Enhancing the Qualityof Net Zero Benchmarks

Contents
Summary........................................................................................................................ 3
Introduction – The growing importance of benchmarks....................................... 6
Focus of the discussion paper....................................................................................................................7
State of play – Net zero benchmarks and the EU Paris-Aligned Benchmark
and Climate Transition Benchmark regulation....................................................... 8
EU Climate Benchmark Regulation.........................................................................................................8
Tools available to achieve objectives...................................................................................................9Portfolio construction and engagement.............................................................................................11
Growth of investment in net zero benchmarks..............................................................................11
Assessment – First generation net zero benchmarks face a series ofchallenges...................................................................................................................... 12
Challenges facing net zero benchmarks............................................................................................12
Assessment of the EU Climate Benchmark Regulation.............................................................12
Conclusion - Towards an enhanced generation of net zero benchmarks......... 15
What should a net zero benchmark look like?......................................................... 16
Prioritise real world emissions reductions..........................................................................................17
Ensure transparency of benchmark rules and consequences...........................................18
Incorporate sectoral and regional approach..................................................................................19
Prioritise publicly available data, integrating alternative alignment metrics..........20
Facilitate engagement....................................................................................................................................21
Appendix......................................................................................................................... 22
Glossary.......................................................................................................................... 30

IIGCC Enhancing the Quality of Net Zero Benchmarks

2Summary
Investors are increasingly committed to aligning their portfolios with a net
zero target. Meanwhile, a significant portion of capital traded in the publicmarkets is increasingly being allocated to strategies that track or seek tooutperform a given benchmark. To ensure that more capital is in alignment
with net zero targets, passive and active investors will benefit from sound net
zero benchmarks that balance the need to incentivise real world emission
reductions, whilst also reflecting the investable universe of traditional
benchmarks to allow for greater adoption.
Index providers have responded to investor interest in climate objectives andare using a range of approaches to construct net zero benchmarks (view
Table 4 in the Appendix1). In 2019, the EU climate benchmarks regulation2
provided standards for ’climate benchmarks’, with the intention of reducing
real economy emissions, as well as incorporating multiple other objectives.
These include reducing investor risk derived from climate change, increasing
exposure to climate-related opportunities and disincentivising greenwashing.
The regulation establishes the criteria that a benchmark needs to meet in order
to be classified as an EU Paris Aligned Benchmark (PAB) or Climate Transition
Benchmark (CTB), with a heavy focus on emission reductions. This includes
reducing the benchmark GHG intensity or absolute GHG emissions (Scope 1, 2
and 3) by 50% and 30%, respectively, relative to the investable universe, andreducing GHG intensity or absolute GHG emissions by at least 7% per annum.
Index providers and benchmark users (i.e., asset managers, asset owners, andindividual investors) face several unique challenges when constructing or utilising
net zero benchmarks in comparison to traditional market benchmarks. These
span the availability and quality of climate data, complexities around forwardlooking metrics, evolving definitions and lack of a precise taxonomy, and thecomplexities around incorporating stewardship and engagement actions.
Recognising these challenges, IIGCC formed a working group to evaluate waysof enhancing the quality of net zero benchmarks, so that net zero alignment with
the Paris goals becomes an attainable objective for a wider range of market
participants. The group engaged with eight index providers on their net zero
offerings to understand the current state of play in the market and what they
consider feasible from a benchmark construction perspective. The working
group also assessed the advantages, disadvantages, and consequences of the
EU regulation.

1
2

The eight participating index providers:Bloomberg
FTSE Russell
ICE Data Indices
MSCI
QontigoS&P Global
Scientific Beta
Solactive
An early conclusion was that this conversation has advanced at a different paceacross asset classes. Net zero benchmarks for equities are most advanced, whilemore progress is needed with regards to fixed income net zero benchmarks,
particularly for sovereign bonds. Given the lack of integration of sovereign bondholdings into net zero investment strategies, innovation in benchmarks reflecting
this asset class has proved particularly challenging. This leaves significant scopefor future guidance to support this innovation.
The working group further concluded that while the EU climate benchmarks
regulation has provided a step in the right direction, they do not meet thefull ambitions of an investor targeting net zero. In practice, benchmarks
implementing the regulations have a tendency to comply with emission
reduction targets through capital reallocation, achieving emissions reductions
by reducing the weight of the highest emitting sectors relative to others. This is
not seen as best practice by the working group, whose recommendations aim topromote real world emissions reductions.
This paper aims to reflect the collective view of the participants in aneffort to provide guidance and promote best practice in the constructionof net zero benchmarks. The working group sees advantages for market
participants refocussing net zero benchmarks through the incorporation of
the recommended principles, as well as a superior outcome for the economictransition towards net zero.

Please note the descriptions of net zero offerings in the market have been provided by the index providers
EU climate benchmarks regulation

IIGCC Enhancing the Quality of Net Zero Benchmarks

3

Key Principles
The working group identified five key principles forthe construction of net zero benchmarks which canhelp achieve the ambitions of net zero investors:

1

Prioritise real world emissions
reductions.

2

Ensure transparency of benchmark rules
and their consequences.

3

Incorporate a sectoral and regional
based approach.

4

Prioritise publicly available data andintegrate alternative alignment metrics.

Benchmark design should be informed by
the incentives they would create in practice.
To the extent possible, net zero benchmarks
should favour avenues to enhance real world’organic’ emissions reductions, over ’paper
decarbonisation’.

Index providers should grant full disclosure on
how constituents of a benchmark are selected
and weighted and disclose any unique features(such as treatment of offsets, decarbonisation
pathways, methods and assumptions), to limitthe ‘black box’ nature of the methodologies.
The most successful benchmarks have a highdegree of predictability over which companies
are included on index rebalancing dates
and this should be the objective of net zeroindex providers. Publishing regular ex-post
attribution analysis to understand how theemissions reductions are being derived fromthe investable universe is recommended.
Transparency allows investors to make informed
and effective investment decisions and,crucially, it helps constituents predict the steps
they need to take to be selected into the index.

IIGCC Enhancing the Quality of Net Zero Benchmarks

Benchmarks should recognise that different
speeds of adjustment are required for different
sectors and regions. They should adopt
a science-based approach to emissions
reductions in high-emitting sectors to ensure
a just transition. Such an approach brings
the benchmark closer to the decarbonisation
path of the real economy, which makes
the benchmark more representative of theinvestable universe, helping asset allocators
for whom the predictability of returns isimportant. This would encourage greater
adoption of net zero benchmarks by bothactive and passive investors.

Net zero benchmarks can make use of a rangeof alternative metrics that better reflect thetransition potential and enhance real world
emissions reductions. Incorporating forwardlooking metrics and forward-looking information
can facilitate lower and more predictableportfolio turnover relative to an index using
financed emissions alone. Applying a carbon
budget with sectoral benchmarks will alignmore closely with scientific modelling andhence market confidence in the applicability ofthe benchmark. Also, considering incorporating
metrics that indicate if a constituent is providing
investment in climate solutions and enabling
activities, such as green capex, will expand
exposure and facilitate greater funding to thecompanies that are key to the transition. Lastly,
favouring companies with reported emissions
data versus estimated data can encourage
greater corporate disclosure.

5

Facilitate engagement to improve issuer
behaviour.
Net zero benchmarks should maximise theiropportunities for engagement to improve issuer
behaviour. While these would differ acrossasset classes, this can be done, for example,
by embedding climate performance-related
signals into the construction methodology andcommunicating these to potential benchmark
constituents. Implementing progressive criteriathat utilises the type of metrics suggested
above can act as a default escalation strategy.
For instance, integrating the Net Zero Investment
Framework’s alignment maturity scale to enableappropriate selective divestment decisions. Thisshould be considered as an area for innovation
amongst index providers.

Ensuretransparency ofbenchmark rules
and theirconsequences

Incorporate a
sectoral andregional approach

Prioritise realworld emissions
reductions

Facilitate
engagement toimprove issuer
behaviour

Prioritise publicly
available dataand integratealternativealignment metrics

4The principles are intended to be implementable across asset classes ashigh level guidance. However, index providers and investors should be wary of
nuances between the asset classes; for example, when it comes to engagement
and the approach to exclusions. A differentiated approach to exclusion/divestment may be appropriate for corporate fixed income investments, and justtransition concerns need to be considered when investing in sovereign bonds.
Benchmarks are complex, multi-faceted products and there is no easy wayof creating the perfect net zero-aligned benchmark. However, the proposed
principles aim to provide initial guidance on a net zero benchmark’s
construction, maintenance and reporting which should be seen as bestpractice to enhance real world decarbonisation. Ultimately, robust net zerobenchmarks that are transparent, recognise sectoral and regional pathways,
consider a range of alignment metrics, and emphasise engagement will betterreflect the investable universe of net zero benchmarks compared to traditional
benchmarks. This therefore increases their return predictability and facilitates
the uptake of net zero-aligned market indices.
The broad principles and specific recommendations are compatible with the
Net Zero Investment Framework3, the most widely implemented methodology foraligning portfolios with net zero objectives by signatories of the Net Zero AssetManagers and Paris Aligned Asset Owners initiatives. The principles aim to foster
real world emissions reductions, which is the primary motivation of the NZIF,
by enhancing disclosure recommendations, sectoral and regional granularity,alignment criteria, selective divestment and engagement actions.
The principles see considerable overlap with those advocated by the Net Zero
Asset Owner Alliance4, indicating a strong and consistent set of preferencesfrom investors seeking to achieve net zero and suggesting that index providers
implementing such principles are likely to lead market adoption of net zerobenchmarks. This paper provides more specific recommendations to support
index providers and investors in applying the principles.
IIGCC would like to thank the working group co-leads, Paul Howard, Scottish
Widows and Lupin Rahman, PIMCO, for steering the work of this paper, as well as
all of the working group participants for their continued contributions in 2022 and2023. IIGCC would further like to thank the eight index providers who presented
to the working group and were engaged in correspondence throughout theprocess, and MSCI and Scientific Portfolio for providing analysis.

