Benchmark Regulation: ESG disclosure requirements and low-carbon benchmark criteria published

Key Points

• The European Commission has published draft delegated regulations under the amended Benchmark Regulation. These set out:
  • the ESG disclosure requirements in relation to benchmark statements and benchmark methodologies; and
  • the minimum standards required for the new "Climate Transition Benchmarks" and "Paris-aligned Benchmarks".

• The proposed rules follow the recommendations made by the Technical Expert Group on Sustainable Finance in its September 2019 report but with some changes, particularly in relation to the ESG disclosures, to align with current market practice in benchmark factsheets.

• The delegated regulations are subject to a public consultation period ending on 6 May 2020 and, thereafter, scrutiny by the European Parliament and the Council for up to three months prior to final publication. As the disclosure requirements under the Benchmark Regulation apply from 30 April 2020, market participants are left hoping for formal notification from their national competent authorities that compliance will effectively be waived until the rules have been finalised.

Background

The EU Benchmark Regulation (BMR), as amended by the EU Regulation on Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks (the Low-Carbon Regulation) (covered in our briefing here) entered into force in December 2019 and created two new categories of benchmark under the BMR – Climate Transition Benchmarks (CTBs) and Paris-aligned Benchmarks (PABs). The Low-Carbon Regulation also mandated various sustainability-related disclosures for benchmark administrators, with regard to both benchmark methodologies and benchmark statements, with the detailed requirements to follow by way of level 2 regulations.

In September 2019, the Technical Expert Group on Sustainable Finance (TEG) published a report setting out its recommendations relating to the new climate benchmarks and ESG disclosure requirements (covered in our briefing here). The TEG report was subject to extensive public consultation.

On 9 April 2020, three delegated acts (the Acts) were published by the European Commission (the Commission) under the Low-Carbon Regulation. The Acts set out:

• details of the minimum content to be included in the disclosure of how environmental, social and governance (ESG) factors are reflected in a benchmark's methodology; 
• details of information to be disclosed in a benchmark statement of how ESG factors are reflected in the relevant benchmark(s); and
• rules on the minimum requirements for a benchmark to be labelled as a CTB or a PAB, and transparency requirements for these benchmarks' methodologies.

In the Acts, the Commission has followed the TEG's recommendations in most areas. However, some changes have been made, to streamline the recommendations and to maintain consistency with international standards. In particular, the Commission took note of the current practice of providing voluntary ESG disclosures in the factsheets of many benchmarks, and sought to more closely align the new rules with market practice.

The Acts are now subject to public consultation, which will run until 6 May 2020. After the consultation, the Acts will need to be adopted by the Commission and will then be subject to scrutiny by the European Parliament and the Council. The scrutiny period usually lasts for three months but can be extended or, if the non-objection process is used, curtailed. Assuming that the Acts are approved at the end of the scrutiny period, the Acts will be published in the Official Journal of the EU and will enter into force twenty days later. The final approval of the Acts will therefore occur after the 30 April 2020 compliance deadline set out in the BMR, leading to speculation that ESMA might issue some form of "forbearance statement", indicating that national competent authorities should not take action against non-compliant administrators until, at the earliest, the rules have been finalised, or, ideally, some time thereafter. 

The Acts

The three Acts cover:

• ESG disclosure requirements in relation to the benchmark statement;
• ESG disclosure requirements in relation to the benchmark methodology; and
• the minimum standards required for a benchmark to be labelled a Climate Transition Benchmark or a Paris-aligned Benchmark.

We discuss each of these in turn below.

Draft delegated act on the explanation of ESG factors in the benchmark statement (the Benchmark Statement Regulation)

The Low-Carbon Regulation introduced the requirement (under Article 27 of the BMR) that, for each prescribed element of their benchmark statements, administrators of ESG benchmarks must include an explanation of how ESG factors are reflected in the applicable benchmark or family of benchmarks. 

The detailed disclosure rules in the Benchmark Statement Regulation vary between benchmark types and, within each type, the relevant ESG factor. The prescribed benchmark types are as follows:

• equity benchmarks;
• fixed income corporate benchmarks;
• sovereign debt benchmarks;
• private equity benchmarks;
• private debt benchmarks; and
• commodity benchmarks.

The disclosure requirements within each type are further broken down by each of environmental, social and governance requirements, and there is a voluntary option to include a weighted average ESG rating of the benchmark. ESG factors are to be disclosed on an aggregated weighted average value basis, rather than at benchmark constituent level, and additional information may be included where relevant.

Annex I of the Benchmark Statement Regulation sets out a standard form disclosure template. Where a benchmark does not pursue ESG objectives, the template must be used nevertheless, but the administrator need only tick a "no" in the relevant box and the disclosure requirements will not apply.

Draft delegated act on the minimum content of the explanation of how ESG factors are reflected in a benchmark's methodology (the Methodology Regulation)

The Low-Carbon Regulation introduced the requirement (under Article 13 of the BMR) that administrators of benchmarks (save interest rate and foreign exchange benchmarks) must provide an explanation of how the key elements of their benchmark methodologies reflect ESG factors. 

As with the Benchmark Statement Regulation, the detailed disclosure rules in the Methodology Regulation vary between benchmark types and, within each type, the relevant ESG factor. For benchmarks which are pursuing ESG objectives, the key disclosure is to set out "a list of ESG factors that are taken into account in the methodology, and an explanation of how each factor is used for the selection, weighting or exclusion of underlying assets". ESG factors are to be disclosed on an aggregated weighted average value basis, and additional ESG factors and related information may also be added where relevant.

