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How the Dax should become more sustainable

I.In the past few months, the rise and fall of the payment service provider Wirecard has triggered discussions about possible inadequacies at Bafin, the responsibility of auditors and the criteria for inclusion in the German leading index Dax. After all, Wirecard ousted Commerzbank from the Dax on September 24, 2018. With a market value of up to 25 billion euros, Wirecard was at times valued higher than Deutsche Bank. The Dax is the most important German stock market barometer and has so far measured the performance of the 30 largest and most liquid listed companies in Germany.

It represents around 75 percent of the market capitalization of the German stock market; from next September it will be 94 percent. The Dax serves as a benchmark for a variety of financial products, such as ETFs (Exchange Traded Funds), which also enable private investors to invest in the Dax, for example as part of private retirement provision.

The bankruptcy of a DAX company is therefore a severe blow to the trust, especially of private investors, in the integrity of the capital markets. Because the Dax is positioned as a group of “blue chip” companies that meet particularly high quality standards. The rise of Delivery Hero to the Dax is also being discussed critically due to a lack of profitability. In addition, the company has no business activities in Germany. This has never happened before in the history of the Dax.

40 instead of just 30 DAX members

Deutsche Börse initiated a market consultation on the selection indices Dax, M-Dax, S-Dax and Tec-Dax with the aim of introducing stricter criteria for inclusion in the relevant indices. Numerous suggestions went in the right direction. The exclusion of companies that are involved in certain arms deals (“Controversial Weapons”) could not prevail.

If you reform the Dax, sustainability aspects should be given greater consideration than before. The previous proposals did not go far enough here. One can expect from a DAX company that it meets high standards in all essential sustainability criteria. In the financial industry, sustainability is defined using three dimensions, which are summarized under ESG (Environment, Social, Governance). It would therefore make sense if in future every DAX company should not be allowed to exceed a certain ESG risk potential – measured by an “ESG risk score”. There are now several established rating agencies that have specialized in measuring sustainability risks.

Rating system can be the solution

How strong the shifts in the Dax could be due to the introduction of such an ESG risk score is illustrated by a scenario calculation in which the current Dax companies (as of September 30) are rated using the ESG rating methodology from Systainalytics. With the help of a scoring model, a company’s ESG risk is assessed based on a variety of criteria. An aggregated ESG risk score is determined from the weighted sum of the individual risk parameters, which then leads to a classification of the companies in one of a total of five ESG risk classes. These range from “negligible” to “low”, “medium” to “high” and “very high”.

If in the future companies with an ESG risk score of “high” or “very high” were no longer allowed to belong to the Dax, prominent names such as Bayer, Volkswagen and RWE would no longer belong to the Dax. Instead, the companies Symrise, Zalando and Qiagen would move up in the Dax. At first glance, this may seem far-fetched, as these three companies are among the founding members of the Dax.

Leading indices need to be reformed

On the other hand, the introduction of an ESG criterion for the DAX would provide clear incentives for companies to take sustainability aspects into account in their strategy more than before. In March of this year, Deutsche Börse itself introduced a new index, the Dax 50 ESG, which includes ESG criteria in addition to the market value and turnover criteria when selecting the index companies. Even if the introduction of specific sustainability indices is desirable, this does not replace a reform of the respective leading indices, such as the Dax in this country. After all, restructuring important stock indices can help ensure that more capital flows into sustainably managed companies and sectors.

The author is the managing director of the Center for Financial Studies at the Goethe University in Frankfurt.

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