sustainability – EU action plan.

Entity level: Transparency on the integration of sustainability risks

What are sustainability risks?

Sustainability risk means an environmental, social, or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment.

 

Identification of sustainability risks

There are various sources of sustainability risks that may impact the financial product and/or service. Not all risks may be relevant to all investments.

Non-exhaustive list of sustainability risks:

Environmental and climate risks: Environmental degradation and climate change are sources of structural alterations that affect economic activity and, in turn, the financial system. Climate-related and environmental risks are commonly understood to comprise two main risk drivers:

Physical risk refers to the financial impact on a company of a changing climate – including more frequent extreme weather events and gradual changes in climate – as well as of environmental degradation such as air, water, and land pollution; water stress; biodiversity loss; and deforestation.

Transition risk refers to a company’s financial loss that can result, directly or indirectly, from the process of adjustment towards a lower-carbon and more environmentally sustainable economy. This could be triggered, for example, by a relatively abrupt adoption of climate and environmental policies, technological progress, or changes in market sentiment and preferences.

Social risk refers to any negative financial impact on a company stemming from the current or prospective impacts of social factors – such as poor labour standards, human rights violations, harm to public health, data privacy breaches, or increased inequalities – on its counterparties or invested assets.

Governance risk refers to any negative financial impact on a company stemming from the current or prospective impacts of governance factors, such as an inadequate governance framework, on its counterparties or invested assets. Governance risk may for example arise from a lack of accountability and transparency of the board, or from the unequal treatment of shareholders and stakeholders.

Bearing in mind these very real risks as well as our obligations under SFDR, Lombard Odier is convinced that proper integration of sustainability risks into our investment decision-making process will mitigate the impact of such risks on the value of our investments, and will help enhance long-term risk-adjusted returns for our clients.

 

integration of sustainability risks

We strongly believe that sustainable value creation for our clients starts with a robust and sound product governance framework, in which the integration of sustainability risks plays a major role. Hence, Lombard Odier is committed to incorporating sustainability risks into the design, selection, promotion, and distribution of its financial products and services.

This integration and management of sustainability risks in our investment decisions and advice is achieved in part by revising and applying in-house policies that prohibit and/or restrict investments in the following sectors: controversial weapons, essential food commodities, tobacco, coal, unconventional oil & gas – as well as in cases constituting severe breaches of the UN Global Compact Principles. 

In addition to the exclusion and restriction policies, Lombard Odier’s sustainable investment framework screens and monitors companies' business practices in relation to their broad ecosystem of stakeholders, and considers the improvement of these practices through the evolution of metrics from the mere consciousness of an issue, to action, and finally mitigation of a sustainability risk.

We have developed a proprietary ESG materiality heatmap and rating methodology that allows us to hone in on the environmental, social, and governance aspects that are truly important to a given company. This framework comprises 14 categories that reflect the potential ESG opportunities and risks across a company’s value chain: these include the upstream risks predominantly related to supply chain or natural resource usage; operational risks directly related to a company’s direct production and operational processes; and downstream risks related to the potential negative impact of products and services sold.

For Lombard Odier, integrating sustainability risks is crucial to the investment decision making process. It amplifies the identification of any investment-related risk, enabling us to make holistic and resilient investment decisions about our investment universe and for our clients’ portfolios.

 

consideration of principal adverse impacts on sustainability factors

What are principal adverse impacts (PAIs)?

Principal adverse impacts on sustainability factors are those impacts of investment decisions and advice that result in negative effects on environmental, social, and employee matters; respect for human rights; as well as on anti‐corruption and anti‐bribery matters.

What are sustainability factors?

Environmental, social, or governance matters that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign, or individual.

Lombard Odier considers the principal adverse impacts of investment decisions and advice on sustainability factors in its discretionary portfolio management and advisory services, where relevant, as follows:

• Principal adverse sustainability indicator number 14 in Table 1, Annex I of SFDR Level 2, related to the exposure to controversial weapons (anti-personnel mines, cluster munitions, chemical weapons, and biological weapons), is considered through our investment exclusion rules.
• Principal adverse sustainability indicator number 10 in Table 1, Annex I of SFDR Level 2, related to the violations of UN Global Compact principles and Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises, is implemented by restricting investments in the severe controversies described below, and is also included in our proprietary ESG materiality rating method via a rating penalty.
• Other principal adverse sustainability indicators in Table 1, Annex I of SFDR Level 2 are considered within the Lombard Odier ESG materiality rating methodology. For each issuer, the weighting of these principal adverse sustainability indicators is set according to the exposure of the relevant industry to the sustainability challenges, with this exposure being defined by the investment manager’s in-house materiality framework.
• Other principal adverse sustainability indicators in Table 2 (environmental) and Table 3 (social), Annex I of SFDR Level 2 are embedded in the investment manager’s ESG materiality rating when available.

Furthermore, a selection of material indicators of adverse impact is considered in the analysis carried out by Lombard Odier, in order to qualify economic activities as sustainable investments under our Lombard Odier Alignment Framework. The way that principal adverse sustainability indicators are taken into consideration may change over time depending on a number of factors, including the changing composition of the portfolio, market conditions, data coverage, and developments in global sustainability analysis.

