By Smadar Shulman and Paulina Lichwa-Garcia.
As the transition to net-zero becomes a critical portfolio management consideration, indices that include the EU minimum standards for Climate Transition Benchmarks (CTBS) and Paris-aligned Benchmarks (PABs) have increased in popularity has picked up speed. Such benchmarks aim to select securities that are overall consistent with a lower-carbon economy.
What are EU PABs and CTBs?
The EU has defined a regulatory framework with minimum standards for benchmarks called PAB and CTB1 in line with the Paris Agreement goals and net-zero by 2050. These are similar in their annual decarbonization trajectories but differ in greenhouse gas (GHS) emission reductions and exclusions from business activities. Figure 1 illustrates their similarities and differences.
Application of the S&P PACT™ on fixed income indices
While the Blueprint regulation provides minimum standards, there are additional elements to consider for fixed income investors. This includes method design, application to a fixed income universe and further consideration of climate-related risk factors.
The recently launched iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG extends the range of S&P PACT indices (S&P Paris-Aligned & Climate Transition indices) to fixed income securities. The index is based on the broad iBoxx € Corporates, which covers euro-denominated investment-grade corporate bonds, and takes into account not only the EU minimum standards for PABs, but also other factors such as transition risk, climate opportunity, ESG score overlay and fixed Restrictions on Income Risk and Reward Profiling.
The iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG offers a differentiated solution for fixed income investors looking for a fixed income benchmark that incorporates the goals of the Paris Agreement that:
- Aims to meet or exceed EU minimum standards for PABs;
- Leverages multiple ESG data sources and uses screening and optimization to determine the constituents and weights of the Climate Index;
- Includes factors designed to manage climate change transition risks and opportunities, in line with recommendations from the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD);
- Provides broad exposure while aiming to efficiently track the underlying index (iBoxx € Corporates) and minimize turnover; and
- Improves the ESG score against the underlying universe.
In addition to the required decarbonization path (using Scope 1, 2 and 3 GHG emissions data) and a minimum set of exclusions, the index also excludes companies involved in fossil fuel operations and power generation.
In addition, the Index aims to reduce companies’ exposure to fossil fuel reserve emissions compared to the underlying Index, which is considered to be a more forward-looking benchmark than historical greenhouse gas emissions. Both transition risks based on ESG and climate data from S&P Global Trucost. That ESG overlay exceeds EU minimum standards by aiming to ESG score2 improvement versus the underlying index universe.
The Index goes beyond minimum EU standards and also aims to replicate the underlying Index efficiently by minimizing turnover and taking into account fixed income constraints (e.g. related to yield, duration, tenor and rating). .
With reference to climate opportunitiesthe index weights green bonds more heavily,3 reflecting the opportunity inherent in such an issue.
Index profile: iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG
Comparing the iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG to the underlying index, Figure 3 illustrates the sustainability-related improvements.
Figure 4 shows a comparison of key metrics and breakdowns by sector, maturity and rating.
At its core, the iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG has the simple objective of providing an indexing solution for products looking to redirect capital into investments aligned to the Net Zero 2050 path. But as a solution to a complex problem, it incorporates multi-layered reasoning in a rule-based manner. The iBoxx EUR Corporates Net Zero 2050 Paris-Aligned ESG aims to meet and exceed EU minimum standards, while also incorporating considerations related to ESG, climate risk-related factors and fixed income risk/return profiles, while closely replicating the underlying benchmark .
1 Regulation (EU) 2019/2089 of the European Parliament and of the Council of 27 November 2019 amending Regulation (EU) 2016/1011 as regards EU climate change benchmarks. Paris-aligned EU benchmarks and sustainability-related disclosures for benchmarks. https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32019R2089&from=EN
2 The ESG score comes from research by Sustainalytics.
3 These are largely based on the International Capital Market Association’s (ICMA) voluntary Green Bond Principles, which require a commitment to use the proceeds (UOP) for green projects: ICMA Green Bond Principles
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Editor’s note: The summary bullet points for this article were selected by Seeking Alpha editors.