IN THIS LIST

TalkingPoints: Setting a New Low-Carbon Standard with the S&P/NZX Carbon Efficient Indices

Incorporating a Minimum Variance Framework into Risk Control 2

FAQ: S&P DJI ESG Scores

A Matter of Degrees: Aligning ESG Strategies with the Paris Agreement

A Guide to S&P Decrement Indices

TalkingPoints: Setting a New Low-Carbon Standard with the S&P/NZX Carbon Efficient Indices

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Ryan Christianson

Associate Director, APAC Lead, ESG Indices

To meet the growing demand for sustainable index-based strategies in New Zealand, S&P DJI has launched the S&P/NZX Carbon Efficient Indices, including the S&P/NZX 50 Carbon Efficient Index and S&P/NZX 50 Portfolio Carbon Efficient Index. The index series is designed to incentivize companies to compare their carbon intensity to their industry group peers.

1. Can you share some background on the S&P Carbon Efficient Indices? What are the key elements and objectives that went into creating the S&P/NZX Carbon Efficient Indices?

Ryan: The idea of implementing a carbon efficient methodology to a benchmark index has been around for over a decade, and S&P DJI began launching the S&P Carbon Efficient Indices in 2009.

The key objective behind the index is to apply a weighting methodology that incentivizes companies to compare their carbon intensity to their industry group peers around the world—recognizing that there is global consensus around climate change, and that environmental threats comprise the top five long-term global economic risks. A company's weight may be adjusted positively or negatively based on its carbon intensity; however, companies are not excluded from the index solely due to their carbon intensity.

In addition to the respective comparison to global industry peers, company disclosure of carbon emissions is also reviewed and affects the weight adjustment of the constituent within the index. Utilizing S&P Global Trucost's environmental dataset, we review both the Scope 1 and Scope 2 carbon emission disclosure statuses.

With the launch of the S&P/NZX Carbon Efficient Indices, we have revamped the entire methodology to recognize the carbon impacts of companies by comparing them to their global industry peers, in addition to their peers in New Zealand.

From a performance perspective, the index series is designed to track the baseline S&P/NZX 50 Index and S&P/NZX 50 Portfolio Index closely, with the aim of providing risk/return characteristics that are similar to the benchmarks.

2. What other types of considerations are taken when evaluating constituents for the S&P/NZX Carbon Efficient Indices?

Ryan: With regard to the weight adjustments, one other component we review is the industry group's "impact level," which is classified as high, medium, or low. High impact industry groups include those such as Energy and Materials, whereas low impact industry groups include those such as Media and Financial Services.

There are two factors that we consider for constituent selection, and these are the "High Non-Disclosing Carbon Emitters" and "Controversies Monitoring" screens. As of March 2021, these two screens applied to zero companies in the S&P/NZX 50 Index.

The "High Non-Disclosing Carbon Emitters" screen excludes any company that is deemed to have high carbon emissions while also not disclosing their carbon intensity. This screen is in line with the objective of the index, as it incentivizes the disclosure of environmental impacts even if the company's emissions are high.

The "Controversies Monitoring" screen uses a third-party data source called RepRisk. Index constituent companies are monitored by RepRisk, a leading provider of business intelligence on environmental, social, and governance (ESG) risks. RepRisk analyzes companies for a range of issues including economic crime and corruption, fraud, illegal commercial practices, human rights issues, labor disputes, workplace safety, catastrophic accidents, and environmental disasters. Using these data, each company is assigned a daily RepRisk Index (RRI) indicator.

If RepRisk reports that a company has met or exceeded an RRI indicator of 75, the company will be removed from the index. It will be considered for reinstatement only when it satisfies all the eligibility criteria and its RRI score has remained below 75 on all days since the previous year's rebalancing date.

3. What S&P Global Trucost carbon data are used in the S&P/NZX Carbon Efficient Indices?

Ryan: The carbon efficient index series utilizes the environmental dataset published by S&P Global Trucost. Specifically, the data used are the absolute and intensity figures for carbon emissions, as well as the disclosure status. Carbon intensity is calculated using the Direct + 1st Tier Indirect emissions, which is a combination of Scope 1, 2, and Upstream Scope 3.

S&P Global Trucost's environmental data are comprehensive, covering over 15,000 companies globally, and locally in New Zealand it covers all 50 stocks within the S&P/NZX 50 Index. Data are updated on an annual basis following a strict process that reviews publicly disclosed information, or in the absence of public disclosure, uses a proprietary environmentally extended input-output (EEI-O) model.

