Proposed regulations for EU Climate Benchmarks receive market pushback (Updated)

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(This article has been updated with comment from ISS.)

Market players have poured cold water on key elements of draft regulations setting out the technical details for the EU’s new Climate Benchmark categories and disclosure requirements for providers of ESG-focused indices.

This comes at a late stage in the development of two new regulatory benchmark categories – consisting of Paris-Aligned Benchmarks (PABs) and Climate Transition Benchmarks (CTBs) – which were initially due to enter into force at the end of April 2020, together with the enhanced disclosure rules.

In a recently concluded public consultation, which garnered 66 total responses (Three things were being consulted on, minimum requirements for Climate Benchmarks which got 36 responses, benchmark statement disclosures 18 responses, and methodology disclosures, 12 responses), data verification emerged as a key point of contention with many submissions arguing against regulations which would hold benchmark providers accountable for the quality and accuracy of the data – such as corporate carbon emissions – which underpin their products.

The constraints are “inappropriate and not practical” said S&P Global in its submission, observing that such data is often sourced from a third party and benchmark providers are therefore not in a position to guarantee its quality. The alternative of requiring benchmark providers to develop their own data sources would “not be practical”, said market data firm IHS Markit.

In addition, European investment trade bodies the International Swaps and Derivatives Association (ISDA) and the Association for Financial Markets in Europe (AFME) contended that enhanced disclosure requirements – which now cover product exposure to a comprehensive list of ESG factors, ESG ratings of major holdings and green revenues among others – may have the effect of causing a “monopolistic situation” in which only major ESG benchmark administrators, who own ESG data arms, are able to shoulder the additional reporting burden.

This was echoed by Dutch corporate governance platform Eumedion who suggested that it could lead to a “lock-in on the side of data purchase” considering the current wave of acquisitions of ESG data providers by index firms.

Prominent think tank Two Degrees Investing Initiative (2dii) specifically queried potential conflicts of interest within the Technical Expert Group (TEG), a European Commission-appointed group of advisers, whose recommendations for the Climate Benchmarks criteria form the basis of the draft regulations. The current proposals “appears to align 100% with [the] financial interests” of some members of the TEG, 2dii said.

The composition of the TEG has prompted disquiet in the past, partly due to the fact that MSCI is the sole index provider officially represented. Last year, MSCI was first among its competitors to launch provisional PAB and CTB benchmarks. In addition, certain metrics proposed by the TEG have been observed as being compatible with proprietary approaches associated with other members of the group.

Responses to the consultations also showed a degree of confusion with regards to the disclosure requirements faced by providers of benchmarks which do not consider ESG factors. Although providers of such benchmarks are supposed to be exempt from the disclosure rules, key sections of the draft regulations suggest that such products must still disclose their alignment with a temperature scenario and other sustainability factors.

The confusion extended to disclosure requirements which would see index providers update the exposure of their ESG-focused products against an exhaustive range of ESG factors – even though the benchmarks in question may only focus on a narrow band of factors, such as climate change. Such rules are “unnecessary bureaucracy” which would be “of little use to users” said S&P.

Separately, a number of submissions called for additional flexibility with regards to the phasing in of Scope 3 emissions which is due to be staggered by sector over a period of five years. Respondents said that without any leeway, administrators of Climate Benchmarks may be unable to manage the resulting increases in carbon intensities – the German Banking Industry Committee estimated a 36% jump after the second year and an additional 11% increase after the fourth year – while still meeting an annual decarbonisation target of 7%.

The consultation also saw market players reaffirming concerns over the use of Enterprise Value (EV) – a valuation which encompasses both market capitalisation of equity and debt – to measure carbon intensity, which remains a key element of the Climate Benchmark criteria despite receiving significant market pushback in the past.

Critics say that using EV to calculate carbon intensity will result in an unstable, fluctuating metric as a result of volatility in the underlying share prices.

In their submissions, WWF said that usage of the “controversial” metric remained “experimental and immature”, while Natixis said that it would create an “artificial bias” and suggested that revenues be used to calculate intensities, as per the recommendations of the Taskforce for Climate Related Financial Disclosures (TCFD). Both 2dii and IHS Markit noted that corporate EV data was not readily available from major investment and ESG data providers.

Responses to the consultation can be accessed here, here and here.

Since this article was published, ISS has submitted this comment:

Before the release of the EU Climate Benchmark requirements, enterprise value including cash was used by many ISS ESG clients to track the absolute negative impact of their investments, i.e. to determine % ownership of investee emissions and calculate an absolute scope 1, 2 & 3 absolute carbon footprint. The issues of using EV (where cash is subtracted) was identified in 2017, and this value has been applied since then. Today ISS ESG provide carbon metrics using EVIC for 24,300 individual companies, plus an additional 3,000 mapped financial subsidiaries. 

Join RI’s EU Action Plan Spring Series #2: Green and sustainable benchmarks tomorrow (May 13) at 2pm BST / 3pm CET. Click to register here. Hugh Wheelan, co-founder of Responsible Investor talks to Sara Lovisolo, Group Sustainability Manager at London Stock Exchange Group, and Member at the EU Technical Expert Group on Sustainable Finance, and Frederic Ducoulombier, ESG Director, Scientific Beta and Director, EDHEC Risk Institute-Asia, to debate the EU’s major work around green and sustainable benchmarks, including climate transition and Paris-aligned benchmarks and ESG disclosure for all investment indices.