Have regulators been deceived on green benchmarks?

New European regulations on green benchmarks have been thrown into the spotlight this week, amid allegations they favour the interests of a handful of ESG data providers rather than supporting “genuine sustainability”.

The European Commission’s proposals to develop benchmarks
for low-carbon investment strategies have been dubbed “flawed and “misguided”
by leading indices platform provider Scientific Beta.

The firm warns the benchmarks do not “respect the spirit of the regulation” and exceed the scope of delegated acts, are overly influenced by the commercial interests of a few ESG data/service providers, and do little to discourage green-washing or support de-carbonisation efforts in the real economy.

The blistering attack represents one of the first ‘breaking of ranks’ regarding the green benchmarks, which have been proposed by the EC’s technical expert group (TEG).

The TEG’s Final Report on Climate Benchmarks and Benchmarks
ESG disclosures, published in October 2019 as part of Europe’s wider green
taxonomy push, recommends a set of minimum requirements that a benchmark must
meet to qualify as a 'Paris-Aligned' Benchmark (PAB) or Climate Transition
Benchmarks (CTB).

These proposals are meant to harmonise and improve
transparency in the market for sustainability benchmarks and ensure a high
level of investor protection.

However, Scientific Beta said the benchmark recommendations
fail to represent investors’ interests and have been “drawn up hastily” by a
working group dominated by providers of ESG data and services. The company also
criticises the proposals for putting forward “pointless and costly” reporting
obligations.

“The composition of the working group that prepared the
proposals is marked by a skew towards providers of ESG data and services and
the under-representation of the potential end-users of benchmarks, especially
pension funds, which are the main European institutional investors,” Noël
Amenc, chief executive of Scientific Beta at EDHEC Business School, and
Frédéric Ducoulombier, ESG director at Scientific Beta, said in a joint
statement.

“The extensive ESG disclosures recommended by the proposals
would primarily, and arguably almost exclusively, benefit [certain] providers
of ESG data and services,” they added.

Instead of specifying how explanations on the incorporation
of ESG dimensions should be provided, the TEG proposals establish long lists of
ESG indicators – 25 for public equity benchmarks – to be computed and disclosed.

If implemented, these disclosures would modify the nature of
the benchmark statement and entail considerable administrative and data
acquisition costs for those in the industry. In addition, the proposed
disclosures would fail to promote informed decision-making in terms of
sustainability.

The TEG proposals set out strong ambitions on ESG disclosure
and allow each benchmark administrator to use their own definitions, for
example in respect of controversial activities. In this, the TEG proposals not
only do little to promote sustainability but also, and most perversely, allow
ESG-washing to be performed under the falsely protective mantle of
sustainability regulation, according to the EDHEC/Scientific Beta analysis.

The same research also questions the relevance and adequacy of the “exotic carbon exposure metric” introduced by the TEG. The proposal in the final report introduces a measure of Weighted Average Carbon Intensity, or WACI, that uses Enterprise Value as denominator.

EU Proposals at odds with TCFD

But this metric is not widely accepted in the industry and is regarded as being at odds with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD). “The recommendation of the TEG to deviate from the generally accepted carbon exposure metric is supported neither by a literature review nor a cost/benefit analysis.

“In addition, Scientific Beta shows that this alternative
metric suffers from significant biases and flaws and that it may lead to
disregarding the efforts made by companies to mitigate their greenhouse gas
emissions. This final effect is a pathetic travesty of the design of the
regulation,” the indices platform stated.

To counter these flaws, Scientific Beta recommends that
climate benchmarks retain full flexibility with respect to sector exposures,
while being required to achieve a high level of decarbonisation in a manner
that controls for any sector effects.

To avoid misleading or irrelevant ESG disclosures, it is critical that commercial ESG ratings not be given regulatory endorsement and that they remain excluded from minimum disclosures, the firm said added.

Scientific Beta’s stance backs Minerva Analytics’ long held view that research plurality is of vital importance to tackling climate change and lack of consistent and reliable data.

“Minerva has always stood for research and policy plurality,
the broadest possible data and flexible frameworks that help by asking good
questions that can adapt to new understanding, not by imposing a one size fits
all simplistic solution,” Minerva chief executive officer, Sarah Wilson said.

“If data and benchmarks are the problem, Minerva believes there's a better way. Smaller vendors with vision, new insights, better frameworks, willing to disrupt, and who are more agile,” Wilson added.