back then we used to speak with a handful of structuring desks that had dedicated ESG teams. This has also changed and pretty much all the banks out there have dedicated ESG specialists in their structuring teams.” Product manufacturers are also starting to understand the ESG space better and are implementing consistency across their fixed income and equity franchises which is how green bond programs came to life. “Client demand is also pushing advisors and distributors to integrate ESG in their advisory framework to look for and deliver better solutions,” says Pfeiffer. Of course, performance remains a potential pitfall that could also hinder adoption - In 2022, ESG indices suffered mostly because of the war starting in Ukraine and the increase in energy prices. “There is always going to be a question mark around how much investors are willing to sacrifice to invest in ESG,” says Pfeiffer. “Structured products are an interesting vehicle to invest in ESG because they provide a defined return, a layer of protection and a timeframe that allows for underlyings to recover but the bottom line is that investors want returns. Is going to be interesting to watch the performance element of ESG going forward.” Despite the challenges around regulation, transparency and adoption, Solactive sees scope for ESG to grow in many markets “across Europe and in Canada, but not so much in the US and Apac”.

Top Solactive underlyings 2020

USDm

Issuance

Market share

Solactive ESG Big Data Europe High Dividend Low Volatility Index

63.28

Solactive ERSTE Green Invest VC Index

23.78

24.74

Solactive Sustainable Development Goals World RC 8 EUR Index

17.34

Solactive Euro 50 ESG 5.5% AR Index

21.65

Solactive Ethical Europe Climate Care Low Carbon Index

16.85

Solactive France Transition EW 5% AR Index

10.01

Solactive ESG Big Data Europe Low Volatility AR 5% Index

14.31

Top Solactive underlyings 2021

USDm

Issuance

Market share

Top Solactive underlyings 2022

USDm

Issuance

Market share

Solactive BBVA ixESG Lideres Globales MXN Risk Control 10% Index

117.90

Solactive Global UN Sustainable Development Goals Index

66.45

Solactive Sustainable Development Goals World RC 8 EUR Index

50.39

Solactive ERSTE Fair Invest VC Index

61.06

Solactive ERSTE Green Invest VC Index

43.65

Solactive XP ESG 15% VT PR

35.96

Solactive ERSTE Green Invest Index

36.02

Solactive Euro ESG 40 AR Index

32.14

Solactive Energy Transition 2021 AR 5% Index

23.19

Solactive ERSTE Green Invest VC Index

28.04

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Société Générale: higher costs and complex processes are a concern The French bank is the most active manufacturer of ESG-linked structured products globally and continues to grow its market share. Société Générale has become the leading provider in this space with an almost 20% market share among issuers of ESG structured products – the French bank has just recently licensed three new indices for the issuance of structured products – the Solactive Transatlantic Biodiversity Screened 100 RW Index, Solactive Transatlantic Biodiversity Screened 150 CW Index and Solactive Transatlantic Biodiversity Screened Index – developed in partnership with Solactive and Iceberg Data Lab.

Like many other product manufacturers, SG has had to adapt its systems to meet the new German DDV code. However, this move is seen as problematic as it increases the risk of ‘green plating’ and adds an extra layer of rules at a country level.

“Most requests for quotes on structured products entail ESG selection criteria or feature, and this takes many different forms,” says Isabelle Millat, head of sustainability, global markets, SG.

Despite the regulatory noise, ESG as a thematic is only starting to leave a mark in the structured products market. It only represents around 10% of the overall issuance and sales. However, the progress made over the last few years is testimony of the potential of ESG in the structured products market.

“However, although ESG continues to gain momentum in the structured products market as demand and activity build up, the current regulatory framework is confusing.” In the past, each institution had its own way to provide this, but now regulators are trying to ategorizat the requirement which is creating new challenges such as ‘green plating’ as some jurisdictions and countries are trying to move forward faster and front run some of the standards and conventions. “We think transparency in reporting will be useful in the long run and will help to build sustainable growth in the market,” she says. “However, it is important to keep a level playing field and a standard set of rules to follow across the EU and beyond, instead of having to apply different standards across markets. “These requirements will eventually be embedded at the product structuring stage and will push issuers to build investment solutions and structured products that are designed to perform well on the reporting’s sustainability indicators,” says Millat. European umbrella The industry’s goal is to have a European framework that allows issuers and distributors to operate across markets with the same requirements. “This will take time as any agreement with regulators involves lengthy discussions but the agreement on the European ESG Template (EET) suggests the industry is keen to have a starting point,” says Millat.

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“These requirements do not apply to other markets and are seen in some quarters as unnecessary background noise,” says Millat.

