New carbon indices address ESG and climate change risks

INVESTORS should consider investing in companies listed on Bursa Malaysia’s two new carbon indices, as they serve as regulatory and other risk management tools.

They are also tools for managing exposure to environmental, social and governance (ESG) and climate risks as well as for benchmarking and product development.

Currently, 77 companies are listed in the FTSE Bursa Malaysia Top 100 Low Carbon Select Index (FBM100LC) and 60 in the FTSE Bursa Malaysia Top 100 ESG Low Carbon Select Shariah Index (FBM100LS).

Reporting on climate change has become so important that Bursa Malaysia has added it to the Enhanced Sustainability Framework for Core Markets and ACE companies, with the aim of improving the quality of their publications.

Malaysian financial institutions and investors are now required to report climate-related exposures of their financing and investment activities to Bank Negara, in line with the guiding principles of the Climate Change Principles Based Taxonomy (CCPT).

The new carbon indices, constructed using FTSE Russell’s ESG rating and carbon data points, can facilitate reporting as the index methodology is transparent.

The objective of the new indices is aligned with those of the CCPT to transition to a low-carbon and climate-resilient economy through targeted reductions in carbon reserves held by parent benchmark companies and emissions.

The new indices can also be used by domestic and international investors with a mandate to manage ESG and climate risks.

The indices aim to reduce carbon reserves and emissions while improving ESG performance.

In terms of benchmarking and product development, indices can be used as the basis for funds and exchange-traded products.

The value of sustainable investments has increased in recent years and these indices provide an opportunity to tap into the global pool of sustainable investments, Bursa Malaysia said.

The FBM100LC is based on the FBM Top 100, while the FBM100LS consists of all eligible companies in the FBM100 that are syariah-compliant, according to the Securities Commission’s Shariah Advisory Council selection methodology.

Both indexes exclude companies that fall under “applicable product and conduct-related exclusion lists”.

The FBM Low Carbon Select Index series is designed to provide increased exposure to companies in the FBM Top 100 universe that demonstrate strong ESG and sustainability practices.

This is in line with the index’s sustainable investing objectives – improving the overall ESG score and reducing the carbon footprint at the index level.

At each index rebalance, the index will tilt towards, or overweight, companies in the FBM100 that are taking steps to reduce their carbon footprint relative to their peers.

Emissions-intensive companies will be underweight or “penalized” in the index.

Companies involved in thermal coal mining and/or power generation activities will be considered ineligible for FBM100LC or FBM100LS.

This will encourage companies to manage their climate risks associated with ownership of fossil fuel reserves.

Companies must meet the negative screening criteria to be eligible for the FBM100LC and FBM100LS, as the indices apply a set of product and behavioral exclusions with revenue-based thresholds.

Exclusions include weapons, tobacco, adult entertainment, gambling, thermal coal, nuclear power generation, and controversy in violation of the principles of the United Nations Global Compact.

ESG scores (as determined by the FTSE Russell ESG scoring model), fossil fuel reserves as well as operational emissions intensities are not used as selection thresholds.

Instead, the index constituent weights will be tilted based on these data points to achieve the index’s sustainable investing objectives.

Since the index applies a minimum equity weighting constraint of 0.5 basis points, constituents with a very low weighting will also be excluded from the final index.

To achieve the index’s sustainable investing objectives, companies in the new indices are overweighted based on their ESG ratings to achieve a targeted 20% improvement in ESG ratings at the index level.

Companies with fossil fuel reserves are underweighted in the index to achieve a 30% reduction in fossil fuel intensity.

Companies in the indices are also overweighted or underweighted based on their greenhouse gas emissions, aiming for a 30% reduction in operational carbon emissions at the index level.

Investors seeking to reduce the carbon footprint of their investment portfolio can target, at the portfolio level, a maximum 30% reduction in fossil fuel reserve intensity, a 30% reduction in carbon emissions and a 20% increase in ESG ratings by tracking these new indices.

Bursa Malaysia plans to promote these new indices to institutional investors, as well as to organize seminars/webinars on the FTSE Low Carbon methodology and criteria for inclusion in the index.

Average levels of ESG compliance against Bursa Malaysia’s listing requirements are high; the top 100 listed companies recorded an average of 98% while the score of all listed companies on the main market stood at 86%.

However, in terms of the overall quality of sustainability information, there is considerable room for improvement, Bursa Malaysia said.

Against a rigorous set of criteria, the top 100 listed companies scored an average of 58%, while the average of all companies listed on the Main Market is 40%.

For companies listed on the ACE market, their level of compliance is 100%, as they are only required to include in their annual reports a simple narrative statement of their management of material sustainability risks and opportunities.

As for the quality of their disclosures, they are assessed using the same rigorous criteria used for their mainstream market counterparts, and the resulting average score is 23%.

Bursa Malaysia has improved sustainability reporting in core and ACE listing requirements based on a multi-year phased implementation approach.

By introducing new carbon indices and improving the sustainability reporting framework, Bursa Malaysia is improving the quality, relevance and attractiveness of its listed companies.

Yap Leng Kuen is a former editor of StarBiz. The opinions expressed here are those of the author.