Case Study — 15 Mar, 2022

Leveraging Innovative Indices on the Journey to Net Zero

The Client: A local government pension Pool

Users: Pension Funds participating in the Pool CEO, CIO, & Head of Responsible Investment of the Pool

Net zero and carbon neutral commitments are on the rise in 2021, as companies, financial institutions, and countries assert their alignment to global climate goals.1 Although targets are being established, many organizations don’t have a clear action plan on the practical steps they will take to decarbonize their businesses by 2050.

Climate risk has potential financial risk, and therefore it could be beneficial for investment managers to understand their exposure. Reducing climate risk change has been a key priority for the clients of a local government pension Pool. Recognizing the urgency of climate change, the CEO, CIO, and Head of Responsible Investment of the Pool working in collaboration with its clients wanted to create a forward-looking plan to reach net zero by 2050 or sooner. This plan was to include designing passively managed low-carbon equity vehicles aligned with the objectives of the Paris Agreement and identifying appropriate climate-based indices to inform the strategy.

Pain Points

The CEO, CIO, and Head of Responsible Investment realized that the organization needed to take its climate strategy to a new level and create a clear plan for reaching net zero. Working along with prospective investors they wanted a diversified index aligned with the EU’s minimum standards for Paris-Aligned Benchmark (Regulation (EU) 2016/1011) to serve as a building block to achieve their net zero goals. In addition, it was important that the index:

  • Capture several types of climate risk. This should include physical risks associated with frequent and extreme weather events (e.g., hurricanes) or the longer-term effects of climate change (e.g., sea level rise), plus transition risks associated with moving to a low-carbon economy (e.g., carbon pricing policies).
  • Have a forward-looking perspective. The index should reflect transitioning in line with the 1.5°C objective of the Paris Agreement to align with the pension Pool clients’ goal of continuing to increase exposure to companies with present and projected carbon emissions within their 1.5°C carbon budget.
  • Be transparent. It was essential that the pension Pool clearly understand the underlying index methodology for selecting and reweighting companies to assess if it met the Pool’s goal of driving real-world change.

The pension Pool contacted S&P Dow Jones Indices (S&P DJI) to learn more about the firm’s index offerings.

Many organizations have set net zero targets, but don't have a clear path to get there. A pension plan wanted to create a progressive plan and be seen as a leader in ESG issues. This plan would require access to cutting-edge information including reputable climate-based indices to benchmark performance.

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The Solution

S&P DJI proposed the S&P PACTTM Indices (opens in a new tab) (S&P Paris-Aligned & Climate Transition Indices), which are designed to measure the performance of eligible equity securities, selected and weighted to be collectively compatible with a 1.5ºC global warming climate scenario, in addition to several other climate-themed objectives. The S&P PACT Indices are designed to meet the requirements of the EU’s minimum standards (opens in a new tab) for climate benchmark labels , including Paris-Aligned Benchmarks (PABs) (Regulation 2016/1011), making them timely net zero investment tools. In fact, the S&P PACT Indices go beyond the EU’s minimum standards, as shown in Figure 1. The methodology comprises multiple climate objectives. Of these requirements, just one stems from the requirements of the EU PAB label, which is the initial 50% reduction in relative greenhouse gas (GHG) emission intensity, followed by a 7% year-on-year absolute self-decarbonization of the index to align with carbon neutrality/net zero by 2050, using Scopes 1, 2, and 3 emissions.2 The S&P PACT Indices methodology can be found here.(opens in a new tab)

S&P PACT Index Methodology Inputs
Source: S&P Dow Jones Indices LLC. Chart is provided for illustrative purposes.

The S&P PACT Indices leverage data from across the S&P Global enterprise, including S&P Global Trucost datasets. The remaining six inputs are intended to address additional climate objectives incorporated in the index methodology: 

  1. 1.5°C compatibility on a forward-looking basis at every rebalance, built on transition pathway models with the Trucost Paris Alignment Dataset . (opens in a new tab)

  2. Reduced exposure to physical risks measured using the Trucost Physical Risk Dataset. (opens in a new tab)

  3. Improved ESG footprint measured by the S&P DJI ESG Scores. (opens in a new tab)

  4. A combined 20% index overweight of companies with publicly disclosed science-based targets that meet best practice standards.

  5. At least four times the “green-to-brown” revenue share than the underlying benchmark utilizing the Trucost Sector Revenues Dataset. (opens in a new tab)

  6. Decreased exposure to fossil fuel reserves to reduce the risk of owning stranded assets from the transition with Trucost Fossil Fuel Dataset. (opens in a new tab)

All of the above climate objectives are simultaneously approached through an optimization that seeks to minimize deviations from the underlying benchmark in terms of active share. The S&P PACT Indices solution is designed to aid the pension Pool to fulfill its objectives.

The Pool can use broad, diversified climate-based indices

The indices exclude securities based on undesirable exposures, then reweight the remaining constituents. The reweighting is viewed through the lens of the Task Force on Climate-related Financial Disclosures’ (TCFD) recommendations on climate-related financial risks and opportunities. Reweighting tilts toward companies that are better aligned with a 1.5°C scenario, report "green" revenues driving their business, robust science-based targets, and relatively higher S&P DJI ESG Scores. It tilts away from those companies with high GHG emission intensity, high potential physical risk, and fossil fuel reserves, using the above data sets.