3
4

Net_Zero_Investment_Framework_final.pdf (parisalignedassetowners.org)
Development and Uptake of Net-Zero Aligned Benchmarks: A call to action for asset owners
and index providers – United Nations Environment – Finance Initiative (unepfi.org)

IIGCC Enhancing the Quality of Net Zero Benchmarks

5Introduction – The growing importance of benchmarks

The market share of investment vehicles that track a benchmark has grownsteadily over the past three decades. Passive investing has emerged as aneasy and cost-efficient way to access leading market indices, standardisedrisk factors, and sectoral or thematic baskets. As of 31 March 2023, over 30% of
global public market assets under management in open-end funds (approx.
US$15.5 trillion) are invested in passive strategies tracking a pre-specified
benchmark (see Figure 1)6. Given the size of passive investing, as well as theimportance of benchmarks for active investment strategies, it is vital to consider
how to construct and maintain benchmarks that align with the global goal oftransitioning to net zero by 2050 or sooner, in line with global efforts to limit
warming to 1.5°C.
As this paper points out, passive investors face uniquely prominent challenges
when aiming to align their portfolios with net zero commitments while adheringto the composition of benchmarks that often disregard for such commitments.

5
6
7

35%

60

30%

50

25%

40

20%
30

15%

20

10%

10

Passive share of total

Passive investment strategies have a mandate to track or replicate theperformance of a given benchmark. In contrast, the mandate of active
investment strategies is to outperform a given benchmark through active
selection and trading of individual securities. While minimising tracking error(i.e., the difference between the return of an investment portfolio and that of its
benchmark) is the main goal of passive strategies, active strategies also needto consider the tracking error to ensure that their strategies do not deviate fromthe investment mandate. As the tracking error increases, so does the risk ofsignificantly underperforming (or outperforming) the benchmark.

Figure 1: Growth of passive investment

Assets under management Open-end Funds (USD Tn)

Benchmarks and market indices5 describe the performance of a given security
market, market segment, or asset class, and they play an increasingly decisiverole in financial markets. They are created by aggregating sets of securities
and/or assets based on pre-set criteria, and their value and composition isdetermined by pre-established rules. Since, by definition, they are rules-based,transparent, and investable, benchmarks serve as a standard point of reference
against which the performance of an investment strategy can be measured.
In essence, benchmarks and their underlying constituents often represent theinvestable universe of an investment strategy and form the basis for evaluating
the performance of portfolio managers.

5%
0%

0
2010 2011

2012

2013

2014 2015 2016 2017
Passive

Active2018 2019 2020 2021

2022 2023

Passive Share

The weighting methods used in constructing broad equity market indices (e.g.,market capitalisation weighting, price weighting, equally weighting, factor
weighting) enforce capital allocation rules that often result in non-aligned
portfolios. The Science-Based Target initiative (SBTi) reported in 2021 that four G7
country equity indices (which typically serve as benchmarks for equity strategies
in the respective geographies) reflected temperature pathways of 3°C or higher.7
This is partly explained by the fact that fossil fuels are a significant contributor
to emissions in all G7 country equity indices, a situation that is likely even more
pronounced in some emerging markets where more liquid energy companies
dominate the market index composition.

This paper uses both terms interchangeably. However, there is a subtle difference between the two. A benchmark is a customized standard of measurement used to evaluate the performance of aninvestment portfolio, while a market index is a specific type of benchmark that tracks the performance of a particular security market, market segment, or asset class. See the glossary for a full list of
definitions.
Analysis by MSCI, excludes fund of funds and feeder funds
SBTi, 2021. No Major G7 Stock Index Aligned with Paris Climate Goals. https://sciencebasedtargets.org/news/g7-stock-indexes-science-based-targets

IIGCC Enhancing the Quality of Net Zero Benchmarks

6

Similarly, broad bond market indices derive their composition from a series of
eligibility criteria covering credit quality, duration, liquidity, seniority, among othercharacteristics, which do not usually include net zero commitments or corporate
activity on climate. As a result, large portions of capital allocated to passive
investments are not aligned with net zero targets.

This discussion document seeks to provide a basis for analysis to strengthen
the quality of benchmarks to facilitate net zero alignment for public market
participants. It seeks to support investors to understand:•

Focus of the discussion paper

How to overcome pertinent challenges to integrating net zero commitments
into benchmark construction.

•

What benchmark products exist for investors integrating net zero targets.

•

How a benchmark can best contribute to the achievement of net zero
objectives.

•

How index providers can accelerate an investors’ transition.

Investors are increasingly committed to aligning their portfolios with the goals of
the Paris Agreement, guided by net zero targets, but a significant share of capital
trading in public markets is allocated to strategies that track benchmarks thatare inconsistent with such commitments.
The Net Zero Investment Framework provides a comprehensive basis for asset
owners and asset managers to measure and manage portfolio alignment
towards the goal of achieving global net zero emissions by 2050 or sooner,
with no or low overshoot. NZIF is the most widely implemented methodology
by institutional investors that are signatories to the Net Zero Asset Managers(NZAM)8 and Paris Aligned Asset Owners (PAAO)9 initiatives, the two net zerocommitments and initiatives supported by IIGCC.
Overall, NZIF aims to assist investors to maximise their real economy influence inthe net zero transition through four pillars: portfolio construction, management ofreal assets, engagement and stewardship, and selective divestment.
Currently, NZIF only provides high-level guidance for investors in benchmark
products. It recommends that benchmarks and indices should reflect company
performance against the alignment and transition criteria set out in the
Framework, weighting in a way that incentivises benchmark constituents to alignto net zero goals and increase revenues from climate solutions.
Relative to active managers, passive investment strategies and indexed funds
have capital allocation constraints. Consequently, their journey towards net
zero alignment requires a different approach and further guidance on how
benchmarks can incorporate net zero targets is needed.

89

The Net Zero Asset Managers initiative
Paris Aligned Asset Owners

IIGCC Enhancing the Quality of Net Zero Benchmarks

7State of play – Net zero benchmarks and the EU Paris-Aligned
Benchmark and Climate Transition Benchmark regulation
Attempting to implement multiple objectives into a single benchmark thatstrives to reflect the investable universe will inevitably involve trade-offs, leading
asset managers and owners to balance multiple objectives with traditionalrisk/return considerations. Alternative benchmarks allow investors to explicitly
consider alternative objectives, such as net zero alignment. The provision of
meaningful net zero benchmarks to accelerate the alignment of capital invested
in the public market with the net zero transition is crucial to achieving global
climate change mitigation goals and reducing climate-related risks.
Index providers and asset managers have received increasing pressure fromasset owners and civil society to boost ‘sustainable investing’ alternatives. To
meet these demands, they are launching new products that incorporate amyriad of factors, and, in turn, alternative benchmarks are being designed toreflect the novel investment strategies. Regulation has a critical role to play in
dictating the development and implementation of meaningful benchmarks thatwould truly unlock the role of financial capital in the transition to a low carbon
economy.

Taking current emissions as the reference point, PABs and CTBs must achieve
50% and 30% emissions intensity reduction, respectively, compared to the“investable universe” - the broad universe from which the benchmark is derived.
From that base, emissions intensity must continue to decline in line with thebroad average required for the economy (7% annually) to meet the scientificestimates of the remaining carbon budget. Emissions intensity should be
calculated using Enterprise Value Including Cash (EVIC) and should include
Scope 3 emissions as per the phase in requirements listed below. The regulations
differ slightly when applied to fixed income corporate instruments, where
benchmarks can use GHG emissions calculated on an absolute basis for unlisted
issuers, rather than based on GHG intensity. Notably, the regulation ruled out
incorporating sovereigns given the state of available information.
As well as the emissions reductions criteria, other significant requirements need
to be met for a benchmark to be branded with a PAB or CTB label:•

Exclusions – Required exclusions differ between CTBs and PABs. CTBs require
the exclusion of companies involved in activities related to controversial
weapons, the cultivation and production of tobacco and companies violating
the UNGC principles or OECD guidelines. PABs require additional exclusions forcompanies involved in coal, oil, gas and highly intense energy production.

•

Sector control (Equity Exposure Constraint) – For equities only, aggregatedexposure to ‘high climate impact’ sectors (as defined by the European
Commission, these are the sectors listed in NACE section codes A to H, and L)
is required to be at least equal to that of the underlying investable universe.
This is done with the intention that climate transitioning investors maintaintheir influence via engagement and voting, thus benchmarks meeting theCommission’s criteria aim to prevent divestment out of ‘high climate impact’
sectors and maintain a realistic image of the real economy.12•

Scope 3 – Scope 3 GHG emissions data for at least the energy, mining,transportation, construction, buildings, materials, and industrial sectors shallbe included in the benchmark methodology. This expands to all asset classes
by January 2025.

EU Climate Benchmark Regulation
Regarding net zero benchmarks, the European Commission’s regulation,
introduced in 2019, has dominated the regulatory landscape. The regulations
established Climate Transition Benchmark (CTB) and Paris Aligned Benchmark(PAB) standards10 , stipulating conditions that benchmarks must meet to use
these labels. These established a foundation on which future recommendations
that further enhance real economy decarbonisation can be made. The EU
Technical Expert Group on Sustainable Finance paper11 states that ultimate
goal of this regulation is Paris alignment, with a primary focus on emissions
reductions.

