Paris-Aligned Benchmarks in Practice. Insights into Implementation.

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The Paris-Aligned Benchmark (PAB) requirements, formalized by the European Commission in 2020, have seen widespread adoption by institutional investors seeking to align portfolios with the 1.5°C temperature goal set by the Paris Agreement and their own climate-risk-driven investment strategies. The European Commission’s introduction of minimum benchmark standards for qualification as EU PAB has supported their use in active and indexed investment strategies alike.

Five years on, PAB standards have been used in many standalone climate indexes as well as those incorporating broader sustainability objectives or other key investment outcomes (factor and thematic exposures, for example). Nevertheless, implementing the methodology at scale has presented challenges. These include the availability, granularity and stability of input climate data, the interpretation and extent of exclusion criteria, and the feasibility of the prescribed decarbonization pathways.

In this research paper, we draw on MSCI’s experience in designing and maintaining PAB indexes to examine these practical realities of implementation. Through a mixture of historical examples, simulation and scenario analysis, we illustrate how PAB standards need not hinder the achievement of the targeted index objectives, whether for global or regional equity universes. In particular, we find that even if real-world decarbonization continues to fall short of company and policy targets, the decarbonization requirements of PAB indexes linked to large regional or global benchmarks should be achievable through careful index construction and rebalancing.