MSCI has pared back the rules governing one of its key Paris Aligned Benchmark (PAB) families to address investor concerns and ensure its “long-term viability”.
The index provider concluded a consultation last week on proposed changes to its Climate Paris Aligned PAB Indexes Methodology, which is designed to comply with the European Union’s climate benchmarking regulation.
The indices go beyond the regulatory requirements, though: they align with the recommendations of the Taskforce on Climate-related Financial Disclosures, overweighting companies that have verified decarbonisation targets, reducing physical climate risk exposure, and pursuing a higher level of annual portfolio-level decarbonisation than prescribed by the EU.
Investors are becoming increasingly concerned about the impact of such strict climate-related limitations on financial performance, especially amid economic headwinds for the green transition.
Earlier this year, the pension fund for Swiss retailer Migros ditched an MSCI Climate Paris Aligned benchmark citing underperformance and an increasingly concentrated portfolio.
It opted instead for a bespoke ‘Climate Action’ benchmark from MSCI, which is also currently being reviewed.
Based on market feedback, MSCI’s Climate Paris Aligned PAB Indexes will no longer consider the potential costs of climate change for a business, and will lower their ambitions around physical climate risk.
“Clients generally preferred retaining the physical risk objective, albeit at a lower target, to reduce its impact on tracking error,” MSCI explained.
The indices will no longer target a gradual increase in the climate transition scores of constituents, or a minimum increase in the number of constituents with validated decarbonisation targets.
It will maintain a commitment to have at least twice the level of exposure to green revenues as the parent index.
The EU requires an index to reduce its greenhouse gas emissions by an annual average of at least 7% in order to qualify as a PAB, but the MSCI version currently targets a 10% cut.
As a result of the review, it will now fall in line with the minimum 7% figure defined by the regulation.
“Most market participants were supportive of the proposed enhancements, highlighting the importance of removing overlapping climate objectives and ensuring long-term index viability,” said MSCI.
MSCI expects to implement the rule suite of changes by the end of the year, but acknowledged that some investors wanted to wait until 2027, to ensure that the update is aligned with potential changes to how PABs fit within the EU’s Sustainable Finance Disclosure Regulation, which is currently being updated.
The index provider said it may consult further if warranted by regulatory changes.