“We must be cautious, look for the right balance and be very transparent on limitations [such as the] lack of data,” says Millat. “But the last thing we should do is to stop working on embedding ESG in our solutions, just because the data is not perfect, labels are not ategorizati etc. We are fostering continuous improvement; it applies pressure for better data to feed the thought process.” The industry in the green finance space, like in other spaces such as ategorizatio finance (DeFi), is not waiting for regulators to try and reach common standards. The guidelines on green bonds, for instance, points Millat, was a structured products industry initiative before the EU even started working on a green bond standard, and in some markets like France the industry is in discussions to agree on a voluntary set of categories for ESG structured products. “The ESG regulatory agenda has been mostly carried out with asset management in mind, but the structured products industry must also have a say because its solutions address bespoke financial goals and ESG considerations of specific investors,” she says. “We have been very involved in some of the main regulatory discussions and provided input and feedback to create viable standards.” Flexibility, transparency The debate around the three ESG building blocks or product components – green or social bond wrapper, underlying, voluntary contribution to environmental or social initiatives – and what makes a product ESG continues with most market

33 participants calling for a flexible ategorization, with different levels in the ESG scale to ensure flexibility and reach. “Rules that are very restrictive can limit investor choice unnecessarily,” she says. “Sometimes it may not be possible from a financial or risk perspective to combine all the features. There should be space for products that only contribute one of these features or all of them or different combinations which would put the product higher up or lower down in the ESG range.” Millat also notes that despite the progress made, the industry must be more precise around the selection mechanisms and show the data points used to measure sectors or pillars. On the other hand, however hard it is, ESG reporting is a must for the industry to progress and mitigate the possibility of ‘greenwashing’.

Top Société Générale underlyings 2019

“Many clients are now moving beyond broad themes and concepts and asking for more granularity and specific exposures on certain E, S or G metrics and themes,” says Millat. Also, it is always good to share where you stand after the trade – in that regard the EU regulation is asking for transparency around principal adverse indicators, and even positive reporting, for instance, around the percentage of sustainable activities.” Last but not least, issuers of ESG products must also be as tangible as possible. “This is where adding concrete contributions to projects such as agroforestry or ocean preservation is also a plus,” says Millat. “Rather than an isolated feature this can complement other ESG features in the product. We think this would encourage adoption.”

USDm

Issuance

Euronext Euro 50 ESG EW Decrement 50 Points Index

456

SBF Top 50 ESG EW Decrement 50 Points

415

iStoxx Transatlantic ESG 100 EW Decrement Index

Stoxx Global ESG Leaders Select 50 EUR Index

Solactive Sustainable Development Goals Impact Index

Top Société Générale underlyings 2020

USDm

Issuance

SBF Top 50 ESG EW Decrement 50 Points

547

iStoxx Transatlantic ESG 100 EW Decrement Index

378

Euronext Euro 50 ESG EW Decrement 50 Points Index

204

Stoxx Global ESG Leaders Select 50 EUR Index

Solactive ESG Big Data Europe High Dividend Low Volatility Index

USDm

Issuance

Euronext Euro 50 ESG EW Decrement 50 Points Index

989

SBF Top 50 ESG EW Decrement 50 Points

438

iStoxx Transatlantic ESG 100 EW Decrement Index

276

MSCI EMU Circular Economy Sustainable Impact Select 50 Points Decrement Index

Solactive ESG Big Data Europe High Dividend Low Volatility Index

Top Société Générale underlyings 2022

USDm

Issuance

SBF Top 50 ESG EW Decrement 50 Points

1,565

MSCI EMU Circular Economy Sustainable Impact Select 50 Points Decrement Index

446

iStoxx France ESG 40 Decrement 50 Index

244

Euronext Transatlantic Sustainability and Climate Screened Decrement 50 Index

Solactive Global UN Sustainable Development Goals Index

Top Société Générale underlyings 2021

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BNP Paribas: ESG growth is supported by the regulatory agenda The French bank is one of the pioneers in the introduction of ESG to the retail structured products market and has remained an active manufacturer of ESG products with a market share of around 10-15% over the last five years. BNP Paribas made the headlines in 2014 following a partnership with the World Bank to launch a series of indexlinked green bonds linked to the performance of linked to the performance of the Ethical Europe Equity Index. Since then, the bank has appeared consistently as a top 15 manufacturer of ESG structured products and top 10 provider of ESG indices. Most recently, the bank integrated a €50m social bond, a social index and social sharing through donations in a structured product linked to the performance of the MSCI Eurozone Social Select 30 index. SRP spoke to Youri Siegel, global market sustainable structuring, BNP Paribas CIB, to discuss the latest developments in the retail structured products market around ESG as well as the bank’s activities and challenges to grow this part of the market. “Building an ESG index requires a lot of skills both on the sustainable part and on the financial portfolio construction part,” says Siegel, adding “the market has learnt that ESG exclusionary filters are not good enough anymore”. According to Siegel, client expectation is increasing, and, in that sense, manufacturers must have both index capabilities and ESG capabilities to deliver meaningful investment products. “We work closely with the QIS teams and co design strategies together,” he says. “ESG data has improved, it is more easily available, and the quality is increasing. Strong ESG expertise and broad access to raw ESG data is becoming a requirement to design meaningful strategies. Lastly, being able to report transparently and on an ongoing basis about the ESG metrics of our indices has become key.” What is your assessment of ESG in the structured products market globally? Youri Siegel: There’s a diversity of practices and approaches of ESG globally, as each region has different agendas, regulations, appetite and investment culture. Despite the challenges created by several external factors – notably the energy crisis and inflation - the trend is growing globally and is helped by regulation and the political agenda. Europe is the most mature market in terms of ESG investing, but Asia and the Americas are gradually gaining momentum on ESG investing with different approaches.

