The European Commission's recent legislative proposals, presented on 24 May 2018, are the first step in putting into law a number of the actions laid out in the action plan on sustainable finance. The proposed measures are intended to help the move towards a European financial system that supports the EU's climate and sustainable development agenda. This is the third in a series of articles focusing on the specific measures that make up the package of proposals.

Low-carbon economy

The European Union has committed itself to reducing carbon emissions by 40% by 2030, compared to 1990 levels. For this to happen, the active involvement of the investment community in the shift towards a low-carbon economy is vital. Benchmarks have an indirect but important impact on investments. Many investors rely on benchmarks that are used to track the return of an investment fund (passive strategy) or measure the performance of an investment fund (active investment strategy).

However, existing low-carbon benchmarks do not always reflect investors’ low-carbon objectives, and so they have been reluctant to accept them. The absence of EU harmonised rules for low-carbon benchmarks has meant there have been no uniform standards for these benchmarks. This has increased the potential for investor confusion and meant the choice of indices to measure the performance of low-carbon funds and products has been limited. The performance of most low-carbon funds is consequently still assessed against conventional benchmarks, which do not take into account the specific characteristics of low-carbon investment strategies.

New low-carbon benchmarks

In order to improve the reliability and comparability of low-carbon benchmarks, the Commission is proposing the creation of two different types of low-carbon benchmarks. These will address different levels of ambition of low-carbon investment strategies:

·       The low-carbon benchmark: By lowering the carbon footprint of a standard investment portfolio, this benchmark will codify the existing practices of ‘decarbonised’ benchmarks. These benchmarks are generally used by investors to hedge climate risks without sacrificing financial returns.

·       The positive carbon impact benchmark: This benchmark will provide investors with a more effective tool to help them contribute to the Paris agreement objective of limiting global warming to below 2° C. It will do this by selecting only companies that make a contribution to this objective.

The Commission will establish (through delegated acts) the minimum standards to be used for the methodology of these two types of benchmarks. This should help to establish a generally accepted market standard to measure a company’s carbon footprint. It will make it easier for asset managers and investors to understand the characteristics of the different low-carbon benchmarks. This could also act as an incentive for companies to improve their disclosure.

Increasing transparency

In addition, in order to avoid 'greenwashing' and improve the transparency of all environmental, social and governance (ESG) benchmarks, the Commission will establish some specific disclosure requirements. These will help investors to better understand the links between the ESG objectives pursued by these benchmarks and their methodology.

The Commission's legislative proposals form part of the EU's commitment to ensure that European investments promote sustainability and support the ongoing fight against climate change.

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