West Yorkshire Pension Fund to Use Derivatives ESG Risk Framework | New

West Yorkshire Pension Fund (WYPF), the £16.3 billion (€19.2 billion) British local government pension scheme (LGPS), has asked investment management boutique WieldMore Investment Management and at the Wheeler Institute for Business and Development, part of the London Business School (LBS), to design a framework for assessing ESG risks and the impact of derivatives.

The framework, originally proposed by London-based WieldMore IM, will be used by WYPF to create an overlay of ESG-sensitive derivatives as the fund gradually builds its portfolio of illiquid alternative assets.

WPYF, WieldMore IM and the LBS hope the project will produce the first comprehensive derivatives rating framework based on ESG principles.

The project is funded by the LBS as part of its research activities. In addition to staff from WieldMore IM, the project team includes researchers from LBS and the University of Bath. SustainAdvisory and compliance specialist Laven will also provide support.

Ola Ajala, Head of Finance at WYPF, said: “Our intention is to grow our portfolio of alternative assets. To do this, we plan to hedge some of our equity assets using options, so that when the opportunity arises to seize attractive opportunities in alternatives, we do not divest from our equity portfolios. actions at the wrong time.

The fund is already investing in infrastructure through GLIL, the £3.6 billion infrastructure investment vehicle launched by WYPF, Lancashire County Pension Fund (LCPF) and Merseyside Pension Fund (MPF), which has now raised capital from several LGPS.

However, Ajala said WYPF aims to expand its portfolio of infrastructure assets and other alternatives. Hedging equity assets would allow the scheme to be more selective and progressive in its efforts to acquire other alternative assets, he added.

“At the same time, we continuously strive to find facts and data to support our understanding of the true degree of sustainability of our key assets. As we also intend to build exposure to derivatives, understanding ESG risks and the impact of derivatives will be a key step in assessing the sustainability of our entire portfolio. WieldMore has convinced us that it is possible to build a comprehensive framework with indicative ESG exposure,” said Ajala.

The framework will rely on a combination of quantitative and qualitative information to assign a score to each derivative position. The UN Sustainable Development Goals (SDGs) will form part of the basis of the rating system, while climate-specific risks will be quantified and assessed using the framework of the Task Force on Climate-Related Financial Disclosures (TCFD).

WYPF provided the research team with the full list of portfolio holdings. Work on the project began earlier this month and the first set of results should be available in three months.

“We aim to be the first to create a model that quantitatively defines the ESG impact of derivatives”

Giuseppe Amitrano, founder and CEO of WieldMore IM

Giuseppe Amitrano, Founder and Managing Director of WieldMore IM, derivatives structuring and trading expert and former head of Scotiabank, Royal Bank of Scotland and UBS, said: “As a signatory of the UN PRI, being aware of ESG is one of our core beliefs. However, applying our expertise to the use of listed derivatives for portfolio hedging and return stabilization purposes means that we have to compromise on our ESG principles, as we have no way to measure the ESG impact of these products on an investment portfolio. Unfortunately, no one in the world does. Solutions have yet to be developed for this problem.

According to analysis by WieldMore, no derivative ESG screening tools currently exist, particularly for non-native ESG products that include securities not created for the primary purpose of ESG.

This equates to around €244 billion of derivatives in the EU that are not used for ESG rating and risk management. The figure is based on 2021 data from the European Securities and Markets Authority (ESMA).

“Our goal is to be the first to create a model that quantitatively defines the ESG impact of derivatives. Our goal is to empower all investors to analyze ESG risks, implement more ESG-aware investment decisions and sequentially disclose their ESG impact to relevant stakeholders. We seek to use the correlation of derivatives with the underlying components of the portfolio, combined with established ESG data and vendor selection, to design a scoring mechanism,” added Amitrano.

LBS team members said: “The project represents an exciting opportunity to enable asset management companies to track ESG impact, comply with regulations and pave the way for more transparent and transparent finance. sustainable”.

The use of derivatives in sustainable portfolios has been the subject of industry speculation and controversy, but relatively limited research.

However, a technical standards document published by the European Commission in April this year regarding the Sustainable Financial Disclosure Regulation (SFDR), the EC said:

“Financial market participants should explain how the use of derivatives is compatible with the environmental or social characteristics that the financial product promotes or with the objective of sustainable investment.”

Amitrano added, “It is more crucial than ever for investment professionals to be able to measure and report the ESG-related risk of their portfolios, including derivatives.”

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Dolores W. Simon