FTSE developed TPI climate transition index – aligning a global equity portfolio with the climate transition

Give a brief overview of your innovative approach to ESG incorporation, its coverage within your firm and why you decided to undertake this approach. 

FTSE Russell created the FTSE Developed TPI Climate Transition Index in collaboration with the Church of England Pensions Board (CofE) and the Transition Pathway Initiative (TPI).  

The partnership sought to embed forward-looking data from TPI into an index that served both the financial and climate objectives of the CofE, as well as provide a product that the wider market could use to support investor stewardship, corporate engagement, and the transition in line with the goals of the Paris Climate Agreement. 

Launched in January 2020, the index provides investors with benchmarks informed by cutting edge analysis to align a broad equity portfolio with climate transition, the goals of the Paris Agreement, and the TCFD recommendations. The Index’s transparent methodology includes tilts and rules that are simply articulated and linked to the Paris Agreement. 

The CofE is moving its £600 million passive developed equity mandate to track the Index, supporting the Pension Board’s objective of aligning its fund with the goals of the Paris Agreement.  

How does this approach stand out in the market? Why is it unique? 

The Index is the first forward-looking equity index that enables passive funds to capture company alignment with climate transition. It combines FTSE Russell’s climate data and expert index design, with TPI’s unique analysis of how the world’s largest and most carbon-exposed public companies are managing the climate transition. The index takes into account: 

• Coverage: Derived from the FTSE Developed index, representing large and mid caps in Developed markets, excluding Korea. 
• Liquidity: Stocks are screened to ensure that the index is tradable. 
• Transparency: Using FTSE Russell’s tilt-based multi-factor methodology. Company engagement on climate change improves their TPI score, which leads to their weight in the index increasing and consequently more investment in-flows. 
• Climate parameter adjustments: Fossil fuel reserves, carbon emissions, green revenues, TPI Management quality, TPI Carbon performance. 

The result is an index that captures the risks and opportunities arising from the climate transition, while also adjusting exposure to companies based on their TCFD-aligned climate governance, and commitments to two-degrees Celsius (2DC) carbon emission pathways. 

Leading and lagging company behaviour is clearly reflected in the areas of climate governance and (separately) 2DC/below 2DC pathways. In particular, companies identified as not aligned to 2DC/below 2DC are removed from the index (but remain eligible for inclusion and can be re-admitted once ‘Paris aligned’ commitments are evident – based on TPI analysis). 

Give a practical example of how you have applied your approach to an investment (security/issuer/sector/asset class/portfolio), including any challenges faced and how you adapted to them. 

The challenge in creating the index was to adjust the index constituent weights using ‘tilts’ (over/under weights) based on a range of constituent-level data, whilst minimising tracking error to the parent benchmark.  

Over an 18-month period the CofE’s objectives and requirements were tested against a variety of simulations, which led to the refinement of the index design. FTSE Russell, TPI and the CofE also undertook a consultation amongst 100 peers on the parameters of the index.  

The result is an index that significantly reduces fossil fuel reserves and carbon emissions exposure whilst increasing exposure to companies generating green revenues. Importantly, the exclusion of companies does not represent disinvestment but differentiation within key energy intensive sectors and therefore a sensible recognition that there is a path for an oil and gas company, steel company, cement company to transition if they set independently verified targets aligned to the Paris agreement. 

What were the outcomes of this initiative for the investment and how have you measured its success? What have you learned from this approach that can be applied more broadly? 

The development of the Index has been an important project for the CofE, which has allocated £600million to a fund tracking the Index. This is a significant switch of its Developed Market passive equities portfolio from an index that, in effect, tracked a 3.8 degree world (and c.20% of its AUM). Adopting this index for the CofE’s passive allocation means the Fund will achieve a 49.1% lower carbon intensity than the benchmark, as well as being invested in companies generating significantly increased green revenue. 

The initiative has had a number of significant outcomes: 

• The Index provides increased exposure to the opportunities arising from the global green economy, with overweights based on FTSE Russell’s Green Revenues dataset. 
• The incorporation of TPI’s core assessments on management quality provides the Index with a forward-looking capability, assessing companies on their plans for transition to a low carbon economy. 
• The Index also supports engagement between investors and companies, incorporating a tool that can signal 2DC transition progress and performance to constituent companies. 
• The Index caters to the growing investor demand for more sophisticated implementation approaches to climate change whilst also meeting existing needs for portfolios with significantly lower carbon emissions (-40%) and fossil fuel reserves (-70%) exposures versus capitalisation weighted benchmarks. 

In terms of applying the initiative more broadly, the creators of the index learned that: 

• It is possible to embed forward-looking carbon data based upon whether companies are aligning with the Paris Agreement. 
• That stewardship and/or engagement objectives can be supported through passive investments. 
• It is possible to incentivise the transition through the use of titles that reward leading companies with double weightings/allocations.
• It is possible to align passive investments to the Paris Agreement.