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Europe is a much bigger market – ESG has been growing steadily in funds and structured products over the last few years, although not all markets in Europe are the same and we must adapt our offering to meet various investors’ needs. More recently the growth is also supported by the regulatory agenda - we spend a lot of time on implementing ESG regulations, and helping our clients adapt to regulations. Demand is strong; if you look at equity structured products linked to QIS and systematic strategies, in France for example, the portion of products that embed ESG in their construction, one way or another, is significant. In the retail space, more than half of the products have ESG features, and this is being driven by distributors and end client appetite. Overall, in Europe, we expect growth to be steady, and accelerated by the regulatory developments. What are the levers and challenges around ESG regulation in your opinion? Youri Siegel: Having a set of rules will increase standardisation and provide a framework for everybody to operate on the same basis and minimize greenwashing risks. However, the journey only begins and there are a lot of uncertainties remaining. We spent a lot of time with other banks and trade associations trying to maximise the convergence on all uncertainties that remain and look for standards and a common ground to operate. The European taxonomy is a strong building block still in the making, but it will be very positive in the medium term. Another positive aspect of regulation is that it increases awareness across the whole financial industry. The level of discussion that we are having with our clients on ESG has really stepped up because they had to look at the regulatory impact. Investors are serious about ESG as they have now the fundamental knowledge of the underlying topics, and we also see a growing number of clients asking for products integrating ESG. Do you think that people are more educated and aware of ESG, both at distributor and end-investor level? Youri Siegel: Retail investors are very aware of ESG issues because it is a topical subject that is everywhere - the radio, the TV, social media. This is positive and shows that younger generations are not only looking for financial returns, but also trying to have a positive impact while investing. ESG investing is a very complicated multi-dimensional topic that we are collectively starting to define.

35 What trends would you highlight within the ESG space? Has there been a shift towards a particular ESG thematic?

What are the main hurdles to increase adoption of ESG structured products?

Youri Siegel: The big shift in the last few months has been the pivot towards Paris-aligned benchmarks (PAB). This is a regulatory benchmark, which is powerful because it better defines what a climate friendly investment is, and it resonates with distributors and investors. We have launched several PAB indices that have been very successful, and we will continue to focus on these indices going forward.

Youri Siegel: I am not concerned about adoption rate, as investors demand is strong. I am more concerned about greenwashing risk and reputation risks arising from still heterogeneous standards in the market that could be challenging across the industry. Regulation is definitely helping but many uncertainties remain to be tackled by regulators.

Investors are increasingly looking at ESG beyond climate. This translates into tackling climate but not without taking into account biodiversity and social issues. The Covid crisis, the energy transition, inflation and the war have increased inequalities. These are more difficult issues to tackle from a data standpoint, but it is possible thanks to gradually increasing data quality and recognized standards on these topics as well.

On the other hand, currently the SFDR is not directly covering structured products, so while we wait for regulatory guidance, we must come up with our own assessment and help match ESG preferences of clients. We are doing advocacy to explain how structured products work and how the funding component and the underlying component should be assessed. We are spending a lot of time on building methodologies, having conversations with trade associations, and keep structured products on the regulator’s agenda.

