Beyond Net Zero: How to Mobilize Passive Investing Towards Paris Alignment With a Focus on the United States
This paper provides a comprehensive and evolving framework for Paris-aligned passive investing, developed through expert consultations, using existing Paris Agreement-related frameworks, taxonomies, data sources, and principles. The framework is then used to analyze existing popular US sustainable funds and EU Paris-Aligned Benchmark funds to see how well they fulfill the criteria, revealing considerable deficiencies in portfolio construction across the board.
Addressing the growing threats posed by climate change is an all-encompassing challenge, one that requires more than just our verbal commitments. Every ambitious promise must come with a plan and be followed by the financial support needed to see it through. Aligning financial streams with the goals outlined in the Paris Agreement is crucial to preventing backsliding and promoting a transition to a stronger, greener economy.
In this spirit, well-intentioned investors have begun to pour their money into passively managed “green” or ESG funds, but the reality is that a lack of standards and transparency has resulted in an investment space that is more gray than green. If we hope to decarbonize and build a climate-resilient, inclusive, and equitable future, it is crucial that investors can buy funds that are aligned with the Paris Agreement. Paris alignment is the standard needed to ensure such a future is possible. This paper introduces a comprehensive and evolving framework with which we can assess these funds and identifies concerning gaps in their portfolio construction, highlighting areas for improvement.
- Across all 35 funds, none was fully aligned with the criteria in our framework.
- Few of the sustainable investing passive funds analyzed incorporate mitigation and resilience into portfolio construction.
- A considerable number of funds include some form of fossil fuel exclusion, but most funds do not consider a deforestation exclusion, physical climate risks and resilience, or climate governance and lobbying in portfolio construction.
- Although no climate-focused fund integrates the just transition theme into its portfolio construction, some broad ESG and social/impact funds do but with significant variance.
- Do no harm exclusions are broadly considered across all types of funds, with weapons and tobacco exclusions being the most prevalent; however, none of the diversified climate or thematic climate funds incorporates exclusions for human rights violations.
- Investment stewardship policies need to be more easily available, transparent, and clearer on tangible action and the need for companies to align with climate change below a 1.5°C trajectory in alignment with the Paris Agreement.
Implications and Recommendations
Gaps in data availability and quality at the constituent company level can make it difficult to develop an index or products using the various criteria proposed in the framework.
The revised EU Benchmark Regulation, as well as its labeled indexes and products, should be enhanced to create funds that are Paris aligned across all criteria.
U.S. asset managers and index providers should work together to create funds that meet the criteria that we outlined for Paris alignment.
Financial regulators should take steps to encourage the growth and improve the transparency of sustainable investing, particularly in the United States.
Asset managers and index providers should provide greater transparency and better disclosures of their methodologies in prospectus and publicly accessible documents because it is not clear how ESG factors are considered and weighted in the security selection process.
Passive fund managers should integrate the Paris Agreement into their stewardship process and make the process publicly available.
Asset owners, including retirement plan administrators, should encourage asset managers and index providers to more closely align with the Paris Agreement.
Asset owners should expect higher tracking errors when benchmarking Paris-aligned passive products against traditional market capitalization benchmarks and consider using PABs.
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