 

Lombard Odier Sustainable Investment Framework

Lombard Odier (hereinafter referred to as “the Bank”) uses a pass/fail approach to define whether a given investment, defined at the company level, is considered as a “sustainable investment” or not. 

Lombard Odier classifies companies into three categories, referred to as sustainable, grey and red companies, with only sustainable companies considered sustainable investments (i.e. falling in the category of #1A Sustainable for the purposes of the planned asset allocation section below).

To be classified as sustainable, a company must meet the following criteria according to the Lombard Odier Sustainable Investment Framework: 

 

1) Contribution

a. The company has at least 30% revenues exposure to sustainable activities understood to include

i.    Activities that are eligible for at least one of the six environmental objectives recognised by the Taxonomy Regulation and that meet the contribution screening criteria as defined by the Bank with objectively applied quantitative thresholds and/or indicators selected based on the Taxonomy Regulation technical screening criteria and considerations of the underlying sector, the nature of their business, data availability, and complemented by a qualitative review; or
ii.    Transitioning or enabling activities not included in the Taxonomy Regulation but that have been mapped by Lombard Odier to at least one of the six environmental objectives recognized by the Taxonomy Regulation or socially sustainable activities identified, that meet the screening criteria as defined by the Bank.

or

b. The company demonstrates significant capital expenditures (or equivalent investment metric relevant for the industry) alignment with the above activities in a.i and a.ii and supports a clearly articulated and ambitious transition strategy to sustainable activities.

A company’s exposure to relevant activities can be established using either:

•    The company’s self-disclosed alignment to the Taxonomy Regulation; or
•    Lombard Odier’s documented assessment of the company and its activities which can be systematically quantitatively performed or fundamentally research based.

 

2) Do No Significant Harm (DNSH) 

Lombard Odier tests if a company, aside or despite any positive contributions, is harming, or significantly harming the sustainable transition across any parts of its business. To assess the “do no significant harm”, the Bank has developed for each environmental objective of the Taxonomy Regulation and social targets in-house quantitative and qualitative tests, including but not limited to i) proprietary sustainability indicators, such as the company’s implied temperature rise, ii) Principal Adverse Indicators (PAIs) including climate change, water and waste related PAIs; and iii) controversy assessment and exposure to harmful activities.
To be considered a sustainable company: 

a.    a company must do no significant harm to any social and environmental objectives assessed at the company level against a sub-set of indicators selected by Lombard Odier depending on the activity exposure of the company; 
b.    a company must have at most 5% revenue exposure to ‘red’ activities that are classified by the Bank as inherently harmful in nature, including to activities related to the mining of thermal coal, the generation of power using coal, the extraction or refining of oil along with selected other activities.

 

3) Governance

According to the Lombard Odier Sustainable Investment Framework, we classifies as sustainable investments only companies that meet good governance standards. The Bank has developed an in-house points-based scoring system that reviews several important factors, including ownership & control, board structure, remuneration and controversies, amongst others.
While the above criteria constitute the minimum criteria applicable to a sustainable company, Lombard Odier may apply additional criteria to its assessment of companies involved in specific activities to act as additional safeguards, particularly in its assessment of Do No Significant Harm criteria. While such additional criteria cannot be used to “pass” companies if they do not meet the criteria above, they may lead companies to “fail” as a sustainable investment even if they meet the criteria above. 
 
Grey and red companies: Only companies classified as sustainable companies are considered by Lombard Odier to be sustainable investments. For all other companies, the Bank applies additional criteria to distinguish between grey and red companies. Companies that do not contribute to the sustainable transition and/or where the Bank identifies material concerns may be classified as grey, where those concerns are material but of a limited nature or with relevant mitigating factors, or red, where concerns are more acute, elevated and avoidable in nature.

There can be no guarantee that the above aims will be achieved.

 

remuneration policy

Lombard Odier’s remuneration policy and related practices aim at protecting the interests of Lombard Odier’s customers, as well as its long-term financial sustainability and compliance with regulatory obligations. In this context, Lombard Odier has established, implemented, and maintains a remuneration policy, which promotes effective risk management and does not induce excessive risk-taking. The determination of variable remuneration integrates measures that can include the consideration of sustainability risks based on the type of products or services provided to external customers.

 

what is the eu taxonomy regulation?³

In a nutshell: The Taxonomy Regulation is a European regulation introduced to establish a framework to facilitate sustainable investment. It aims to create a ‘green list’ of environmentally sustainable economic activities.

The Taxonomy was conceived as an investment tool that should facilitate sustainable investment by identifying and defining, through the use of science-based criteria, activities that qualify as sustainable.

what are the MIFID II ESG amendments?

In a nutshell: The MIFID II ESG amendments require firms to: 

•    Obtain information about clients’ sustainability preferences as part of their investment objectives
•    Illustrate in suitability reports how services provided meet clients’ expressed sustainability preferences
•    Describe how sustainability factors are taken into account in the investment advice process.

¹ EU Commission Action Plan: Financing Sustainable Growth, 8 March 2018.
² Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (SFDR)
³ Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 (EU Taxonomy)