Top BNP Paribas underlyings 2019

USDm

Issuance

Euronext Eurozone ESG Leaders 40 EW Decrement 5% Index

502

Solactive Climate & Energy Transition Index

Euronext France ESG Leaders 40 EW Decrement 3.5% Index

Euronext Transatlantic ESG Leaders 60 EW Decrement 5%

MSCI Europe Select Green 50 5% Decrement Index

MSCI World Select ESG 30 Index

Top BNP Paribas underlyings 2020

USDm

Issuance

Euronext Eurozone ESG Leaders 40 EW Decrement 5% Index

226

Euronext Transatlantic ESG Leaders 60 EW Decrement 5%

Euronext Eurozone ESG Leaders 40 EW Decrement 4% Index

Solactive Ethical Europe Climate Care Low Carbon Index

iStoxx Global Responsible Waste Management Select 30 Price EUR Index

iStoxx Europe ESG Leaders Select 30 EUR Index

USDm

Issuance

Euronext Core Euro & Global Climate Change EW Decrement 5% Index

431

Euronext Transatlantic ESG Leaders 60 EW Decrement 5%

392

Euronext Eurozone ESG Leaders Select 40 EW Decrement 5% Index

S&P Global Clean Energy 3.5% Decrement Index

S&P Global Water 3.5% Decrement NTR Index

S&P Global Clean Energy 3.5% Decrement NTR Index

USDm

Issuance

S&P Transatlantic 100 ESG Select Equal Weight 50 Point Decrement Index

376

Euronext Eurozone Diversity & Governance 40 EW Decrement 5% Index

165

Euronext Transatlantic ESG Leaders 60 EW Decrement 5%

140

Top BNP Paribas underlyings 2021

Top BNP Paribas underlyings 2022

Euronext France ESG Leaders 40 EW Decrement 3.5% Index

ECPI Circular Economy Leaders NTR 3.5% Decrement Index

ECPI Global ESG Future Mobility NTR 3.5% Decrement Index

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CACIB: we’re closer to defining what makes a product ESG Credit Agricole is one of the fastest growing manufacturers in the ESG structured products space. Credit Agricole Corporate & Investment Bank (CACIB) is one of the fastest growing manufacturers of ESG structured products gaining significant market share over the last three years. This stood at around 10% at the end of 2022. The French bank is also a pioneer in the green bond market following the launch in 2017 of its first green note on Taipei Exchange, also becoming the first foreign issuer to be accredited by the Taiwanese exchange for the issuance of green bonds. In 2018 it launched of a sustainable product range based on two layers including green investments, for which the invested amount was earmarked exclusively for finance companies and projects playing a key role in energy transition, and green financial performance, where the financial return was linked to the performance of a green equity index. Later in 2018, CACIB launched its first green investment solution for Crédit Agricole’s Italian clients under its Climate Action Green Notes programme as it began to rebuild its equity derivative activities in 2019 with the creation of dedicated trading, structuring and sales teams, and a new strategy focused on ESG. At CACIB, Mahdi Bouayad, head of ESG & index solutions, believes that ESG will continue to be an area of growth because it is being pushed across the board by product providers, distributors and end investors while the role of regulators trying to provide a set of rules will bring further growth. Product evolution “If we take a few steps back, we can see that 10 years ago ESG was coming mostly from the sell-side with banks starting to develop new indices and structures,” says Bouayad. “This created a dialogue in the market that has increased awareness, triggered new projects and got the attention of regulators. The more awareness the more interest and penetration in the market.” According to Bouayad, the focus on different ESG thematics comes from recent regulatory developments and the fact that the methodology of some indices is defined in the EU Benchmark regulation. “These developments allow to standardise and provide comparability between products,” he says. “By standardising methodologies, the comparability between indices increases.” As a result of this shift towards standardisation the bank has

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seen increased demand for Paris Aligned Benchmarks (PAB) indices as well as carbon offset strategies and expects the social aspect of ESG to gain more traction in 2023 as “any transition towards a green economy would also have to consider social aspects”. “Using structured ESG products in the fixed income space could help increase adoption in the new world of higher rates,” says Bouayad. “We will also probably see a shift towards credit - CLNs with an ESG selection of names - and multi-asset products with ESG underlyings.” Social focus Bouayad also believes the market will go through a similar process seen with the E in ESG with the developments of social bond programs to support new product launches as well as new social indices. “The ‘S’ will also have more weight in the product offer because of Mifid 2 ESG and the percentage of alignments with SFDR,” he says. Matthieu Monlun, head of domestic markets & CA group sales, equity solutions, CACIB, notes that the ‘S’ will gain more visibility as there is a place for social bonds in the market. “We think they will resonate with distributors. We want to promote an issuance programme for social notes with a user policy dedicated for social notes, meaning that we have a framework in place with a pool of assets that is already identified and will route the proceeds towards those social projects,” says Monlun, adding that the ‘G’ will remain in the sidelines because of the data available and existing challenges from a sales perspective considering that the distribution channels are mostly focused on the environment. The increasing number of ESG underlyings on offer and the shift towards customisation has created new problems for manufacturers which must go through several regulatory hurdles to bring new products to market. “In the French market, having different types of underlyings is quite a challenge because you need to go through the math and mechanisms required by the AMF,” says Monlun. Despite the regulatory pitfalls, France remains the biggest market for ESG and has room to grow and develop further on a qualitative basis with innovation, according to Monlun. In terms

37 of volumes, the expansion of ESG structured products will come from other countries in Europe and Asia. “In Asia, most issuers and private banks would need dedicated teams focused on increasing awareness - the demand from the clients it is quite low today, so the initial push must come from international banks working with local distributors,” he says. Cautious outlook Although everyone is talking about ESG and an increasing number of players are integrating ESG criteria into their product development, the lack of a precise definition for an ESG product continues to hinder progress. Bouayad also notes that there are open questions beyond structured products like the need to have physical replication of the bond or the stock in a portfolio. “Things are not that clear yet, but there are lots of discussions in the market to define what makes a product ESG,” he says. “The AMF is working on it, and we have also a discussion among French banks to work on labels that would define what makes a product ESG. Our view is that we collectively must focus on the impact space.”

Top CACIB underlyings 2019

According to Bouayad, there is a lot of work to do to meet the requirements of the new Mifid ESG regulation including defining the percentage of alignment with the taxonomy to establish how green is the product; and the percentage alignment with SFDR to see how sustainable the product is. “With these two measures we are already in a world that makes a product either sustainable or green,” says Bouayad. “My feeling is that end investors will ask a higher percentage of alignment with each measure meaning that we will end up with either a product that is highly sustainable or highly green. “It’s very important that final investors understand the taxonomy, and see the difference between the various shades of ESG, but this is just a first step because we’re talking only about France/ Europe and these guidelines do not apply in Asia and the Americas.” Meeting the requirements of the Mifid ESG regulation will not be easy as the European guidelines emphasise the role of ESG data providers and the need to improve data quality. “This will bring additional challenges in the coming years,” concludes Bouayad.

