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Russia’s largest coal miner in index with thermal coal exclusion

Sustainalytics failure to link special purpose financing vehicle and parent company leads to mistaken inclusion in JP Morgan index.

JPMorgan included a bond issued by Russia’s largest coal miner in an ESG index that excludes thermal coal after Sustainalytics failed to make a link between its special purpose financing vehicle and the company itself.

A bond issued by SUEK Securities, a special purpose vehicle which issues bonds to finance Russian coal giant SUEK, was included in a roughly $1 billion ETF run by LGIM which tracked the index. A spokesperson for LGIM said that the holding, which accounted for 0.01 percent of the portfolio, had been sold on Tuesday. The bond was removed from the index itself by 31 March as part of JPMorgan’s exclusion of Russian securities from its indexes.

“The initial presence of this bond in the portfolio was due to lack of external ESG data coverage, which we understand has now been resolved,” the LGIM spokesperson said. “SUEK is now covered by the relevant ESG data providers, meaning that it would have been excluded from the index and the ETF regardless of the Russian invasion.”

The JPMorgan ESG CEMBI Broad Diversified Custom Maturity Index uses data from Sustainalytics and two other providers to make its decisions. A Sustainalytics spokesperson said that, given the data it had available at the time, the firm did not initially link SUEK Securities to its parent company when it entered Sustainalytics’ coverage.

“We identified new information on the relationship between the entities in the first half of May, and we immediately moved to link the subsidiary to the parent and update the research,” the spokesperson claimed.

SUEK Securities has now been tied to its parent company and has been flagged for thermal coal on Sustainalytics’ platform. However, this update came after the bond had already been ditched from JPMorgan’s index over the invasion of Ukraine.

“Data on corporate family trees, especially in the fixed income space, is complex and dynamic, and thus we have in place an ongoing monitoring process that scans for updates to these parent-subsidiary relationships – due to mergers, spinoffs, as well as new information we receive from our third-party reference data providers”, the Sustainalytics spokesperson added. “Our internal quality control processes were robust enough to update the linkage of these entities and identify the underlying product involvement.”

The mistake was uncovered by the Anthropocene Fixed Income Institute (AFII), which said that investors in the LGIM ETF had suffered a “real economic loss when they should not have been exposed”.

SUEK, the largest coal producer in Russia and sixth-largest in the world, raised $500 million in September last year in a widely criticised deal that was nonetheless more than three times oversubscribed, with Fidelity Investments taking 7.4 percent. The firm failed to make its inaugural coupon payment in March due to uncertainty over its sanctioned status, but said at the end of April that it had since been able to make payments. The bonds are currently trading at 12.5 cents on the dollar.

The JPMorgan ESG CEMBI Broad Diversified Custom Maturity Index excludes issuers involved in thermal coal, tobacco and weapons, as well as those in breach of the UN Global Compact and with a customised ESG score lower than 20. At least five of the top 10 holdings in the LGIM ETF are bonds from issuers involved in oil and gas, including Petrobras and Ecopetrol. According to the LGIM website, the top holding is a bond from Indonesian gas pipeline firm Perusahaan Gas Negara, while the fund’s ESG report gives it an implied temperature alignment of 3.7C.

Ulf Erlandsson, chief executive of the AFII, said that case highlighted “how a passive vehicle clearly needs to have some active overlays in terms of understanding fundamental market ESG factors.

“The SUEK deal was something that any active manager would have spotted a mile away,” he continued. “Unfortunately, we see more cases where a reasonably market knowledgeable investor would step out on adverse ESG impact, but where ESG passives are buying.”

JP Morgan declined to comment.