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ESG and Climate Derivatives in Equity Exposure Management

Most efforts to manage climate and ESG portfolio risks have involved reducing holdings of stocks negatively exposed to these risks, and increasing those that are positively exposed. Professionally managed ETFs and mutual funds have been a natural starting point for investors to align exposures with their objectives, but index derivatives could have a critical part to play, being one of the largest global markets with a substantial role in the financial system and the management and transfer of risk. We investigate the potential for derivatives to help market participants seek to efficiently align exposures with their objectives, while facilitating transparency, price discovery and market efficiency.

Factors include broad-market factors, regions, country, sector/industry and style factors. Physical replication includes direct holdings, active and index-replicating funds and physically replicated ETFs. Synthetic exposure includes OTC TRS, listed futures and synthetic ETFs. Hybrid recognizes underlying products could have a mix of both physical and synthetic, as well as the top-down allocations.

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