10 EU climate benchmarks regulations
11 TEG final report on EU climate benchmarks and benchmark ESG disclosures - 30 September 2019 (europa.eu)
12 Handbook of Climate Transition Benchmarks, Paris-Aligned Benchmarks and Benchmarks’ ESG disclosures, 2019. https://finance.ec.europa.eu/sustainable-finance/disclosures/eu-labels-benchmarksclimate-esg-and-benchmarks-esg-disclosures_en

IIGCC Enhancing the Quality of Net Zero Benchmarks

8

•

•

Disclosure – Considering exclusively current emissions as the reference point
for analysing a portfolio, PAB and CTB may increase the weight of issuers ofconstituents that set and publish GHG emissions reduction targets when:◊

The issuers publish Scope 1, 2 and 3 GHG emissions ‘consistently andaccurately’◊

The issuers have reduced GHG intensity (or absolute emissions, whereapplicable) by 7% per annum for at least three consecutive years

A multitude of tools are at the disposal of index providers and investors whenattempting to account for such objectives. Table 1 below provides an overview ofthese tools when benchmarks are being constructed and how engagement canbe enabled when investing in benchmark products.

Transparency – Further requirements are stated for assurances oftransparency, including transparency requirements for estimations,disclosures of the decarbonisation trajectory and accuracy of the data
sources utilised. See the regulations for more information.13

Tools available to achieve objectives
To overcome the challenge of incorporating a net zero objective into benchmark
investment strategies, index providers are implementing different approaches,with a range of objectives. Objectives such as accounting for:•Climate transition risks and opportunities: These include benchmarks withthe objective to protect investors against climate transition risks (i.e., reducing
carbon beta), for example by selecting net zero aligned constituents, or by
reducing the risk of exposure to stranded assets. Others have the objective
to outperform traditional benchmarks by gaining exposure to the structural
tailwinds produced by a low carbon transition, for example, by seeking
greater exposure to companies investing in climate solutions.

•

Net zero and Paris alignment: These are normative goals-based
benchmarks, whereby the goal is to achieve a certain level of Parisalignment, defined by the Paris Agreement as limiting warming to well
below 2C. As discussed later, this adds additional complexities, such as
the way in which Paris alignment is defined (i.e., the carbon budget), andthe way in which alignment is defined. To the latter, there are a multitude
of possible approaches, such as defining a self-decarbonisation trajectoryof the benchmark, utilising alignment criteria metrics to score benchmark
constituents against the Net Zero Investment Framework’s alignment maturity
scale, verified Science Based Targets, green revenues and capex, or acumulative benchmark divergence metric (CBD)14, amongst others.15

13 EU climate benchmarks regulations
14 IIGCC member briefing: Discussing a cumulative metric to improve the assessment ofemissions targets – IIGC
15 https://assets.bbhub.io/company/sites/63/2022/07/GFANZ-Portfolio-AlignmentMeasurement-August2022.pdf

IIGCC Enhancing the Quality of Net Zero Benchmarks9Table 1. Market environment: tools at the disposal of index providers and investors utilising benchmarks

Portfolio Construction
Emissions Reducing•

Tilting••

Tilts towards solutions (e.g., green revenue uplift)•

Decarbonisation Trajectory (PAB/CTB)
Transition Pathways•••

Optimisation

Engagement•

Promote adoption of net zero targets by investees•

Voting/escalation policies

Sector-based exclusions (e.g., ex-fossil fuels)
Rules-based exclusions (e.g., for constituents
involved in fossil fuel financing)

Low Carbon•

Avoidance / divestment / debt denial•

Strategy dependent••

Optimisation•

Voting/escalation policies•

Exclusion-based•

Broad ESG (e.g., ratings-based)

Carbon Reduction Target (e.g., 30% lower thanparent)••Tilting“Best-in-class” or “leaders”•

Promote adoption of net zero targets by investees

Thematic•

Solutions-oriented•

Solutions orientation potentially makes this less
impactfulMarket-based (i.e., standard benchmarks)•

Exposure-specific••

Blends of factors and ESG characteristics•

Materiality of risk focused with shareholder value
orientation••“Narrower” universe

Market-cap weighted••

IIGCC Enhancing the Quality of Net Zero Benchmarks

Climate risk disclosures

Promote adoption of net zero targets by investees
Voting/escalation policies

10Portfolio construction and engagement

Growth of investment in net zero benchmarks

Early adopters in the space relied on outright exclusions and tilting
methodologies, often extensively tailored by activity and with a range ofrevenue thresholds. More recently, the introduction of EU’s CTB and PAB has
resulted in more sophisticated products that incorporate carbon reduction
through optimisation techniques. However, these do not always grant thetransparency that is needed for constituents to understand the steps to be taken
to be selected in the index. There are few examples in the market of providers
incorporating granular carbon budgets into the construction methodologies,
and it is still highly uncommon to see benchmarks that consider differentiateddecarbonisation pathways across sectors and regions.

An increasing amount of investment is being channelled into products that trackor seek to outperform net zero benchmarks. See Figure 216. Since 2017, investment
in net zero benchmark products has increased from approx. USD 10.2bn to USD
100bn in April, 2023. The over 9-fold rise has been largely driven by passive
investment strategies such as PAB and CTB ETFs which accounted for approx.
USD 76bn. This upward trend is expected to continue as pressure continues togrow on the investment community to comply with net zero commitments, totreat climate change risks as financial risks, and to tap into the opportunities
stemming from the transition to a net zero future.

Some benchmarks facilitate engagement opportunities by informing
their constituents on key climate issues that are being considered, or by
implementing progressive criteria in the methodology to act as an escalation
strategy. It is not always clear, however, how index providers are interacting withasset managers or asset owners to maximise engagement opportunities, or ifthey are applying differentiated strategies across asset classes. This is relevant
because when it comes to opportunities for influencing the behaviour of issuers,
there are fundamental differences among asset classes. While equity investors
hold stock enabling them to engage (vote, resolutions, ask AGM questions),
escalate (collective action, public statements, pre-declarations, propose
directors), and, ultimately, divest, fixed income investors provide fresh funds tocompanies or governments, have important engagement leverage at the pointof rebalancing, and do not have voting power.
Table 4 in the Appendix shows an extensive list of net zero products available in themarket, provided by the index providers that engaged with IIGCC’s working group.

As noted earlier, regulation has a critical role to play in dictating the development
and implementation of meaningful benchmarks that can unlock the role of financial
capital in the transition to a low carbon economy. The EU climate benchmarks
regulation described above has dominated investment into net zero benchmark
products in recent years. ETFs meeting the criteria of the EU regulation make up
a significant proportion of AUM of publicly traded funds incorporating net zero
objectives. Hence, a robust regulation is key to foster desired real world outcomes.17

Figure 2: Growth of net zero benchmarks (listed equities andcorporatebonds)
120
100

AUM USD Bn

Index providers vary in their approach to incorporating data. For example, some
integrate Scope 3 data into the index construction immediately, relying on
sector averages and estimates, whilst others choose to avoid such inclusions
due to data coverage and quality challenges. There is also a growing trend ofincorporating forward-looking metrics such as Science Based Targets (SBT) into
the construction process by tilting in favour of those corporates that have set
credible SBTs. However, the extent to which targets can be used by index providers
for PABs and CTBs is limited under the EU regulation. Additionally, most providers
have a process for penalising corporates that have not disclosed data. This is likely
to be easer in developed markets, where the regulation is more stringent, andfirms have greater awareness and resources to invest in the net zero transition.

100.0

80

75.9

60

40
24.1

20

0

Q1 2017

Q3 2017

Q1 2018

Q3 2018 Q1 2019

Q3 2019 Q1 2020 Q3 2020 Q1 2021

Q3 2021

Q1 2022

Q3 2022 Q1 2023

Total Net Zero Funds (publicly traded)
PAB/CTB ETFs (passive strategies)
PAB/CTB/Net Zero Mutal Funds (active strategies)

16 Analysis by MSCI
17 The gross majority of PAB/CTB strategies (85 out of 112) were launched in or after 2019, the year in which the EU regulation was published. A minority of funds were launched before the regulation and haveupdated their rules to comply with the EU regulation.

IIGCC Enhancing the Quality of Net Zero Benchmarks

11Assessment – First generation net zero benchmarks face aseries of challenges
While it is to be welcomed that new financial products and benchmarks areembedding net zero objectives and incorporating climate science, some fallshort of the commitments needed to achieve the goal of net zero emissions
globally by 2050 or sooner. It is to be expected that the first generation ofclimate-related and net zero benchmarks will require adjustments, giventhat they face a multiplicity of additional challenges compared to traditional
benchmarks. Below is a non-exhaustive list of some of the most prominent
challenges.

Taxonomy and evolving definitions – Benchmarks that incorporate guiding
principles, such as ‘Paris alignment’ or ‘net zero alignment’ require a clear
definition to be codified into their rules. This presents a complication because
decarbonisation and alignment pathways are dependent on complex and notalways compatible assumptions about policy, technology curves, and socioeconomic factors over a long period of time at a global scale.18 Figure 4 in the
Appendix shows the vast number of potential decarbonisation pathways that
limit median warming to below 1.5C.

Challenges facing net zero benchmarks

Furthermore, alignment rules and required rates of decarbonisations are
expected to be evolving over time; incorporating such changes will increase theburden for both index providers and users of benchmarks.

Climate data availability and quality – Climate data metrics integrated
into benchmark methodologies will affect the weightings of the constituents.
Harmonising vast amounts of data from multiple sources, filling data gaps
when some data points are not available, ensuring data quality, ensuring thecontinuity and sustainability of climate data collection efforts, as well as dataconsistency, are all necessary additional actions that can often be cumbersomeand expensive. As technology allows for greater data accuracy and availability,
greater convergence is expected in the accepted metrics and sources used.
Complexities around forward-looking metrics – Closely related to the firstpoint, emerging forward-looking metrics can help provide insight into the
future decarbonisation of an index constituent; for example, by incorporating
the potential effect of current actions, such as green capex investment andexpressed future decarbonisation pathways. However, data coverage here is
still limited as the empirical track record to provide supporting evidence is stillinsufficient. Similarly, companies’ decarbonisation pathways expressed ex-antemight deviate from the reality ex-post, either because action was bolder orinsufficient, and depending on the trajectory of the real economy the degree oftracking error can be expected to increase over time.

