“Stock markets have started with an attempt to price carbon emissions but need to go quite a lot further.”
With Michael Syn, President and Head of the Global Markets Division, SGX Group and Don Guo, Group Chief Investment Officer at Prudential plc
Singapore Exchange (SGX Group) has an ambition for at least one quarter of the $13.7 trillion of global assets tracking the MSCI Equity Indexes to switch to the new MSCI Climate Action Indexes suite.
Michael Syn, President and Head of the Global Markets Division at SGX Group, said the exchange believes transition investing will soon become an essential part of the capital market. He also sees transition finance offering massive opportunities to customers to create value and manage risk in both the derivative and stock markets.
“We have started this journey by thinking very narrowly about climate transition,” Syn said. “Not pricing in the negative externalities of greenhouse gas emissions is the greatest market failure in the history of mankind.”
An appropriate financial solution is essential for efficient functioning of the market to orchestrate global activity by signaling the price of emissions, according to Syn. To achieve this common goal, SGX and MSCI have developed a unique benchmark methodology for climate transition after a considerable period of consultation with asset owners globally.
Singapore, as a major financial center, is taking the lead on climate change. For example, SGX Group is one of the founding members of the Net Zero Financial Service Providers Alliance (NZFSPA), while its Special Adviser Yeo Lian Sim is vice chair of the Taskforce on Climate-related Financial Disclosures (TCFD). The city-state has an important role to play as countries are in different stages of development in Asia, a region that is expected to contain the five largest economies in the world by 2030.
“We are happy to lead this new category of climate aware, or transition, investing,” Syn said. “We are focused on building a global ecosystem of climate solutions based on equity asset class, the most important form of permanent capital, with the ambition to deliver global impact.”
Climate Action Indexes
In October 2022, MSCI announced the launch of the MSCI Climate Action Indexes, which are designed for investors looking for companies making progress towards transitioning to a low-carbon future with exposure to all sectors of the economy. The MSCI Climate Action Indexes include companies that are taking concrete steps to reduce their carbon emissions. They are evaluated on the basis of a range of climate indicators, including their current carbon intensity and their potential to lead in the climate transition relative to their peers. The indexes also follow the Glasgow Financial Alliance for Net Zero (GFANZ) recommendations on addressing real-economy emissions reductions.
“We have a market mechanism to help address climate change and an addressable pool of participants who are globally relevant,” Syn said. “We believe MSCI Climate Action will eventually become an essential part of the investor’s toolkit, facilitating the flow of capital towards credible transition plans, and supporting price discovery and risk management thanks to an effective sectoral bottom-up approach.”
Prudential plc, one of Asia’s largest asset owners, noted that there remains a significant part of the economy that is not yet green, and financing the acceleration of decarbonization at scale can create impact. The company is the anchor investor of the iShares MSCI Asia ex-Japan Climate Action ETF listed on SGX – the largest equity exchange-traded fund launch in Singapore.
“We recognize the importance of fortifying the climate resilience of our portfolio, in line with our mission to safeguard the long-term sustainability of our investments on behalf of our policyholders,” said Don Guo, Group Chief Investment Officer at Prudential. “By supporting companies demonstrating transition leadership, we are assuming a larger role in facilitating the green transformation across all sectors.”
Green Premium, Brown Discount
Today all cash flows are discounted at the same rate but some activities, such as reforestation, reduce greenhouse gases while others, such as burning coal, increase greenhouse gases. Therefore, some cash flows should have a green premium and others have a brown discount – which will fundamentally change tenets of finance, Syn argued.
“At the same time, this change can be easily integrated into the machinery of the way investing works today, which is why we are taking this approach,” he said.
For example, asset owners and managers can switch from the cap-weighted MSCI Asia Ex Japan to MSCI Climate Action Asia Ex Japan and receive the same strategic asset allocation, limited tracking error without any optimization, while putting their money to work by promoting transition and punishing companies that fail to make efforts to change from brown to green in their own sector.
