Free CFA Institute Sustainable-Investing Practice Exam with Questions & Answers | Set: 10

When investors worry about a company’scapital structure or financial sustainability, they often scrutinizedividend policies(option A). Excessive dividend payouts can weaken a company’s capital base and impair its ability to reinvest or meet debt obligations. Auditor compensation (B) and board elections (C) are governance considerations but don’t directly address financial viability or leverage concerns.

Conduct-based exclusionary screeningspecifically targets companies thatviolate internationally accepted normsor ethical standards. Child labor infractions directly contravene widely acceptedinternational labor and human rights principles, making them a frequent and high-priorityexclusion criterionin ESG mandates. By contrast, industries like gambling or alcohol may be excluded based onvalues-basedscreens or religious/ethical preferences, but they are not inherently conduct-related violations of global norms.

Reshoringrefers to the process of moving production or sourcing back to a company’s home country or a country with higher labor costs, typically in response to geopolitical, supply chain, or ESG concerns. This is distinct fromoffshoring, which involves shifting production to low-cost regions, andjust transition, which relates to workforce and community adaptation in climate policy shifts.

One of the key challenges in ESG integration, according to the CFA’s materials, is thatinvestors and companies often disagree on what ESG issues are “material” to financial performance. While data complexity and algorithm reliance (options A and B) can pose hurdles, it is thediscrepancies in materiality thresholdsthat most commonly hinder effective ESG integration. Asset owners and managers may have different views compared to corporate management on what issues truly drive long-term value or pose significant risk.

A decrease in injury frequencyreflects improvedworker safety practices—acore “S” (social) factorin ESG risk scoring. Cash flow projections relate to financial analysis (B) but not ESG directly. A decrease in water reuse (A) wouldworsenenvironmental performance, not improve it.

Brown divestmentrefers to companiesactively selling off polluting assets(like coal plants or oil reserves) to third parties, thus removing these “brown” businesses from their balance sheets. CFA materials explain this as acorporate-level divestment strategy, distinct from investor portfolio screening (option A) or proactive investment in environmental solutions (option B).

The CFA sustainable investing guidance highlights that forhard-to-abate sectors—like airlines—residual emissions are expectedeven when best practices are implemented. This does not represent a management failure if the company is usingall available, feasible decarbonization strategies. Instead, it underscores the structural challenges of the sector, not poor management.

The best time to influence terms and disclosures in private debt markets isbefore the debt is issued—this is when lenders (investors) have the most leverage to negotiate terms and insist on ESG-related covenants or disclosures. Once funds have been allocated (or when supply of funds is ample), it’s much harder to impose new conditions.

ESG rating agencies collect data from abroad range of sources, including public documents from nonprofits, regulatory filings, and expert analysis. They do not restrict themselves to audited disclosures only, nor do they exclude commonly used inputs such as CDP data—so statement B is correct.

Fordefined benefit pension plans, the key priority is tomeet future obligations to beneficiaries—which is afiduciary duty. CFA materials emphasize that thislong-term dutyincreasingly requires considering ESG risks and opportunities, as these can materially affect financial performance and liabilities over decades. While reputational and ethical factors may play a role, the ultimate driver is thefiduciary obligation to secure retirement benefits.

Stewardship codes drafted by fund managers typically emphasizemonitoringandpublic policy commitmentsbut oftenunderstate the importance of managing conflicts of interest. Conflicts of interest can arise when asset managers act on behalf of different clients with potentially conflicting priorities, making explicit policies and governance structures for handling these conflicts crucial to effective stewardship.

TheUnited Kingdomwas the first to introduce a formal corporate governance code, known as theCadbury Report (1992). This groundbreaking document established best practices for corporate governance, emphasizing theroles and responsibilities of boards, transparency, and accountability. It became the model for many global governance frameworks and was a direct response to financial scandals at the time.

TheCSRDstrengthens and expands the EU’s sustainability disclosure requirements. Key features include:

Mandatory assurance/audit of sustainability information(option B).

Broader application than NFRD (but doesnot apply to allentities; option A is incorrect).

The CSRDfollowsand replaces the NFRD (not predating it; option C is incorrect).Thus, the correct focus is therequirement for third-party verificationof sustainability reporting.

Historically, ESG integration began inactive-listed equity strategiesbecause equities offeredgreater flexibilityfor asset managers to engage with companies directly through shareholder voting and engagement. Active equities also allowed for moredirect influenceon corporate ESG practices compared to fixed income or infrastructure investments, which typically have fewer levers for direct engagement.

TheEU’s taxonomy for sustainable activitiesis a prominent example of apublic policy framework—it sets criteria and definitions for sustainable economic activities, guiding investors, companies, and governments in aligning with climate and environmental objectives.

Option A is incorrect becauseboth asset owners and managerscan integrate ESG factors into strategic asset allocation.

Option C is incorrect becauseshareholder engagementextends far beyond the annual general meeting, encompassing ongoing dialogue and stewardship activities.