Scientific Beta (France) SAS
Scientific Beta was originally created by EDHEC, a French academic institution recognized for its research in Finance, with the aim of promoting the highest level of transparency in the field of Index Management, especially in so-called “smart beta” Indices, which are an alternative to market cap Indices.
ID: 471544832578-84
Lobbying Activity
Response to References to ESG factors enabling market participants to make well-informed choices
5 May 2020
THE ACT SHOULD RESPECT THE SCOPE OF DELEGATION
Reg. 2019/2089 calls for the Benchmark Statement to “contain an explanation of how ESG factors are reflected". Instead of specifying how this should be done, the act presents a long list of ESG indicators to be disclosed.
Such extensive disclosure would create significant administrative costs for all Benchmark administrators and material data licensing costs for those not affiliated with ESG data providers.
The proposed disclosures would change the nature of the Statement, which Reg. 2016/1011 (Rec. 43) intended as a description of what the Benchmark measures and how susceptible it is to manipulation. As per the Regulation, the Statement should be of reasonable length and focus on providing the key information and minimum disclosures are concerned with index construction and management, not performance.
We thus find serious grounds to consider that the act goes beyond the scope of the legislative delegation enjoyed by the Commission and recommend it be redrafted to limit itself to specifying what qualitative explanations of ESG incorporation should be provided.
As per Reg. 2019/2089, benchmarks that do not pursue ESG objectives need only state as much to comply. By making sustainability disclosures especially onerous, the act would de-incentivise the adoption of benchmarks pursuing ESG objectives and the voluntary uptake of these disclosures.
THE REGULATOR SHOULD PROTECT INVESTORS AGAINST MISLEADING INDICATORS
Close to half the indicators mandated by the act are ESG ratings and voluntary disclosures of the same are encouraged. However, the divergence of ESG ratings frustrates the possibility of meaningful comparisons across providers and even makes them unfit as indicators of ESG performance/risks.
This divergence is well known and a diverse cross-section of industry respondents to the TEG Call for Feedback underlined the danger of including such indicators into disclosures. It has also been documented by foremost academic research; Chatterji et al. (2016) note that ratings cannot guide issuers while Berg et al. (2019) call their ambiguity “an impediment to prudent decision-making that would contribute to an environmentally sustainable and socially just economy.”
While the Commission streamlined the disclosures put forward by the TEG, it retained overall ESG ratings for top 10 constituents (without providing for their weight to be disclosed). For sustainability’s sake, it is critical that the regulator steers clear of condoning these dangerously misleading metrics.
RECOMMENDED DISCLOSURES SHOULD ADD VALUE TO INVESTORS
Indicators that receive regulatory endorsement should not only be theoretically relevant but also be specified and implemented to permit meaningful comparisons across Benchmarks and administrators.
In addition, the potential benefits of disclosures should be balanced against their costs.
We trust that, provided definitions and criteria were fully specified and highly standardised, index exposure to activities regarded as beneficial or detrimental could assist in decision making. Information in respect of conduct-related controversies, while also relevant, entails significant issues of comparability as assessment is by nature more subjective and provider methodologies diverge.
The Commission should be commended for reducing much of the conceptual confusion of the TEG proposals, and considerably improving the informational potential of proposed disclosures.
To realise this potential while keeping cost at bay, an administrative body should be tasked with making available the data to be used to produce mandated disclosures. As with UN lists, the data would be freely available to interested parties. This would include not only objective data but also controversy assessments, e.g. in the spirit of the Council on Ethics supporting Norway’s and Sweden’s reserve funds. This would ensure comparability and minimise direct and indirect costs to investors.
Read full responseResponse to Minimum standards for benchmarks labelled as EU Climate Transition and EU Paris-aligned Benchmarks
5 May 2020
REGULATION SCOPE SHOULD NOT BE RESTRICTED BY MARKET ANCHORING
Rec. 6 introduces an expectation that Benchmarks “provide a realistic image of the real economy” and assumes this can be done by setting minimum exposure to certain sectors as per their levels in the “underlying investable universe”; “baseline” decarbonisation is appreciated relative to that universe (Art. 9-10).
Such anchoring reduces the scope of strategies covered by 2019/2089. Investors use various strategies within their portfolios – including some that target sectors other than those specified in Art. 3 and others that do not impose sector constraints.
By reducing the diversity/attractiveness of index strategies that may qualify as Climate Benchmarks, the act would limit the Regulation’s ability to reorient capital flows towards a more sustainable economy & reduce the scope of strategies scrutinised for greenwashing.
The scope of 2089/1089 should be preserved by (i) giving full flexibility in respect of sector exposures while requiring that a high level of strategy decarbonisation be achieved in a manner that controls for sector effects; (ii) assessing baseline decarbonisation in relation to the standard version of each index.
Greenwashing concerns could be addressed by disclosures, e.g. by reporting decarbonisation relative to the investable universe benchmark and by distinguishing between strategies that are designed to align with the sector weights of said benchmark and those that are not so constrained.
CARBON INTENSITY MEASUREMENT SHOULD BE PROTECTED AGAINST CAPITAL MARKET BIASES AND INSTABILITY
While the standard version of Intensity relies on revenues–a flow variable–to normalise greenhouse gas (“GHG”) emissions–another flow variable, the act adopts Enterprise Value (“EV”)–a stock variable mixing market value of equity capital & accounting value of debt capital, measured at fiscal-year end (“FYE”).
Rec. 11 states that the choice of metric “is not biased for or against a particular sector”, however, several TEG members publicly acknowledged that adopting EV in lieu of revenues was aimed at the coal sector. An unintended consequence of this tweaking is to introduce a bias against (in favour of) any sector that suffers (benefits) from a lower (higher) than average capitalisation of revenues.
Use of capitalisation also introduces capital market instability into measurement – 2 companies differing only by FYE will have different intensities as the metric depends on market conditions at FYE (think 31/12/2019 vs. 31/03/2020).
Instability is acknowledged by Art. 7(3) which introduces a deflator to maintain the stringency of the decarbonisation pathway when the average EV of index constituents rises. As this adjustment is asymmetrical, year-on-year decarbonisation requirements may dramatically increase when equity markets contract (and trigger portfolio adjustments most unconducive to setting long-term decarbonisation incentives for issuers).
Intensity should be defined as per standard market practice and TCFD recommendations; adjustments should be made symmetrical.
VALUE CHAIN EMISSIONS SHOULD BE INCORPORATED IN A MANNER THAT REWARDS ISSUER DECARBONISATION EFFORTS
In most sectors, value-chain (Scope 3) emissions dwarf those from sources owned or controlled by the reporting company or pertaining to purchases of electricity, heating and cooling (Scope 1+2). Their proper consideration is important but, as stated in Rec. 8, data are of insufficient quality.
Joint consideration of all emissions would drown out the corporate-level signal present in Scope 1+2 emissions in a sea of noisy product and activity-based Scope 3-estimated emissions.
To avoid disregarding issuer emissions reduction efforts, Scope 3 emissions should be considered indirectly via metrics that can support security-level analysis. We recommend the reduction of potential emissions from fossil fuel reserves be accepted as minimum requirement for an initial period of 4 years.
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