Qontigo is introducing flagship STOXX indices that comply with, and exceed, the requirements laid out in the new European Union Climate Benchmarks regulation.
The new indices are constructed to follow the ‘EU Climate Transition Benchmark’ (CTB) and ‘EU Paris-aligned Benchmark’ (PAB) requirements, embedded in the European Benchmark Regulation legal framework.1 The EU benchmark classification has entered the process of becoming a law and is devised to bring harmonization and transparency in climate-aware investments, foster climate-friendly investments and avoid ‘greenwashing.’
A total of 12 indices make up the new STOXX suite, including CTB and PAB indices based on the STOXX® Europe 600 Index, EURO STOXX® Index, EURO STOXX® Total Market Index, STOXX® USA 500 Index, STOXX® USA 900 Index and STOXX® Global 1800 Index. The indices use ISS ESG carbon, climate and tobacco producers´ data, as well as Sustainalytics’ Global Standards Screening and controversial weapons research. They all follow the EU provisions in terms of decarbonization trajectory, activity exclusions and sector exposure constraints.
“These new STOXX benchmarks not only meet the requirements for CTB and PAB indices, but also further include climate analysis on how companies are dealing with the challenges, and opportunities, of climate change,” said Stephan Flaegel, Head of Benchmarks and Indices at Qontigo. “These indices complement our existing family of Low Carbon and Climate indices; and we expect to see continued interest from investors in all of them as climate change climbs in the ranking of priorities. The benchmarks are based on rigorous rules, a transparent methodology and leading data that help Qontigo continue to set the standard in the climate space.”
For investors, the EU climate benchmarks are tools that help reduce exposure to climate-related financial risks, and allow for increased allocations to companies well positioned to capture opportunities in the transition to a low-carbon economy.
Different decarbonization paths
CTB and PAB rules set holdings requirements and specific emission objectives for financial indices tracking low-carbon strategies. The two benchmark types differ in their level of restrictiveness and ambition. CTBs allow for more diversification while forming a portfolio that is on a decarbonization trajectory, and PABs incorporate more stringent carbon limitations in line with global commitments to work towards keeping global warming between 1.50C and 20Cabove pre-industrial levels.
Under the new parameters, low-carbon indices will qualify as either CTB or PAB if they meet the following criteria:
- Demonstrate a significant reduction (set at 30% at index level for CTBs and 50% for PAB) in overall greenhouse gas (GHG) emission intensity2 relative to their underlying investment universe or parent index.
- Be sufficiently exposed to sectors with high impact on climate change.
- Be able to reduce their own GHG emission intensity by at least 7% on average every year.
- Exclude companies involved in controversial weapons and tobacco production,3 or deemed in breach of global norms.4 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.5
Going beyond requirements
Because of STOXX’s history in managing low-carbon and climate indices, the new STOXX Climate Benchmarks are able to exceed the EU requirements in some areas.
Firstly, Scope 3 carbon emissions data is used across all sectors from the first date of inception of all STOXX CTBs and PABs, instead of incrementally up to four years following index creation as allowed in the new legislation.
Secondly, STOXX PABs surpass the requirements in activity exclusions. The indices will additionally remove companies that raise more than 10% of revenue from power generation coming from coal.
Additional features of STOXX indices
As part of its construction methodology, the STOXX Climate Benchmarks also offer investors features not considered by the EU rules.
For STOXX PABs, Qontigo will also exclude companies that ISS ESG identifies as significantly hindering the United Nations’ Sustainable Development Goal No. 13 of mitigating climate change.
Additionally, Carbon Risk Rating data6 will be used to overweight climate leaders and underweight climate laggards in the STOXX indices. Constituents’ weights are also tilted by ISS ESG’s Carbon Budget data, which assesses what climate scenario the company is aligned with until 2050. This ensures the index is in line with global warming pathway goals.
The STOXX benchmarks also consider the ‘green-to-brown ratio’ at index level. This ratio is at least equal to the parent universe for CTBs and multiplied by at least four for PABs.
Finally, in addition to the decrease in GHG emission intensity relative to their underlying investment universe or parent index, Qontigo has added a requirement that the current portfolio should also be aligned with the International Energy Agency’s 20C scenario until 2050.
“With our philosophy of providing clients with state-of-the-art solutions, our belief was that we should raise the bar in climate transition strategies,” said Flaegel. “It is important to evaluate how companies are dealing with climate change and how they differentiate themselves from their competitors.”
The STOXX CTB and PAB indices also have trading volume, country, sector and weight constraints to ensure liquidity and diversification.
Risks and opportunities
The new Climate Benchmarks offer investors another way to incorporate climate goals in a systematic way that is transparent and objective, and that relies on preeminent capabilities in index administration and carbon data. Importantly, they also serve as a tool to manage risks and opportunities arising from climate change. All indices are suited as underlying for financial products or as benchmarks for portfolios.
Together with existing low-carbon indices, the CTBs and PABs come to further channel capital flows, and build momentum, into a climate campaign that is fundamental to the development of our world.
1 EU CTB and EU PAB were originally introduced in February 2019, when co-legislators agreed to amend the European Benchmark Regulation. In that context, a Technical Expert Group (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. The indices are constructed to follow the requirements outlined by the European Commission 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 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.
3 Tobacco exclusion is recommended for EU PABs in the European Commission’s draft supplementing paper, but not for EU CTBs. STOXX includes the tobacco exclusion to CTBs.
4 STOXX will exclude companies that are non-compliant based on Sustainalytics’ Global Standards Screening assessment. Global Standards Screening identifies companies that violate or are at risk of violating commonly accepted international norms and standards, enshrined in the United Nations Global Compact (UNGC) Principles, the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises, the UN Guiding Principles on Business and Human Rights (UNGPs), and their underlying conventions.
5 ISS ESG tracks securities that have disclosed science-based targets with the Science Based Targets initiative (SBTi) in line with the level of decarbonization required to keep global temperature increase below 20C. STOXX will use this data to identify which of the following three groups companies fall into: a) companies with concrete targets and emission reduction targets verified by the SBTi; b) companies that have committed with the SBTi but do not yet have approved science-based targets. Committed companies have 24 months to have their targets approved and published by the SBTi; c) companies that have not committed with the SBTi. Securities with targets verified by the SBTi will be overweighed in the index. Securities with no commitments or no SBTi-approved targets will be subjected to incremental underweighting and will not be eligible for selection starting 2025 and 2030 respectively.
6 ISS ESG’s Carbon Risk Rating (CRR) data assesses the climate-related performance of companies, taking industry-specific challenges, risk profiles, and companies’ positive impact. It establishes how an issuer is exposed to climate risks and opportunities. It provides investors with critical insights into how issuers are prepared for a transition to a low carbon economy and is a central instrument for the forward-looking analysis of carbon-related risks at portfolio and issuer level. This data is used to overweight companies contributing to the solving of climate change challenges and penalize companies from sectors not compatible with climate change mitigation. ISS ESG’s Carbon Budget data helps assess which climate scenario companies are aligned with. This Carbon Budget data is used in the weighing process of the STOXX Climate Transition Benchmark and STOXX Paris-Aligned Benchmark Indices to ensure the indices are aligned with the IEA’s 20C scenario until 2050.