New carbon indices address ESG, climate change risks

INVESTORS should consider investing in companies listed on the two new carbon indices on Bursa Malaysia as they serve as tools in the management of regulatory and other risks.

They are also tools for the management of environmental, social and governance (ESG) and climate risk exposure as well as benchmarking and product development.

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

Climate change reporting has become so important that Bursa Malaysia has added it to the enhanced sustainability framework for companies on the Main and ACE Markets, in a move to improve the quality of their disclosures.

Malaysian financial institutions and investors are now required to report on climate-related exposures of their financing and investment activities to Bank Negara, under the guiding principles of the Climate Change Principle-based Taxonomy (CCPT).

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

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

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

The indices target reductions in carbon reserves and emissions while improving ESG performance.

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

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

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’s screening methodology.

Both indices exclude companies that fall under the “applicable products and conduct-related exclusion lists.”

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

This is in line with the index sustainable investment objectives – improvement in aggregate ESG score and reduction in carbon footprint on the index level.

At each index rebalance, the index will tilt towards, or overweight, FBM100 companies that take action to lower their carbon footprint in comparison to their peers.

Companies with high emissions intensity will be underweighted or “penalised” on the index.

Companies that are involved in thermal coal extraction and/or power generation activities will be deemed ineligible for FBM100LC of FBM100LS.

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

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

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

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

Instead, the index’s constituent weights will be tilted based on these datapoints to achieve the index’s sustainable investment objectives.

As the index applies a minimum stock weight constraint of 0.5 basis points, constituents with a very small weight will also be excluded from the final index.

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

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

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

Investors looking to reduce their investment portfolio’s carbon footprint can aim to achieve, at portfolio level, a maximum of 30% reduction in fossil fuel reserves intensity, 30% reduction in carbon emissions intensity and 20% uplift in ESG ratings by tracking these new indices.

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

Average ESG compliance levels against Bursa Malaysia’s listing requirements are high; the Top 100 listed companies recorded an average 98% while the score for all Main Market listed companies stood at 86%.

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

Against a stringent set of criteria, the Top 100 listed companies scored an average of 58%, while the average across all Main Market listed companies is 40%.

For ACE Market-listed companies, their compliance level is at a full 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 being assessed using the same stringent criteria that was used for their Main Market counterparts, and the resultant average score is 23%.

Bursa Malaysia has enhanced sustainability reporting in the Main and ACE Markets listing requirements based on a multi-year, phased implementation approach.

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

Yap Leng Kuen is a former StarBiz editor. The views expressed here are the writer’s own.

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