Scientific Beta warns against design flaws in European Commission proposals on Climate Benchmarks and Sustainability Disclosures


Press Release - Boston, London, Nice, Paris, Singapore, Tokyo, May 4, 2020

Scientific Beta warns against design flaws in European Commission proposals on Climate Benchmarks and Sustainability Disclosures

This draft regulation makes the weights of stocks in the new climate indices depend more on their stock market performance than on their ecological performance

In the context of the ongoing consultation on the draft delegated acts implementing the November 2019 update of the EU Benchmarks Regulation, the smart beta index provider Scientific Beta takes exception to key provisions of the European Commission's projects and puts forward remedial proposals.

In a letter dated May 4 addressed to the European Commission in response to the call for feedback that it carried out on these draft delegated acts, and which will also be sent to the European Council and the European Parliament, Scientific Beta criticises the lack of a serious study and the significant flaws in this draft regulation. In particular, Scientific Beta worries about the substitution of enterprise value for revenues in the definition of carbon intensity, which introduces capital market biases (e.g. real estate development, software, and online retailing will be particularly favoured) and instability into carbon metric measurement. It observes that the dramatic rise in carbon intensity sustained by index products that embarked the new metric vindicates its earlier warnings that these products would fall foul of the decarbonisation trajectory of the regulatory proposal if faced with a significant fall in equity markets. Last but not least, it explains that the insistence on incorporating value-chain emissions data of insufficient quality to support security selection will lead to financial decisions that will disregard the greenhouse gas emissions reduction efforts in the real economy, which it calls a travesty of the objectives of the Regulation. Scientific Beta recommends giving administrators flexibility in sector allocations while neutralising sector effects to assess decarbonisation, to use the standard version of carbon intensity and to incorporate important value-chain considerations with metrics of sufficient granularity.

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. Scientific Beta calls for sustainability disclosures not only to be theoretically relevant but also be to be fully specified and highly standardised to permit comparisons. In this spirit and to minimise costs to investors, it calls for the creation of an administrative body to produce the data required for sustainability disclosures, including in respect of controversies, in the manner of the Council of Ethics set up to support Nordic reserve funds. Instead of being a business opportunity for the ESG data and service providers that drove the work of the Commission, this act should be the occasion to build a stronger European Union identity on matters of sustainability.

Commenting on the company's stand, its CEO, Professor Noël Amenc, states that "Like all providers that are highly active in the area of ESG, and particularly Low Carbon, investing, we support initiatives that aim to favour the adoption of high standards. Unfortunately, this proposal does not go in the right direction and our previous criticism of the proposal from the Technical expert group on sustainable finance (TEG) remains relevant for the most part. 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. Scientific Beta was set up by an academic institution to advance state-of-the-art equity investing based on scientific ethics and we believe that it is our duty to highlight the flaws and risks that this draft regulation poses for the fight against climate change. In very concrete terms, the new carbon metric will allow a company that has a better stock market performance than the market average to participate proportionally more in the emission of greenhouse gases than others. Ultimately, this regulation makes the weights of stocks depend more on their stock market performance than on their ecological performance."

For more details, please refer to the following documents:

Scientific Beta Letter to the European Commission, May 4, 2020

Unsustainable Proposals, A Critical Appraisal of the TEG Final Report, Scientific Beta Publication, February 2020

As part of its policy of transferring know-how to the industry, EDHEC-Risk Institute has set up Scientific Beta. Scientific Beta is an original initiative which aims to favour the adoption of the latest advances in smart beta design and implementation by the whole investment industry. Its academic origin provides the foundation for its strategy: offer, in the best economic conditions possible, the smart beta solutions that are most proven scientifically with full transparency of both the methods and the associated risks.
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