knowledge 27 February 2020 |

Sustainable Finance:  New Benchmarks

What are the new benchmarks?

The new benchmarks have been created by way of an amendment to the existing EU Benchmark Regulation¹.  (For a summary of the principal aspects of the Benchmark Regulation see our guide from the time of its introduction here.)

An EU Climate Transition Benchmark (“Transition Benchmark”) is defined as a benchmark:

• which is labelled as an EU Climate Transition Benchmark;
• where “…its underlying assets are selected, weighted or excluded in such a manner that the resulting benchmark portfolio is on a decarbonisation trajectory ²; and
• it is constructed in accordance with the minimum standards laid down in…” delegated acts to be adopted by the Commission.

An EU Paris-aligned Benchmark (“Paris Benchmark”) is defined as a benchmark:

• which is labelled as an EU Paris-aligned Benchmark;
• where “…its underlying assets are selected, weighted or excluded in such a manner that the resulting benchmark portfolio’s carbon emissions are aligned with the objectives of the Paris Agreement… ;
• it is constructed in accordance with the minimum standards laid down in [delegated acts to be adopted by the Commission ]…; and
• …the activities relating to its underlying assets do not significantly harm other environmental, social and governance (ESG) objectives.”.

As is apparent from the above definitions, the Paris Benchmark is the more climate-friendly of the two, and imposes more testing criteria.

What are the new obligations?

All Benchmarks

Existing information obligations are enhanced to take into account environmental, social and governance (“ESG”) concerns:

• Methodology:  a benchmark administrator is already required to publish or make available “…the key elements of the methodology…for each benchmark provided and published…”.  From 30 April 2020, the administrator will also be required to explain how those key elements reflect ESG factors (except for interest rate and foreign exchange benchmarks). 
• Benchmark statements  will be subject to a series of increasing obligations over time:
  • by 30 April 2020, benchmark administrators must ensure that:
    • benchmark statements generally are updated to include “…how ESG factors are reflected in each benchmark…”.  For benchmarks that do not pursue ESG objectives, it will be sufficient “…to clearly state in the benchmark statement that they do not pursue such objectives”;
    • for significant equity and bond benchmarks, as well as Transition Benchmarks and Paris Benchmarks, benchmark statements will need to include details of “…whether or not and to what extent a degree of overall alignment with the target of reducing carbon emissions or the attainment of the objectives of the Paris Agreement is ensured, in accordance with the disclosure rules…” set out in the new sustainability-related disclosures Regulation (as to which, see our briefing here);
  • by 31 December 2021, benchmark administrators must (save for interest rate and foreign exchange benchmarks) include in benchmark statements an explanation of “…how their methodology aligns with the target of carbon emission reductions or attains the objectives of the Paris Agreement.”.

Further guidance on the specific information to be provided and the format for its publication is expected to be set out in delegated acts to be adopted by the Commission in due course.

EU Climate-transition and Paris-aligned benchmarks

A new chapter in the Benchmark Regulation provides that the provision of, and contribution to, Transition Benchmarks and Paris Benchmarks will be subject to additional requirements set out in a new Annex III.  These require an administrator of a Transition Benchmark or Paris Benchmark to:

• Publish Methodology:  formalise, document and make public any methodology used for the calculation of the benchmark (eg the list of the main constituents of the benchmark; selection and weighting of factors used in benchmark methodology; criteria applied to exclude assets or companies associated with a level of carbon footprint or fossil fuel reserves incompatible with the benchmark);
• Consult on Changes:  adopt procedures for introducing changes to such methodology.  These procedures must be made public and allow for consultation with benchmark users on any proposed changes; and
• Annual Review:  at least annually, review the methodologies, taking user views into account, to ensure the benchmark reliably reflects its stated objectives.

In addition, as noted above, benchmark statements will need to include details of “…whether or not and to what extent a degree of overall alignment with the target of reducing carbon emissions or the attainment of the objectives of the Paris Agreement is ensured, in accordance with the disclosure rules…” set out in the new sustainability-related disclosures Regulation (as to which, see our briefing here).

Benchmark administrators must comply with these new requirements by 30 April 2020. 

Endeavour to provide Transition Benchmarks

An administrator which is located in the European Union and provides a “significant benchmark” must endeavour to provide a Transition Benchmark by 1 January 2022. 

Other Amendments

The EU took the opportunity to make some non-climate-related changes to the Benchmark Regulation.  Briefly summarised, the more noteworthy provisions include:

• Compelling maintenance:  the power of a competent authority to compel (i) an administrator to continue publishing, and (ii) a supervised entity to contribute to, a critical benchmark is extended to a maximum of five years (previously two years); and
• Transitional rules extended:  the transitional period for the provision and use of existing (at the time of introduction of the Benchmark Regulation) critical benchmarks and benchmarks published by a third-country administrator was extended until 31 December 2021.  This was particularly important in the context of the financial markets’ transition from inter-bank offered rates (such as LIBOR).

Comment

While these amendments to the Benchmark Regulation create additional work for benchmark administrators in particular, they also build another important part of the new framework that the EU requires for its transition to a sustainable finance market.  As such, the EU will expect administrators and supervised users of benchmarks to welcome and fully engage with the work required to implement these new obligations.