MSCI responds to 2DII study on low-carbon and traditional indices

Article updated 22 June to include a response from MSCI.

The MSCI World index has decarbonised much faster than its lower-carbon equivalents, the MSCI World Low-Carbon Leaders and MSCI World Low-Carbon Targets indices, according to an analysis by 2 Degrees Investing Initiative (2DII).

This is true for both emissions intensity – which measures the level of emissions per $1 of revenue and portfolio weight – and absolute emissions. MSCI World delivered a cumulative 29 percent emissions intensity reduction over six years, compared to the 17 percent and 19 percent reductions reported by MSCI Low-Carbon Leaders and MSCI World Low-Carbon Targets indices respectively, said the EU ESG think tank.

In absolute terms, MSCI World is estimated to have shrunk its initial carbon footprint three times more than that of its low-carbon counterparts across the same period. Both absolute and intensity measures do not include customer-derived or Scope 3 emissions.

The findings may mean that marginal emissions reductions are easier to achieve with a higher baseline of emissions, 2DII said, although it noted that MSCI World’s overall emissions intensity continued to dwarf those of its low-carbon counterparts.

“These findings are material and meaningful for investors seeking to maximise year-on-year emissions reductions of their investees,” said 2DII co-founder and research author Jakob Thomä. The results underline the “overall inconsistency” of investment products which aim to maximise emissions reductions yet tilt away from high-carbon stocks, he added.

In response to the study, MSCI noted that the carbon intensity measure used by 2DII did not factor in the potential emissions from fossil fuel reserves as per the methodology for its low carbon series.

The study also did not appear to adjust for movements in enterprise value when calculating emission intensities, said MSCI. A hypothetical increase in enterprise value, which is determined by market capitalisation, could lead to an overall intensity reduction where no real world reductions have taken place. RI previously reported on the controversy around the EU’s selection of enterprise value to underpin its emissions intensity metric in 2020.

Additionally, year-on-year decarbonisation is not an objective of either the MSCI World Low-Carbon Leaders or Low-Carbon Targets indices, a spokesperson from the index provider said. MSCI does not report the emissions intensity of the Low-Carbon Targets index, which aims for a 50 percent reduction compared to MSCI World, “but we have quality control processes around rebalances and constraints in optimisation that would report errors if this component were to fail”.

Tesla query

Thomä also queried Tesla’s dominance of the MSCI Environmental Index, currently weighted at almost 50 percent as of Q1 2022. This means investors “effectively invest in one company and then an index of small and mid-cap companies”, he said, compared to the strategy’s “traditional” allocation, which included a diverse set of small and mid-cap growth companies. The index was launched in 2008.

Crucially, the fact that Tesla is included despite being misaligned with global climate goals based on MSCI’s in-house ratings raises questions regarding “the logic of green services and the problems with emissions accounting”, said Thomä. “How does an environment index conclude that Tesla is a leading constituent and not just any but [nearly] 50 percent of the index, while at the same time classifying the company as only 2.63C aligned?”

MSCI said that Tesla’s inclusion in the index was based on the the company’s clean-tech revenue and not its assessed temperature score, or implied temperature rise (ITR). Tesla’s ITR is based on several factors including the company’s lack of a decarbonisation target and the greenness of its customers’ grid, said MSCI. Running a Tesla in New York, for example, is greener than doing so in Michigan, where 60 percent of energy comes from natural gas and coal.

More broadly, the MSCI Environmental index has never had the objective of investing in growth companies, said the spokesperson. “We have other indexes which represent the performance of companies with traditional or non-traditional growth characteristics.”

Tesla is currently facing multiple lawsuits alleging widespread racial discrimination, including two filed by California’s Department of Fair Employment and Housing, and the federal-level US Equal Employment Opportunity Commission. In April, a judge ordered the company to pay $15 million to settle a previous racial discrimination lawsuit.

The MSCI Environmental Index screens out companies with “very severe controversies pertaining to ESG issues”, according to a product factsheet. Tesla has an ESG rating of A from MSCI, which is considered average across the automobiles industry.

The 2DII analysis is produced under its newly launched 1in1000 research programme, led by Thomä, which focuses on helping financial institutions manage climate change-related risks, in addition to risks from social cohesion and resilience.

Separately, 2DII transferred ownership of its landmark PACTA scenario analysis tool to US-based green nonprofit RMI, formerly the Rocky Mountain Institute, earlier this month. RMI has committed to invest in scaling up PACTA and keeping it free for users. The tool, launched in 2018, is widely used by banks, investors and regulators to measure the climate alignment of portfolios.