Smart beta index provider Scientific Beta has highlighted “significant flaws” in the European Union’s climate benchmarks.

In a letter to the European Commission, the index provider, which was acquired by the Singapore Exchange in January, said there was a lack of “serious” study in the EU’s draft regulation which are designed to introduce new standards on climate change.

Last year, the EU Technical Expert Group published two types of climate benchmarks; the EU Climate Transition benchmark and the EU Paris-aligned benchmark in a move to increase transparency for investors and “de-incentivise” greenwashing.

Major index providers such as FTSE Russell, MSCI, Solactive and S&P Dow Jones Indices have all launched climate indices in response to the EU’s new benchmarks.

However, Scientific Beta has warned the “overly prescriptive” nature of the benchmark requirement and its move to broad-universe capitalisation weights reduces the flexibility to provide investors with climate benchmarks aligned with the diversity of their investment strategy.

The firm stated in the letter: “We feel strongly that climate-conscious investors should not be corralled into one particular class of indices or excessively restricted by implicit methodological options.

“Ensuring flexibility and alignment with investor needs would also contribute to combatting greenwashing by enhancing the scope of effective control exercised over the quality of the claims made by administrators in respect of the climate characteristics of their products.”

Scientific Beta stressed the importance of the benchmarks retaining full flexibility in respect of sector exposures.

“We recommend that the targeted level of decarbonisation be achieved through intra-sector security selection and weighting choices.

“Doing so prevents the gaming of decarbonisation by cross-sector reallocation, which the draft delegated act encourages and which in our view constitutes greenwashing.”

Furthermore, the index provider cited “grave reservations” about the novel ‘carbon intensity’ measure introduced by the EU adding the innovation appears counterproductive.

The letter stressed the importance of having academic and cost-benefit analysis support when utilising novel metrics.

“Scientific Beta questions the authority of the Commission with respect to the imposition of extensive and expensive sustainability disclosures and warns against officially condoning indicators, (ESG ratings) whose inherent divergence has been described in academic literature as an impediment to prudent decision-making.

“We call for sustainability disclosures not only to be theoretically relevant but also be to be fully specified and highly standardised to permit comparisons.”

In terms of next steps, the index provider called for the creation of an administrative body to produce the data required for sustainability disclosures similar to the Council of Ethics set up to support Nordic reserve funds.

Instead of becoming a business opportunity for ESG data providers, Scientific Beta said this would lead to a stronger EU identity of sustainability issues.

ETF Insight: Are ETF and index providers taking ESG seriously?

Noël Amenc, CEO of Scientific Beta, commented: “Unfortunately, this proposal does not go in the right direction. Ultimately, this regulation makes the weights of stocks depend more on their stock market performance than on their ecological performance.

“Even though we have planned to provide versions of our flagship indices that will comply with these standards, which will be a business opportunity for us, we will not recommend that our clients adopt these indices.

“We believe that it is our duty to highlight the flaws and risks that this draft regulation poses for the fight against climate change.”

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