The next climate index pitch is a tracking error budget

Scientific Climate Indices has put a number on the second act of climate indexing. Its newly formed physical-risk series targets an average 15% reduction in long-term physical climate risk for around one percentage point of tracking error against the benchmark, which is a trade a trustee board can evaluate without asking what the label means.

The first wave of this market sold disclosure: MSCI, which put a product operator atop its ESG business, committed in 2015 to reporting the carbon footprint of its flagship indices, a step the provider says came from investor demand, and what followed, on its account, was unprecedented visibility into the carbon intensity of those indices, their exposure to heavy emitters, and their downside exposure to extreme weather and climate policy. A decade on, the appetite has returned with three forces arriving at once—physical risk, the pull of passive implementation and regulatory change—and the product has changed shape with them, as allocators no longer shop for a carbon number but for an index that reads as a credible low-carbon benchmark and still works as an instrument a fund can hold in size.

Standard Life's transition plan, released earlier this year, places climate-aligned benchmarks inside the group's net-zero work, with physical risk—becoming more apparent, more frequent and more costly—cited as part of what motivated it. One of the UK's largest asset owners is buying a hedge rather than stating a value.

Shahyar Safaee, deputy chief executive at SCI, makes the fiduciary case rather than the ethical one. The financial literature, he says, indicates that these risks already affect markets but may not be reflected reliably in equity prices, and that their long horizons, inherent uncertainty and complex transmission into company cash flows make them particularly difficult to assess. “For long-term investors, physical climate risk is therefore a fiduciary matter rather than simply an ESG consideration,” he says.

Physical risk and transition risk remain distinct products sharing one label. LSEG's FTSE TPI climate transition index series underweights fossil fuel reserves, overweights companies generating green revenues and accounts for emissions-reduction commitments, which makes it a bet on policy, technology and demand moving against carbon, while SCI's series is closer to a bet on weather and geography hitting assets. Buyers are taking both: the LSEG series has drawn the New York State Common Retirement Fund, Phoenix Group, Brunel Pensions Partnership and the Church of England Pensions Board, with Taiwan's Bureau of Labor Funds the latest addition.

The two pitches leave the second act of this market to be decided on published tracking error, not greenness. SCI's pairing of a 15% risk reduction with a one-point error budget is the number rivals now have to beat, and a provider that cannot say what its index costs a mandate in basis points is selling a label into a market that has begun buying benchmarks.

This publication has argued that fiduciary duty has hardened into mapped legal terrain, and that the allocators winning mandates treat ESG as a reporting capability rather than a voting record. Physical-risk indices are that argument sold as a product, with the diligence file written in tracking error; SCI has priced its claim at a single point of it, and the providers that follow will have to publish the same two numbers or ask buyers to take the risk reduction on trust.