The global demand for ESG derivatives is increasing

The global demand for ESG derivatives is increasing ...

Sustainability finance has dramatically increased in recent years, with the number of environmental, social, and governance (ESG)-linked funds expected to reach 80% by 2021. Now, global asset managers are working to meet client growing demand for ESG derivatives.

Lynx Asset Management, based in Sweden, recently added CME Groups E-mini ESG S&P 500 futures contract to its sustainability-linked suite as part of a strategy to meet growing institutional client demand for sustainability-linked investments.

The contract has helped the $6.5 billion investment manager boost trade in the new market, which is the most liquid of all the ESG ones we are monitoring, according to Despina Xanthopoulou, the director of Sustainability and Business Development.

Xanthopoulou believes that when you launch an ESG version of the S&P 500, you will gain traction. The Stockholm-based company, which has many international clients, from US pension funds to Middle East Sovereign wealth funds, has been beefing up its sustainability strategy for several years.

We are very aware [of the industrys growth] and have been monitoring the emergence of ESG equity indices since 2018 and onwards, according to the researcher. We currently have 40 equity indices in our monitoring list, compared to zero three to four years ago.

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The Minds' Meeting

From institutional size to regional requirements, the profile of companies seeking ESG index exposure varies widely.

Xanthopoulou believes that our clients have many needs and that they bring different strengths. In the Nordics region, for instance, fossil fuels and controversial weapons are a very sensitive area, while, in the United States, we don't see similar concerns. From there, we get more questions about our [business] connections.

Offering the S&P 500 ESG contract to clients, according to Joe Kelly, was a two-way street. We started offering it after a discussion of the minds.

We have a large number of clients who said, Hey, we want you to make an effort to ensure that when these contracts meet certain conditions [i.e., liquidity thresholds], they become part of our portfolio. Simultaneously, in the background, we were saying, it seems like there are more and more people making these contracts more liquid so there is an ability to express our firm values which are very aligned with ESG, make our clients happy, and make them some money at the same time.

Campbell's Absolute Return Multi-Strategy Fund, which trades 120 different ESG contracts, offers the contract.

Futures Trade is on the rise.

The move by Lynx and Campbells comes as CME Group continues to see strong trading growth for its E-mini S&P 500 ESG and E-mini S&P Europe 350 ESG futures contracts.

Many clients have begun to trade these products this year, including hedge funds and CTAs (commodity trading advisers), which has increased intraday liquidity, according to Paul Woolman, CME Group's head of EMEA equity products and alternative investments.

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CME Groups E-mini futures follow the S&P 500 ESG Index, which updated eligibility requirements in April. According to Woolman, trading volumes involving 837 accounts have increased by 50% this year.

Graphic: E-mini S&P 500 ESG Futures Annual ADV and OI Since Launch

Campbell expects to expand its sustainability-linked futures business in the near future, according to Kelly.

He underscores the fact that ESG regulation is uneven. One organization may have a really strong opinion on a particular ESG data set, while another may use another set and come up with other conclusions.

Vanessa Battaglia, senior counsel at Travers Smith, a UK-based law business that advises clients on environmental, social, and governance issues, spoke up more.

The key (challenge) in the ESG space, especially when it comes to derivatives related to sustainability, is KPIs, such as what kinds of metrics apply to these transactions and how the parties should be thinking about them, according to a researcher.

Woolman cautions that standardized index construction may not be able to check all ESG boxes the way an individual stock might. However, the futures contract provides a liquid market and S&P provides a defined ESG methodology for portfolio management.

The most important criteria for clients when it comes to an ESG index derivative such as the S&P 500 ESG, is liquidity, and is the ESG methodology adequate, according to Woolman. Market participants recognize the need for standardization with a future in order to benefit from a common pool of users that builds liquidity.

ESG is poised for even greater growth.

Why are more traders switching to ESG futures? According to Kelly, the greatest benefit in the long run will come from a liquidity build-up that will make ESG trades more profitable for sustainability-minded investors.

Kelly believes that if I am a futures investor and have a social perspective to where my money will go, I will want to be involved in these contracts. Liquidity is going to increase, and you will make money based on this broad spectrum of values expressed in the ESG market.

Xanthapoulou agreed that additional regulatory guidance is required to appropriately and legally structure ESG derivatives in order to support future development.

However, the industry should overcome its growing pains and expand significantly in the medium to long term. According to a January Bloomberg Intelligence report, worldwide sustainability-linked assets might reach $50 trillion by 2025, up from $40 trillion this year.

I can see people diversifying their portfolios to more environmental-friendly assets and contracts in the next five years, significantly increasing commerce, according to Xanthapoulou.

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