Complexities around incorporating stewardship and engagement – A key
lever in enacting change in the behaviour of a firm is for investors with voting
rights to engage with them to effectively maximise their real economy influenceon the transition to net zero. An important part of net zero benchmark design isto embed mechanisms that enable investors to utilise this influence.
As more and better technological tools emerge to address these challenges, net
zero benchmarks should continue to improve. The same is true for regulation,
which both influences and learns from market developments.

Assessment of the EU Climate Benchmark
Regulation
Given the emergence of a multiplicity of financial products incorporating net
zero objectives, and considering the complexities involved in meeting suchcommitments, the standards introduced by the EU Commission were an
important step in the right direction. Climate Transition Benchmark (CTB) andParis Aligned Benchmark (PAB) standards have provided a focal point for the
decarbonisation effort, and they have helped popularise the notion that ongoingemissions reductions are critical rather than a nice-to-have.
Table 2 below describes some of the strengths and limitations of the regulation.

18 https://www.abrdn.com/docs?editionId=8a4a2333-f0cf-4a9c-b87f-ae3040fc8ab5

IIGCC Enhancing the Quality of Net Zero Benchmarks

12Table 2: Strengths and weaknesses of the EU climate benchmark regulation
Positive aspects of the regulation•••

Importance of emissions reductions isemphasised as a critical goal. By concentrating
attention on the need to ensure that there is an
ongoing approach to cutting emissions, it stresses
the importance of reducing companies’ carbon
emissions intensity (and absolute emissions whereapplicable).

Intends to prevent lower emissions being
achieved simply by significantly underweighting
high emission sectors (i.e., energy and mining).
By dictating that the combined weight of ‘highclimate impact’ sectors should be the same as forthe broad universe from which the benchmark is
derived.
Provided clarity into a market ecosystem
where there was limited understanding of what
respecting a carbon budget meant, and that
rapid immediate actions are required to staywithin it. In doing so, it prevented a “free-forall” from gaining momentum in which it would
likely have been difficult to assess the merits ofcompeting approaches.

Areas to improve
•

•

•

•

Does not distinguish between organic emissions
reductions versus those achieved by changes
in the portfolio composition. Thus, emissions
achieved by weighting changes and divestment
are judged to be as valid as those achieved bychanges in a company’s practices and businessmodel. In practice, several index providers reported
that changes in weights played a primary role,both in equities and fixed income.
The emphasis of the regulations on current
emissions rather than on future plans andcommitments risks diminishing the efforts ofinvestor engagement with companies in highemitting sectors. The structure of the regulation
imposes a relatively slow change in weights
relative to potentially greater ambition in some
corporate targets, potentially disincentivising boldcorporate action and reducing the influence ofinvestor engagement.

Particularly for companies operating in highemitting sectors, there remains large scope forcapital to be misallocated as a result of index
weights changing purely due to volatility inthe denominator rather than in a company’s
emissions. Whilst the use of enterprise value
including cash (EVIC) poses some advantages,
such as alignment with PCAF19 and the Net Zero
Investment Framework’s Target Setting Guidance20,
there are inevitable complications.
The regulations do not incorporate a link withthe taxonomies that are evolving to incentivise
scaling up investment in climate solutions or
enabling activities critical to the transition.

19 https://carbonaccountingfinancials.com/en/standard
20 https://www.iigcc.org/media/2021/12/NZIF_IIGCC-Target-Setting-Guidance.pdf

IIGCC Enhancing the Quality of Net Zero Benchmarks

13Some of these points can lead to unfortunate unintended consequences.
Given that there is a wide disparity in the emissions intensity among companies
within the same sector, as well as among sectors within the ‘high climate impact’
group, it is possible to achieve seemingly high emissions intensity reductions
with minimal changes to capital allocation. For example, for a given global
equity index, excluding the top 50 emitters (measured in terms of absolute
Scope 1 and 2 emissions) can roughly halve the total carbon footprint of theindex. Excluding the top 100 high intensity emitters (measured as total emissions
relative to sales), which represent only 3% of the index weight, has a similar
impact on the carbon intensity of the overall index.21
Following the regulation, it has become apparent that benchmarks complying
with the regulations tend to overweight less material sectors to climate change,such as communications, technology and health care (see Figure 3). The
benchmarks also reallocate to the lowest emitting sectors within the group ofindustries defined as ‘high emitters’22 in the regulation, away from the energy
sector which sees the largest reduction in capital allocation (4% from theinvestable universe – see Table 3 in the Appendix for a full breakdown of sectoral
allocations.).23
This trend of sectoral bias is at odds with two important dynamics of thetransition: that today’s high carbon companies may be deploying capital toward
tomorrow’s low carbon technologies, and that investor influence can support
these companies in decarbonising at the necessary pace. In other words, there
is a risk of ‘hitting the target whilst missing the mark’.

Figure 3: Sector breakdown of a standard global equity index vs a
‘Paris Aligned’ version
30%

25%

20%

15%

10%

5%

0%

-5%

Technology Financials

Consumer
Discretionary

HealthCareCommuni- Industrials* Consumer
cations
StaplesStandard global equity index

Materials*"Paris-aligned" global equity index

Energy*Real
Estate*Utilities*

Difference

Furthermore, if the goal of climate benchmarks is to provide ‘a realistic image ofthe real economy’24, a degree of flexibility should be encouraged; for instance,by incorporating differentiated regional and sectoral pathways. Several index
providers that engaged with the working group expressed a concern that
regulation has partly reduced index innovation in the industry, as participants
compete to deliver variations on a subset of products with specifications known
in advance.

21 https://www.fulcrumasset.com/inst/uk/en/fulcrum-blog/the-carbon-half-time-show/
22 * Shows the index sectors compatible with the “high climate impact” sectors as defined by the EU Low Carbon Benchmark Regulation based on NACE codes from A to L.
23 fulcrum-the-tracking-error-error-why-climate-alignment-calls-for-bolder-steps.pdf (fulcrumasset.com)
24 Commission Delegated Regulation (EI) 2020/1818, Art. 6

IIGCC Enhancing the Quality of Net Zero Benchmarks

14

Conclusion - Towards an enhanced generation of net zerobenchmarks
As discussed above, the current regulations have room for improvement toenable greater efficiency in the next generation of net zero benchmarks. Index
providers and their users can also innovate to further improve and close gaps
in critical areas. Advances in the following areas will allow for better nuance inbenchmark construction.
•

Engagement – Innovation is encouraged in expanding engagement
opportunities that drive corporate behaviour change. Greater collaboration
among index providers, users, and regulators is needed to maximise
engagement opportunities, and to better understand how benchmarks canfacilitate differentiated engagement opportunities across asset classes.

•

Additional asset classes – Further work is required in incorporating
additional asset classes into net zero benchmarks, as well as designing
differentiated approaches for existing asset classes. The regulations have yet
to explore methodologies for sovereign bond benchmarks, whilst offerings
amongst index providers for fixed income in general is limited. As better data
becomes available on this front, through initiatives such as PCAF and ASCOR,
net zero benchmarks should innovate accordingly.

•

Sectoral, regional, and temporal nuance – Net zero benchmarks should
strive for better sectoral, regional, and temporal nuance. In a global context,
sectoral classification disregarding for regional disparities is likely tointroduce biases, and it is likely to be disadvantageous to emerging market
countries where transition financing needs are elevated. While the EU climate
benchmark regulation specifies that a fixed decline in emissions intensity
relative to the investable universe should be achieved at any point in time theoptimal relationship is likely to be dynamic rather than static.

•

Forward-looking metrics and climate solutions – Innovations that help
consider future decarbonisation pathways, incorporate climate solutions, andproducts such as green and sustainability-linked bonds, may offer scope formore substantial deviation from the approach used to construct traditionalbond indices.

IIGCC Enhancing the Quality of Net Zero Benchmarks

It is important that net zero benchmarks are not boxed into a single definition but
rather have room to account for investor objectives and innovation. Regardlessof whether an investor is seeking active or passive investment products, thebenchmark or index selection is an active decision of the investor client. Shoulda client wish for factors such as net zero commitments to be reflected in theirchoice of benchmark, it is crucial to make a distinction on the precise objectiveof the client and to reflect these into a well-designed benchmark.

15

What should a net zero benchmark look like?
Here, we outline a set of recommendations that would enable benchmarks tobetter contribute to real world decarbonisation, derived by our working group.
The group prioritised five broad principles that they agreed should be integrated
into the construction, maintenance and reporting processes of equity andcorporate bond net zero benchmarks. Regardless of the investor’s objectives, theworking group views these characteristics as implementable. The principles see
considerable overlap with the principles outlined by the Net Zero Asset Owner
Alliance’s call to action for asset owners and index providers25, and provides
more specific recommendations to support the application of the principles.
The principles are intended to be implementable across asset classes as
high-level guidance. However, index providers and investors should be wary of
nuances between the asset classes, for example when it comes to engagement
and the approach to exclusions. A differentiated approach to exclusion/divestment may be granted for corporate fixed income investments, and justtransition concerns would be relevant when investing in sovereign bonds. As waspointed out earlier, to date, significantly less progress had been made in fixedincome net zero benchmarks, and in particular for sovereign bonds, which limits
the scope of this paper.

Following identification of the principles, IIGCC reached out to the index providers
who had engaged with the working group, most of whom responded with theirviews on the feasibility of implementation of such recommendations, as well as
indicating to what extent they felt the recommendations were already integrated
into their processes. These views are also documented below.

Ensuretransparency ofbenchmark rules
and theirconsequences

Designed to enhance real world decarbonisation efforts, the first principle isoverarching, with the succeeding principles aiming to enable this primaryobjective. Therefore, there is considerable overlap between this principle and theother principles.

