SRI goes cross-asset

As bonds, equities and structured investments become increasingly intertwined, some banks are taking a single-platform approach to encompass Green bond issuance, bespoke equity-linked structuring and ethical index development.

In February, JP Morgan became the latest bank to address the fragmented nature of its sustainable investment activities with JP Morgan Ethos Investments – a new cross-asset platform for ethical, social and governance investment activities that it hopes will open the door to a broader range of investors as ESG mandates move further into the mainstream.

“The cross-asset approach reflects the structure we see on the buyside. We’ve seen investors grouping their ESG teams together and increasingly we are dealing with a head of ESG investments,” said Nicolas Robin, head of EDG specialist structuring at JP Morgan “It doesn’t make sense any longer to have multiple teams speaking to the same person.”

The US bank estimates that assets under management in ESG portfolios currently stand at around US$30bn–$40bn, though that could rise to as much as US$2.5trn including all investments that have some ESG criteria applied. Ethical investing reached an inflection point in late 2014, when interest moved beyond ESG specialists to group CIOs at major asset management firms.

“With a platform approach on the basis of a partnership, we’ve found we are better equipped to engage with clients, particularly in larger scale products,” said Robin. “The ESG space is becoming very crowded and it’s harder for clients to distinguish between opportunistic players and real specialists.”

Launched in conjunction with the World Bank and S&P Dow Jones Indices, JPM’s Ethos platform aims to bring together all ESG-related products, including trackers and capital-protected notes on passive indices, as well as actively managed funds and bespoke portfolios.

The platform mirrors similar efforts by BNP Paribas, which partnered with the European Investment Bank and environmental assessment and ratings firm Vigeo to launch its Tera Neva platform last November.

BNPP’s decision was largely driven by growing interest for equity-linked participation in Green bond issues as investors sought to boost razor-thin yields from a supranational-dominated issuer base.

The inaugural issue on the French bank’s platform was a €500m bond for the EIB with full principal protection and payout linked to Solactive’s Ethical Europe Climate Care Index, which is constructed with Vigeo environmental assessment methodology.

“There’s a lot of demand for Green bonds, but the yields are typically low, so indexing the returns to the equity thematic is one of the key elements of getting the extra yield that investors want,” said Jean-Eric Pacini, head of equity derivatives sales, EMEA, at BNP Paribas.

As a Green bond pioneer, The World Bank has issued more than US$500m-equivalent in equity-linked Green bonds, beginning in mid-2014 with US$50m of notes linked to the Ethical Europe Equity Index. The Solactive-managed benchmark uses analysis by third parties Vigeo and Forum Ethibel, a Belgian environmental consultancy and audit firm, to select sustainable companies that have no major involvement in weapons, tobacco, gambling or nuclear.

The first equity-linked notes were placed privately with BNP Paribas but have since been offered to institutional investors and retail across Europe and the US.

New names are expected to come alongside predicted growth in the market. Overall Green bond issuance hit US$27bn-equivalent in 2015, according to Thomson Reuters data, while Moody’s forecasts issuance to exceed US$50bn in 2016.

But equity-linked activity remains a small portion. Out of €11bn of Green bonds lead managed by BNP Paribas, just €1.1bn have an equity-linked element. The World Bank’s equity-linked Green bond issuance accounts for just 5% of its €9bn issued to date.

“We’re waiting for the second wave of issuers in the equity-linked Green bond space and we think that we’re bound to see interest from corporates that are currently issuing vanilla Green bonds,” said Robin. “The average Green bond issuer is already open to innovation, so is more inclined to look at a structured issue than your average issuer.”

Structured access

So far, it has been equity and structured notes businesses driving developments. BNP Paribas has raised more than €3bn in sustainable equity solutions in the last three years as investors looked to reduce the carbon risk in their portfolios. That includes €750m in the first quarter, with ESG interest growing to represent around a third of all thematic investments on the bank’s structured products platform.

“Bringing capital protection through structured product brings a lot to climate control and ethical investments as most investors are medium to long-term holders, so it is very helpful for reducing risk,” said Neven Graillat, global head of sustainable investment solutions at BNP Paribas.

The French bank hopes to boost its position following its recent collaboration with FTSE Russell to create a new climate index. The FTSE Divest-Invest Developed 200 Index reduces exposure to fossil fuels and their associated companies while increasing exposure to those invested in the green economy. Constituent weights are determined by FTSE Russell’s LCE model that captures changes in the revenue mix of companies.

The bank intends to issue delta one products, swaps and structured notes linked to the index later this year.

“For the first time, investors are being offered a way to assess companies based on their green revenues. Using data modelled by FTSE’s LCE, the index offers an innovative tool to help manage investors’ carbon risk while tilting towards companies engaged in the transition to a greener economy,” said BNPP’s Graillat.

S&P Dow Jones Indices will provide a range of thematic benchmarks for JPMorgan’s Ethos platform, to be used for equity-linked indexation of Green bonds and underlie bespoke products including certificates, capital-protected notes and other structured products such as autocallables.

The provider has launched two benchmarks to date in collaboration with JPM. The Europe 350 and Global 1,200 Climate Change indices are already up and running, with the bank offering leveraged products to private banks and asset managers that can boost returns by three or five times with relatively simple payoffs, and total return swaps that pay Libor plus or minus the returns of the index, that can also be tailored to meet investors’ bespoke requirements.

Performance boost

One of the barriers to further growth is the historical underperformance of ethical benchmarks. However, that could be changing.

A 12-month view shows that Solactive’s Ethical Europe Climate Care Index outperformed the pan-European Stoxx 600, while the iStoxx Europe ESG Select 30 indices slightly underperformed the wider benchmark (see chart).

In an attempt to address long-held concerns about ESG performance compared to traditional benchmarks, the S&P climate indices add smart beta filters for low volatility and high dividends. Further benchmarks will be added offering more regional and granular exposure to the climate change theme.

“There’s still demand for broad-based indices, but we’re beginning to see a switch to thematic interest,” said JPM’s Robin. “Carbon efficiency and climate change have been very popular for months, but we’re beginning to see interest in efficiency in general and other themes such as diversity and human capital.”

Slumping energy prices and volatile stock markets through the start of the year may also have forced a rethink of the relative benefits of green energy companies.

In April, Peabody Energy, the world’s largest private sector coal company, filed for bankruptcy. Arch Coal, the second largest US coal firm behind Peabody, filed for bankruptcy protection in January.

That was highlighted by the S&P 500 energy sector index, which shed almost 15% from the start of the year to mid-February, while the S&P Global 1200 Climate Change index remained flat.