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Incorporating a Minimum Variance Framework into Risk Control 2

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Gaurav Sinha

Managing Director, Head of Americas Global Research & Design

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Laura Assis Iragorri

Analyst, Global Research & Design

S&P Dow Jones Indices

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Cristopher Anguiano

Senior Analyst, Global Research & Design

INTRODUCTION

In this paper, we introduce the new S&P 500® Futures Daily Risk Control 5% Index (the Risk Control 2 Minimum Variance), which is the latest enhancement to S&P DJI’s Risk Control 1 (RC 1) and Risk Control 2 (RC 2), and a variation on our existing standard RC 2 methodology.[1]

Our risk control techniques began with RC 1, which allocates to equity and cash to achieve a target volatility.  RC 2 then introduced fixed income as another asset class and allocates between an equity and liquid bond index to target a specific volatility.  The bond sleeve in RC 2 is generally a risk reduction tool.  However, in volatile periods when no suitable combination of equity and fixed income is able to attain the target volatility, RC 2 rotates its bond sleeve completely to cash, thereby defaulting to RC 1.

In this new index, we take RC 2 a step further, to RC 2 Minimum Variance.  We allocate to equity and bonds like RC 2; however, unlike RC 2, we introduce cash as an extra alternative rather than a complete swap when underlying volatility picks up.

Incorporating a Minimum Variance Framework into Risk Control 2 Exhibit 1

WHY A NEWER VERSION OF RC 2?

Though RC 2 takes the RC 1 approach a notch higher by introducing bonds, it still has one shortcoming.  In instances when the volatility target is relatively too low (i.e., during periods of sell-off), the bond sleeve of RC 2 switches completely to cash.

While allocating to cash reduces index volatility, thus bringing it in line with the target, this comes at a cost of higher turnover resulting from this bond-to-cash swap.  Our new optimized approach addresses this problem through its innovative technique and significantly reduces turnover.

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FAQ: S&P DJI ESG Scores

COMPANY BACKGROUND

  1. Who is S&P Dow Jones Indices?  S&P Dow Jones Indices (S&P DJI) is home to iconic financial market indicators, such as the S&P 500® and the Dow Jones Industrial Average®. The largest global resource for essential index-based market concepts, data, and research, it is a major investor resource to measure and trade the markets.

    ESG at S&P DJI

    S&P Dow Jones Indices has been a pioneer in environmental, social, and governance (ESG) indexing for 20 years, starting with the 1999 launch of the Dow Jones Sustainability World Index. Today, we offer an extensive range of indices to fit varying risk/return and ESG expectations, from core ESG and low-carbon climate approaches, to thematic and fixed income ESG strategies.

    S&P Dow Jones Indices and SAM, part of S&P Global, have a long history of collaboration since joining forces to launch the world-renowned Dow Jones Sustainability World Index in 1999.

  2. Where does S&P DJI get its ESG data?  S&P Global provides the data that powers the globally recognized Dow Jones Sustainability Indices (DJSI), S&P 500 ESG Index, and others in the S&P ESG Index Series. Each year, S&P Global conducts the Corporate Sustainability Assessment (CSA), an ESG analysis of over 11,000 companies. The CSA has produced one of the world's most comprehensive databases of financially material sustainability information and serves as the basis for the scores that govern S&P DJI's ESG indices.

S&P DJI ESG SCORES

General Questions

  1. What are the S&P DJI ESG Scores?  S&P DJI ESG Scores are environmental, social, and governance scores that robustly measure ESG risk and performance factors for corporations, with a focus on financial materiality. They are a second set of ESG scores calculated by S&P Global ESG Research, in addition to the S&P Global ESG Scores that are used to define the Dow Jones Sustainability Indices constituents.

    The S&P DJI ESG Scores are the result of further scoring methodology refinements to the S&P Global ESG Scores that result from S&P Global's annual Corporate Sustainability Assessment (CSA), a bottom-up research process that aggregates underlying company ESG data to score levels. The scores contain a total company-level ESG score for a financial year, comprising individual environmental (E), social (S), and governance (G) dimension scores, beneath which there are on average over 20 industry-specific criteria scores that can be used as specific ESG signals (see Exhibit 1).

    faq-spdji-esg-scores-exhibit-1

    A company’s total ESG score is the weighted average of all criteria scores and their respective weights. Each individual ESG dimension score (e.g., a company’s “E” score) is the weighted average of all criteria scores and weights within a specific ESG dimension. Total ESG scores range from 0-100, with 100 representing best performance.

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A Matter of Degrees: Aligning ESG Strategies with the Paris Agreement

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Jaspreet Duhra

Managing Director and Head of EMEA Environmental, Social, and Governance (ESG) Indices

Having already witnessed some of the consequences of climate change around the world, more and more investors are now factoring ESG into their investment decisions. Enter the S&P PACT™ Indices (S&P Paris-Aligned & Climate Transition Indices), created to give market participants access to strategies designed to be compatible with limiting global warming to 1.5°C.