Incorporate a
sectoral andregional approach

Prioritise realworld emissions
reductions

In summary, the broad principles are:
1. Prioritise real world emissions reductions
2. Ensure transparency of benchmark rules and their consequences
3. Incorporate a sectoral and regional based approach
4. Prioritise publicly available data, integrating alternative alignment metrics
5. Facilitate engagement to improve issuer behaviour
Collaboratively, the principles and more specific recommendations listed below
will enable benchmark products to have the real world impact they need to havefor an orderly transition to net zero.

Facilitate
engagement toimprove issuer
behaviour

Prioritise publicly
available dataand integratealternativealignment metrics

The recommendations are compatible with the Net Zero Investment Framework,
aiming to encompass real world emissions reductions: the primary motivation of
the NZIF.
25 NZAOA_Development-and-Uptake-of-Net-Zero-Aligned-Benchmarks.pdf (unepfi.org)

IIGCC Enhancing the Quality of Net Zero Benchmarks

16

1. Prioritise real world emissions reductions
A critical feature of achieving net zero is for the
economic system as a whole to adapt. The IIGCC
working group considers it important to set out therole investors can play in the different strategies
they engage in. Although different investors will
ascribe different levels of importance to how closely
an index performs relative to a parent universe; theextent to which it avoids potential stranding risk; howfrequently it turns over, etc., having clarity over the
relationship between emissions reductions ascribedto a paper portfolio and those achieved in the real
economy is essential for a net zero benchmark.
The working group has identified the following
recommendations:•

Net zero benchmarks can have their greatest
real economy impact when they adopt a
process based on emissions reductions in thereal economy, i.e. where the dominant influencecomes from organic declines in emissions or
allocating capital to industry best performers
rather than ‘declines on paper’, which stem purely
from weighting changes that result in inter-sector
reallocations.

•

Enhancing real world impact entails having aframework that is formally based on a carbon
budget and extends beyond current emissions toincorporate targets, as the following principles lay
out in more detail.

•Benchmarks that facilitate engagement withconstituents are highly desirable to enhance realworld decarbonisation.

IIGCC Enhancing the Quality of Net Zero Benchmarks•

Index providers should publish attribution
analysis to understand how the emissions
reductions are being derived from the investable
universe, explaining the contributory effects fromsources such as organic ‘real-world’ reductions,benchmark divestment and reweighting effects,
EVIC or sales-based intensity influences or othersources; the results should be compared with theobjectives set out for the index.

Index provider views: Most index providers
felt that there are approaches that enhancereal world decarbonisation in superior ways toothers, and that robust innovation can provide
opportunities for investors seeking real world
impact. Whilst there was a slight concern froma small number of index providers regarding
the feasibility for implementation of such a
principle in the current market, there wassignificant support for the intention and a clear
willingness to work towards the ambition. All
recognise that emissions reductions stemming
purely from sectoral shifts is undesirable.
The index providers saw the recommendations
as being at least partially incorporated into
their own practices, however, they agreed there
are areas for improvement.

Prioritise realworld emissions
reductions17

2. Ensure transparency of benchmark rules andconsequences
The importance of transparency is clear acrossmost aspects of the operation of a net zerobenchmark, and the potential consequences of any
specific design should be highlighted to investors.
For investors targeting a net zero objective, it iscritical that a benchmark being tracked shoulddeliver on that objective, meaning clarity on thebenchmark’s objectives and proposed mechanisms
for achievement is of significant importance.
Undoubtedly, improvements can and need to bemade in this respect, as outlined by the FCA in a firmly
worded letter to benchmark administrators upon
review of ESG benchmarks.26
Specifically, the IIGCC working group makes thefollowing recommendations:•

Provide clarity over how the benchmark’s
operation will lead to the selection of assets, theirweighting within the index as well as how theindex aligns with the net zero objective; further
disclose the consequences of the approach for
portfolio characteristics such as tracking error,
concentration and turnover in various real-world
scenarios. The effects of any optimisation processused should be published each year.

•

Publish attribution analysis to understand how
the emissions reductions are being derived
from the investable universe, as per the firstprinciple, explaining the contributory effects fromsources such as organic ‘real-world’ reductions,benchmark divestment and reweighting effects
and EVIC or sales-based intensity influences orother sources, clearly distinguishing changes
due to numerator and denominator. The results
should be compared with the objectives set out
for the index. An example of attribution analysis isprovided in the Appendix, Figure 5.

•

Describe index construction rules and constraints,
highlighting key features that may be unique suchas the importance of decarbonisation starting
references and nuances of intensity calculation
approaches.

•

Benchmarks should be transparent about theprocess used for companies in each sector andhow relative sector weights are established;
regardless of whether the benchmark is
constructed relative to an existing index, theimpact of weighting choices on sector andcountry exposure relative to a parent universeshould also be reported each year.

Index provider views: The providers agreed
with the working group that transparency is
critical to allow investors to make informed
decisions and achieve their net zero objective.
They felt these recommendations were atleast partially incorporable into a benchmark’s
construction, maintenance and reporting
processes. Most providers viewed all therecommendations as practicable, with themain concerns arising around the resources
and complexity of attribution analysis.
All of the providers that responded saw therecommendations as being at least partiallyintegrated in their respective practices, throughthe public disclosing of index construction
methodologies as well as complementary
reports and research projects. A limited
number viewed all of the recommendations as
being integrated into their practices.

Ensuretransparency ofbenchmark rules
and theirconsequences

26 FCA outlines where improvements are needed in ESG benchmarks | FCA

IIGCC Enhancing the Quality of Net Zero Benchmarks18

3. Incorporate a sectoral and regional approach
A one-size-fits-all-approach to emissions reductions
is not judged by the working group to represent bestpractice. Sector based pathways that recognisevariability across economically important sectors
and regions is inherent for an optimal net zerotransition. This may further facilitate stewardship andengagement actions in the long term and ensure that
capital markets support best-in-class high carbon
participants. The working group recognised theadded complexity behind incorporating sectoral andregional decarbonisation pathways into benchmarks,emphasising the importance of transparency.
The working group recommends the following:•

When determining index weights, the working
group judges it to be best practice for benchmarks
to assign different emissions reductions pathwaysfor different sectors, incorporating carbon
budgets.

•

The base year for assessing the carbon budget
when constructing the index should be madeclear.

•

Benchmarks should be transparent about theprocess used for companies in each sector andhow relative sector weights are established.

•

For complete transparency, index providers should
provide a clear methodology for:◊How the carbon budget used in the benchmark
is established◊

Which data sources are used◊

Which metrics are used to evaluate companies’or sovereigns’ performance◊

The basis on which the budget is allocated todifferent entities•

Recognising the lack of sector-specific regional
pathways, benchmarks should nevertheless
integrate regional considerations where possible
and phase in as coverage and quality improves.
Investors should engage with pathway providers
to improve the regional granularity of pathways.

•

It is critical to distinguish high-emitting sectors fromother parts of the economy, as well as emerging
markets from developed countries, defined as
sectors in NACE code categories A-H and J-L in the
Net Zero Investment Framework.27•

The working group advocates that index providers
use publicly available sector and country
benchmarks to ensure that investors can use
the index construction approach as part of their
engagement with companies and sovereigns,
such as those available from TPI.

27

Net_Zero_Investment_Framework_final.pdf (parisalignedassetowners.org)

IIGCC Enhancing the Quality of Net Zero Benchmarks

Index provider views: The index providers werehighly supportive of incorporating sectoral andregional-specific pathways into a benchmark’s
construction, with the majority viewing allof the recommendations as feasible for
implementation. There was acknowledgementthat there are some limiting factors in thecontext of pathway availability, granularity andstandardisation.
Despite the support for the integrationof such pathways, the number of index
providers actually incorporating these into abenchmark’s construction was limited, withmost suggesting they only partially followed
the recommendations outlined above. Therewas recognition that the EU climate benchmark
regulations limit the opportunity to apply therecommendations.

Incorporate a
sectoral andregional approach19

4. Prioritise publicly available data and integratealternative alignment metrics
While absolute emissions reductions are essential, arange of alternative metrics are available that betterreflect transition potential and enhance real world
emissions reductions. Investors and index providers
should consider the value of integrating these metrics
into the construction and maintenance processesof benchmarks, while maintaining a transparent
approach.
The working group therefore recommends thefollowing:•••

For transparency, the methodology should
prioritise publicly available data and be replicable,
outlining the sources used, encompassing full
PCAF-aligned reporting and include data quality
scores. The limitations of the data used and risksof data available should be described, and if
relying on intensity metrics using EVIC or WACI,
the difference between emissions reductions on
this metric and the change in absolute emissions
should be published.
Data points that reflect the ten alignment criteria
set out in the Net Zero Investment Framework
should be considered for integration into theconstruction of benchmarks to recognise
constituents that are leading the transition,utilising TPI, SBTi and Climate Action 100+ data.28
Further support for identifying alignment data
points is available in IIGCC’s data catalogue.29•

Green capex, and other metrics indicating to what
extent the constituent is providing investment inclimate solutions and enabling activities suchas green revenue, should be considered forincorporating into the construction of a benchmark.
This is particularly relevant for corporate bondbenchmarks, given that bond markets are more
likely to be the providers of working capital tofacilitate capex for the transition.

•

Where companies’ or sovereigns’ commitments
to reduce future emissions are included in theweighting process, index providers should set out
how future weights will vary depending on entities’
performance relative to their prior commitments.

•

The index provider should set out whether
companies not reporting emissions are penalisedin the weighting process.

•To improve the alignment of a benchmark, investors
and providers should consider the incorporation of a
Cumulative Benchmark Divergence Metric, explainedin a recent IIGCC paper.30

Forward-looking metrics should be incorporated
into the construction process. Specifically, Science
Based Targets or equivalent assessed against
sector-specific pathways, indicating the ambitionof entities.

