What is a benchmark?
A benchmark is “a standard or point of reference against which things can be compared”. Benchmarks are generally used as a measurement of the performance of a market or asset class. Money managers, such as State Street Global Advisors, create funds that seek to replicate or track these benchmarks.
Paris-Aligned Benchmarks (PABs) aim to align investment portfolios with the goals of the 2015 Paris Agreement. This is a global treaty which aims to keep the rise of global temperature well below 2°C above pre-industrial levels. PABs offer a way for investors to align their investments with these goals and gradually reduce investment in high carbon emitters.
How do Paris-aligned benchmarks work?
To be classified as a PAB, an index must meet specific criteria defined by technical experts of the European Union (EU). The criteria are designed to ensure investments are in line with the Paris Agreement requirements for carbon emission reduction. The EU regulation ensures transparency, consistency, and reliability in how these benchmarks are developed and used by investors.
Key requirements all PABs must meet include:
1. Carbon intensity reduction and decarbonisation over time
The benchmark must demonstrate a meaningful reduction in carbon intensity of 50% compared to a standard market benchmark. From this initial reduction, the benchmark is required to reduce its carbon intensity at 7% per year.
This reduction trajectory is aligned with the decarbonisation pathways needed to meet the Paris Agreement’s climate goals. These goals are based on EU calculations and climate scenarios from the Intergovernmental Panel on Climate Change (IPCC).
2. Exclusion of fossil fuel-based activities
Companies involved in environmentally harmful practices above stringent thresholds are excluded from PABs. This includes high-carbon activities such as coal mining or oil exploration.
3. Maintain investment in high climate impact sectors
Rather than remove exposure to the sectors with the highest climate impact, PABs maintain exposure in sectors that are crucial for a low-carbon transition. This means the benchmarks are required to reallocate between or within these high-climate sectors, for example, investing in renewable rather than fossil fuel-based energy would likely be in alignment with this goal.
Why are Paris-aligned benchmarks important?
PABs are part of the EU’s sustainable finance agenda. This agenda aims to support companies and the financial sector in channelling investments to the transition. They do this by encouraging private funding of transition projects and technologies and facilitating financial flows to sustainable investments. By investing in strategies tracking PABs, investors may also mitigate financial risks linked to a low-carbon transition.
Who are Paris-aligned benchmarks for?
PABs are suitable for a range of investment motivations. Investors may want to avoid risks associated with high carbon-emitting companies or, they might wish to align with global climate goals. PABs can help with either objective.
Risk warning
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
Last edited: 05-09-2024
