Climate Action

Rodolphe Bocquet on the role of index providers in the ESG space

Ahead of the Sustainable Investment Forum Europe 2021, Rodolphe Bocquet from Qontigo talks to Climate Action about the role of index providers in the ESG space and how forward scenario analysis can assist regulatory frameworks to mitigate climate risk.

  • 08 April 2021
  • Rachel Cooper

Ahead of the Sustainable Investment Forum Europe 2021, Rodolphe Bocquet from Qontigo talks to Climate Action about the role of index providers in the ESG space and how forward scenario analysis can assist regulatory frameworks to mitigate climate risk.

How important is the role of index providers in sustainable finance and ESG?

The role of passive investment has been rising tremendously over the last decade, even though Europe still lags the US in that domain. This gives index providers great responsibilities to enable investors to play an active role in the transition towards sustainable economic pathways. In 2020 for the first time, net new money inflows for Europe-based ESG ETFs exceeded non-ESG ETFs. Interestingly, some Asset Owners start to shift their policy benchmarks to climate-aligned benchmarks as AP2 and the ECB did last year. The shift from “brown” to “green” is underway and likely to accelerate. In this context, index providers will need to upgrade their offering: (i) to keep up with regulatory and labels evolutions leading to higher baseline requirements for Sustainable Investment solutions and (ii) to shift away from the historic basic exclude/include indices towards more sophisticated optimized solutions and indices focusing on delivering real-world societal impact.

Do you think forward scenario analysis can assist with the development of effective financial regulatory frameworks and mitigate climate risk?

Yes, of course. Several central banks within the NGFS have already developed pilot projects (Dutch, English and French central banks). In 2022 the European Central Bank announced that climate stress testing will become mandatory for systemic banks under its supervision in Europe. The European Banking Authority is also considering a climate-based adaptation of prudential ratios (Natixis has been leading the way in implementing voluntary green/brown supporting/penalizing ratio internally). There is still a long way ahead to develop climate stress test models, though, both in terms of data and methodology, and to adapt them to investment portfolios. The current climate footprinting of companies is very insufficient to assess transition risk. However, to mitigate climate risk, it will take much more than climate stress testing developments. According to World Bank(1), only 22% of global GHG emissions are currently covered by a price signal (quota or tax), and the IMF has assessed that the average price is 2$ per tCO2, light years away of what is needed to significantly curb emissions. 

Do you have specific climate indexes at Qontigo and how do your tools assist institutional investors when integrating ESG or climate considerations into their portfolios?

Qontigo offers a comprehensive array of climate and sustainability indices, which constitute the Qontigo Sustainable Investment Ecosystem. These indices increase liquidity and lower trading costs to help meet specific and diverse sustainable investment goals

To future-proof our indices and optimize impact for our clients, STOXX created the STOXX Paris-Aligned Benchmark Indices, which go beyond meeting the minimum requirements of the PAB and CTB methodologies. Additional enhancements, which also ensure that the benchmark is well diversified and comparable to their underlying universes, include but are not limited to:

  • Inclusion of Scope 1, 2 and 3 emissions from the inception as opposed to over a 4-year period
  • Lower thresholds for exclusions based on revenues related to fossil fuel activity
  • Higher green/brown ratio
  • Additional ISS Carbon Risk Rating and Carbon Budget tilts
  • Diversification and weight capping
  • Rewarding energy-efficient securities
  • Mandating science-based corporate target setting using a phased approach

The STOXX Paris-Aligned Benchmark Indices (PABs) incorporate stringent carbon emission limitations in-stock selection, in line with the global warming target of the Paris Climate Agreement. They aim for 60% greenhouse gas (GHG) intensity reduction.The STOXX Climate Transition Benchmark Indices (CTBs) allow more sectorial diversification and help investors adopt a portfolio decarbonization trajectory. They aim for 40% greenhouse gas (GHG) intensity reduction.

An ISS climate performance report for the STOXX PAB Indices published in June 2020 showed that compared to the parent index, the STOXX® Europe 600 PAB Index outperformed its underlying benchmark index by 2.9% on an annual basis since inception, and had a substantial reduction in GHG intensity, lower exposure to fossil fuels, a better Carbon Risk Rating performance with the risk-return profiles and industry and country being comparable to the parent index. Other STOXX® PAB Indices also showed similar results.

In partnership with our clients, we developed the Euro iSTOXX Ambition Climat PAB Index, for which the requirements are even more stringent. This index is based on liquid securities from the EURO STOXX Total Market Index. The index follows the EU Paris-aligned Benchmark (EU PAB) requirements outlined by the Technical Expert Group (TEG) on climate benchmarks. The index is designed to help investors shift towards a low-carbon economy and align investments to the Paris Climate Agreement.

Companies identified as non-compliant based on Sustainalytics Global Standards Screening (GSS) assessment or are involved in anti-personnel mines, biological and chemical weapons, cluster weapons, depleted uranium and white phosphorus weapons are not eligible for selection. Tobacco Producers, as identified by ISS ESG, are also not eligible. Securities that generate revenues above a certain threshold from coal, oil and gas exploration or processing activities are excluded. Additionally, securities that derive more than 10% of their revenues from thermal coal, based power generation, or more than 50% from power generation with carbon intensity of lifecycle emissions higher than 100gCO2e/kWh are not considered for selection.

The index aims to reduce its greenhouse gas intensity by at least 60% when compared to the benchmark. The index is also designed to meet the year-on-year 7% decarbonization target.

Made possible by Qontigo´s open architecture and best-of-breed data, the Euro iSTOXX Ambition Climat PAB Index relies on ISS ESG as the world’s leading, independent source of climate data which provides the most complete set of carbon data and emissions scenarios and Science-Based Ts and carbon strategies data are used to overweight climate leaders and underweight the laggards.

What impact-orientated strategies does Qontigo offer?

We see our PAB indices are the first of our impact offering. We, however, will develop this year a much more comprehensive array of impact indices.

First, developing indices targeting investors eager to maximize their exposure to corporates contributing positively to society while maintaining broad market exposure, so-called SDG-target versions of our benchmarks. We will rely thereon data partners that have the ability to evidence corporates alignment with societal goals (SDG), such as Entis and Clarity. We are very proud to be the exclusive distributor since its inception of the Asset Owner Platform on Sustainable Development Investment (AOP-SDI) created by APG, PGGM, BCI and AustralianSuper; and powered by Entis.

Second, we will launch a new breed of impact indices for investors looking to support corporates leading the transformation in specific sustainability-related thematic. These new “sustainability megatrends” stand-alone indices will fall under a specific framework developed with external stakeholders to ensure its integrity.

World Bank. World Bank Report: Carbon Pricing Covers 22% of Global Greenhouse Gas Emissions (2020, June 8)

Rodolphe Bocquet will be speaking at the Sustainable Investment Forum Europe in April, bringing together asset owners and managers, ratings agencies, banks, UN and Government policymakers, investors, development banks, think tanks, and NGOs committed to driving forward the sustainable finance agenda. Register your place for free here.