Euronext has launched a futures contract based on 80 large cap companies in the Eurozone that have been selected for their performance related to the transition away from fossil fuels as well as environmental, social and governance (ESG) factors.
The move is the latest example of an industry-wide trend towards introducing new futures contracts based on ESG indices. Exchanges and index providers are responding to a dramatic increase in assets invested in ESG strategies, with European institutional investors leading the way.
Euronext, which operates the second largest derivatives exchange in the Eurozone, launched its new futures contract on 1 June with backing from four firms acting as market makers: BNP Paribas, DRW, Optiver and Société Générale. The four firms are posting bids and offers on the central orderbook of the Euronext Optiq platform as well as arranging block trades for clients.
Charlotte Alliot, head of institutional derivatives at Euronext, said she expects the contract to be used by institutional managers, exchange-traded fund issuers, insurance companies and other investors in the same way as conventional futures – as a tool to track the benchmark and to hedge their risks. It will also allow investors to gain exposure to the Eurozone’s sustainable economy and support climate action, Alliot said.
The contract is based on the Euronext Eurozone ESG Large 80 index, a free float market capitalisation index made up of the highest-ranked companies in the Euronext Eurozone 300 index.
The selection of the 80 companies is based on scoring by Vigeo Eiris, a Paris-based provider of ESG data and assessments that recently became a part-owned affiliate of Moody's.
Alliot describes it as "an index with convictions" that was developed in response to a growing need from market participants for a climate action benchmark. The index excludes companies who are not closely adhering to the UN Global Compact, as well as the 20% lowest-ranking companies in terms of social and governance assessments, and companies involved in coal, tobacco or weapons.
The index does more than exclude stocks that do not meet its criteria, however. It also includes companies that are leaders in the ESG movement and the energy transition, as measured by Vigeo Eiris. In addition, the index is constructed to align with the balance of economic sectors represented in the Eurozone 300 index.
Among its uses, the index can serve as an underlying for structured products and exchange traded products.
Alliot said the index was designed in collaboration with several banks that approached Euronext asking it to develop a public benchmark for the Eurozone with a strong ESG component.
"This group of banks asked us to create a working group with a real conviction around ESG and a strong approach to exclusion. It was agreed that we should develop an index that was larger than 50 stocks, but not too big either. We came back with 80 names to better represent the Eurozone economy while preserving high levels of liquidity," she said.
Euronext will continuously adapt its index criteria since ESG rules and European regulations are evolving quickly.
"We have created a scientific and user committee to match our index to regulatory challenges and market requirements," Alliot said. "Also, in addition to an annual rebalancing of the index, companies facing critical controversies with regards to the UN Global Compact criteria will be excluded from the index on a quarterly basis to systematically take into account company evolutions."
The index reduces the carbon footprint by more than 70% compared to the Euronext Eurozone 300 starting benchmark. "We are particularly proud of this, considering the European Commission’s Technical Expert Group on Sustainable Finance recommended in their last report that sustainable benchmarks should decarbonize by at least 50%," Alliot said.
Appeal to institutional investors
Euronext, which offers more than 40 ESG indices, is launching the new futures contract in a blossoming market. In October 2018, Nasdaq introduced futures based on the OMX Stockholm 30 index, which tracks the top Swedish stocks, and in February 2019, Eurex began offering futures on three ESG indexes. In November last year, both CME and ICE entered the ESG derivatives fray.
What sets Euronext's product apart, said Alliot, is its strong exclusion filters and the fact that the contract is not charged by the exchange at a premium, reflecting Euronext and Vigeo Eiris’ view that taking part in sustainable growth should be accessible to all.
The index has been well received, Alliot said, particularly by product issuers, who are attracted by its significant decrease in carbon footprint, clear methodology, deep liquidity, and the fact it is a public index open to all investor types.
The development of other derivative products based on the index will be linked to the success of the futures contract, she added. "You need to build liquidity in the futures before you launch other contracts, but this is very much our intention."