FTSE Russell – a leading provider of benchmarks that are used extensively by investors across the globe – has removed 34 companies from the FTSE4 Good All-World benchmark (the “FTSE4Good Index”). The companies were removed for failing to meet climate performance standards imposed by the newly introduced ‘Climate Change Score’ system, which is based on parameters created by the Transition Pathway Initiative (“TPI”), an initiative backed by 132 investors with over US$50 trillion in assets under management.
What is the FTSE4Good Index?
The FTSE4Good Index is designed to measure the performance of companies demonstrating specific ESG practices, with the aim of providing a tool for market participants that create and/or assess sustainable investment products.
According to FTSE Russell, the FTSE4Good Index can be used by investors in four main ways:
- “Financial products: as tools in the creation of index-tracking investments, financial instruments or fund products focused on sustainable investment;
- Research: to identify companies with specific ESG practices;
- Reference: as an evolving global ESG standard against which companies can assess their progress and achievement; and
- Benchmarking: as a benchmark index to track the performance of sustainable investment portfolios.”
Investors are increasingly using indices such as the FTSE4Good Index for these purposes (for further information on this increasing investor interest, please read our earlier blog posts here and here).
The new climate performance standards
Prior to FTSE Russell’s introduction of the new ‘Climate Change Score’ system in June 2021, companies were only required to meet broad ESG standards to ensure inclusion on the FTSE4Good Index. However, the introduction of the ‘Climate Change Score’ – which is based on the TPI’s methodology for analysing the climate performance of listed companies – means that companies now must meet minimum scores to ensure FTSE4Good Index inclusion.
The score thresholds are determined by FTSE Russell’s classification of developed and emerging markets, as well by companies’ sub-sector classification, with the most carbon intensive sectors set higher standards. By way of an example, companies in “primary impact subsectors” (such as the fossil fuel, mining and transport sectors) must show that the risks and opportunities of a transition to a low-carbon economy are integrated into their operational decision-making, whilst other “developed market companies” are only required to show that they are “building capacity” towards this integration.
Following the introduction of the ‘Climate Change Score’ system, FTSE Russell gave companies until June 2022 to meet the required standards, or face being removed from the FTSE4Good Index. FTSE Russell also highlighted that 208 companies, representing 13.5% of the stocks in the FTSE4Good Index, were not compliant with the new standards as of June 2021 and so were at risk of being removed in June 2022.
It is notable that 174 companies identified as non-compliant in June 2021 improved their climate performance to ensure compliance.
The majority of the 34 companies removed from the FTSE4Good Index were from the emerging markets and in the “primary impact subsectors” mentioned above, including (but not limited to) companies in the mining, construction, oil & gas, power and shipping sectors. The removals are relevant for both retail and institutional investors, given that FTSE Russell’s range of sustainable investment indices, which includes the FTSE4Good Index, are tracked by over US$260 billion of passive money.
As ESG-related regulations and interest from investors increases in the immediate future, so too will the risk of further divestment from companies that do not pay sufficient attention to ESG-related issues.