Overview of the EU Benchmark Regulation and the Low Carbon Benchmark Regulation

What is the law/regulation?

As part of a broader European Union (“EU”) initiative on sustainable development which seeks to place environmental, social and governance (“ESG”) considerations at the heart of the financial system, and following a report of the High-Level Expert Group on Sustainable Finance in January 2018, the European Commission made a legislative proposal on low carbon benchmarks and positive carbon impact benchmarks.

Regulation (EU) 2019/2089, known as the “Low Carbon Benchmark Regulation”, was published in the Official Journal on 9 December 2019 and entered into force on 10 December 2019 in order to amend Regulation (EU) 2016/1011 known as the “Benchmark Regulation”.

The Benchmark Regulation establishes uniform rules for benchmarks in the EU. It defines a benchmark as “any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund with the purpose of tracking the return of such index or of defining the asset allocation of a portfolio or of computing the performance fees”.

It also provides for three regimes depending on whether one qualifies as a benchmark ‘administrator’, a benchmark ‘contributor’ or a benchmark ‘user’. A benchmark ‘administrator’, defined as “a natural or legal person that has control over the provision of a benchmark”, is subject to several requirements including, but not limited to, the requirement to be registered or authorized by the national competent authority of the member state in which they are located and to have in place robust governance arrangements which include a clear organizational structure, processes to prevent or manage conflicts of interest and transparency. 

In amending the Benchmark Regulation, the Low Carbon Benchmark Regulation seeks to ensure the integrity of low-carbon benchmarks by introducing two new types of “climate benchmark”, the:

• EU Climate Transition Benchmark (“CTB”), and
• EU Paris-Aligned Benchmark (“PAB”).

There are currently a large number of low-carbon indexes in the market, often labelled and marketed in the same way, despite having different degrees of ambition. Therefore, clarification on these objectives was considered necessary in order to respond to growing concerns regarding potential “green washing”.

A CTB is a benchmark where the underlying assets are selected, weighted or excluded in such a way that the resulting benchmark portfolio provides for a ‘decarbonization trajectory’, which is defined in the Low Carbon Benchmark Regulation as a “measurable, science-based and time-bound movement towards alignment with the objectives of the Paris Agreement”.1

A PAB is a benchmark where the underlying assets are selected, weighted or excluded in a way that the resulting benchmark portfolio’s carbon emissions are aligned with the objectives of the Paris Agreement. It is ambitious in its goals and selects only components which already actively contribute to the attainment of the 2°C temperature reduction target set out in the Paris Agreement. This means in essence that the carbon emissions savings of each underlying asset exceeds its carbon footprint.

What is its scope and impact?

In terms of scope, the Benchmark Regulation applies to the provision of benchmarks, the contribution of input data to a benchmark and the use of a benchmark within the EU. The aim of the Benchmark Regulation is not to protect users of benchmarks worldwide. Article 2(1) states that the Benchmark Regulation applies to the “provision of benchmarks, the contribution of input data to a benchmark and the use of a benchmark within the Union”. Further clarity is provided in the EMSA Q&A on the Benchmark Regulation,2 where ESMA's view is that the Benchmark Regulation does not apply to the provision of benchmarks that are exclusively used outside the EU. The same reasoning applies to the contribution of input data with respect to a benchmark that is exclusively used outside the EU.

In practical terms, an entity located outside the EU could still fall within the scope of the Benchmark Regulation if it acts as an administrator of or a contributor to a benchmark. For example, a non-EU entity that is an “administrator” could fall within the scope of the Benchmark Regulation if it provides an index that is used by “supervised entities”3 in the EU. A non-EU firm that is a “contributor” could be caught by the Benchmark Regulation although this largely depends on whether it is a “supervised contributor”4 or not.

The Low Carbon Benchmark Regulation is intended to provide investors with a user friendly tool for comparative analysis of low-carbon benchmark methodologies by obliging benchmark administrators to make significant disclosures regarding the methodology used to measure and reconcile ESG factors and low-carbon factors in the composition of CTBs and PABs.

The Low Carbon Benchmark Regulation mandates that administrators of all benchmarks or families of benchmarks – save interest rate and currency benchmarks, and subject to an opt-out for those benchmarks not pursuing environmental, social and governance objectives – must provide certain disclosures:

• ESG methodology disclosures: from 30 April 2020, an explanation of how the key elements of the benchmark methodology reflect ESG factors;
• ESG benchmark statement disclosures: from 30 April 2020, inclusion in the benchmark statement of an explanation of how ESG factors are reflected in each benchmark. For those benchmarks or families of benchmarks that do not pursue ESG objectives, benchmark administrators only need to state clearly in the benchmark statement that they do not pursue such objectives; and
• Paris alignment disclosures: from 31 December 2021, inclusion in the benchmark statement of information on the degree of alignment with the target of carbon emission reductions or attainment of the long-term global warming target of the Paris Agreement.

Therefore, while the Low Carbon Benchmark Regulation focuses on benchmark administrators, it may have an impact on benchmark users, such as portfolio and asset managers.

The Low Carbon Benchmark Regulation reinforces the EU’s commitment to the transition towards a low-carbon and greener economy, the continuing growth of sustainable finance and the positioning of the financial sector as a leading global destination for investment in green technologies.

What is the timeline?

The Low Carbon Benchmark Regulation entered into force on 10 December 2019. Obligations under the Low Carbon Benchmark Regulation take effect at different times:

• ESG methodology disclosure obligations apply as from 30 April 2020.
• Inclusion in the benchmark statement of how the methodology aligns with the target of carbon emission reductions of the Paris Agreement must be included from 31 December 2021.
• Administrators located in the EU and providing significant benchmarks are required to endeavor to provide one or more CTB by 1 January 2022.
• Administrators of CTBs are required to select, weight or exclude underlying assets issued by companies that follow a decarbonization trajectory by 31 December 2022, in accordance with certain requirements.

What are the Key Considerations for Asset Managers?

As mentioned above, the main impact of the amendments to the Benchmark Regulation will be felt by those entities that are administrators of or contributors to benchmarks within the EU. Although non-EU asset managers are unlikely to be administrators of EU Benchmarks, they may contribute to sustainable benchmarks.

Asset managers that are administrators of CTBs and PABs will need to ensure that they are able to provide information to comply with the requisite disclosures as set out in the Low Carbon Benchmark Regulation. Asset managers (both located in the EU and outside the EU) that are contributors to CTBs and PABs will need to understand the methodologies used to create the benchmarks and the information that administrators need to receive to ensure that information that they provide to administrators enables those administrators to comply with their obligations.

Finally, asset managers that use CTBs and PABs will need understand the disclosures introduced by the Low Carbon Benchmarks so that they can make meaningful use of the information and determine the extent to which benchmarks are genuinely focussed on ESG consideration.