“As capital starts moving, the market starts pricing in green and brown, and this signal causes change,” Syn said.
Capital has already started moving with almost $6.5 billion tracking MSCI Climate Action via ETFs across the US, Europe, Japan and now Singapore – but SGX Group has larger ambitions.
“MSCI Equity indexes have a total AUM of about $13.7 trillion tracking it and the ambition is that at least a quarter of those assets will switch to Climate Action,” according to Syn.
He stressed that this change in financing will not require new capital, but a shift of existing funds to MSCI Climate Action indexes from the corresponding parent indexes. “It is a new category in capital markets and we think it is the future,” he said.
Real-World Decarbonization
ESG strategies have faced accusations of not addressing real-world decarbonization and rather decarbonizing merely on paper by optimization at portfolio-level. For example, investors may sell all their holdings in carbon intensive companies to make their portfolios look cleaner, but this does not help reduce greenhouse gas emissions as another investor will buy them.
Instead, the MSCI Climate Action index methodology seeks to give credit to carbon-emitting companies that demonstrate credible climate-transition plans through science-based targets, while punishing those that do not. This is what committed firms are asking for, both on the investors and companies’ side.
There has also been a backlash against ESG in some jurisdictions, but momentum is being driven by the rational self-interest of asset owners not wanting to leave money on the table, according to Syn.
As funds flow into MSCI Climate Action ETFs, SGX expects derivatives to gain more traction for switch trades, such as selling shares from MSCI Asia ex Japan to buy MSCI Climate Action Asia ex Japan. Derivatives and futures are the classic instruments for large transition trades and can be cleared at SGX’s clearing house, Syn noted. As portfolio evolves, managers also need to re-align their derivatives with their mandates to prevent additional tracking error or correlation noise.
“SGX’s version of impact is that if we can get this part of the market to work, then we will have contributed to solving the largest-ever market failure,” he said.
ESG Disclosures
The index methodology is probably immune to trivial greenwashing because it relies on rule-based methodology that is rigorously monitored at regular intervals, Syn argued.
There is also an effort to keep the selection process linear so that all parties can understand it – when promoting stewardship as a complementary tool for investors to encourage the transition in exchange of their stable capital. The ESG disclosures are public, which means that if they are wrong or misleading there are civil and criminal penalties, as is the case for financial disclosures.
“As a significant investor and asset owner with long-term investment horizons and liabilities, Prudential also bears a responsibility to diligently manage the risks associated with greenwashing to the best of our ability,” said Guo at Prudential. “While there is no unified framework for defining greenwashing, we are taking initiatives to develop controls across our investment processes.”
Stock markets globally are doing important work in making sure that listed companies under their supervision provide standardized and higher-quality ESG disclosures, according to SGX.
“This is one of the things which made me feel that the world could take collective action to solve problems,” Syn said.
In July this year, the Accounting and Corporate Regulatory Authority and Singapore Exchange Regulation launched a public consultation on the recommendations made by the Sustainability Reporting Advisory Committee to advance climate reporting in Singapore.
SGX sits at the intersection of a number of very large Singapore and international companies, with more than 40% of its listed companies from overseas.
“We have to make sure that we choose what is acceptable for large international firms and domestic Singapore companies, which can be mom and pop shops, and also capture private and public equity,” Syn added.
He explained that all disclosure comes at a cost, so each such disclosure needs to be purposeful. Therefore, SGX has developed the ESGenome platform to make it as easy as possible for companies to disclose ESG data and benchmark themselves against peers. For example, companies can automatically create their annual sustainability report from their previous disclosures.
“We are trying to make it easier by digitizing the disclosure experience and also make it easier for consumers by standardizing ESG data,” Syn said.
While there has been widespread adoption of the TCFD framework, Syn argued that there is more distance that needs to be traveled.
“Stock markets have started with an attempt to price carbon emissions but need to go quite a lot further, and the next stage will be related to biodiversity,” he said. •
