Frankfurt-based index provider Solactive has unveiled two new series of equity indices for investors who specifically wish to integrate low carbon and climate change considerations into their portfolios.
The indices are designed to align investment with the Paris Agreement on climate change.
They are the Solactive ISS ESG Provisional Climate Transition Benchmark Indices (CTB) and the Solactive ISS ESG Provisional Paris-Aligned Benchmark Indices (PAB).
Each series harnesses carbon emission data from ISS ESG, the responsible-investment arm of Institutional Shareholder Services (ISS), to construct indices that are aligned with the Paris climate agreement – a global framework to avoid dangerous climate change by limiting global warming to well below 2°C.
The methodology removes firms operating in non-ESG-friendly industries and then reweights remaining constituents in favour of those with lower carbon emissions. The main difference between the CTB and PAB indices is that the PAB indices take a more severe approach by targeting a significantly lower carbon intensity.
Index construction is based on the criteria of the European Union’s Technical Expert Group on Sustainable Finance (TEG). The TEG sets out standards for companies reporting ESG-related disclosures as well as for the construction of climate benchmarks. Its framework aims to reduce the risk of greenwashing – the process of conveying a false impression about how a company’s products are more environmentally sound.
According to Solactive, the indices within each series may serve as the underlying for passive investment products, such as ETFs, or as performance benchmarks for emission-related strategies.
Timo Pfeiffer, Chief Markets Officer at Solactive, commented, “Our two new index frameworks allow investors to proactively address climate change-related risks in their asset allocation. We are very proud to deliver an index series that gives investors potentially a holistic and reasoned strategy to tilt their portfolios towards a greener future.”
Methodologies
Each series initially consists of two indices covering the global developed and European equity markets. They are based on the parent Solactive GBS Developed Markets Large & Mid Cap Index and the Solactive GBS Developed Markets Europe Large & Mid Cap Index.
The Solactive ISS ESG Provisional Climate Transition Benchmark Indices exclude issuers with operations in controversial weapons as well as firms that are proven violators of international norms related to the environment, human rights, corruption, and labour rights.
The remaining constituents are reweighted so as to reduce the total carbon intensity of the index by 30% relative to the parent universe while adhering to certain constraints: constituents are capped at twice their weight and floored at half their weight relative to the parent index, and exposure to ‘high impact’ sectors must not decrease.
The Solactive ISS ESG Provisional Climate Transition Indices take a similar approach by initially utilizing the same exclusion criteria, while also removing firms with excessive revenue derived from the following industries: coal mining and power generation (1% revenue threshold), fossil fuel production, exploration, distribution, and services (10%), and electric power generation from fossil fuel sources (50%).
The constituents that remain are reweighted so as to reduce the total carbon intensity of the index by 50% relative to the parent universe, while adhering to the same constraints as above.
Furthermore, at each semi-annual rebalance, both index series incorporate ongoing decarbonization by targeting a further reduction in their total carbon intensity of at least 7% per annum.
Solactive is not the only index provider to roll out climate change indices. MSCI launched a similar series of equity indices in June 2019, while FTSE Russell has begun introducing sovereign bond indices that adjust country weights by preparedness and resilience to climate change risk.
The innovation in indexing mirrors the demand coming from investors. According to data from Societe Generale, ESG ETFs attracted record-high net inflows of $6.3 billion globally in January 2020, more than three times the monthly average during 2019.