Morningstar Sustainalytics has developed a new framework for assessing how companies are progressing on their decarbonisation promises.
With the energy transition underway, many companies around the world have committed to decarbonising their operations and reaching net-zero emissions by 2050.
Increasingly more corporations have also set interim targets for 2030 in order to map out a pathway to reach the net-zero objective.
But having a plan is just that. It is not the same as actually taking action.
A recent report from the World Resource Institute looked at 40 indicators of progress for the 2030 and 2050 targets to limit global warming to 1.5°C, including measures such as phasing out coal in electricity generation and halting deforestation.
Of the 40 indicators assessed in the report, the institute found that not a single one was on track to reach its targets.
Investors are, therefore, increasingly keen to get an insight into where companies are likely to be in their decarbonisation journey over the next five, 10 and 20 years.
What [investors] were looking for was insights about the actions companies are taking to give them confidence that they're on track to meet their commitments and targets
To cater for this need, Morningstar Sustainalytics has developed an assessment framework for tracking a company’s progress on climate change measures and analysed the policies and progress made for more than 3500 companies around the world.
The research confirmed the World Resource Institute’s findings and shows the world is currently on a trajectory that would see the targeted temperature rise double by 2050.
“If you take all companies together, the outcome is a 2.9°C [rise in temperature]. Only one company is currently aligned with 1.5°C – Novartis,” Anya Solovieva, Global Commercial Lead, Climate Solutions for Morningstar Sustainalytics, says in an interview with [i3] Insights.
Morningstar Sustainalytics has been developing the new framework for the past two years and Solovieva says it was in direct response to investors’ needs.
“The impetus for it really was that we heard from investors that they have had insights into company targets and commitments, but what they were looking for was insights about the actions companies are taking to give them confidence that they’re on track to meet their commitments and targets,” she says.
The framework consists of two parts. First, analysts try to establish what policies and targets companies have in place to decarbonise their operations. Morningstar Sustainalytics looks at existing policies and historical trends to assess where their emissions are likely to be in 2050 versus the net-zero scenario.
Then they overlay this data with an analysis of corporate actions taken today to achieve these targets. “We undertake a comprehensive assessment of management. We have a pool of just over 80 indicators and for each company we will assess 20 to 30 of them,” Solovieva says.
Not every indicator is relevant to all types of businesses. For example, certain indicators are more relevant for assessing supply-chain emissions than others.
“There are certain companies where the [carbon] intensity is really in the supply chain. For example, Apple is a company that has the majority of their emissions in their supply chain,” Solovieva says.
“So for an investor it’s really relevant to assess the actions Apple is taking to manage those emissions within the supply chain. Do they require their tier-one suppliers to have decarbonisation targets?”
If CEO remuneration is linked to meeting climate targets, then that might give investors more confidence that they would actually expect actions to be taken
Other indicators look at whether management remuneration is tied to achieving key carbon reduction targets. Is the CEO’s salary linked to meeting climate targets?
“If CEO remuneration is linked to meeting climate targets, then that might give investors more confidence that they would actually expect actions to be taken,” Solovieva says.
Together these indicators give a picture of how, and how quickly, companies are transitioning to a net-zero world and identify those that are falling behind.
This gives a better understanding of the risks in investment portfolios, Solovieva says.
“Right now, the starting point is just understanding where the exposure is. It is about knowing which companies have higher exposure and under which scenario, but then also under what time period,” she says.
“There are longer-term risks and medium to short-term risks. So how are you performing on those?”
Trouble in Texas
Although more investors are recognising the risks stemming from the energy transition, there also has been pushback against implementing measures that restrict investing in carbon-intensive businesses.
A recent high-profile case saw Texas implementing a black list of asset managers that had divested from coal-generated power plants.
The US state, which is the largest producer of oil and gas in the country, passed a bill in 2021 that prohibits state institutions from investing with financial organisations that are perceived to ‘boycott’ energy companies.
Texas Comptroller Glenn Hegar ordered state organisations, including the US$160 billion Teacher Retirement System of Texas, to divest of no less than 348 specific funds and 10 asset management companies.
Solovieva, who is based in Morningstar Sustainalytics’ New York office, is no stranger to the debate, but says despite Texas’ position, the world is moving clearly towards net zero.
“Globally, what I’ve seen from investors, banks and asset managers is a commitment towards decarbonisation, towards trying to meet net-zero goals. Partly, that is driven by asset owners globally, who have made really big commitments. I think that’s just the reality,” she says.
“So there are these commitments and asset managers know that they need to deliver on those mandates if they want to be able to have mandates from some of the largest asset owners globally.
“GPIF (Government Pension Investment Fund in Japan) made some really big statements, so if you want to win any of those mandates, you have to have a strong process [in place].”
She says many asset managers take a pragmatic approach to addressing the issues in the US and simply tailor their conversations to the type of asset owner they are dealing with.
“I think this is no secret, but we’ve heard that asset managers will have two marketing materials: one for red states and one for blue states. It just depends on what they highlight about their processes, depending on who they’re speaking to,” she says.
In her own conversations with clients, she says the focus is squarely on energy transition and climate change as risks that investors need to consider.
Increasingly, she finds investors are not only concerned about transition risk, but also about physical risk, including the susceptibility of companies to catastrophic events such as hurricanes, flooding and fires.
The reality is that acute physical hazards, such as floods and fires, could cause a repricing event. As a portfolio manager, wouldn't you want to know what those probabilities are?
“We’re actually working on a research piece on this to get some concrete facts about physical risks,” she says.
“The reality is that acute physical hazards, such as floods and fires, could cause a repricing event. As a portfolio manager, wouldn’t you want to know what those probabilities are?
“You don’t have to make a decision, but you should have a complete picture of what that risk is. And so when we start to talk about it in those terms, we’re actually getting a positive reception from investors.”
She believes physical risk will only become a more pressing issue in the near future as several organisations and interest groups are starting to look into it.
“It is partly going to be driven by the ISSB (International Sustainability Standards Board) standards coming out. They have very strict criteria around exposure around physical risk,” she says.
“And the TCFD (Task Force on Climate-related Financial Disclosures), of course, already calls for not only direct impacts, but indirect views as well.
“In my view, by the end of Western summer, come September, the conversations around the necessity to better assess physical climate change impacts or exposures is going to really accelerate.”
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