Index provider views: Once again, the index
providers that responded to the proposed
recommendations were highly supportive andviewed them as feasible for implementation.
The prioritisation of publicly available data
was welcomed to enhance convergenceand transparency amongst providers. A
slight concern was raised regarding the data
availability that maps across to the Net Zero
Investment Framework’s alignment criteria,
however it was recognised improvements arebeing made in this respect.
Most providers see their practices as at least
partially incorporating the recommendations
and plan to incorporate some of the principles
as data quality and coverage improves,particularly green capex which is currently
limited.

Prioritise publicly
available dataand integratealternativealignment metrics

28 Net_Zero_Investment_Framework_final.pdf (parisalignedinvestment.org)
29 IIGCC-Data-Service-Providers-Catalogue.pdf
30 IIGCC member briefing: Discussing a cumulative metric to improve the assessment of emissions targets – IIGCC

IIGCC Enhancing the Quality of Net Zero Benchmarks

20

5. Facilitate engagement to improve issuer behaviour
For net zero indices following a carbon reduction
pathway, the working group acknowledged
that, to an extent, a gap exists between portfolio
decarbonisation and real-world outcomes. Thishas been the subject of much industry debate
and increasingly, the value of stewardship andengagement, and the importance of capital provision
for carbon intensive sectors is being recognised.
Whilst the choice of any individual investor to divest
may be considered to be appropriate in certain typesof optimised pathway strategies, further innovation
can provide solutions to enhance engagement, which
can improve corporate behaviour and, crucially,
enable emissions reductions in the real economy.
Thus, facilitating engagement is crucial in improving
the level of alignment on the Net Zero Investment
Framework’s maturity scale set out in the Target
Setting Guidance.31
The working group identified the following
recommendations:•

Investors and index providers should engage
with existing and potential constituents of abenchmark to explain climate-related signals
embedded into the index methodologies with theaim of improving corporate behaviours. This isparticularly important for fixed income indices, forboth corporates and sovereigns, which are on theedge of inclusion in the index. Investors and index
providers should report on these engagement
strategies, including any significant outcomesfrom the engagements.

•

Metrics that align particularly well withengagement strategies should where possible beincorporated into construction methodologies,
particularly data points that can be mapped
across to the alignment criteria outlined in the
Net Zero Investment Framework.32 For instanceinclusion criteria, especially for high-emitting
sectors; or weighting systems that favour
companies using science-based targets;assessment relative to a carbon budget from arecognised provider, such as TPI or SBTi, that aligns
with a net zero objective; and the favouring ofcompanies with reported emissions data versus
those for whom it has been estimated.

•

Implementing progressive criteria that utilises thedata points suggested above can act as a default
escalation strategy. For example, integrating
the Net Zero Investment Framework’s alignment
maturity scale to enable appropriate selective
divestment decisions. This should be considered
as an area for innovation amongst index
providers.

Index provider view: For the final principle,
the intention of facilitating engagement was
favourable amongst the providers. There wasparticularly strong support for embedding
signals within the construction methodology
which increase investors’ ability to engage withand increase effectiveness of engaging withconstituents. Several responses suggested thatproviders view their actions as limited, and thatthe primary impact from engagement camefrom the actual owners of the capital. However,there was some support for index providers
to engage directly with potential constituents,
with the view that, like other financial market
participants, index providers have a role to play
to improve climate performances.
The majority of index providers view theircurrent practices as encompassing therecommendations at least partially, primarily
through the inclusion of data in construction
methodologies which act as signals to andfacilitate investor engagement with (potential)
constituents of the benchmark.

Facilitate
engagement toimprove issuer
behaviour

31 NZIF_IIGCC-Target-Setting-Guidance.pdf
32 Net_Zero_Investment_Framework_final.pdf (parisalignedassetowners.org)

IIGCC Enhancing the Quality of Net Zero Benchmarks

21

Appendix
Table 3: Sector breakdown of a standard global equity index vs a ‘Paris
Aligned’ version
Standard
global equity
index‘Parisaligned’
global equity
index

Difference

Technology

23.0%

28.0%

5.0%

Financials

15.0%

17.0%

2.0%

Consumer
Discretionary

11.0%

8.0%

-3.0%

Health Care

11.0%

18.0%

7.0%

Communications

9.0%

12.0%

3.0%

Industrials*

9.0%

6.0%

-3.0%

Consumer Staples

8.0%

6.0%

-2.0%

Materials*

5.0%

2.0%

-3.0%

Energy*

4.0%

0.0%

-4.0%

Real Estate*

3.0%

3.0%

0.0%

Utilities*

3.0%

1.0%

-2.0%

Sector breakdownby weight

IIGCC Enhancing the Quality of Net Zero Benchmarks

22

Figure 4: IPCC AR6 pathways – different rates of decarbonisation
requiredMedian Warming 2100 (C)2019 - 2030 Decarbonisation % vs Median Warming in 2100

Figure 5: Attribution analysis, Scientific Portfolio33
250
222

1.6

200

1.5

150

1.4

100

1.3

50

1.2

0

-20

-42

12

-7

2

148

-18

1.1

1

0

10

20

30

40

50

60

70

80

GHG
emissions2014

Sectoralallocation

Intra-sectoral
allocation

GHG
emissions
intensity S12

GHG
emissions
intensity S3

SalesMarketGHG
Capitalisation emissions
2019

90

2019 -2030 Decarbonisation (%)

33 This figure is an illustration of the possible outputs of a decomposition model proposed by the EDHEC Business School’s newest venture Scientific Portfolio. The model makes it possible to distinguish between
five factors that influence changes of greenhouse gas emissions of an equity portfolio over time: sector allocation (weight of a given sector in portfolio), intra-sectoral allocation (weight of a stock in the
sector), emissions intensity of the firms (expressed as tons of CO2e per million dollars of sales), sales and market capitalisation. This illustrative figure is based on the analysis of a climate impact index
over the period 2014-2019; the absolute emissions correspond to the greenhouse gas emissions in TCO2e (tons of CO2 equivalent) for 1 million dollars invested in the instrument. The decomposition showsthat the climate impact index achieves its decarbonisation mainly through organic emissions intensity reductions and intra-sectoral allocation, which confirms the ability of the index to reduce its absoluteemissions while limiting sector exposure bias.

IIGCC Enhancing the Quality of Net Zero Benchmarks

23

Table 4: Eight index providers’ net zero offerings34
Index
providerBloomberg

Bloomberg

Bloomberg

Indices

Asset class

PAB/CTB?

Core characteristics

Bloomberg
Paris-Aligned& ClimateTransition
Indices

Equities/
Corporate
bonds

PAB/CTB•

Aims to reflect the technical requirements as set out in the Delegated Act•

Fixed income: Applies a rules-based, exclusion approach to achieve decarbonisation trajectory withmonthly rebalancing.

Bloomberg
MSCI ParisAligned &ClimateTransition
Indices

Corporatebonds

Bloomberg
Government
Bond Carbon
Scored Indices

Sovereignbonds

PAB/CTB

N/A••

Designed to meet and exceed the minimum PAB/CTB standard•

Does not exclude issuers with aggressive emissions reductions targets, or those that are carbon transition
solution providers.

•

•
•
•

FTSE Russell

FTSE Russell

FTSE Global
Climate IndexSeriesEquities

FTSE TPI Climate
Transition IndexSeriesEquities

No

•
•

No

Equities: applies rules-based / optimised constraints to comply with minimum requirements and semiannual rebalancing•••

Achieves the target decarbonisation while minimising tracking error volatility and implementing
optimisation constraints for duration, yield, and sector exposures, including overweighting companies
with credible emissions reductions targets

The series reweights all index-eligible issuers by adjusting market value weights according to their
Climate Risk Score, increasing allocation to countries that score higher, relative to their peers, on specificclimate-related issues
Bloomberg’s Government Climate Risk Scores measures a country or region’s progress in meeting thetemperature rise and climate goals set out in the Paris Agreement on a 0-10 scale, with 10 being best
The indices do not include one type of index or methodology, but a group of alternative weighting
methodologies applicable to any Bloomberg Government Bond Index, including both standard andcustom indices.

Designed to reflect the performance of a global and diversified basket of securities where their weights
are varied based on three types of climate-related factors (carbon emissions, fossil fuel reserves, andgreen revenues data)
Aims to maintain similar risk/return characteristics to the underlying universe.

Objective is to consider past- and forward-looking trends, and favour constituents that are positioned toprevail in a low carbon economy thus supporting effort to address climate change.
Adjusts market capitalisation weights based on the level of greenhouse gas (GHG) emissions, green
revenues, fossil fuel reserves, climate governance score (TPI MQ), carbon performance score (TPI CP)

Companies with targets that are not aligned with a scenario of 2 degrees or below 2 degrees warming,or a country’s NDC plan are scored at zero but are eligible for re-entry into the index once their targets
improve.

34 Please note the descriptions of net zero offerings in the market have been provided by the index providers

IIGCC Enhancing the Quality of Net Zero Benchmarks

24

FTSE Russell

FTSE EU Climate
BenchmarkEquities

PAB/CTB••

Index Series•
FTSE Russell

FTSE Climate
Risk-Adjusted
Government
Indexes

Sovereign
bonds

N/A

•
•
•
•

FTSE Russell

FTSE Greenrevenue IndexSeriesEquities

No

•
•
•
•

FTSE Russell

FTSE
Environmental
Markets IndexSeriesEquities

No

•
•
•
•
•

ICE Data
Indices

Government
CarbonReduction
Indices

Sovereigns

N/A

Adjusts market capitalisation weights based on the level of GHG emissions, green revenues, fossil fuelreserves, climate governance score (TPI MQ), carbon performance score (TPI CP) in line with minimum
standards of EU Low Carbon Benchmark regulation
Scope 3 GHG emissions data incorporated on an ongoing basis in line with regulation.

