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First of its kind ESG Index - iTraxx MSCI ESG Screened Europe Index

The latest trends in ESG investing have been promising with investors increasingly wanting to incorporate ESG based criteria to their portfolios. By September 2019, assets in ESG equity and fixed income funds had reached over $700 billion, according to the IMF. 2019 also saw record inflows into ETFs and index funds with ESG mandates with AUM exceeding $220 billion as of March 2020. Even in the face of the current pandemic, sustainable funds saw inflows of $14.8 billion in the first quarter of 2020.

Following these developments in the ESG space, there has been significant interest from market participants for a CDS index which would allow investors to gain exposure to (or hedge) ESG screened European corporate credit risk.

IHS Markit is well placed to offer such an index given its expertise as an index provider, and the ESG offering is a natural expansion of our franchise involving the highly liquid iTraxx and CDX indices. In March 2020, IHS Markit launched the iTraxx MSCI ESG Screened Europe Index, which is a broad European corporate CDS index derived with ESG criteria. The index will be available for trading from 22nd June 2020 onward.

Index overview

The index is constructed using the forthcoming iTraxx Europe index series as the starting point, and thus, the iTraxx MSCI ESG Screened Europe index also tracks the most liquid segments of the European CDS market, but with entities not qualifying stringent ESG criteria screened out.

The index follows a three-step screening methodology based on MSCI ESG Research:

  • Value-based screen

Value-based screening results in exclusion of entities breaching specific revenue thresholds due to their involvement in the below activities:

  • Controversy-based screen

Controversy-based screening is applied to identify companies based on how well they adhere to international norms and principles such as the UN Global Compact and ILO Core Conventions.

The MSCI ESG Controversy scores are provided on a scale of 0-10 with 0 being the entities involved in most severe controversies. The iTraxx MSCI ESG Screened Europe index excludes entities with MSCI ESG Controversy scores of 0.

  • ESG Ratings-based screen

MSCI ESG Ratings aim to measure the key ESG risks and opportunities faced by a company and how well those risks are managed with respect to its industry peers.

The iTraxx MSCI ESG Screened Europe index excludes entities with MSCI ESG Rating of BBB and below.

Potential use cases

Being a broad sector-diversified index, iTraxx MSCI ESG Screened Europe index can be used as a macro instrument to gain exposure to or hedge broad ESG European corporate risk. Due to the similarities in the ESG screening methodology applied to the iBoxx bond indices, the iTraxx MSCI ESG Screened Europe index could also be an effective hedging instrument to bond portfolios tracking forthcoming iBoxx MSCI ESG indices.

The index liquidity may also be significantly driven by buyside demand with asset managers, insurance companies and hedge funds wanting to gain long exposure (protection seller position) to ESG companies. The similarities and high correlation of the index with the overall iTraxx Europe index allows sell-side trading counterparties to use the iTraxx Europe index to hedge their protection buyer positions.

Similarities to iTraxx Europe

Below is a depiction of the sector and ratings comparison, spread and total return comparison to highlight the similarities between the iTraxx MSCI ESG Screened Europe index and iTraxx Europe index. The iTraxx Europe has 125 constituents. For Series 33, the iTraxx MSCI ESG Screened Europe index has 81 constituents.

Since the index is not available for trading yet, there is no composite spread data on this index as of now. However, below is a comparison of on-the-run theoretical spreads of the ESG index versus those of the iTraxx Europe index. The theoretical spread is constructed using the quoted spreads of the underlying single name CDS in the index. Once the index starts trading IHS Markit Pricing Service will publish composite pricing for the iTraxx MSCI ESG Screened Europe index based on contributed data.

The iTraxx MSCI ESG Screened Europe index rulebook and index composition of Series 33 are available for download on the iTraxx documentation page. The index will be available for trading from 22nd June 2020 onward at the 5Y tenor with a fixed coupon of 100 basis points.

Posted 12 May 2020 by Srichandra Masabathula, Associate Director, Indices, IHS Markit

IHS Markit provides industry-leading data, software and technology platforms and managed services to tackle some of the most difficult challenges in financial markets. We help our customers better understand complicated markets, reduce risk, operate more efficiently and comply with financial regulation.

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