Ongoing Support for Transition-focused Indexes
GFANZ urged to ‘un-pause’ work on guidance or pass it off to investor networks.
The Glasgow Financial Alliance for Net Zero (GFANZ) has been encouraged to resume its work on transition-informed indexes (TII) and heighten the ambition of its guidance.
The Institute of Energy Economics and Financial Analysis (IEEFA) has published a report outlining its recommendations for bolstering GFANZ’s draft guidance on TIIs, including red lines for the inclusion of fossil fuel developers, bypassing GFANZ’s proposal for a ‘transition potential’ category, mandatory transition plans, and increased transparency on climate lobbying.
This follows GFANZ’s decision to pause this work as it restructures to focus more specifically on mobilising private finance to support climate transition efforts across emerging markets. The pause gives GFANZ “breathing room” to strengthen its TII guidance to protect investors from greenwashing risk, IEEFA has said.
“TIIs emphasise inclusivity and the role of engagement, embodying a more popular and direct theory of change when compared with EU climate benchmark counterparts,” Alasdair Docherty, IEEFA’s Sustainable Finance and Data Analyst for Europe, told ESG Investor.
“Having been devised by investors, unsurprisingly they are likely to be popular with investors. Benchmarks that come pre-endorsed by the type of institutions that would adopt them perhaps give these indexes the best chance of displacing standard climate agnostic indexes in core investment processes.”
GFANZ published a consultation on the draft guidance in October, outlining recommendations for index providers and users to voluntarily and independently develop and adopt transition-informed indexes that support decarbonisation efforts at the individual company level.
The body proposed three categories of transition-informed indexes: transition-potential (companies demonstrating potential to align with net zero in a time-bound manner), transition-engaged (companies in development, as well as those aligning to net zero), and net zero (companies that are fully aligned or provide a climate solution).
The IEEFA paper noted that the guidance should specifically require those adopting a TII to ring-fence capital so it cannot be used to facilitate fossil fuel expansion. The existing draft GFANZ guidance currently does not encourage mechanisms that might prevent fossil fuel support.
It also does not fully convey the significant risk of carbon lock-in and greenwashing-related risks associated with transition finance, instead implying leniency and a lack of urgency, the IEEFA report said.
In addition, IEEFA has recommended that GFANZ introduce more transparency around corporate climate lobbying and stronger guardrails to ensure that any company included in a TII has credibly committed to net zero alignment with a clear transition plan in place.
“Participation [in the GFANZ consultation] by a wide range of market participants – asset owners, asset managers, consultants and service providers – across the globe attests to the relevance of this topic,” said Thomas Kuh, Head of ESG Strategy at Morningstar Indexes.
“GFANZ provided a forum where these market participants could address relevant issues across the investment value chain.”
Who should take the lead?
GFANZ’s decision to pivot to emerging markets does not make work on TIIs less relevant to them, IEEFA’s Docherty said.
“A clear benefit of a TII approach is that, by assessing the individual credibility of a company’s proposed transition pathway, unintended systematic biases should be less of a concern,” said Docherty.
“TIIs’ promise to ensure emerging markets don’t receive short thrift would therefore still fall squarely under the alliance’s new remit.”
As such, he said it “wouldn’t be entirely unsurprising for GFANZ to simply ‘un-pause’ and continue to develop the guidance”.
“At this time, it appears unlikely that GFANZ would resume this work,” countered Kuh from Morningstar Indexes.
“But it isn’t going away as an issue for investors, and I am optimistic that the effort will be of value.”
The draft guidance has achieved a level where other market participants could carry it forward themselves, both Kuh and Docherty agreed.
They pointed to investor networks such as the Asia Investor Group on Climate Change and the Institutional Investors Group on Climate Change. The latter convened stakeholders on the topic of alternative net zero benchmark methodologies over a year ago.
“TIIs will only gain broad support if investors trust they capture an opportunity set of entities making timely and credible attempts to decarbonise,” said Docherty.
“There is a balancing act to be had. An inclusive approach to benchmark design will be attractive to investors but setting the bar too low risks transition-informed indexes not being taken seriously. Raising the bar will likely limit the opportunity set by a little more than GFANZ’s might have initially envisaged.”
It would be better to set the bar high than low to maintain index integrity, he said.
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