Sustainability: What is the Question Exchanges are Trying to Answer?

Last month, the Sustainable Stock Exchanges (SSE) initiative and the World Federation of Exchanges (WFE) published a report into work by derivatives exchanges to support sustainable development, and laid out a roadmap for future initiatives in this field.

In an environment where market actors and consumers now expect certain standards of responsible behaviour as a minimum, reports such as that by the SSE and WFE help cement the role that exchanges can play in setting and meeting these standards, and reinforces the importance of capital market infrastructure in supporting market change of any kind.

In many respects, fulfilling that role – providing the right tools, infrastructure and rules for sustainability-related products and services – is no different from any other product development or strategy question faced by an exchange: What does the market need, what is the best way to provide a solution, and how can you generate interest, liquidity, momentum?

But there are additional complexities in sustainability, driven by the fundamental need to consider these commercial challenges within a wider ethical framework, and ensure that the relevant products and services meaningfully address the sustainability concern in question. The focus by SSE and WFE on derivatives exchanges is particularly timely, recognising as it does the particular pertinence of these complexities for commodity derivatives exchanges, where decisions made will have a material impact on the underlying physical commodities markets. The challenge lies in ensuring this impact is positive and meaningful.

Identifying key issues

The first challenge is to identify the key issues in which the market is involved, or which most need to be addressed, the impact of each issue, and how exactly the risks and impacts could be mitigated through exchange-led initiatives.

At the LME, it took a significant amount of time and market engagement to develop responsible sourcing rules identifying that the market focus was around human rights and conflict financing. We worked hard to establish our scope in addressing those issues, and build up the expertise needed to create requirements.

We – and our market more broadly – are now going through that same process for a much wider spectrum of concerns, starting with carbon emissions. Questions around scope – such as what the metals industry can reasonably achieve in terms of reducing emissions, which emissions are the priority, which data is most pertinent – are complicated by an increasing understanding that progress cannot come at any cost. Achieving lower emissions cannot be at the expense of other environmental or sustainability concerns.

Setting the right level

Questions around scope are closely followed by those around the appropriate ambition of the requirements. Make the demands too exacting and you can inadvertently exclude those who might use that product, undermining its potential impact. Equally, if the bar is too low, it runs the risk of just ticking a box, greenwashing, or failing to generate any real progress.

There are also commercial considerations. The very best sustainable product will have limited benefits if it does not work for the market and remains unused.

At the LME, there was a long debate over whether to introduce a hydroxide or carbonate lithium contract – not because one was better for the environment, but because it was essential to provide a product that not only supported a sustainable future, but also delivered a service the market needed. In the case of the LME’s responsible sourcing rules, it became clear that metal brands not considered to be meeting responsible sourcing standards could trade at a discount to those that had – rather than good sourcing practices commanding a premium. If commercial success here sounds cynical, it is worth bearing in mind that if we do not get those decisions and those numbers right, the wider benefits evaporate for everyone.

Measurement and transparency

Finally, consideration needs to be given to how to measure the impact of new products and rules, verify that those measurements are accurate, and provide appropriate reporting.

The world of sustainability is well-served by existing guidelines and rules across the spectrum, from mine-site auditing to reporting principles and guidance. In many cases, these are backed up by standards that are applicable in practice, and against which compliance can then be assessed. The LME prioritised using existing standards for responsible sourcing; however, even in that relatively well-established area, the learning curve for the creation and audit of appropriate standards has been immense and is ongoing. Supply chains are complex and multinational, and tracking and tracing across the lifecycle of metal remains a daunting task. For some areas of sustainability, this work is still in its infancy, and good standards might not yet exist.

Clarity over what exactly is being measured can also be difficult. On the environmental side, the current debate focuses on consistent taxonomies for “green”, so that market participants across different industries can compare like with like, and the debate about methodologies for measuring everything from emissions to recycled content continues.

Transparency remains vital here. It has real power to share learning and drive progress, and different methodologies can be overcome if the appropriate clarity is provided. The LME’s parent company – HKEX – is leading the way here. Its STAGE platform provides reliable and transparent information on green data and products, and the LME will follow suit shortly with the launch of LMEpassport for sustainability-related information.

Finding the right balance

But a core balance has to be struck between volume and quality of data. There already exists a wealth of information in company reporting, increasingly through centralised platforms like STAGE and LMEpassport, but working out what data has value, is reliably and accurately measured, and is easily available often remains an ongoing question.

Finding the right balance between a genuine product that is interesting to the market, drives progress and is logistically feasible remains extremely complex. At the LME, we vastly underestimated back in 2017 how difficult it would be to “write some responsible sourcing rules”, and the challenges outlined above represent just some of those facing exchanges and their markets.

Further education and socialisation is needed. New products and services, centralised policy-making and individual action, discussion about financing and innovative technological solutions are all essential to ongoing progress. The LME is immensely proud to be part of industry efforts to move this agenda forward. We and our peers have proved the value that exchanges can offer in this work, and we look forward to taking the next steps.