Objective is to allow sovereign bond investors to consider climate change risks in their investment
portfolios

Monthly market value weights are tilted by annual country climate scores to improve exposure to climate
risks while minimising tracking error
Climate risk quantitatively assessed on physical risk, transition risk and climate resilience

The ‘advanced’ solution variant of the index aims to maximise environmental benefits without tracking
error constraints or targets by increased powers on tilts.
Aims to reflect performance of global companies engaged in the transition to a green economy,
capturing changes in revenues derived from green goods, products and services

Companies are analysed and categorised using the FTSE Green Revenues Classification System (tiers 1 + 2)
Eligibility in the indices depends on the portion of green revenues as classified by the FTSE Green
Revenues Classification System to total company revenue

Indexes within the series weighted either by Market Capitalisation or tilting according to percentage
eligible revenues, with capping.
Series measures the performance of global companies that have significant involvement inenvironmental business activities and the green economy.
Split into two sets:

Environmental Opportunities Indexes - Measures the performance of a range of companies that havesignificant involvement in environmental business activities (>20% exposure to tiers 1+2 Green Revenues).
Environmental Technology Indexes - Measures the performance of pure play companies whose corebusiness is in the development and deployment of environmental technologies (>50% exposure to tier 1
Green Revenues)
Some indexes divided by Green Revenue Sector, others by region. Each series also includes “Top 100”
variant including largest 100 eligible companies by market capitalisation.

•

Objective is to minimise the estimated tracking error versus the parent index•

Constraints of the index include maximum and minimum bond weights of 500% and 20% respectively,
index duration within +/- 0.25 of the parent index, maximum country weight = 50%, index carbon metricinitially set to 20% target reduction relative to the parent index••

IIGCC Enhancing the Quality of Net Zero Benchmarks

Objective is to align with regulatory objectives, capturing the goals of the Paris Agreement whilstreflecting the performance of the parent index

Uses optimisation process to tilt weights of constituent countries to lower the weighted average carbon
footprint of the overall index

Information used based, in part, on CO2 per capita (EDGAR Carbon Data Report).

25

ICE Data
Indices

Corporate
Climate Indices

Corporate
bonds

PAB/CTB/
No

•
•
•
•

MSCI

ClimateChange Indexes

Equities/
Corporate
bonds

CTBaligned

•
•
•

MSCI

Paris-aligned
Indexes

Equities/
Corporate
bonds

PAB

•
•
•

MSCI

MSCI

Climate Action
Indexes

Equities

Low Carbon
Indexes

Equities

No

•
•

No

•
•
•

MSCI

Fossil Fuels
Exclusion
Indexes

Equities

IIGCC Enhancing the Quality of Net Zero Benchmarks

No

•
•

Two PAB variants, two CTB variants and two ‘Net Zero’ variants not meeting EU regulation (by using
revenues to measure emissions reductions)

Non-EU regulatory variants have targets of 7% y-o-y emissions reductions; Excl. fossil fuel variant must be
at least 50% the carbon level of the parent index, whilst the other must be at least 30% below

The index carbon reduction is met by applying weighting tilt factors to constituents ranked based on theirrelevant carbon metrics, adjusting weights based on market capitalisation
All include basic ESG exclusionary filters (i.e., emissions disclosures, controversial weapons/tobacco,
DNSH). Three variants include an additional filter targeting certain fossil fuel-related businessinvolvements.

Objective is to represent the performance of the parent index whilst re-weighting based on opportunities
and risks associated with the transition to a lower carbon economy, while minimising exclusions andexceeding the minimum standards of the EU CTB criteria
Emissions reduction targets captured in MSCI’s Low Carbon Transition score

Underweight companies facing higher transition risk, maintain higher green/fossil fuel revenue ratio thanthe parent, overweight companies providing solutions.
Aims to address climate change in a holistic way, reducing exposure to physical and transition risks andincrease exposure to sustainable opportunities while exceeding the minimum standards of the EU PAB
and incorporating TCFD recommendations.
Designed to reduce its GHG intensity by 10% every year; achieved through re-weighting and selection ofcompanies during rebalancing, using MSCI’s Climate Value-at-Risk

Optimisation parameters target an increased weight for companies based on their Low Carbon Transition
Score (+10%), emission reduction targets (+20%) and green revenues (x4/100% minimum increase).
Designed to represent the performance of companies that have been assessed to lead their sector peersin terms of their positioning and actions relative to a climate transition
Select top 50% of companies by count in each GICS sector based on emissions intensity for scopes 1, 2
and 3, science-based targets, risk management and green revenues.

Intended to help identify potential risks associated with the transition to a low carbon economy while
representing the performance of the broad equity market, addressing carbon emissions and fossil fuelreserves
Low Carbon Target Indexes re-weights stocks based on their carbon exposure in the form of carbon
emissions and fossil fuel reserves

Low Carbon leader indexes aim to achieve at least 50% reduction in the carbon footprint of the parent
by excluding companies with the highest carbon emissions intensity and the largest owners of carbon
reserves whilst minimizing the tracking error relative to their parent index.
Developed for use by institutional investors who aim to eliminate or reduce some or all fossil fuel reserves
exposure from their investments

The two variants, Ex Fossil Fuels Index and Ex Coal Index, have specific screening criteria and are free floatadjusted market capitalisation weighted.

26

MSCI

MSCI

QontigoGlobalEnvironment
Indexes

Equities

ClimateTransition
Corporate Bond
Indexes

Corporatebonds

STOXX Low
Carbon Series

Equities

No

•

CTB

No

STOXX Climate
Change Series

Equities

STOXX EU
ClimateBenchmarks

Equities

No

Section 22
of Qontigo’s
rulebook

PAB/CTB

Designed to maximize exposure to environmental impact themes by including companies that focus onoffering products or services that contribute to a more environmentally sustainable economy by making
a more efficient use of limited global natural resources

Companies deriving 50% or more of their revenue cumulatively from the six Environmental Impact
themes are eligible for the index based on their level of involvement and strategic commitment to the six
environmental themes.
Aims to re-weight securities by reducing exposure to absolute greenhouse gas emissions, absolute
potential absolute emissions, and weighted average “Green Revenues” to weighted average “Fossil fuelbased Revenues”. These indexes exceed the minimum standards of EU CTB

Emission reduction targets (30%), annual emission reduction target (7%), at least equivalent ratio of Green
Revenue/ Fossil fuels-based Revenue.

•

Designed to help investors decarbonise their portfolios and limit the exposure to climate-related risks•

Excludes coal and penalises stocks with missing data.

•••

Section 13.5
of Qontigo’s
rulebook
Qontigo••Section 13.4
of Qontigo’s
rulebook
Qontigo•Carbon-tilt overweights low emitters and underweights high emitters; Price weighted – free-float market
cap multiplied by the corresponding Z-score carbon intensity factor of each constituent

Incorporates the CDP climate change scoring methodology which evaluates companies based onprogress in the transition towards low carbon economy
Three categories: Climate Awareness, Climate Impact, Climate leaders.

•

Encourage climate stewardship and corporate engagement to meet carbon reduction goals•

Scope 3 data used from inception••

CTB aims for 40% GHG intensity reduction, PAB aims for 60% intensity reduction
Both CTB and PAB baseline exclusions are for companies that fail:•Global Standards Screening•

Tobacco producers (0% revenue threshold)••Controversial weapons

Significant obstruction to the UN Sustainable Development Goal (SDG)•

12, Responsible Consumption and Production•

14, Life Below Water••

IIGCC Enhancing the Quality of Net Zero Benchmarks••

13, Climate Action
15, Life on Land

ESG Controversy Rating of Category 5 (Severe) (as identified by Sustainalytics)

PAB imposes additional activity exclusions as well.

27

Qontigo

STOXX Climate
Transition Risk

Equities

No•

Section 14.16
of Qontigo’s
rulebook
S&P Global35

S&P Net Zero
2050 ParisAligned andClimateTransition(PACT) Indices••
Equities

PAB/CTB

Corporate
bonds

PAB

•

Incorporates additional climate objectives to reduce climate physical and transition risk, increase
exposure to climate opportunities (in alignment with the TCFD) and broad ESG objectives. Also aligns witha 1.5°C scenario on a forward-looking basis using Trucost’s Transition Pathway Model

S&P Net Zero
2050 Carbon
Budget Indices

EquitiesNo

S&P Carbon
Control IndicesNo

Weights are determined using a glass-box optimization to minimise the difference in constituent weights
relative to the underlying index in terms of stocks, sectors and countries.

•

Incorporates additional climate objectives to manage risk and climate change opportunities (inalignment with the TCFD), increasing exposure to companies with higher ESG Risk Score and green bonds,
and reducing exposure to stranded assets•••

Equities

Applies exclusions based on companies’ involvement in specific business activities, violations of theprinciples of the United Nations’ Global Compact (UNGC), and involvement in relevant ESG controversies.

Indices align with EU Low Carbon Benchmark regulation•
S&P Global

Reduces overall GHG emissions intensity (50% for Paris-Aligned and 30% for Climate Transition) andfollows minimum 7% self-decarbonization rate in line with the IPCC’s 2018 Special Report on 1.5°C••
S&P Global

Weighted by free-float market cap adjusted for Climate Transition Value-at-Risk with individual
constituents, industry and country constraints applied.
Indices align with EU Low Carbon Benchmark regulation••iBoxx EUR
Corporates Net
Zero 2050 ParisAligned ESG

Securities screened for sustainability criteria using Global Standards Screening, Controversial Weapons,
Thermal Coal and Oil Sands••

S&P Global(former IHS
Markit)Leverages WTW’s proprietary Climate Transition Value at Risk data, assessing the anticipated impact of aclimate transition on company valuations through forward-looking, bottom-up analysis••

Implements a weighting strategy which aims to minimise turnover and track maturity, rating, industry,
option adjusted duration and duration times spread profile of the parent index, while meeting a range of
ESG constraints

Applies exclusions based on companies’ involvement in specific business activities, violations of theprinciples of the United Nations’ Global Compact (UNGC), and involvement in relevant ESG controversies.