US$m

Issuance

Solactive EthiFinance ESG France 30 Equal Weight 5% AR Index

6.7

Solactive Euro 50 ESG 5.5% AR Index

2.6

Top CACIB underlyings 2020

USDm

Issuance

MSCI Europe Select Green 50 5% Decrement Index

95.2

Solactive EthiFinance ESG France 30 Equal Weight 5% AR Index

56.5

MSCI France Select ESG 30 5% Decrement Net Index

25.4

Solactive Euro 50 ESG 5.5% AR Index

6.1

Top CACIB underlyings 2021

USDm

Issuance

MSCI Europe Select Green 50 5% Decrement Index

498.1

MSCI Transatlantic Select Green 50 5% Decrement Gross Index

114.4

MSCI France Select ESG 30 5% Decrement Net Index

98.7

Solactive EthiFinance ESG France 30 Equal Weight 5% AR Index

80.7

MSCI EMU Sustainable Select 50 5% Decrement Index

38.8

Top CACIB underlyings 2022

USDm

Issuance

MSCI France Select ESG 30 5% Decrement Net Index

657.8

MSCI Euro Climate Select 50 Paris Aligned 5% Decrement Net Index

302.8

MSCI Europe Select Green 50 5% Decrement Index

96.6

MSCI Transatlantic Select Green 50 5% Decrement Gross Index

15.0

MSCI Europe Select Blue Cycle 50 Decrement 5% EUR Index

10.5

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Natixis: The role of ESG data providers has become increasingly important Natixis is the third most active manufacturer of ESG structured products and an active user of indices developed in house for its structured product offering The French bank has 10 live ESG products worth an estimated US$85.80m as well as 88 live ESG products with decrement features worth an estimated US$5.2m, according to SRP data. The French bank also has exclusive rights on a number of sponsored indices from different index providers including Stoxx, FTSE Russell, Nasdaq, KRX, SGX, Solactive, Euronext, S&P DJI and MSCI. David Azria, head of equity derivatives sales and Hong-My Nguyen, head of green & sustainable investment solutions at Natixis Corporate & Investment Banking talk about the bank’s ESG strategy in the structured products market and beyond, the arrival of social bonds and the challenges around regulation. “ESG encompasses all parts of our activity and is an absolute key pillar of our product strategy,” says Azria. “Natixis has been involved in ESG for many years, and we have set up the specific organization in order to address ESG needs, which have become more and more complex over time.” Natixis launched its Green & Sustainable Hub within its Corporate & Investment Banking (CIB) division in October 2017 to enable all the teams within the division – sales, structuring and trading - to develop ESG products. The bank’s ESG strategy and activity for 2023 includes a target of €3 billion of green and social programme within BPCE and Natixis CIB for its structured product business. “This engagement is testimony of the potential our clients have in various regions to access our ESG solutions which cover equities, fixed income and credit,” says Azria. “Our conviction goes further because it’s crucial for us to align our sustainable commitment with ESG products, which we design and distribute. Developing products for investment purposes is also parallel with our commitment to balance our funds and portfolio.” As part of this commitment, Natixis has put in place a ‘Green Weighting Factor mechanism’ to align the bank’s financing projects with a trajectory in line with the Paris agreements. The in-house mechanism is aimed at promoting financing deals that have an affirmative climate impact and support the transition to a low-carbon economy, while providing for a negative adjustment for financing deals with environmental risks - this mechanism has applied to Natixis’ new financing deals across all business sectors since 2019. “This enables us to take into consideration also aspects of ESG in our activity whether it is on investment products or on the

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financing activity, so that we have a holistic approach in our way of conducting business,” says Azria. Market trends Since 2015 Natixis has issued more than €8 billion of equity index-linked products with an ESG component. “This is the traded volume across all our client segments,” says Azria, adding that a large part of Natixis’ ESG structured products issuance is driven by retail distribution activity in the French market. “We sell 60% of our ESG products in this market – [it’s] the most active market in Europe on ESG products. We have also witnessed growing demand coming from Asia and the Middle East. For example, the number of requests coming from Asia has doubled over the last two years and we see this trend growing every year,” he says. New demand is forcing Natixis to reassess its capacity to issue structured notes to meet the needs of its clients “which are also changing and becoming more diversified - in the past, most of the requests were on green bonds, whereas now we are starting to see requests on social asset”. “Most of the activity comes from the retail mass market, but more and more private banks and clients belonging to premium segments as well as institutional clients like insurance companies and asset managers are also investing in ESG structured products,” says Azria. “The increasing demand has boosted the notional, but we also had to enlarge our offering to address all retail clients.” In terms of evolution, the bank sees “a strong appetite coming from institutional investors in Asia and in Europe we begin to see new demand coming from Switzerland, Italy, Germany, UK and Spain”. Are there any concerns around the performance of ESG structured products? Do you have evidence that they are delivering value to investors? David Azria: We have not witnessed any missed performance of ESG product versus benchmark products. This is because large parts of the products sold in the retail market are autocallable products which can deliver the maximum of performance with just a small increase in the underlying. Some products did not redeem early on the first year because of the turbulence in the equity market as we saw in 2022 but once the markets are up again, they will deliver very profitable returns, and completely in line with the performance of benchmark

39 indexes. In terms of performance, there is definitively no cost to the final investor. On the contrary.

financial impact of meeting the new requirements around data and the organizational changes to manage regulation.

