What’s ahead for 2024?

1. Many roads lead to Paris

Since the creation of the first guidance for achieving net zero through a Paris-Aligned Benchmark (PAB) and its less stringent version Climate Transition Benchmark (CTB) in 2019 by the European Commission, we have seen an increase in adoption by a wide range of investors. We have also seen increased scrutiny pointing to several shortcomings and unintended consequences of PAB. Most prominently, the UN-convened Net-Zero Asset Owner Alliance (NZAOA) released its guidance, “Development and Uptake of Net-Zero-Aligned Benchmarks.” The document’s 10 core principles act as a call to action, along with the Institutional Investors Group for Climate Change (IIGCC) guidance, “Enhancing the Quality of Net Zero Benchmarks.”

Based on our discussions with clients, we expect to see more nuanced and thoughtful approaches to decarbonizing benchmarks ‌in 2024. This will include indices that consider different speeds of decarbonization, depending on the region and sector of companies in the portfolio, such as Bloomberg Transition Pathway Indices, launching this year, as well as indices that avoid extensive and mechanical exclusions without offering a road to redemption.

2. From targets to action

In 2023, we saw a rise in the prominence of forward-looking data. The concept aims to incorporate companies’ signals about their intent to improve their carbon emissions by committing to a target or other aspects of green credentials. This has, however, proven to be elusive, and the link between companies’ disclosure and meaningful action has been shown to be weak, at best.

In 2024, we expect more companies to start disclosing transition plans that translate their commitments into specific objectives and actions aimed at reducing real-economy greenhouse gas (GHG) emissions, thereby providing accountability. Similarly, we also anticipate new datasets and frameworks to emerge that rigorously assess credibility of company targets and plans, as well as concrete actions companies take to achieve net-zero goals.

3. Is biodiversity going to be the next “climate”?

As we continue to grapple with the financial ramifications of nature loss, a significant shift is occurring in regulations pertaining to biodiversity and sustainability. In Europe, nurturing healthy ecosystems has been recognized as one of six critical environmental objectives in the recently established taxonomy. This goal is also reflected in the Sustainable Financial Disclosure Regulation (SFDR), where it’s a mandatory impact indicator.

To illustrate this trend further, the voluntary reporting standards under the Taskforce on Nature-related Financial Disclosure (TNFD) have set the stage for the International Sustainability Standards Board (ISSB) to review biodiversity-related disclosures. This should influence subsequent reporting standards, as seen by the biodiversity-related disclosure in the Corporate Sustainability Reporting Directive (CSRD).

Market participants increasingly recognize the financial significance of nature-related issues, marking a pivotal shift in how sustainability is integrated into financial decision-making. Collaborating with the Taskforce on Nature-related Financial Disclosures (TNFD), the BNEF report “When the Bee Stings: Counting the Cost of Nature-Related Risks” analyzes 10 instances where companies suffered materially due to poor interactions with nature. The study covers three types of risks: physical, transitional and systemic, as exemplified by cases like the 2007 Bernard Matthews avian influenza outbreak, Tesla’s Berlin gigafactory delay and 3M’s legal liabilities for water pollution. The report emphasizes the intertwined nature of climate change and nature loss, as well as its financial implications for companies and economies.

The emergence of reliable datasets and frameworks for assessing biodiversity impacts is expected to mature in 2024. These tools will provide investors with clearer guidelines and benchmarks for biodiversity investments.

4. Consistent, truly multi-asset approach

Sustainability has a wide-ranging footprint in equity portfolios dating back decades. The fixed-income corporate space has leveraged ‌equity datasets, and sovereign indices are becoming mainstream.

A good example of that is the Bloomberg Government Climate Score index, which rewards countries with a better sustainability profile by increasing the weight of bonds in the index issued by countries with higher ESG scores. This index looks at countries’ carbon transition, power sector transition and climate policies. Proprietary BNEF data collected as part of the Climatescope project drives the power transition score and features unique country-level capacity and generation data, as well as forecasts for wind and solar capacity additions and clean energy investment data.

Creating a consistent approach between equity, corporate and sovereign bonds within a portfolio is becoming commonplace. However, only a handful of investors look at total portfolio alignment, incorporating commodities and securitized assets.

Next year, we expect to see more comprehensive coverage of all asset classes in sustainability, allowing investors to develop truly multi-asset portfolios that are net-zero aligned. To understand more about how to extend sustainable investing to commodities space, please read our blog.

5. Is this the end of ESG as a sustainable objective?

There are several key regulatory milestones in 2023 that will influence how investors will approach the fund investment process, as well as disclosure and classification requirements, in the years to come.

Reclassification of Article 9 funds tracking PAB and CTB marked the end of 2022 and beginning of 2023, due to the lack of clarity surrounding sustainable investment requirements. Subsequent guidance from the commission’s Q&A released in April last year provided some level of comfort to investors by “safe harboring” passively tracked PAB/CTBs as sufficient for the fund to be treated as an Article 9 product.

However, the critical milestone we saw last year was the release of Financial Conduct Authority’s (FCA) Policy Statement setting out its final rules on UK Sustainability Disclosure Requirements (SDR) and investment labels. The aim of SDR is to improve transparency and provide investors with guidance in an environment when all sustainable products face heightened scrutiny over greenwashing risks.

One particular aspect of the guidance that caught investors’ attention is that ESG-scored financial products (where, typically, financial materiality is taken into account) aren’t considered in scope for any of the three proposed sustainable labels. This is also the case for indices using controversial product- or conduct-based exclusions.

In addition to SDR, following its consultation on guidelines regarding fund names that use ESG or sustainability-related terms, the European Securities and Markets Authority (ESMA) confirmed several key changes to be reflected in its final guidelines. These include: a higher threshold for sustainable investments; a new category for transition-related terms (addressing PAB and CTB exclusion requirements); and the separation of environmental, social and governance (ESG) terms, as well as measuring impact and transition terms.

The SDR will certainly drive the reclassification of all funds with sustainability aspects in 2024. Regardless of whether investors adopt sustainability labels, we expect to see significantly closer attention being paid to fund marketing and naming. For sustainability laggards that held back due to lack of clarity or guidance, these regulatory milestones provide a clear path forward. The judgment on whether products using ESG scores are being considered sustainable products is out, and we await the impact on investment flows.

6. Synthesizing index construction to achieve clarity and transparency

Index construction techniques for achieving a diverse range of sustainability goals have increased in sophistication in recent years. Starting with simple exclusions, through to tilting, optimization or a combination of techniques, we have seen a proliferation of complexity. While the maturity of sustainable index construction is great news in principle,‌ the additional complexity complicates investors’ ability to understand and explain how indices are constructed — and what truly drives the allocation.

In 2024, we think complexity for its own sake will fade on the back of pressure from investors. We expect more thoughtful approaches that get to the core with simple-to-understand, meaningful indices. This doesn’t mean we won’t see optimized methodologies or indices that tilt based on several sustainability inputs. It does mean we’ll see clear, transparent setups of optimizers, as well as careful examination of correlation between different datasets when tilting the constituents to make sure the results are intuitive and explainable.

Learn more about Bloomberg’s sustainable indices offerings.