As with the Benchmark Statement Regulation, the Methodology Regulation sets out a standard form disclosure template. Where a benchmark does not pursue ESG objectives, the template must be used nevertheless, but the administrator need only tick a "no" in the relevant box and the disclosure requirements will not apply. The information in the template must be updated whenever the benchmark methodology is changed.

Draft delegated act as regards minimum standards for EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks (the CTB and PAB Regulation)

The Low-Carbon Regulation introduced two new low-carbon benchmark labels: EU Climate Transition Benchmarks (CTBs) and EU Paris-aligned Benchmarks (PABs). The CTB and PAB Regulation sets out the minimum requirements to be met in order for a benchmark to be labelled a CTB or a PAB.

The key requirements can be summarised as follows:

• Reference Temperature Scenario: the methodologies used to construct CTBs and PABs must use the 1.5°C temperature reference scenario referred to in the IPCC's¹  Special Report on Global Warming of 1.5°C, with no or limited overshoot.
• Equity Allocation Constraints: the exposure of CTBs or PABs to certain specified sectors (including transportation, construction, real estate and manufacturing) must be at least equivalent to the corresponding exposure of the underlying "investable universe"².
• Calculation of Greenhouse Gas: administrators of CTBs and PABs must calculate the greenhouse gas intensity of these benchmarks using the same currency for all of their underlying assets, and must recalculate the greenhouse gas intensity and the absolute greenhouse gas emissions of those benchmarks annually.
• Scope 3 (GHG) emissions data: administrators are required to include Scope 3 GHG emissions data³  in CTB and PAB methodologies, but the requirement is being phased in as follows: 
  
  • data relating to the energy and mining sectors must be included from the date on which the rules start to apply;
  • data relating to additional prescribed sectors (including the transportation and construction sectors) must be included from two years after the introduction of the rules; and 
  • data relating to all other relevant sectors must be included from four years after introduction of the rules. 

• Weight increase of companies that set and publish GHG emission reduction targets: administrators of CTBs and PABs may only increase the benchmark weight of companies that set and publish GHG emission reduction targets where those companies:
  
  • consistently and accurately publish their Scope 1, 2 and 3 GHG emissions; and
  • have reduced their GHG intensity or, where applicable, their absolute GHG emissions, including Scope 1, 2 and 3 GHG emissions, by an average of at least 7% per annum for at least three consecutive years.
• Decarbonisation trajectory: the decarbonisation trajectory target of CTBs and PABs must be at least, on average, an annual 7% reduction of GHG intensity. Administrators must disclose the decarbonisation trajectory targets and, if the targets are not met, the reasons for that failure and the steps that they will take to reach the adjusted compensating target referred to below.

• Loss of label: if a target is missed, the administrator must upwardly adjust the following year's targets in compensation. If a target is missed (i) in a given year and this is not compensated in the following year, (ii) two years in a row, or (iii) three times in any consecutive 10-year period, the administrator may no longer label the benchmark as a CTB or PAB. Thereafter, the benchmark may be relabelled as a CTB or PAB if it meets its decarbonisation trajectory target for two consecutive years, but only if it has not already lost the label twice.
• Baseline reduction of GHG intensity or absolute GHG emissions: for CTBs, the GHG intensity or the absolute GHG emissions must be at least 30% lower than the combined GHG intensity or absolute GHG emissions of all of the investable instruments in the asset class in question. For PABs, this figure is higher, at 50%. 

• PAB excluded companies: PABs may not reference any companies which:
  
  • are involved in any activities related to controversial weapons;
  • are involved in any activities related to tobacco;
  • are in violation of the United Nations Global Compact principles or the Organisation for Economic Co-operation and Development Guidelines for Multinational Enterprises;
  • derive 1% or more of their revenues from exploration, mining, extraction, distribution or refining of hard coal and lignite;
  • derive 10% or more of their revenues from the exploration, extraction, distribution or refining oil fuels;
  • derive 50% or more of their revenues from the exploration, extraction, manufacturing or distribution of hydrocarbons, hydrogen and carbon monoxide mixtures present in gaseous state;
  • derive 50% or more of their revenues from electricity generation with a GHG intensity of more than 100 g CO2 e/kWh; or
  • significantly harm one or more of the environmental objectives referred to in the EU Taxonomy Regulation (once in force).

Next Steps 

Under the amended BMR, the new requirements must be met by 30 April 2020, but the final rules will not be known until 6 May 2020 at the very earliest - creating a sort of "regulatory paradox". Administrators will not want to base their preparations on the draft rules, given that the consultation process could conceivably result in change. It is extremely unlikely that the compliance date itself will be moved, as this is a level 1 requirement set out in the BMR itself and any amendment would be complex and time-consuming. Administrators therefore find themselves in the uncomfortable position of hoping for guidance from ESMA that national competent authorities should effectively "waive" the requirements until finalisation of the rules, or, ideally, until a time thereafter when the market has had time to familiarise itself with the new requirements and adapt as necessary.

Authors: Amelia Howison, Lorraine Johnston, Mike Logie and Kirsty McAllister-Jones.




1. Intergovernmental Panel on Climate Change.
2. "Investable universe" is defined as the set of all investable instruments in a given asset class or group of asset classes.
3. Broadly, indirect emissions that (i) are not indirect emissions from the generation of purchased energy, and (ii) occur in the value chain of the reporting company (including both upstream and downstream emissions).