The EU is moving forward with plans for a legislative proposal on ESG benchmarks and is awaiting recommendations from PwC on the topic.
Policymakers have already created methodologies for climate-related benchmarks as part of regulation agreed back in 2019, which sought to increase transparency and credibility for increasingly popular “green” indices. The Climate Transition Benchmark (CTB) and Paris-aligned Benchmark (PAB) labels were launched in 2020 and have proven one of the biggest success stories to come out of the EU’s controversial Action Plan on Sustainable Finance, gaining traction with some of the world’s biggest investors.
Swedish pension fund AP2 has shifted more than half of its entire SKr400 billion (€38.1 billion; $40.8 billion) portfolio to PABs created by its internal investment teams. At the end of 2021, BlackRock aligned $9 billion of assets with CTBs developed by MSCI. Amundi followed suit in March, overhauling a range of “ESG” ETFs worth more than €13 billion to track CTBs and PABs from MSCI.
But the 2019 legislative agreement also contained a requirement for the European Commission to present a report to the European Parliament and Council on “the feasibility of an ‘ESG benchmark’” by the end of 2022. “That report shall be accompanied, where appropriate, by a legislative proposal,” the agreement states.
Consequently, the Commission asked PwC to undertake a study on the “potential creation of an EU ESG Benchmark label” earlier this year. According to its website, the study “will inform the European Commission about possible features for a new EU ESG benchmark label that would become a key lever to align investments with long-term sustainability considerations”.
“Many investors are currently relying on so-called ESG benchmarks to justify the sustainability-related feature[s] of their portfolio or of the investment products they make available. However, the comparability and reliability of existing ESG benchmarks is affected by a lack of harmonisation of their methodologies and the diverging levels of ambition of the objectives pursued,” the website states.
As part of the study, PwC recently closed a questionnaire aimed at benchmark providers, constituents and users.
The Commission would not tell Responsible Investor the number or type of respondents that participated in that questionnaire, saying they did so “on a confidential basis” and that broader feedback from the consultation would be included in a final report, slated for Q4.
“Just like the PAB and CTB labels helped standardise climate-focused investment strategies, and tackle greenwashing in the context of those specific strategies, the aim of [an ESG] label would be to further structure ESG-related claims made to benchmark users and, eventually, end-investors,” the Commission told RI in an email.
“The study from PwC will provide insight on whether there is a need and an appetite, considering the evolution of the market for ESG benchmarks, for an EU ESG Benchmark label to be created. Depending on the conclusions – ie, whether an EU ESG benchmark label would appropriately address shortcomings observed in the market – the report would also provide the Commission with suggestions on the standards to be attached to that label.”
Yet while the climate benchmark methodology is underpinned by quantitative decarbonisation targets tied to meeting the goals of the Paris Agreement, there are no equivalent metrics or frameworks against which to assess the credibility of ESG indices. This has led to concerns from some market participants that a methodology around ESG benchmarks could rely too heavily on the use of ESG ratings.
RI reported on Monday on findings from think-tank 2 Degrees Investing Initiative, which indicated that most investors were dissatisfied with the current focus of such ratings and would like them overhauled.
The head of sustainable indices at one large asset manager, who asked not to be named, told RI: “CTBs and PABs are focused on a pretty measurable thing – carbon emissions, which companies mostly report. So you can track the decrease in those emissions over time. But ESG has several dimensions, and currently ESG data looks different depending on which provider you use, so is the Commission going to make a decision on whose data we’re allowed to use? Or what ESG data should look like?
“Before you try to determine what an ESG benchmark is, you need to think about what an ESG rating should be, and how you use those ratings to inform benchmarks. That’s really complicated.”
The European Parliament and Council told the Commission in 2019 that its recommendations on the creation of an ESG benchmark label must “tak[e] into account the evolving nature of sustainability indicators and the methods used to measure them”. The Commission is scheduled to close a separate consultation on “whether a possible policy initiative on ESG ratings… is needed” next month, on the back of a similar survey by European supervisors which closed in March.
Find out more about this topic from industry leaders at the RI Europe 2022 conference, taking place in person in London on 14-15 June.