Sustainability and ESG in ETFs

The three ESG dimensions

Environmental (E)

For example greenhouse gas emissions, energy and water use, pollution and biodiversity.

Social (S)

For example working conditions and occupational safety, human rights in supply chains, product safety and data protection.

Governance (G)

For example board composition and independence, remuneration, accounting and anti-corruption measures.

How ESG indices select companies

Exclusions

Companies are excluded if they operate in certain business areas or breach international norms such as the UN Global Compact. Revenue thresholds usually apply, and they differ between index providers and indices. Typical exclusion areas:

• Weapons
• Thermal coal
• Tobacco
• Gambling
• Adult Entertainment
• Arctic Drilling

Best-in-class

Within each sector, companies with better ESG ratings are selected or given a higher weight. Companies from emission-intensive sectors can therefore remain in the index if they score better than their peers.

ESG integration

ESG data is used alongside financial metrics for selection or weighting, without necessarily excluding companies.

SRI indices

Some index families call stricter variants “SRI” (socially responsible investing). They usually combine exclusions with best-in-class selection and contain considerably fewer companies than the parent index. What exactly is excluded is set out in the index methodology.

Climate benchmarks (CTB and PAB)

EU Climate Transition Benchmarks (CTB) and Paris-aligned Benchmarks (PAB) must meet the minimum standards of Commission Delegated Regulation (EU) 2020/1818, including a greenhouse gas intensity at least 30 % (CTB) or 50 % (PAB) lower than the investable universe and a year-on-year decarbonisation of at least 7 % on average.

Limits and risks

• ESG ratings from different providers often agree only to a limited extent because they use different criteria, weights and data. The same company can be rated well by one provider and average by another.
• An ESG filter changes the composition: country, sector and single-stock weights differ from the parent index. Returns and volatility can therefore be higher or lower than those of the parent index.
• Classification under Article 8 or 9 of the Sustainable Finance Disclosure Regulation (SFDR) describes what the provider discloses about sustainability. It is not a quality label and not an official assessment of sustainability.
• ESG data is partly based on estimates and company disclosures and is updated with a delay.

More on SFDR Articles 6, 8 and 9 in the academy