The European Commission Action Plan: An assessment of the reform areas for PRI signatories provides an overview of the main reform areas. Action 5 focuses on developing sustainability benchmarks. 

Key points 

  • By mid-2018, the Commission intends to adopt delegated acts, within the framework of the Benchmark Regulation2, on the transparency of the methodologies and features of benchmarks to allow users to better assess the quality of sustainability benchmarks.
  • Subject to the outcome of its impact assessment, it is also to put forward by the same date an initiative for harmonising benchmarks comprising low-carbon issuers, based on a sound methodology to calculate their carbon impact, to be put into operation once the climate taxonomy is in place.
  • The Commission’s technical expert group3 will, following a stakeholder consultation, publish a report on the design and methodology of low-carbon benchmarks by mid-2019.

Comment

Benchmarks are indices that play a central role in the price formation of financial instruments and other relevant assets in the financial system. Indices serve as information aggregates, reference values and benchmarks for financial instruments. Recent innovations in benchmark formation have helped address new investor needs, including on ESG issues. While the focus of action in this recommendation is on index methodology, it is the use of indices by investors as benchmarks of investment performance that is the longer-term reform objective.

There are four main types of benchmark-related industry participants: (1) those that contribute the data; (2) the administrators who provide the indices; (3) the product issuers who issue index-related products; and (4) the end customers. In some cases, organisations are active in more than one of these areas.

The Commission action follows on the findings of the HLEG on Sustainable Finance, which made the following observations:

  • Traditional benchmarks reflect the status quo. As a result, their methodologies reflect sustainability goals only to a limited degree.
  • In response, index providers have been developing ESG benchmarks to capture sustainability goals, but the lack of transparency regarding their methodologies has affected their reliability .
  • Transparency is needed to reduce the risk of greenwashing.
  • The current use of benchmarks is a key driver of short termism.

The proposed action is framed in the context of the existing 2016 EU Regulation on Benchmarking, but it should be noted that the source for the EU regulation was the pre-existing IOSCO benchmark, published in 2013. Although it was the explicit intention of the EU regulation to transfer the internationally agreed IOSCO principles into binding regulations for the EU single market, in certain aspects the regulation goes beyond the IOSCO principles. EU market law is reflective of wider international developing norms, and will be of interest to PRI signatories operating outside the EU.

Signatories may wish to monitor the activities of the Technical Expert Group that will examine indices.

The proposed changes would allow investors to monitor investment performance against a range of sustainability benchmarks. This would impact product development, internal reporting and client reporting. In advance of the proposal, investors might want to engage providers on ESG index methodologies.

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