Approximately 70% of our ESG issuance is autocallable products, but this weight tends to diminish because with the rise of interest rates, there is more demand for capital protected products and we can also deliver those.

On the other hand, there is a big cultural change which will impact how we innovate and develop products for investors. When you are dealing with ESG products you must involve now legal and regulatory teams, and product development has become extremely transversal across the bank.

The ‘S’ of ESG is becoming more relevant. Why? Hong-My Nguyen: Natixis has launched a social bond programme to respond to social issues, that become even more acute with the new inflation context. We think this will be the main topic of ESG investing towards the second part of the year. Our approach is different from other CIBs because we have a real local and regional footprint with our Banques Populaires and Caisses d’Epargne networks, allowing us to deploy real capabilities to help small businesses. The use of proceeds of new social ESG products will finance small businesses that would not survive otherwise. Our social bond framework - Local Economic Development targets businesses that are in regions with high poverty, high unemployment, and very low business creation rates. We are leveraging the synergies between our CIB capabilities and our local footprint to serve end investors with new ESG products that will help to the development of local economies which in today’s context is very important.

We think this is a good thing because the greenwashing is a huge source of stress amongst market participants. We believe that a common language and transparency will help to avoid sensitive situations. There is uncertainty in some areas and a lot of work around the implementation, but this will bring clarity and create a positive ecosystem with the right infrastructure to make ESG move forward. David Azria: In this context, the role of ESG data providers has become increasingly important over time, and a key element of our product development as we want our indexes to have the highest standards. The cost of collecting ESG data has increased and the need to partner with data providers as well, but there is value for that cost. The construction of robust indices needs relevant and exhaustive data as manufacturers need to be able to disclose underlying information. What are your plans for 2023? How do you see the market evolving?

Hong-My Nguyen: The regulatory landscape has completely changed over the last couple of years. On one hand, there’s the

Hong-My Nguyen: On the index site, we want to focus on a more thematic approach. We are very strong on environmental underlyings, and we see the Paris Aligned Benchmark (PAB) theme as an example of new developments that is going to be largely adopted by the market. We also see biodiversity and social thematics as drivers of product development.

Top Natixis underlyings 2019

US$m

Issuance

Top Natixis underlyings 2020

US$m

Issuance

Euronext Climate Objective 50 Euro EW Decrement 5% Index

893.4

Euronext Climate Objective 50 Euro EW Decrement 5% Index

962.9

Euronext Climate Orientation Priority 50 EWER

7.7

NXS Climate Optimum Prospective VT Index

5.4

Solactive Electric Car Makers 8.50% VT Index

7.6

NXS Climate Optimum Prospective VT Index

5.5

Euronext Climate Objective 50 EW Index

1.1

Top Natixis underlyings 2021

US$m

Issuance

Top Natixis underlyings 2022

US$m

Issuance

Euronext Climate Objective 50 Euro EW Decrement 5% Index

815.7

iEdge ESG Transatlantic Water EW 50 Decrement 5% NTR Index

474.4

iEdge ESG Transatlantic Water EW 50 Decrement 5% NTR Index

233.3

iEdge ESG Transatlantic SDG 50 EW Decrement 5% NTR Index

371.5

iEdge ESG Transatlantic EW 50 Decrement 50 Points GTR Index

101.6

MSCI World Health Care Select ESG Top 50 5% Decrement Index

297.6

CAC Large 60 Responsible Investment SW Decrement 5% Index

69.6

CAC Large 60 Responsible Investment SW Decrement 5% Index

70.6

Euronext CDP Environment Eurozone EW Decrement 5% Index

35.6

iEdge ESG Transatlantic EW 50 Decrement 50 Points GTR Index

63.7

Is regulation preventing further adoption and the development of new products?

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Barclays: ESG indices are more liquid Barclays is one of the issuers that has increased its focus and activity around ESG structured products over the last few years. The UK bank made its first foray into ESG structured products in 2012 after launching a partnership with MSCI to launch a family of co-branded Environmental, Social & Governance (ESG) fixed income indices for institutional investors to use in index-linked investment products. The bank’s first ESG structured products sold to retail investors came to market in 2018 following a partnership with Qontigo (then Stoxx) to license the Euro iStoxx 50 ESG Focus and the Euro iStoxx 50 ESG Focus GR Decrement 5% indices to be used as underlyings for a range of structured products. The next step taken by Barclays in the ESG space was to roll out a green structured notes programme to offer institutional and retail investors ‘green investments’ which uses the proceeds of the notes to the financing or re-financing of eligible green activities such as renewable energy, energy efficiency and sustainable transportation loans and contribute to the bank’s net zero goals as well as providing £100bn of green financing by 2030. Shortly after the launch of the programme, the UK bank closed a £400m green bond to support climate-related products and initiatives and deployed its first in-house developed ESG underlying - the Solactive Climate Change Europe BTI PR Index - via a structured deposit sold by Causeway Securities in the UK market. SRP spoke to Arnaud Heckenroth (right), managing director, head of equities structuring Emea, to find out the bank’s latest activities and plans in the ESG space. How would you describe activity/demand from product manufacturers around ESG structured products? We see a continued increase in demand for ESG products. In particular, the design of systematic indices which meet specific ESG objectives remains a very important topic. Green structured notes have also been particularly popular. The rapidly evolving regulatory environment is driving some of the new product design. What would you highlight from your ESG structured products offering? How is the ESG market evolving? Our Green Structured Notes program has been a highlight in our offering. It offers a fully green solution combining green use of proceeds and green indices. Staying close to the changes in regulatory environment, we updated our index requirements throughout the year and our approach is very well received by our clients. Our partnership with Ossiam on ESG ETFs linked to our Shiller Barclays Cape is another key