Targets a defined carbon budget from each index’s launch year to 2050, based on the IPCC 2021 Report’s
estimate for worldwide emissions to limit warming to 1.5C with an 83% probability
Aims to achieve the budget through a constraint on ownership of scope 1, 2 and 3 GHG emissions that
results in an initial footprint reduction and a yearly decarbonisation rate

Weights are determined using a glass-box optimization to minimise the difference in constituent weights
relative to the underlying index in terms of stocks, industries and countries.
Weights are determined using a glass-box optimization to minimise index-level weighted average carbon
intensity, subject to index active share, industry group weight, country weight and diversification constraints
Applies exclusions based on companies’ involvement in specific business activities, violations of theprinciples of the United Nations’ Global Compact (UNGC), involvement in relevant ESG controversies, andcompanies with low S&P DJI ESG Scores within their GICS Industry Group35 © 2023 S&P Dow Jones Indices LLC (S&P DJI). All rights reserved. The information provided is a summary of certain S&P DJI indices. Please refer to S&P DJI’s published materials and methodologies for more
information available at https://www.spglobal.com/spdji/en/

IIGCC Enhancing the Quality of Net Zero Benchmarks

28

S&P Global

S&P Carbon
Efficient Indices

Equities

No

•
•
•

S&P Global

ScientificBeta

S&P Fossil Fuel
Free Indices

Equities

SciBeta
Climate Impact
Consistent
Indices

Equities

No••

Standard
version/PAB

Solactive ISS
ESG ParisAligned
BenchmarkIndex Series

Equities/
Corporate
bonds

PAB

Overweights or underweights companies that have lower or higher levels of greenhouse gas emissions
per unit of revenue, calculated using the S&P Carbon Global Standard
Excludes companies deemed high non-disclosing carbon emitters, according to Trucost

Measures the performance of companies in the underlying index that do not own proven or probablefossil fuel reserves with greater than 50% recovery probability
Each index is float-adjusted market capitalisation weighted.

•

Core ESG and non-reporting exclusions for both indices, additional exclusions in PAB•

Broad capitalisation-weighting anchoring to target sector neutrality, with liquidity, signal consistency,
carbon intensity and sector exposure constraints••
Solactive

Designed to reduce exposure to high-carbon companies in a systematic way, while maintaining
respective GICS industry group weights of its underlying index•••

Weighting as per carbon intensity within carbon-oriented classification sectors, and adjustments made fordisclosure, SBTs and climate mitigation revenues (no capitalisation-weighting anchoring within sectors)

Standard version holds immediate target reduction of 0% (as opposed to 50% for PAB).

Equities benchmarks overweight companies with SBTs and holds constraints: Maximum 0.5% individual
weight deviation from parent index, individual weight cap maximum of 5% and sector weight deviation
minimum of 5% and 0.5 x parent index weight

Fixed income constraints: Rating buckets, maturity buckets, sector deviation, issuer-level deviation: + / 2.5% vs parent. Issuer weight 3% cap, bond level deviation + / - 0.2%, turnover constraint: parent + max. 5%
Immediate consideration of scope 3 emissions for equities and fixed income.

Solactive

Solactive ISS
ESG Screened
Paris-Aligned
SeriesEquities

PAB•

Similar to Solactive ISS ESG Paris-Aligned Series, but with additional activity-based exclusions, higher
initial decarbonization (55%), higher overweight of companies with SBTs (at least 10%), additional
overweight of companies with significant positive contribution to environmental SDGs by at least 10%

Solactive

Solactive ISS
ESG Net Zero
Pathway IndexSeriesEquities

PAB•

Similar to Solactive ISS ESG Paris-Aligned Series, but with additional activity-based exclusions (e.g., civilian
firearms), exclusions based on ESG rating

Solactive Paris
Aware Global
Government
Bond IndexSeriesSovereignand/orcorporatebonds

Solactive

•
N/A

•
•

•

IIGCC Enhancing the Quality of Net Zero Benchmarks

Additionally, weights are tilted using three factors: SBTs, quality of climate disclosures, green revenues
Solactive Paris Aware Global Government Index tracks global local currency government bonds ofinvestment grade-rated countries and features a minimum reduction of 14% in carbon intensity (percapita) compared to the investable universe as well as a 7% reduction per year against itself

Solactive Paris Aware Global Aggregate Index combines constituents of the Solactive Paris Aligned Global
Corporate Index and the Solactive Paris Aware Global Government Index with the sovereign part receiving
an aggregate weight of 70% and the corporate part a corresponding weight of 30%. The index reflects therespective decarbonization features of its parts

Series is named “Paris Aware” and not labelled as a PAB since the EU Regulation does not cover sovereign
bonds. In practical terms the series features PAB-like decarbonization features for the sovereign part while
the corporate bonds part is fully compliant and labelled as a PAB

29

Glossary
Active investing: Investment strategies that have thegoal of “beating the market” or getting better returns thancertain standard benchmarks.
Benchmarks: Benchmarks have various key functions.
They serve as portfolios for investors seeking passive
exposure to a particular market segment, are used as
performance standards against which to measure thevalue generated by active managers, act as proxies
for asset classes, and provide a reference point for
determining the price or value of various financial
instruments or transactions.36
Broad market indices: Indices that track the performanceof a large group of stocks picked to represent the broader
stock market. Most stock market indices are constructedbased on market capitalisation, the higher the market
value the greater the weight of that security in the index.
Examples of broad-based indices are the S&P 500,
NASDAQ Composite, MSCI World Index.
Net zero benchmarks: an investment benchmark thatincorporates specific objectives related to greenhouse gas(GHG) emissions reductions and the transition to a low
carbon economy through the selection and weighting ofunderlying constituents.
Cumulative benchmark divergence metric (CBD):
Method of assessing climate target alignment. It evaluates
the cumulative divergence of the company target
pathway from the benchmark through time, yielding asingle % measure of relative alignment (he more positivethe value, the less aligned the company’s targets: themore negative the value, the more the targets outperformthe benchmark).37
Constituent securities: Individual securities within amarket index.
Divestment: It is the opposite of investment. The reductionof some kind of asset for financial, ethical, or politicalobjectives, or the sale of an existing business by a firm.

Double Materiality: materiality should be understood fromtwo perspectives, the financial materiality, and the impact
materiality. The first, involves considering factors that, inthe broad sense, can affect the value of the company. The
second involves environmental and social impact of thecompany’s activities on a broad range of stakeholders.
(European Commission, 2019)
Exchange-traded funds (ETFs): A basket of securities
that trades on an exchange just like a stock does. They
typically track a particular index, sector, commodity, orother assets.
Fiduciary duty: Fiduciary duty is the requirement thatcertain professionals, like lawyers or financial advisors,work in the best financial interest of their clients.
Benchmark provider or Index Provider: Data providers
that construct indices and benchmarks for a variety ofasset classes.
Indexing refers to strategies intended to replicate theperformance of benchmark indices.38
Indices: Sets of securities and/or assets that havebeen aggregated based on pre-set criteria and whose
aggregate value and composition is determined by predetermined rules. (CFA Society UK)39
Inflation-adjusted return: A measure of return that takes
into account the time period’s inflation rate.
Investment mandate: A set of instructions laying out how
a pool of assets is to be invested, and the investment’s
expected risk/return profile.
Market capitalization weighting: Assign a weight toeach market index constituent based on its market
capitalization i.e., the product of the number ofoutstanding shares and the current market value of eachsecurity.

Mutual Fund: Investment vehicle consisting of a portfolioof stocks, bonds, or other securities, overseen by aprofessional manager. Unlike ETFs, Mutual Funds do notoffer the possibility for intra-day trading.
Net Zero alignment (NZA): Net zero refers to a state inwhich the greenhouse gases going into the atmosphereare balanced by removal out of the atmosphere. In 2020,
the IIPCC stated that limiting warming to 1.5°C implies
reaching net zero carbon emissions globally around 2050
and concurrent deep reductions in emissions of noncarbon forcers, particularly methane.40
Optimisation: A benchmark construction approachin which the universe is defined according to whether
potential members perform sufficiently well according to aparticular scoring metric.
Passive investing: Any rules-based, transparent, andinvestable strategy that does not involve handpicking
investments to outperform benchmarks. Index investingis the purest form of passive investing and aims to match
the performance of benchmark indexes. (CFA, 2022)
Paris-Alignment (PA): The Paris Agreement sets out aglobal framework to avoid dangerous climate change bylimiting global warming to well below 2°C and pursuingefforts to limit it to 1.5°C. Paris-Alignment refers to activities
that are consistent with the Paris Agreement’s long-term
mitigation goal.
Tilting: A process in which the weights of the constituent’s
benchmark are redefined based on performanceaccording to one or more metric.
Tracking error: The difference between a portfolio’s
returns and the benchmark or index. It is typicallycalculated as the standard deviation of the difference inthe portfolio and benchmark returns over time.

36 CFA Society UK. https://www.cfauk.org/-/media/files/pdf/pdf/5-professionalism/3-research-and-position-papers/benchmarks-and-indices.pdf
37 IIGCC, 2023 From asset to portfolio alignment.
38 CFA Institute. 2022. Passive Equity Investing. Charlottesville, VA: CFA Institute. https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/passive-equity-investing
39 https://www.cfauk.org/-/media/files/pdf/pdf/5-professionalism/3-research-and-position-papers/benchmarks-and-indices.pdf
40 IIPCC, 2020. https://www.ipcc.ch/sr15/chapter/chapter-2/

IIGCC Enhancing the Quality of Net Zero Benchmarks

30

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Disclaimer: All written materials,
communications, surveys andinitiatives undertaken by IIGCC
are designed solely to support
investors in understanding risks
and opportunities associatedwith climate change and takeaction to address them. Our work
is conducted in accordance withall relevant laws, including dataprotection, competition laws andacting in concert rules. Thesematerials serve as a guidance
only and must not be used forcompeting companies to reachanticompetitive agreements.
IIGCC’s materials and services tomembers do not include financial,legal or investment advice.