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July 14, 2009
FTSE Develops Classification System for Environmental Products and Services
    by Robert Kropp

Investors preparing to gain exposure to the global transition to a low-carbon economy now have a classification system to help guide their investment decisions.


As most major economies move toward the adoption of such tools as carbon pricing to combat climate change, the need for investors to have a system by which they can identify companies engaged in clean technologies grows. To supply a solution to this need, FTSE Group, the UK-based index company, has developed the FTSE Environmental Markets Classification System (EMCS), which the company describes as "the world’s first comprehensive global classification system for environmental markets."

"Most classification systems look at markets through a post-industrial, fossil fuel lens," said David Harris, Manager of the Responsible Investing Unit at FTSE, "And finding companies in the environmental fields can be challenging."

FTSE took over the FTSE Environmental Technology Index Series (ET50), which is designed to represent the performance of the top 50 global environmental technology companies, from Impax Asset Management in January, 2008. To establish whether a technology or company qualifies for the ET50 index, FTSE and Impax formed an Environmental Technology Advisory Committee.

"We created the FTSE Environmental Markets Classification System", Harris said, based on the findings of the Advisory Committee.

The EMCS employs a classification structure that identifies environmental market companies by allocating them into six sectors and 24 subsectors. It defines companies in the environmental market as those "that provide products and services offering solutions to environmental problems, or that improve the efficiency of natural resource use."

The first sector, Renewable & Alternative Energy, includes such providers of products and services as wind power, solar energy, renewable and independent energy producers, and biofuels.

"The renewable and alternative energy industry sector has performed really well in the market," Harris observed, with a 78% return on investment over the last five years.

The second sector, Energy Efficiency, includes companies that provide energy-efficient products and services to the electrical power network, industrial markets, buildings, and transportation.

The third sector, Water Infrastructure & Technologies, includes companies that provide products and services for the supply, management, and treatment of water. The fourth sector includes pollution control companies, while the fifth includes companies engaged in waste management, reuse and recycling.

Regarding the sixth sector, Environmental Support Services, Harris said, "The sector covers such companies as environmental consultants, carbon trading companies, and general environmental companies."

FTSE used the EMCS as the basis for a new family of indices, which is named the FTSE Environmental Opportunities Index Series. The new index series is designed to draw its constituent companies from a wider universe than does the ET50 Index. While the ET50 requires that its constituent companies derive at least 50% of revenue from environmental products and services, the Environmental Opportunities Index Series lowers the threshold for inclusion to 20% of total revenue.

"We needed to create indices with a wider investment universe than the ET50," Harris said. "The 20% threshold of the new family of indices gives significant exposure and a much wider investible universe."

As a result, the FTSE Environmental Opportunities All-Share benchmark index contains just under 500 companies, as opposed to the 50 listed in the ET50 Index. Harris said, "The average size of the company in the ET50 is much smaller as well." Derived from the benchmark index is the FTSE EO 100 tradable index, which focuses on the top 100 largest companies by market capitalization.

In addition, seven new equity indices which use the new environmental markets classification have also been added to the new Index Series. The indices cover markets in the US, UK, Japan, Europe, Asia Pacific, and Asia Pacific ex Japan. The UK AIM Index, which has 66 constituents, includes companies listed on the London Stock Exchange's Alternative Investment Market (AIM). AIM's 1,700 international growth companies include 79 that are identified as cleantech. AIM states that "more money has been raised on AIM by cleantech companies in the last five years then on any other exchange."

Determining the new classification system, and deriving the new FTSE Index Series from it, was not without debate within the Advisory Committee, according to Harris.

"There was a lot of debate over nuclear power," he said. "It’s a low carbon activity, but there are too many questions over such issues as waste. So it didn't qualify."

Another technology debated within the Advisory Committee was coal bed methane production, which produces methane from coal mining operations and keeps the dangerous greenhouse gas (GHG) from escaping into the atmosphere. However, according to Harris, "Coal bed methane technologies were determined to be too closely aligned with the fossil fuel sector, so they weren't included in the classification system."

By creating the EMCS, FTSE aims to remove a potential barrier to investment in renewable energy and aligned products and services that have the potential for significant growth in the transition to a global low-carbon economy. The indices created out of the EMCS joins a growing number of global indices that track such issues as sustainability and environmental performance.

One such index, released in June, is the NASDAQ OMX CRD Global Sustainability 50 Index, which is made up of companies that are determined to have taken a leadership role in sustainability reporting.

 

 
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