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initiative. This partnership combines the unique IP of the Shiller Barclays Cape Sector Value indices with the ESG expertise of the Ossiam team, providing a truly unique product. The ETFs have in excess of 1.2bn USD AUM with assets doubling in the last 12 months. An insightful piece was also produced in collaboration with professor R. Shiller around Greenium and how value investing can help reduce exposure to it. The market is evolving. While initially we were seeing most demand on climate related indices and broad ESG indices, it has progressed to combine ESG and thematic indices or a greater focus on the S and the G of ESG. Also “all green” solutions have showed the limits in available assets in particular in the context of structured note. Expanding the eligible asset universe and the different dimensions of ESG as a source of investment is clearly a trend. What are the main challenges around ESG adoption – regulation, lack of standards, reporting…? We are in a transition phase and as every transition, it imposes new governance, processes and a change in mindset when designing products. While it is a heavy lift, it is also very welcome. All players are keen to develop relevant solutions and guidelines will improve the quality of products for end-investors. What is your outlook for the ESG segment of the structured products market? It will continue to grow and will become a meaningful part of the European structured products market. We see life insurance companies increasingly asking ESG products hedged through structured products. The French and Belgium markets have been early adopters. The trend is expanding across Europe. Clarifying ESG naming requirements will bring further confidence in ESG products. Do you think there is scope to increase ESG adoption using structured products? Yes. We believe the need to transition towards a low carbon economy and to improve ESG metrics will have a strong positive echo with structured products. Main ESG indices are becoming more and more liquid. More and more ESG assets are being financed which provides a growing capacity for Green or ESG structured notes. Every year the demand is stronger. What are your plans for next year? We have ambitious targets and product development ambitions for 2023. Increase in activity in ESG structured products is part of the strategy of the bank to grow our sustainable activities.

Top Barclays underlyings 2019

US$m

Issuance

MSCI Europe Countries ESG Select 50 Points Decrement Index

120.0

Top Barclays underlyings 2020

US$m

Issuance

S&P EuroUSA 50 ESG Select Equal Weight 50 Point Decrement Index

64.9

Stoxx Global ESG Leaders Select 50 EUR Index

32.5

Top Barclays underlyings 2021

US$m

Issuance

S&P EuroUSA 50 Low Carbon ESG Select Equal Weight 50 Point Decrement Index

176.1

S&P EuroUSA 50 ESG Select Equal Weight 50 Point Decrement Index

92.0

S&P Europe 50 ESG Select EW BEL DEU FRA NLD 50 Points Decrement Series 2 Index

6.0

Solactive Climate Change Europe BTI PR Index

4.1

S&P Europe 50 ESG Select EW BEL DEU FRA NLD 50 Points Decrement Index

0.6

US$m

Issuance

Top Barclays underlyings 2022 Euro Stoxx 50 ESG Index

56.1

Solactive Climate Change Europe BTI PR Index

33.6

MSCI World IMI Digital Economy Select 50 5% Decrement Net Index

13.5

S&P Europe 50 ESG Select EW BEL DEU FRA NLD 50 Points Decrement Index

9.1

Stoxx Europe 600 ESG-X Index

3.0

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ESG in the US structured products market ESG activity in the US retail structured products market remains subdued compared to other markets but the final rules on climate change expected to be released by the SEC this year will bring clarity about how people think about and use ESG in their investments and could have a positive impact in the market.

ESG will always have a significant political element to it

aurence Black, founder of The Index Standard and Jay Watson managing director and head of analytics, talk about the most recent developments in the US market, the challenges around product design and standardising methodologies and the need to balance innovation and complexity.

Black (pictured) notes that the adoption of ESG in the US has been uneven California for instance is pro-ESG - they have concerns about climate change because they are feeling climate change tremendously with wildfires and huge storms. At the other end of the spectrum, there are a couple of states (Florida, Texas) that have rejected ESG and have banned several ESG-friendly financial institutions from providing services in these states. “We have seen a few ESG indices in the

