Having already witnessed some of the consequences of climate change around the world, more and more investors are now factoring ESG into their investment decisions. Enter the S&P PACT™ Indices (S&P Paris-Aligned & Climate Transition Indices), created to give market participants access to strategies designed to be compatible with limiting global warming to 1.5°C.
We talked with Francois Millet, Managing Director and Head of Strategy, ESG and Innovation at Lyxor ETF, and Jaspreet Duhra, Senior Director and Head of EMEA ESG Indices at S&P DJI, about the evolving role of ESG in mainstream investing and how these indices may help market participants envision a less fraught future.
Indexology Magazine: Why do you think ESG investing is becoming more important to investors around the world, and do you think the recommitment to climate initiatives in the U.S. adds to the momentum?
Francois: The pandemic triggered a realization that humans are extremely dependent on natural systems. Many investors now work on the widespread conviction that climate and exponential inequalities are major risks—and that mitigating these risks, and building a more inclusive and resilient world with long-term focus, is a precondition for financial stability.
ESG investments captured more than 50% of net inflows to ETFs in Europe last year. This more than offset the negative influence of the official U.S. position on the Paris Agreement at the time. But it's great to see the U.S., which produces around 15% of the world's greenhouse gas emissions, rejoining the Agreement. This recommitment to climate initiatives should bolster the ESG transformation that's already underway and make the Paris Agreement stronger than ever.
Indexology Magazine: Why were the S&P PACT Indices created, and what specific climate goals do they seek to achieve?
Jas: The world is on a dangerous trajectory of warming that is already impacting society and the economy. Regulators are taking action and as investors increasingly take stock of the climate risks in their holdings, more and more are looking to align their investments with a scenario in which warming increases by no more than 1.5°C. The S&P PACT Indices were created with this goal in mind.
The indices are designed to meet the minimum standards for EU Paris-aligned Benchmarks and EU Climate Transition Benchmarks, which means that in addition to lowering carbon emissions relative to their underlying benchmarks, the indices also seek to decarbonize on an absolute basis at a rate of 7% year-on-year. This is the rate of decarbonization required to achieve net-zero emissions by 2050 and limit warming to 1.5°C according to the Intergovernmental Panel on Climate Change. Interestingly, these indices are also designed to maintain the same exposure to high-climate-impact sectors as their benchmarks, which means the decarbonization can't be achieved by just tipping all the weight into low-climate-impact sectors.
We have also gone beyond the EU Low Carbon Benchmark requirements by aligning with the recommendations of the TCFD (Taskforce on Climate-related Financial Disclosures). We believe that the TCFD approach of breaking climate issues into transition risks, physical risks, and opportunities provides a holistic assessment. It's particularly important that our index takes climate change's physical risks into account, as we already see these risks playing out today.
