Cautious urgency can resuscitate GFANZ 'transition-informed' indexes

Executive Summary

Despite growing diffidence towards collaborative action, financial institutions remain committed to their net-zero pledges. Combined with the fact that passive investing continues to dominate asset flows, the critical importance of benchmarks that can align assets with an orderly transition is both clear and growing by the year.

Recognising that traditional lower-carbon indexes, including ex-fossil fuel variants, do not equate to the emissions reductions required to achieve net zero by 2050 (or sooner), the EU formalised two methodologies that now underpin Paris-Aligned Benchmarks and Climate Transition Benchmarks. Assets managed against these indexes, collectively referred to as EU Climate Benchmarks, have grown considerably since their 2020 inception, but flows stagnated in 2024. This reflects concerns over divergence from parent indexes, unintended systematic biases and potentially counterproductive real-economy outcomes. Some doubts seem overblown, yet there is legitimate pause for thought as to whether EU Climate Benchmarks can support companies on non-linear (or nascent) decarbonisation trajectories. Demand for alternative approaches has grown. In the coming years, we might expect to see the establishment of transition-informed indexes (TIIs, proposed by the Glasgow Financial Alliance for Net Zero, GFANZ) and taxonomy-led offerings such as Investing for Transition Benchmarks (as proposed by the EU Platform on Sustainable Finance, EUPSF).

During Q4 2024, GFANZ held a consultation period for its voluntary guidance on the development of TIIs. They represent a departure from incumbent climate-aware benchmark offerings, which largely seek reduced exposure to outsized carbon emitters. GFANZ proposes a more inclusive approach to benchmark construction, one that is based not on historical emissions profiles or sectoral exclusions but on the assessment of each individual entity’s forward-looking net-zero alignment credentials. In doing so, TIIs overcome some of the criticisms levelled at existing climate benchmarks. But without well-defined guardrails, TIIs carry significantly elevated greenwashing risk.

Notably, less than a month after the consultation deadline, GFANZ put TII development on pause while the alliance undergoes its own period of transition. It would be surprising, however, for TIIs not to resurface in a similar guise given their clear alignment with GFANZ’s new strategic direction. Assuming this pause is temporary, the restructure gives GFANZ much-needed breathing room to shore up its TII guidance, which in IEEFA’s view lacked the requisite urgency and emphasis on guardrails to garner broad investor support.

As it stands, TII guidance builds on GFANZ’s past efforts to define transition finance in sector-agnostic terms. At the time, IEEFA encouraged financial institutions to adopt more nuanced assessment frameworks than high-level guidance had provided. Those recommendations remain valid in the context of index construction. Stakeholders can look to guidance from the likes of the Assessing Transition Plans Collective, Climate Bonds Initiative or the EU Platform on Sustainable Finance in that regard. However, IEEFA would add some key considerations for future iterations of voluntary guidance that might reduce the risk of greenwashing and prevent carbon lock-in:

• Red lines for fossil fuel developers: To prevent transition-intended capital from being channelled into incompatible economic activity, fossil fuel developers should be removed from all fixed-income indexes. Short, time-bound expectations should be placed on equity indexes, with exceptions made only for companies with demonstrable commitment to the drastic overhaul of core business models.
• Skip to “transition-engaged” index variants: Leniency is implied in existing guidance through to 2030, significantly raising the risk of carbon lock-in by prolonging support for entities with no clear or credible timeline for net-zero alignment. Greater urgency is required given likely lead times before TIIs become commercially available.
• Stronger guardrails including mandatory transition plans: Any investable company credibly committed to net-zero alignment should have a transition plan by the time TIIs are expected to gain wider momentum. Transition plans should be a minimum requirement (with concessions based on regional considerations) and accompany greater emphasis on the need for guardrails.
• Transparency on lobbying: Discussion of corporate lobbying is entirely absent from voluntary guidance, despite its insidious and unquestionable impact on climate. This topic should be on the agenda.

The importance of exercising “cautious urgency” in this manner cannot be overstated. In IEEFA’s view, TIIs will only gain broad support if investors trust they capture an opportunity set of entities making timely and credible attempts to decarbonise. To do so will likely limit the opportunity set by a little more than GFANZ’s might have initially envisaged, but the bar is better set high than low to maintain index integrity and ensure broad investor support. Ultimately, there is no singularly correct net-zero-aligned benchmark approach, and choice will be key to continued uptake. Existing offerings and those in development each offer alternative theories of change, meaning TIIs (and in future, Investing for Transition Benchmarks) should not cannibalise existing assets. In fact, an approach that is more inclusive by design should hold wider appeal for investors, giving net-zero-aligned benchmarks a better chance of displacing traditional (climate-agnostic) indexes in core investment processes. Should this come to pass, the environmental benefits could be substantial. IEEFA would encourage sophisticated investors to implement elements of different methodologies, including low (and diminishing) carbon exposure, transition plan assessments, engagement progress indicators and sustainable capex considerations, to suit their own beliefs and preferences.