We talked with Francois Millet, Managing Director and Head of
Strategy, ESG and Innovation at Lyxor ETF, and Jaspreet Duhra, Senior Director and Head of EMEA ESG Indices at S&P DJI, about the evolving role of ESG in mainstream investing and how these indices may help market participants envision a less fraught future.

Indexology Magazine: Why do you think ESG investing is becoming more important to investors around the world, and do you think the recommitment to climate initiatives in the U.S. adds to the momentum?

Francois: The pandemic triggered a realization that humans are extremely dependent on natural systems. Many investors now work on the widespread conviction that climate and exponential inequalities are major risks—and that mitigating these risks, and building a more inclusive and resilient world with long-term focus, is a precondition for financial stability.

ESG investments captured more than 50% of net inflows to ETFs in Europe last year. This more than offset the negative influence of the official U.S. position on the Paris Agreement at the time. But it's great to see the U.S., which produces around 15% of the world's greenhouse gas emissions, rejoining the Agreement. This recommitment to climate initiatives should bolster the ESG transformation that's already underway and make the Paris Agreement stronger than ever.

Indexology Magazine: Why were the S&P PACT Indices created, and what specific climate goals do they seek to achieve?

Jas: The world is on a dangerous trajectory of warming that is already impacting society and the economy. Regulators are taking action and as investors increasingly take stock of the climate risks in their holdings, more and more are looking to align their investments with a scenario in which warming increases by no more than 1.5°C. The S&P PACT Indices were created with this goal in mind.

The indices are designed to meet the minimum standards for EU Paris-aligned Benchmarks and EU Climate Transition Benchmarks, which means that in addition to lowering carbon emissions relative to their underlying benchmarks, the indices also seek to decarbonize on an absolute basis at a rate of 7% year-on-year. This is the rate of decarbonization required to achieve net-zero emissions by 2050 and limit warming to 1.5°C according to the Intergovernmental Panel on Climate Change. Interestingly, these indices are also designed to maintain the same exposure to high-climate-impact sectors as their benchmarks, which means the decarbonization can't be achieved by just tipping all the weight into low-climate-impact sectors.

We have also gone beyond the EU Low Carbon Benchmark requirements by aligning with the recommendations of the TCFD (Taskforce on Climate-related Financial Disclosures). We believe that the TCFD approach of breaking climate issues into transition risks, physical risks, and opportunities provides a holistic assessment. It's particularly important that our index takes climate change's physical risks into account, as we already see these risks playing out today.

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A Guide to S&P Decrement Indices

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Tianyin Cheng

Senior Director, Strategy Indices

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Izzy Wang

Analyst, Strategy Indices

INTRODUCTION

Decrement indices have gained popularity as the underlying assets of equity-linked structured products in Europe and Asia. According to Structured Retail Products, among the 318 products across asset classes in France that matured or autocalled between April 2018 and March 2019, more than 32 were linked to decrement indices.

One of the reasons behind this recent popularity is the low interest rate environment that has emerged since the 2008 Global Financial Crisis, which has posed challenges for structured product issuers to design attractive products. This environment triggered a search for new underlying assets or strategies that might deliver cheaper optionality. Decrement indices aim to provide a solution to this challenge. S&P DJI has developed a flexible, transparent, and rules-based decrement index framework, which features:

  • Globally accepted, independent underlying indices such as the S&P 500®;
  • Transparent methodology based on the S&P DJI decrement framework; and
  • Customization options in underlying index and decrement parameters.

Exhibit 1

How Decrement Indices Work

A decrement is an overlay applied to an underlying index. It is constructed by periodically deducting a predefined fee, either in the form of a fixed percentage or index points, from the underlying index (see Exhibit 1).

Given an underlying index, decrement indices can be calculated in different ways, depending on which parameters are chosen (see Exhibit 2). All the parameters can be customized. Decrement type and application are the most important parameters, as they primarily determine the amount of decrement deduction and how it is applied to an underlying index.

Exhibit 2


Decrement Type

The performance reduction applied to an underlying index can be either fixed percentage or fixed point. The logic of the fixed-percentage decrement is that dividend yield tends to be stable over the long term. During the past 10 years, the trailing 12-month dividend yield for the S&P 500 was relatively stable, at about 2%. On the other hand, a fixed-point deduction assumes a relatively high level of stability in dividend amounts in the short term, as companies are inclined to maintain more stable dividend policies compared with their earnings.

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