Sample S&P Global Datasets Leveraged for the S&P PACT Indices are designed for the following purposes:

Evaluate carbon intensity of a portfolio

Trucost Carbon Emissions Data (opens in a new tab) contains information on over 22,000 companies,3 covering Scopes 1, 2, and 3 with metrics on quantities and intensities of carbon-equivalent emissions (tCO2e, tCO2e/USD 1 million revenues) and their estimated damage cost equivalents (USD), along with impact ratios. Granular sector revenue data is apportioned to 464 business sectors, with data going back to 2005 where available.

Estimate carbon data when not available

Trucost Environmentally-Extended Input-Output (EEIO) Model (opens in a new tab) brings together a vast database of industry-specific environmental impact data with quantitative macroeconomic data on the flow of goods and services between different sectors of the economy. The EEIO model lets users estimate environmental impacts for a company’s own operations and across their entire global supply chain, given the availability of company revenue details by industry sector.

Address physical risks

Trucost Physical Risk Dataset (opens in a new tab) offers an asset-level approach to the assessment of physical risk at the company and portfolio level. This includes detailed information to help understand the exposure of company-owned facilities and capital assets to seven climate-related physical impacts (i.e., flood, water stress, heatwave, cold wave, hurricane, sea level rise, and wildfire) under different climate change scenarios. Scores at an asset basis can then be aggregated to a company level.

Track a company's progress on meeting the Paris Agreement goal

Trucost Paris Alignment Dataset (opens in a new tab) assesses company-level alignment with the Paris Agreement goal to limit global warming to well below 2°C from pre-industrial levels. This dataset enables investors to track their portfolios and benchmarks against the goal of limiting global warming to 1.5°C and 2°C climate change scenarios.

Calculate the proportion of a company's "green" revenues

Trucost’s Sector Revenues Dataset (opens in a new tab) provides an assessment of the proportion of company revenues linked to the business activities linked to green/brown power generation. The dataset 15,000+ listed companies in Trucost’s Core Plus universe, including company revenue data going back to 2005.

Take a deep look at fossil fuels

Trucost Fossil Fuels Dataset (opens in a new tab) identifies companies within a global universe of 5,000 firms that have any revenues derived from fossil fuel activities. This includes the percentage of revenues companies derive from their business activities in fossil fuel extraction, power generation, and clean energy sectors.

Score a company's ESG stance

S&P DJI ESG Scores (opens in a new tab) are rooted in S&P Global’s esteemed Corporate Sustainability Assessment (CSA), a robust survey-based approach to evaluating corporate ESG performance with a focus on financial materiality. Backed by 20 years of investment performance data, the S&P Global CSA research methodology is characterized by thoroughness and granularity, rigorous standards for verification, and data source transparency. Conducted annually, the assessment intends to identify companies that are better equipped to recognize and respond to emerging sustainability opportunities and challenges. The S&P DJI ESG Scores methodology can be found here. (opens in a new tab)

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Key Benefits

The CEO, CIO, and Head of Responsible Investment quickly saw many advantages of the S&P PACT Indices relative to other strategies that were reviewed. As a result the Pool selected and subscribed to the index offering. In particular, the responsible individuals valued having:

  • Indices that align with a 1.5°C trajectory, while maintaining broad, diversified asset exposure.
  • Indices that seek to meet the EU‘s minimum standards for PABs under Regulation 2016/1011 and the TCFD‘s recommendations using S&P Global Trucost datasets that informs both transition and physical risks.
  • Index weights (opens in a new tab) relative to the benchmark index, that are clearly attributable to climate and ESG factors.
  • A forward-looking perspective that increases exposure to companies with present and projected carbon emissions within their 1.5°C carbon budget.
  • A thoroughly transparent rules-based structure supported by methodology research and other educational pieces.
  • The ability to save costs through index-based investing, which is low cost relative to active management.

The S&P Developed Ex-Korea LargeMidCap Net Zero 2050 Paris Aligned ESG Index is proprietary to S&P Dow Jones Indices. The fund based on the S&P Developed Ex-Korea LargeMidCap Net Zero 2050 Paris Aligned ESG Index is not managed, sponsored, endorsed, marketed or promoted by S&P DJI or its affiliates and neither S&P DJI nor its affiliates have any liability with respect thereto.

1 “Informing the journey to net zero and carbon neutrality,” S&P Global, Oct. 4, 2021,  http://www.spglobal.com/esg/insights/informing-the-journey-to-net-zero
2 The GHG Protocol classifies a company’s GHG emissions into three scopes. Scope 1 emissions are direct emissions from owned or controlled sources. Scope 2 emissions are indirect emissions from the generation of purchased energy. Scope 3 emissions are all indirect emissions (not included in Scope 2) that occur in the company’s value chain, including both upstream and downstream emissions.
3 All data as of February 2021.

Location

Europe