Investors warned about carbon intensity metric in EU climate indices

Investors wanting to allocate to EU climate benchmarks without encouraging greenwashing should ensure the underlying methodologies make as little use as possible of the carbon intensity measure mandated by the EU regulation, Scientific Beta has said.

The regulation on the EU climate benchmarks requires that the carbon intensity measure used in portfolio construction be based on enterprise value, including cash (EVIC).

Another way of normalising emissions is by revenues, which is a feature of the weighted average carbon intensity metric recommended by the Task Force on Climate-related Financial Disclosures (TCFD).

Scientific Beta said normalising emissions by revenue is an established market standard and that the EVIC variation “has not been properly justified or thought through”.

According to the index provider, enterprise value imports equity market volatility.

“This weakens the link between changes in measured carbon intensity and underlying emissions, and produces carbon intensity volatility that facilitates greenwashing,” it said in a press release today.

“From a climate impact point of view, one should avoid guiding portfolio construction by enterprise value-based carbon intensity,” it said.

Scientific Beta has been sharply critical of proposals for and drafts of the rules for the EU climate benchmarks. Some say it would have been nice if it had shared its views earlier in the rules’ development process.

The index provider considers that the European Commission fixed some issues in response to feedback on the draft delegated act, but that the final delegated act insufficiently addressed the “fundamental” issue of the volatility imported by using an enterprise value-based measure of carbon intensity.

“At this stage, all we can do is explain what the flaws are and what steps investors can take to avoid associating with greenwashing,” said Frédéric Ducoulombier, Scientific Beta’s ESG director.

The group advising the Commission on its sustainable finance action plan recommended enterprise value as the denominator for the carbon intensity measure. It said it allowed for the applicability of the methodology to both equity and/or fixed income investments and did not bias for or against any particular sector.

It also said back tests conducted by members of the group indicated that enterprise value led to less index turnover than alternative metrics.

Andreas Hoepner, an independent member of that group and its successor, previously told IPE that a revenue-based intensity measure biased it in favour of sectors such as coal, and that in his personal view, this could be considered greenwashing.

In a draft protocol about decarbonisation target-setting, the Net-Zero Asset Owners Alliance said that if members used intensity-based rather than absolute metrics or targets, they were recommended to use enterprise value, or EVIC, “to allocate emissions to the relevant parts of the balance sheet”.

This was because most Alliance members were invested in corporate bonds as well as equities.

Many index providers have been launching EU climate benchmark-aligned indices; recent announcements about such moves have come from Research Affiliates and MSCI.

According to one industry source, the final delegated act is expected to be adopted by the European Parliament and EU Council this month. 

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