New European Union (EU) rules establishing Climate Benchmarks standards have come into application, part of the region’s plan to channel investment capital towards the fight against global warming.
The standards are based on recommendations from a Technical Expert Group on sustainable finance (TEG),1 and define two benchmark types — the ‘EU Climate Transition’ (CTB) and ‘EU Paris-aligned’ (PAB) benchmarks — which set holdings criteria and emissions objectives for financial indices tracking low-carbon strategies.2 The rules, which were over two years in the making, were devised to bring harmonization and transparency in climate-aware investments, foster climate-friendly investments and avoid ‘greenwashing.’
The European Commission is now drafting regulation that will legislate on minimum requirements and technical points for the benchmarks. Additionally, as of Apr. 30 benchmark administrators need to disclose minimum environmental, social and governance (ESG) indicators across benchmarks that carry an ESG approach.
The legislation puts climate action at the heart of Europe’s financial regulation, at a time when more and more asset owners in the region have embraced low-carbon policies. Existing low-carbon indices have allowed investors to implement sustainability policies and have created incentives for companies to incorporate climate goals and improve reporting.
Objectives and requirements
CTBs and PABs differ in their level of restrictiveness and ambition. The former seek to form a portfolio that follows a decarbonization trajectory, while the latter incorporate more stringent carbon limitations compatible with the Paris Agreement of 2015, under which countries committed to work to keep global warming below 20C above pre-industrial levels and to pursue efforts to limit the increase to 1.50C.3
Based on parameters in TEG’s final report, low-carbon indices will qualify as either CTB or PAB if they meet the following criteria:
● Demonstrate a significant decrease (set at -30% at index level for CTBs and -50% for PABs) in overall greenhouse gas (GHG) emissions intensity relative to their underlying investment universe or parent index.4
● Be sufficiently exposed to sectors with high impact on climate change.
● Be able to reduce their own GHG emissions intensity by at least 7% on average every year.
● Exclude companies involved in controversial weapons and tobacco production, or deemed in breach of global societal norms. PABs should additionally exclude companies that derive pre-determined revenue thresholds from activities in coal, oil and natural gas.
● Corporate target setting: companies that set science-based decarbonization targets can have their index weight increased.
New family of Qontigo indices
Qontigo and its index arm STOXX plan to unveil in coming days a new suite of indices that comply with, and exceed, the CTB and PAB requirements. STOXX has advanced sustainable investing since 2001, innovating in ESG, low-carbon and climate-impact strategies with over 150 indices.
“Over the past decade, but in particular after the COP 21 climate conference in Paris, climate change has dramatically risen among priorities for both European investors and the European Commission,” said Willem Keogh, Head of ESG and Thematic Solutions at Qontigo. “The new benchmark requirements will help in creating a climate framework and providing solutions where investors could assess how they can integrate climate-change risks and opportunities into portfolios. As index providers, we will continue to support the transition to a low-carbon economy with products that are rules-based, transparent and that go beyond minimum requirements.”
The Climate Benchmark Regulation is part of the European Commission’s Action Plan on financing sustainable growth that was launched in 2018.5 Measures in the Plan include the creation of a taxonomy of sustainable finance practices, mechanisms to enhance investor responsibilities and portfolio disclosure, and improved transparency in corporate reporting. The agency seeks to steer private capital to finance an estimated 180 billion euros that it needs every year to reach climate and energy targets.
Europe at forefront of climate investments
European asset owners are already at the world’s forefront of integrating environmental principles into portfolios. About half of all professionally managed assets in Europe are invested along sustainable principles, according to the latest data from the Global Sustainable Investment Alliance (GSIA), for which climate-aware norms are a main criterion.
ESG regulation has gathered pace in Europe, as public opinion interest has converged with authorities’ appraisal of the need to implement sustainable standards in financial markets. Barrie C. Ingman, Regulatory Advisor at FactSet, has talked of an ‘ESG regulatory phenomenon’ that is set to become a fifth pillar of financial regulation, joining prudential rules, conduct rules, financial crime rules, and payments and market infrastructure rules.6
Please visit this blog in coming days to find out more about the new STOXX indices observing CTB and PAB requirements.
1The indices are constructed to follow the requirements outlined in the TEG’s Final Report (September 2019), considerations detailed in the Report on Benchmarks Handbook (December 2019) and the draft Commission delegated regulation (April 2020). The methodology may be adapted to meet final requirements once the European Commission outlines the final delegated acts.
2 EU CTB and EU PAB were originally introduced in February 2019, when co-legislators agreed to amend the European Benchmark Regulation. In that context, the TEG received a mandate to suggest minimum technical requirements for the methodology of both climate benchmarks and recommendations on ESG disclosures, including associated disclosure templates.
3 For more on the Paris Agreement, visit the United Nations Climate Change dedicated page here.
4 Data used to determine the decarbonization trajectory includes Scope 1 (direct emissions) and Scope 2 (indirect emissions), while Scope 3 (other indirect emissions) data is required to be phased in during a period of four years.
5 The three main objectives of the Action Plan are: reorient capital flows towards sustainable investment; manage financial risks stemming from climate change, environmental degradation and social issues; and foster transparency and long-termism in financial and economic activity.
6 FactSet, ‘ESG Regulation – Where to Start?’ Apr. 29, 2020.