EU mulls industry-wide ESG disclosure for index providers by 2021

While proposed measures are voluntary, investor demand is expected to drive pressure

By 2021, European index providers across all asset classes may be required to disclose an array of sustainability data for their mainstream index constituents, if new recommendations from experts are accepted by the European Commission.
In a report published today by the Technical Expert Group on Sustainable Finance – a team of 35 market participants and specialists asked to advise the Commission on how it can develop policy interventions to support ESG in financial markets – a number of disclosure recommendations are put forward for consideration, including average and specific sustainability ratings, reported vs estimated emissions information, exposure to carbon intensive and controversial sectors, and degree of board independence and diversity.
The recommendations relate to all benchmarks offered within the EU, except those covering interest rates and currency.
While equities face the most exhaustive requirements, other asset classes such as fixed-income, hedge funds and commodities will be asked to report on proxies when verified ESG data is not readily available. For example, indices covering hedge funds could be asked to disclose the percentage of constituents managed by signatories to the Principles for Responsible Investment.
The report is the result of a market consultation on sustainability within passive investment products and benchmarks, and will form the basis of legislation which got the green light – in principle – from European Parliament and the Council of the European Union earlier this year. The original proposal referred solely to indices being branded as ESG, but was widened to cover other indices as a result of a push by MEPs.
Although “benchmark administrators”, as they are known in the report, will be given non-disclosure as an option in the recommended reporting template, the TEG argues that ESG disclosure is already expected by the market “even when the investment product does not pursue ESG objectives”.
While corporate bond indices are within the scope of the disclosure rules, sovereign issuances are not included due to a lack data of data – although the TEG recommends that this policy is reviewed post-2020.
In addition to ESG disclosure for mainstream benchmarks, the report also addresses the second pillar of the Commission’s legislative proposal around passive investing: the need to create a new regulatory product category for indices being sold as ‘low carbon’.The political negotiations that concluded in Spring saw the creation of two categories: Climate Transition Benchmarks (CTB) and the more ambitious Paris-Aligned Benchmarks (PAB). These were revisions of those in the Commission’s original proposal, which were less ambitiously aimed at ‘Low-Carbon’ and ‘Positive Impact’.
CTBs will be aimed at investors looking to protect their assets against climate transition risk, and have a 30% carbon intensity reduction compared to their parent index, while PABs are for investors “at the forefront of the transition” with a 50% carbon intensity reduction.
Both CTBs and PABs will be required to ‘self-decarbonise’ at least 7% year-on-year on aggregate, in line with the IPCC’s most ambitious 1.5°C scenario.
Indices stand to lose their EU label if they miss the trajectory target over two consecutive years or on three occasions in a consecutive 10-year period.
Interestingly, it is recommended that CTBs and PABs are prohibited from having a reduced exposure to “high climate impact sectors” – such as the extractives, construction and forestry – compared to their parent index, because these sectors are “where most of the solutions necessary to a low-carbon economy lie”.
Because of this, the TEG does not address cleantech indices such as those focused on renewable energy, although this policy is recommended to be reviewed.
A constraint on sector allocation is possible to prevent greenwashing.
Construction for both index categories should, according to the recommendations, include Scope 3 emissions data for utilities and the mining sector at the date of implementation; with data for the transportation, buildings, materials and industrial sectors two years later, and emissions for every sector to be incorporated after four years.
Given the lack of established frameworks to measure Paris-alignment, disclosure of data providers and methodology is particularly emphasised in the report, to allow transparency and comparability.
Finally, the TEG recommends that companies involved in controversial weapons activities and those found in violations of global norms are excluded under both index categories, to align with the Commission’s broader ‘do no harm’ approach within the EU Action Plan.
The report is open to market feedback for the next six weeks, and a final benchmarks report will be published in September. Related Delegated Acts are expected to enter into force in 2020.