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US annuity market over the last couple of years,” says Black. “Annuities are aimed at an older demographic, which suggests that both older and younger generations seem to be driving the demand.” According to Black, The Index Standard, which is focused on the US insurance space, the new ESG indices come from benchmark providers such as MSCI and S&P which have taken their standard benchmarks and added ESG versions for annuity products. He points at “an interesting layer of innovation from some banks”. Société Générale have partnered with an ESG AI firm called Entelligent and they use a combination of ESG data overlaid with artificial intelligence to provide stocks that are ESG friendly; Citigroup have partnered with ESG Book, formerly known as Arabesque, to launch an ESG index for the structured products space;

and we’ve also seen an interesting spin on ESG from BNP Paribas which is focusing on the G (G for “Governance”) of ESG and they have partnered with ISS, who identify stocks with good governance. Also, BlackRock have taken an ESG ETF that tracks an MSCI ESG index and wrapped that up into a vol control version and Credit Suisse have also taken an MSCI ESG index and combined that with bonds and commodities. “Each index takes a long time to design and by the time the insurance companies have chosen them and packaged them, they have incurred significant costs, so they’re very thoughtful in what they do because it is a huge effort to bring an annuity to the market,” says Black. “For a country that has a divided opinion on ESG we have seen some interesting developments in the annuities market.”

43 Recent macroeconomic and geopolitical events have raised questions around ESG. Is this complicating things and raising new questions? Jay Watson: It seems generally accepted that we must rethink how the whole ESG framework operates given the war in Ukraine and what has happened to energy generation and energy prices. The answers to questions around, for example, weapons manufacturers and nuclear power are now less clear. ESG will always have a significant political element to it, which makes it contentious. There has always been the issue with ESG of what you are aiming for and is an ESG provider giving you that – neither of those is obvious. The first is coming into question again, and regarding the second, everybody knows that there are so many different ESG providers with so many different ranking systems that it’s very difficult to understand whether something is what you think it is. ESG is a very complex area. What are the challenges around product design? Laurence Black: Designing an index is incredibly difficult. You need to show a representative back-test, but the key thing is to have a good look-ahead performance. That’s the key challenge when you’re designing any index, but with ESG, it adds another layer of complexity. If I was designing an ESG index five years ago, you would have got data challenges. If you were able to screen and identify ESG stocks, you probably would have gotten a solid performance in the last few years, however this may not continue. Looking at some of the performances of these ESG indices we can see that their performance has been in line with similar benchmarks. Are there any issues when designing ESG indices aimed at the insurance and retirement space? Laurence Black: Designing an ESG index for the insurance space is even more complex because in the US there’s a real focus on the last 10 years of illustration - you need to design an index that has

a good illustration and, critically, good forward-looking performance. In addition, as opposed to structured products, these indices can get billions of dollars in the insurance space, so you need deep liquidity because the banks, as hedge providers, are selling options in the billions. If you have a thematic ESG index with, say, a solar stock that has got a market cap of just US$100 million, that is just not going to be liquid enough to offer in an annuity that needs a multi-billion dollar capacity. Different index providers use diverging methodologies and in some cases the ESG version of an index has less ESG components than the benchmark. Is there a need to standardise methodologies? Jay Watson: It is a difficult problem. There is no right answer. In general, there is no unique ESG solution, as it were, because there is almost intrinsically so much subjectivity to it. We should aim for transparency at least, but among the ESG raters some are more, some are less transparent as to how they do things. They process vast quantities of data and it’s very difficult for anyone to appraise them, so you end up relying on reputation and their professionalism. The European Union is doing the right thing in at least trying to prevent greenwashing, but it’s difficult to see how a one-size-fits-all type framework could really satisfy most people. ESG has become a theme that has brought innovation and complexity to the structured products market. Is there a risk of overcomplicating underlyings and misleading investors? Laurence Black: The level of innovation has increased in the US market. We’ve seen the use of AI, we’ve seen intraday vol control, then you overlay those two things with ESG and then maybe a risk control with mean variance optimization. I don’t expect this level of innovation to slow, because we expect incumbents to innovate and new players will bring other interesting features. You need to have a simple story that you can convey to the end investor. There are lots of ways to express ESG, but I think

by just having an index ESG-branded, it’s seen as a simple way to convey that story, despite the fact that there’s a tremendous amount of complexity hidden underneath some of these indices. Some of these newer techniques like artificial intelligence and natural language processing can play a part in improving ESG and there’s a huge amount of data that needs to be evaluated. The fact that you’ve got various issuers and providers who are applying these techniques to the ESG space should drive more precise outcomes and this innovation is going to continue, without a doubt. Are decrement indices starting to resonate in the US market? Is this a case of too little too late? Laurence Black: The trend for decrement indices started in Europe, but we’re beginning to see some decrement indices used in the US annuity space as well. We’ve seen a couple of indices with decrement over the last few months with variable decrements, which suggests the US market is slowly beginning to adopt the decrement index feature. Although now that rates have risen, these may be less relevant. A decrement index is designed specifically to underly a structured product, or an annuity - it’s designed to have a good participation rate and may give you 100 to 150% higher participation rates versus without decrement, because the decrement makes the option cheaper. To explain that to an end consumer can be challenging, but in the US people prefer high participation rates, so it’s giving what people want. Jay Watson: Decrement is an ingenious way of making the option more out-ofthe-money and that’s why it is cheaper, and so the participation can go up. I think the need for decrement is less now, with higher rates and option budgets. It’s not obvious to me that decrement will be a big thing in the future, now that rates are back to historically normal levels, rather than being historically spectacularly low or even negative, which was just astonishing. That need has withdrawn to a very large extent as budgets are back up to normal.