Author Details

Rumi Mahmood

Rumi Mahmood
Senior Associate, MSCI Research

Helen Droz

Helen Droz
Vice President, MSCI Research

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The Implied Temperature Rise of 'Paris-Aligned' Indexes

  • Today, 90% of public companies have an Implied Temperature Rise above 1.5°C, making it difficult for a diversified benchmark, including a Paris-Aligned Benchmark Index, to have an Implied Temperature Rise of 1.5°C, or even 2°C.
  • The MSCI Indexes that align with the minimum requirements of Paris Aligned Benchmark Indexes exhibited Implied Temperature Rises around 0.8°C lower, on average, than their respective parent indexes, in the range of 2.1°C to 2.2°C.
  • While these indexes do not show an Implied Temperature Rise below 2°C today, they are designed to implement year-on-year self-decarbonization so as to be aligned with a 1.5°C target over the long term.

MSCI Implied Temperature Rise is an intuitive climate-focused metric that can be used to assess the net-zero alignment of a company or portfolio, as we have reviewed in previous research. The same methodology can be applied to an index’s current holdings. How do temperatures look for today’s constituents of climate-focused indexes, in particular those that are designed to meet or exceed the requirements of the EU Paris-aligned Benchmarks (PAB) standard?1

 

Constructing PAB Overlay Indexes

A PAB version of a cap-weighted parent index, such as the MSCI ACWI Index, first excludes particular categories of fossil-fuel-intensive companies. The MSCI PAB Overlay Index methodology then applies the following required adjustments:

  • A reduction in index-level carbon intensity of at least 50% from the parent index
  • Subsequent annual reductions in its own index-level carbon intensity by 7% 2

 

Implied Temperature Rise of MSCI PAB Overlay Indexes vs. Parent Indexes

MSCI Implied Temperature Rise data as of Oct. 29, 2021. Source: MSCI ESG Research LLC, MSCI PAB Overlay Indexes

The holdings of the MSCI PAB Overlay Indexes, as of the end of October, exhibited consistently lower temperatures versus their parent indexes (0.7°C to 0.8°C lower) as a result of these fossil-fuel-related exclusions and decarbonization relative to the parent indexes. On average, they had 66% lower financed emissions. But why do the MSCI PAB Overlay Index holdings not exhibit an Implied Temperature Rise of 1.5°C today when they are designed to align with the goal of a 1.5°C rise? To answer this question, we need to understand what an index Implied Temperature Rise assessment shows us, and what these indexes are designed to do.

 

Present State vs. Future Decarbonization

The Implied Temperature Rise for an index reflects an assessment of the underlying companies’ projected emissions and budgets as measured today, taking into consideration those companies’ credible climate-related commitments. It is a forward-looking temperature estimate based on the holdings’ current emissions trajectories. It does not, however, take into consideration the index-level year-over-year self-decarbonization that is a crucial feature of the complete index methodology.

As 90% of the world’s public companies have an Implied Temperature Rise above 1.5°C,3 it would be exceptionally difficult for a diversified benchmark, including a Paris-Aligned Benchmark Index, to have an Implied Temperature Rise of 1.5°C, or even 2°C. An index with an Implied Temperature Rise of 1.5°C today would likely have a high level of concentration and a significant shifting of weights toward the relatively few companies that have an Implied Temperature Rise of 1.5°C or below. This would pose considerable index-construction challenges in terms of balancing diversification and liquidity,

Additionally, the MSCI PAB Overlay Indexes’ annual decarbonization adjustment to achieve a trajectory for 1.5°C alignment cannot be achieved by merely reducing weights to or excluding high-emitting sectors, as the indexes are required to maintain a certain level of exposure to all sectors. Instead, the required 7% annual decarbonization can be accomplished in only two ways:

  • The current index constituents reduce their emissions (intensity) compared to the previous year.
  • The index constituents are changed so that, in aggregate, the index’s emissions are reduced over time.

The future decarbonization produced by these two types of constituent-level changes are not factored into the index’s current Implied Temperature Rise, however. It is important to delineate between where the holdings are today versus where they are designed to be in the future. Over the long term, the MSCI PAB Overlay Indexes are designed to be aligned with a 1.5˚C Implied Temperature Rise through the implementation of decarbonization over time.

 

 

1”EU climate benchmarks and benchmarks’ ESG disclosures.” European Commission, September 2019.

2The minimum year-on-year self-decarbonization for EU PAB benchmark indexes is 7%. This is in line with or beyond the decarbonization trajectory from the Intergovernmental Panel on Climate Change (IPCC) 1.5°C scenario. Please see for more details: “TEG Interim Report on Climate Benchmarks and Benchmarks’ ESG Disclosures.” European Commission, June 2019.

3The MSCI Net-Zero Tracker showed that a near-10% decarbonization rate is required for net-zero alignment starting from MSCI ACWI IMI, as of October 2021. See, “The MSCI Net-Zero Tracker: A quarterly gauge of progress by the world’s listed companies toward curbing climate risk.” MSCI, October 2021.

 

 

Further Reading

What Implied Temperature Rise Means for Funds

Net-Zero Alignment: Portfolio Construction Approaches for Investors

Climate Reality Bites: Actually, We Will Not Always Have Paris

Measuring the Temperature of Your Portfolio

Stress Testing Portfolios for Climate-Change Risk

MSCI Implied Temperature Rise Methodology