Published 9 February 2022 by Audra Walton
With the rise in ESG investing, we have been asked many times recently if there is a way to calculate whether a passive fund is likely to partially or fully divest a company's stock based on the ESG criteria of the underlying index. The ESG criteria may be new, as part of the growing incorporation of ESG factors by indices, or it may be that something has changed for the company (a rating for example) that means it no longer meets the existing criteria of the underlying index. Either way, many companies are concerned that developments of this nature could have a notable impact on shareholdings.
Companies' concerns are not unfounded. We have seen issuers removed from the Dow Jones Sustainability Indices when their S&P ESG Global rating dropped, and a similar phenomenon with the MSCI ESG Indices as influenced by MSCI's ESG and temperature rise ratings.
But having carefully researched passive holders for several clients in an effort to determine what percentage have overlapping criteria, we found that it is not usually the case that the top passive holders track the same index, or that the indices they track change ESG criteria frequently. It is typically a fairly diversified bunch, and a high percentage of indices’ ESG incorporation is either exclusionary, sectoral, or thematic - i.e. not factors that will be adjusted by the indices in a re-weighting. This should come as some consolation to issuers, particularly those that have high levels of index fund investment.
Nonetheless if you are concerned and would like to analyse your risk, you can follow these steps to understand more about the key ESG requirements of your passive holders.
1. Obtain a Shareholder Identification Report, that has the following:
a) ownership on a fund/sub-fund level basis
b) fund 'type' (passive, active, growth, GARP, ETF, index, etc)
c) ESG data such as exclusions (ideally)
2. Filter so that you are only looking at ETFs and passive/tracker funds.
3. Starting with your largest passive shareholder, copy the name and search online for the prospectus or fact sheet. Often you will quite easily find a web page with details of the 'benchmark' index, but the benchmark index is not always one and the same as the index tracked. To find this you usually have to read the prospectus.*
4. Once you find the index tracked, search for it online to see if you can find a methodology (sometimes this is a pdf). Within the methodology, you will be able to determine what ESG factors influence inclusion, and exclusion, as well as the frequency of re-weighting.
5. Make a note of this information for each shareholder. Once you have researched all those with a notable holding, you can then look across the list to see if they share any ESG requirements.
*Note that when you read the prospectus you can also check for investible universe criteria that the fund employs before replicating the index. For example a passive ESG fund may exclude thermal coal companies irrespective of what is included on the index tracked.
This process is not quick, and in some cases it is isn't possible to find the methodology of the index. But on the whole, if one follows these steps, they will begin to see if there are indeed overlapping ESG criteria across top passive holders (stemming from the index tracked). Knowing this can help the IR team proactively try to influence key metrics by filling out a ratings agency questionnaire for example, or pushing internally for GHG reduction commitments.
With the proportion of funds considered ESG growing, and the number of passives increasing too, this may be more important than ever in the months and years to come.
CMi2i, the world’s leading forensic capital markets intelligence firm, specialises in the world’s most accurate Equity & Debtholder identification service and supports issuers and their advisors with their ESG investment, investor relations, M&A, AGMs/EGMs, corporate governance, shareholder activism and capital restructuring goals through its integrated approach. The company has supported more than 1000 corporate transactions and over 500 clients worldwide.