Analysis: Investors and providers critical of proposed EU green index rules

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There is growing concern from investors and other players over proposed EU regulation that would introduce rules and standards for low-carbon indices – going beyond recommendations made by a European Commission High Level Expert Group (HLEG) on sustainable finance.

The proposals are currently subject to a public consultation that will close next week. But they have already garnered warnings and criticism from a number of big names including Amundi, DWS and S&P DJSI, with experts saying they risk being “prescriptive”, “counter-productive” and moving financial markets in the wrong direction.

The Commission says in the documentation that the regulatory proposal “is built on the HLEG report on sustainable finance, which recommends taking steps to improve financial market benchmark transparency and guidance.”

However, whereas the HLEG focused on the need for “greater transparency and guidance on benchmarks”, which it defined as “the most high-profile indices”, the Commission has turned its attention specifically to branded ‘low-carbon’ benchmarks.

The regulatory proposal “targets those indices that include sustainability considerations, in particular, low-carbon indices,” it claims. “Only those providers will be affected by this proposal.”

Stan Dupré, CEO of the 2° Investing Initiative and one of the members of HLEG, hit back against the suggestion that the proposals build on the group’s advice, saying: “HLEG did not recommend or discuss the proposed regulation on low-carbon and positive carbon impact benchmarks.”

“A number of other ideas were discussed, but not this one. On this topic, we recommended index providers to be transparent about the exposure of standard benchmarks to climate and sustainability parameters.”

Other former members of HLEG, who did not want to be identified, echoed Dupré’s comments, with one saying: “There was a suggestion that low-carbon benchmarks need to have transparency, but we agreed in the HLEG that it wasn’t a major priority because more transparency is needed everywhere in the market.”

However, the Commission says the move – which goes beyond transparency measures – is needed to minimise the risk of ‘greenwash’ as the market develops.

It points to the fact that, already, “different categories of low-carbon indices with various degrees of ambition have emerged in the marketplace”. It says that a targeted consultation with asset managers revealed that the low uptake in low-carbon indices is partly due to doubts about methodology.

It concluded that investors should have access to “all the necessary information to select a low-carbon or positive carbon impact index which reflects their investment style”, and that there should be greater standardisation and comparability between indices.

Finally, it wants to improve corporate disclosure on climate topics by making it central to firms’ inclusion in such indices.

A number of options are outlined in the proposal, all of which ultimately create regulatory product categories for both ‘low-carbon’ and 2°C-aligned or ‘Positive Carbon Impact’ indices.

The overall objective is to encourage (but not mandate) retail and institutional investors to use low-carbon and carbon positive benchmarks. All index providers branding their products as “low-carbon” will, under EU regulation, be required to align their methodologies with the new guidelines, or rebrand them.

Late last year, HSBC Global Asset Management became the first big name to launch products branded launched ‘lower carbon’, rather than ‘low carbon’.The French financial markets trade body, Association Française des Marchés Financiers (AMAFI), said in feedback to the Commission that benchmarks should acquire the low-carbon/positive-impact labels “only on an optional and not on a mandatory basis”.

“HLEG did not recommend or discuss the proposed regulation” – Stan Dupré

The Commission’s preferred choice for how to implement the regulatory categories is to create a framework which contains “minimum standards” for how the constituents of low-carbon indices are selected and weighted, and how carbon footprints and savings are calculated. The latter may be based on existing EU-approved footprinting methodologies, according to the documentation.

The obligation to use carbon footprinting methods for all low-carbon indices has sparked alarm among some experts.

“We deplore several things,” said Sebastien Godinot, an economist at the WWF European Policy Office, in relation to the proposals.

“The Commission chose one single type/methodology of climate benchmarks with one single metric (carbon footprinting) while there are several other ways to do it. We are highly concerned that this could be counter-productive to develop 2°C aligned climate-benchmarks (that don’t necessarily have to rely on carbon foot-printing metrics, or avoided emissions),” he said.

There is disagreement on whether carbon footprints and avoided emissions – both included in the proposals – are relevant and viable metrics to measure the climate-alignment of companies. This has created concerns about whether codifying their use in regulation might end up misdirecting asset allocation, from a climate perspective.

AMAFI also used its consultation response to insist that Scope 3 emissions – those resulting from a company’s products – “should not be a must have” under the new rules, as suggested.

Murray Birt, Senior ESG strategist of DWS (formerly Deutsche Asset Management) told RI that “while the Commission is right to focus on the role of investment benchmarks as part of the sustainable finance agenda, using carbon footprint data is the first step but does not give a holistic picture of risks and opportunities from broader ESG factors, carbon price risk or physical climate risk.”

“EU policymakers should encourage a shift to sustainable benchmarks without being too prescriptive in their design”, he added.

Godinot called for several methodologies and metrics to be allowed — while requiring climate benchmark providers to explain how the climate objective is reached.

Others to voice similar concerns include Maximilian Horster, Managing Director of Climate Solutions at ISS, who told RI the proposals “appear to be going beyond their initial objective of creating a minimum standard that will encourage market flexibility and innovation”, and David Harris, Head of Sustainable Investment at FTSE Russell, who told reporters recently that he was “cautious” about the level of prescriptiveness of the proposals.

S&P Dow Jones Indices told RI of its “concern that, as drafted, the Commission’s proposed amendment on low-carbon and positive carbon impact benchmarks could create an overly restrictive framework. In particular, the introduction of a prescribed or singular benchmark methodology could actually limit investments in this space by limiting investor choice”.

Originally, the Commission wanted to tie the benchmarking proposals to the green taxonomy being developed concurrently as part of the EU Action Plan on sustainable finance. That would have meant index providers would have to select constituents using official EU categories.

However, intervention from the EU’s Regulatory Scrutiny Board – which said the taxonomy may introduce risks for index providers – meant the Commission “unbundled” the two initiatives and no link will be required.

As well as having standards around building low-carbon benchmarks, the regulatory proposal also wants to address broader sustainability disclosure in branded benchmarks. As a result, a second part of the proposals will require providers of indices “which pursue or take into account ESG objectives” to report on how they do so. A list of requirements will be developed by the Commission.Here, Amundi has pushed back as it seems non-ESG benchmarks escape scrutiny. It told the Commission it “strongly disagree[s]” with the idea that the regulation “exempts from mandatory ESG disclosure administrators of benchmarks that do not promote or take into account ESG objectives”.

“We do not ask for an obligation to develop indices that systematically would include ESG criteria, but we think that users of indices should be informed that such administrator for such an index has or has not taken any step in this direction,” said Europe’s largest asset manager.

The consultation closes on Wednesday 22 August. For a list of current responses to the consultation, see here.