New EU climate benchmarks are getting industry take-up but not everyone is embracing them
- The EC has finalised minimum standards for two categories of EU climate benchmarks
- Products and mandates based on the benchmarks are emerging
- The regulatory backing of the benchmarks has been questioned
Barring any objections from the European Parliament or the European Council, it’s now a done deal: the criteria for the EU’s new climate benchmarks have been finalised. The European Commission adopted the relevant delegated acts on 17 July, about three months after publishing the draft versions with a four-week feedback period.
Index providers were already lining up provisional versions of the benchmarks well before the Commission had published the draft rules for consultation and there has been more industry activity since then.
In late April, for example, Solactive extended its EU climate benchmark set with the addition of fixed-income indices, which it said made it the first index provider to offer the benchmarks for both equity and fixed income.
On the investor side, in June Amundi announced it had won a mandate to manage a euro-zone equity index fund for Caisse des Dépots, EDF, and 10 major French insurers. It said this was the first investment solution fully eligible for the EU Paris-Aligned Benchmark (PAB) label, which at the time was pending finalisation of the rules. Amundi, Lyxor, Franklin Templeton have all in recent months launched ETFs tracking PAB-based indices.
The PAB is often described as the more ambitious of the two EU benchmark categories, needing to start with a -50% reduction in greenhouse gas (GHG) intensity relative to the market-weighted investable universe, compared with 30% for the Climate Transition Benchmark (CTB). It also specifies fossil fuel exclusions. A key feature of the benchmarks is that the index GHG intensity has to decrease yearly by at least 7% on average until 2050.
According to Andreas Hoepner, professor of operational risk, banking and finance at University College Dublin and a member of the sustainable finance technical expert group that advised the Commission, changes that were incorporated in the final benchmark standards mean that “from a climate perspective they are getting even purer”.
The Commission itself has identified several objectives for the benchmarks. One is to reallocate capital towards “climate-friendly” investments. Others are to improve transparency and comparability, and prevent administrators from making misleading claims.
At Amundi, Laurent Trottier, global head of ETF, indexing and smart beta management, says the EU labels could help investors understand what they’re investing in.
Trottier says: “It’s not a question of claiming that one solution is superior to any other, but at least they know if the index has the label PAB then it’s fulfilling a set of requirements. Then the investor can agree or not, but at least it helps to sort the wide mix of solutions available.”
In the UK, Brunel Pension Partnership has been inspired by the work on the EU climate benchmarks, according to its chief responsible investment officer Faith Ward. The local authority pension pool has a target to reduce the carbon intensity of its listed equity portfolios by 7% each year until 2022, when it will review its new climate policy.
It is the investor’s first specific target for decarbonisation and, at this stage, it is a relative one. However, it is looking at benchmarks more broadly, which Ward has said are “fundamentally flawed when it comes to climate”.
She adds: “We will use the EU work to inform our thinking about solutions, and making further progress on decarbonisation is a core driver of that broader work.”
For some, however, the regulatory backing of the benchmarks raises concerns. For the Paris-Aligned Investment Initiative (PAII), a project coordinated by the Institutional Investors Group on Climate Change (IIGCC) and steered by major asset owners, this is because other benchmark constructions may result in a greater emissions reduction impact.
“The way the PAB is now being incorporated into various regulations merits consideration. The implication seems to be that it [and the CTB] are the only benchmark constructions that should be used for ‘sustainable’ products or funds, but it is only one way to drive alignment,” says Daisy Streatfeild, investor practices programme director at IIGCC. “This is why we encourage the EU to take a broader view of the possibility for alternative benchmark constructions which take into account additional criteria in relation to Paris alignment, to be considered as part of the investor toolbox in offering Paris-aligned products or portfolios.”
“We will use the EU work to inform our thinking about solutions, and making further progress on decarbonisation is a core driver of that broader work”
Faith Ward, Brunel Pension Partnership
With regard to the PAB, the PAII’s key concerns are to do with the initial 50% emissions reduction relative to the benchmark and the 7% per year reductions. This is from the perspective that, to reach net-zero global emissions by 2050, it is the high-carbon companies in particular that need to reduce their emissions.
Its draft net-zero investment framework reads: “While the PAII wants to incentivise allocation of capital to assets whose emissions are declining over time and to climate solutions, it considers this may be more effectively achieved by maintaining investment in order to maximise real-world impacts by driving reductions in companies that need to transition, rather than initially excluding issuers from a benchmark to achieve an immediate highly ambitious reduction for an individual portfolio.
“The limitation of focusing on a singular 7% year-on-year carbon footprint reduction is that it also does not take into account benchmarks with regional or geographic exposures that are relevant to an investor’s assets and may necessarily require different emissions reduction pathways.”
At think tank 2° Investing Initiative, the view is that the EU climate benchmarks regulation was neither necessary nor appropriate.
“We think the direction of travel on metrics will be misleading, and that the evidence isn’t there that the regulation of low-carbon benchmarks more generally will drive climate impact in the real economy,” says Jakob Thomae, its managing director.
The index provider Scientific Beta has been very critical of several aspects of the EU climate benchmarks. It essentially argues that the final rules will allow index providers to develop indices that meet the EU climate benchmark criteria and yet are meaningless in terms of encouraging companies to reduce their emissions. According to the firm, it and investors using such benchmarks could be accused of participating in greenwashing.
However, Scientific Beta believes it is possible to design indices within the EU climate benchmarks framework that “have meaning” from a climate-impact point of view, and is setting out to do so. Its ESG director, Frédéric Ducoulombier, has some suggestions for what investors should look out for when assessing EU climate benchmark offerings, if they are out to maximise their contribution to emissions reductions.
He says: “From a climate-impact perspective, is there a clear rule to include/exclude, or weight, companies based on climate performance and that sends clear signals to companies and other stakeholders, or are inclusion or weighting decisions dependent on mixed climate and financial signals?
“Relatedly, can you at least find a consistency between constituent weight and company-level performance, or is the index composition driven by portfolio-wide indicators in a manner that allows compensation across companies?”.
A third suggestion is to check if there is an attempt to align with sector-level decarbonisation pathways, although Ducoulombier says this would not necessarily be easy to do within the framework of the EU climate benchmarks.
At Qontigo, Stephan Flagel, head of indices and benchmarks, says it is aiming to differentiate its PAB offering by also incorporating forward-looking data and that its STOXX CTB and PAB indices also encourage climate stewardship and corporate engagement.
EU sustainable finance: Impact uncertain
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EU sustainable finance: Impact uncertain