Free Practice Questions for CFA Institute ESG-Investing Exam

Stewardship codes share similar principles across different regions, emphasizing long-term value creation, accountability, and the active role of shareholders in corporate governance. (ESGTextBook[PallasCatFin], Chapter 6, Page 276)

Quantitative ESG analysis involves analyzing measurable data such as issuer-reported metrics, third-party ESG scores, and other numerical ESG indicators to assess performance. (ESGTextBook[PallasCatFin], Chapter 7, Page 374)

Fiduciary duty (Option A) is the primary driver for ESG investment in pension plans. Trustees are legally obligated to act in the best interests of beneficiaries, which includes considering ESG factors that affect long-term risk-adjusted returns.

Option B (Loss aversion) is a behavioral bias, but pension ESG investment is based on financial materiality rather than loss avoidance.

Option C (Personal ethics of members) may influence individual choices, but pension plans follow fiduciary principles rather than personal beliefs.

References:

OECD Report on Fiduciary Duty and ESG Integration

PRI Guide for Pension Fund Trustees

UK Pension Regulator: ESG and Fiduciary Responsibilities

A minimum requirement for PRI membership is the establishment of accountability mechanisms to ensure that responsible investment policies are effectively implemented within the organization. (ESGTextBook[PallasCatFin], Chapter 9, Page 509)

An Emissions Trading System (ETS), also known as a cap-and-trade system, is designed to control and reduce greenhouse gas (GHG) emissions by setting a total emissions cap and allowing participants to trade allowances.

How it works:

A government or regulator sets a cap on total emissions.

Companies receive or buy carbon allowances (permits to emit a certain amount of CO₂).

Companies can trade allowances—if they emit less, they can sell excess permits; if they emit more, they must buy additional permits.

Key examples:

EU Emissions Trading System (EU ETS) (largest globally)

California Cap-and-Trade Program

China’s National Carbon Market (launched in 2021)

Why not A or B?

A is incorrect because an ETS does not directly set a price on carbon—it allows the market to determine the price based on supply and demand.

B is incorrect because an ETS does not involve direct investment in renewable energy (that would be carbon offset programs).

References:

European Commission: EU Emissions Trading System (ETS)

World Bank: State and Trends of Carbon Pricing 2023

Sustainable resource use (Option B) can directly contribute to restoring ecosystem services, such as:

Reforestation and sustainable agriculture, which enhance biodiversity.

Circular economy practices, which reduce waste and pollution.

Option A (Pollution) is incorrect because pollution negatively affects ecosystems and degrades biodiversity.

Option C (Climate change) is incorrect because it generally has adverse effects on nature, such as rising temperatures and habitat loss.

References:

TNFD Nature-Related Risks and Opportunities Framework (2023)

UNEP: Global Biodiversity Outlook

IPBES Global Assessment on Biodiversity and Ecosystem Services

Excluding investments in companies that sell pork in predominantly Muslim countries falls under norms-based exclusion, as it is guided by religious and cultural norms. (ESGTextBook[PallasCatFin], Chapter 4, Page 192)

Primary ESG data is obtained from both public documents and direct company disclosures (Option C), including:

Sustainability reports, financial filings, regulatory disclosures (public documents).

Company surveys, management interviews, direct engagement (company sources).

Option A is incorrect because ESG analysts often require direct engagement to get non-public data.

Option B is incorrect because some ESG data (e.g., emissions data, labor policies) is publicly disclosed in regulatory filings.

References:

GRI Sustainability Reporting Standards

PRI ESG Data Guide (2022)

CDP Climate and Water Disclosures

ESG performance attribution is used to measure the impact of ESG factors on investment returns.

Why C (Brinson and risk factor attribution) is correct:

The Brinson model decomposes portfolio returns into allocation and selection effects.

Risk factor models help determine whether ESG factors explain investment performance.

Why not A or B?

A is incorrect—ESG attribution in fixed-income portfolios is complex due to limited data and different risk structures.

B is incorrect—commercial ESG tools exist, but attribution still requires custom modeling.

References:

CFA Institute: ESG Performance Attribution Guide (2023)

Engagement (Option B) is the active process of fund managers interacting with investee companies to:

Encourage ESG improvements.

Address material risks impacting long-term value.

Option A (Monitoring) is passive observation, not action.

Option C (Corporate sustainability) applies to company policies, not investor actions.

References:

PRI Active Ownership 2.0 Report

UK Stewardship Code

OECD Investor Engagement Best Practices

Quantitative ESG analysis involves numerical, measurable data that can be compared across companies and time periods.

Why A (Issuer-reported carbon emissions) is correct:

Carbon emissions data (Scope 1, 2, and 3) is measurable and numeric, often reported in metric tons of CO₂ equivalent (MTCO₂e).

This data can be used in financial models to assess climate risk.

Why not B or C?

B (Executive compensation policies) are qualitative, as linking pay to ESG goals involves policy assessments rather than hard data.

C (Investments and policies credibility) involves subjective judgment rather than numerical data.

References:

CDP Climate Disclosure Framework

SASB Standards for Carbon Emissions Measurement

ESG factors can impact credit risk at both issuer and industry levels by influencing financial stability, regulatory compliance, and reputational risks.

Issuer level: A company's ESG risk exposure (e.g., environmental violations, governance scandals) can lead to downgrades or higher borrowing costs.

Industry level: Sectors like coal mining, oil & gas, and tobacco face systemic ESG risks (e.g., climate regulations, social opposition).

Credit rating agencies (e.g., Moody’s, S&P, Fitch) integrate ESG risks into credit assessments.

References:

S&P Global’s ESG & Credit Ratings Framework

Moody’s ESG Risk Assessment Reports

Engagement teams focusing on governance issues are often organized by sector because governance practices and challenges can vary significantly across industries, making a sector-based approach more effective. (ESGTextBook[PallasCatFin], Chapter 6, Page 283)

Climate Action 100+ is a global investor initiative aimed at engaging with the world’s largest corporate emitters to curb greenhouse gas emissions and improve governance on climate-related issues. (ESGTextBook[PallasCatFin], Chapter 3, Page 153)

Greenwashingoccurs when a company or investormisrepresents or exaggeratestheir ESG commitments to attractcapital or public approvalwithoutsubstantially integrating ESG principles into decision-making.

Why C (Investor 3) is correct:

Investor 3 focuses on ESG reporting to attract capital, rather than makingmaterial improvementsin ESG performance.

This suggests that ESG isused as a marketing toolrather than being fully embedded in investment decision-making.

Companies and funds that highlight ESG in disclosures without actual performance improvementsfacegreenwashing risksand potential regulatory scrutiny (e.g.,EU SFDR anti-greenwashing rules).

Example:A fund that claims to be "carbon neutral" but continues investing in fossil fuel companies without credible transition plans.

Why not A (Investor 1)?

Investor 1 is conducting ESG risk analysis, which is alegitimate approachto ESG integration.

Identifying risks fromenvironmental regulations(e.g., carbon taxes, emissions limits) is acore part of financial risk managementand not greenwashing.

Why not B (Investor 2)?

Investor 2 integrates ESG into business value creation(e.g., improving employee retention through better working conditions).

This isa concrete, measurable ESG practicerather than an attempt to mislead stakeholders.

References:

PRI: "Addressing Greenwashing in ESG Investing" (2023)

EU Sustainable Finance Disclosure Regulation (SFDR) and Greenwashing Risks

Harvard Business Review: "The ESG Mirage: When Reporting Doesn't Equal Impact" (2022)