Investors are starting to realize that net-zero commitments and targets do not necessarily translate into effective action. Without committed investment dollars, clear transition plans and sound governance policies, these commitments will not result in the magnitude of emissions reductions needed to achieve global ambitions of net-zero emissions by 2050. Success will require not only a commitment to adapting to net-zero emissions, but also leadership buy-in, sound strategy and access to science-based metrics.
In short, corporate assessments must go beyond emissions trajectories and reduction targets and give more weight to the actions and management practices that companies are currently implementing. How can investors achieve this? In this article, we highlight some of the challenges investors face when assessing companies’ net zero targets. We then outline different approaches to measuring alignment to net-zero emissions and their implications. Finally, we discuss the importance of assessing not only climate transition plans, but also their governance structures and implementation.
Business imperatives require large-scale transformation
While the Earth still faces an average global temperature increase of 2.5 degrees Celsius above pre-industrial levels by the end of the century,1 Companies and investors alike must act quickly and boldly to correct this trajectory. When it comes to companies’ pledges to reach net-zero emissions by 2050, ambitious commitments are one thing, and effective action is another. For many industries, successfully achieving science-based objectives will require significant transformation of business strategy, supply chain management, and product design, among others. Facilitating such a transformation will require the implementation of several strategic and governance-related processes. As companies try to understand the changes needed to reach net-zero emissions, investors are grappling with a different set of challenges.
Investor commitments are in unstable territory
Within the financial sector, there appear to be mixed signals when it comes to commitments to decarbonize the economy and prevent global temperature rise. Some companies are withdrawing from sector-focused initiatives, while others are sticking to their ambitious goals and public commitments. For example, Norges Bank Investment Management (NBIM) has announced its net-zero strategy with a key goal for all its portfolio companies to achieve net-zero emissions by 2050.2
For investors setting their own net zero targets, it is becoming increasingly clear that looking at historical emissions performance and commitments to reduce emissions is not enough, given the deep cuts in emissions needed to keep global temperature rise below 2 degrees Celsius. Assessments of corporate strategies should be forward-looking and evaluate the extent to which companies are indeed changing course and whether they are likely to meet their stated emissions targets. Active involvement is another tool investors can use to hold companies accountable. Whatever the approach, it’s clear that to achieve their own decarbonization goals, investors will have to dig deeper when assessing companies’ alignment with net-zero emissions and climate-related targets.3
The current investment obligations are not sufficient
For companies, aligning activities with a net-zero scenario typically means setting a science-based target through the Science-based targeting initiative (STBi). Although the SBTi has been criticized for its governance practices and the types of scenarios used in its methodology, it is widely accepted as a reliable approach for net zero strategies.4
For investors, on the other hand, the list of possible approaches to align their activities with a net zero scenario is much longer. And for those who have received leadership support to adapt to net zero, a daunting next step awaits; developing a methodology that is both in line with climate science and in line with their approach to asset allocation.
Differences in the landscape of portfolio matching metrics
The Glasgow Financial Alliance for Net Zero (GFANZ) recently released a report which sets out the metrics that investors can use to manage and document their progress towards net zero targets.5 The report highlights four approaches, each with significant differences in terms of the impact on companies’ investment strategies, and their potential effectiveness in transforming the real economy. A deeper discussion of the pros and cons of each of these approaches deserves a separate analysis, but for our purposes we’ll talk about binary measures, the Maturity Scale Alignment, and our own addition of the Portfolio Emissions Reduction category.
The Binary statistics This approach, where targets are based on the percentage of portfolio companies with science-based targets, lends itself to real-world impact when combined with active corporate involvement. However, the binary approach says very little about the overall portfolio alignment to net zero when looking at the magnitude of negative impacts that companies without targets have. Additionally, companies may withdraw from initiatives, deprioritize objectives, or simply not be transparent about their progress toward objectives. For example, our research shows that roughly 60% of companies assessed have not committed to reporting their progress on key climate-related milestones.6 creating a significant information gap for investors trying to assess the extent to which portfolio companies are focused on net zero.
The Maturity scale alignment approach offers a potential solution to these problems by allowing the categorization of companies based on their alignment with a net-zero strategy (e.g. aligned, potential to align, incompatible with a low-carbon economy). It also takes into account more detailed company-level indicators and the existence of the governance structures necessary to achieve the stated objectives. The method set out by the The Paris Aligned Investment Initiative follows the maturity scale matching approach and is increasingly used by investors.
The Reduction of portfolio emissions approach (i.e. reducing the carbon footprint of investment portfolios) is not included as an alignment metric by GFANZ, despite being part of the EU Paris-Aligned Benchmarks methodology. The main argument against such an approach is that merely reducing portfolio emissions does not necessarily mean a corresponding reduction in actual emissions.7 Furthermore, company-level analysis based purely on historical corporate emissions says very little about where the company is going in terms of any transition plan.
In Figure 1 we present a change to the categories presented by GFANZ, with an additional category on portfolio emissions reductions, and our thoughts on the strengths and weaknesses of each category.
Source: GFANZ and Morningstar Sustainalytics. For informational purposes only.
Changing course to deliver on Net Zero’s promises
Claims for positive climate impact and carbon neutrality must be carefully formulated to accurately capture the assumptions and limitations of the different approaches. For investors looking to set a net-zero target, it will be important to understand both the nuances of the different methodologies and what impact they can have on investment strategies. With regard to the underlying emissions data, for any of the above approaches to work, investors will need assessments of companies’ transition plans, as net-zero policy commitments and targets do not necessarily equate to net-zero tuning. The same should apply to business assessments, where transition plans, green investments and climate risk management analysis should complement reduction targets and net zero commitments.
In Sustainalytics’ Low Carbon Transition Rating, the research and analysis of more than 85 company-level climate management indicators will form a cornerstone of the methodology, providing investors with comprehensive assessments of the transition preparedness of companies across all subsectors. Initial findings based on a test universe show that of the companies that have set targets of 1.5 degrees with the SBTi, only 15% to 20% have the governance structures in place to be likely to achieve these targets.8 In a follow-up blog, we will delve deeper into the importance of assessing how well companies are managing their net-zero transition plans.
Are you an asset manager trying to navigate the increasingly muddy waters of net-zero investing strategies? Get in touch and find out how Sustainalytics’ Low Carbon Transition Ratings and other climate solutions can help. Please contact our team or your customer advisor.
Webinar on request
Find out how to effectively respond to climate regulatory initiatives, promote engagement activities and support net-zero strategies in our on-demand webinar The Net Zero transition: developing climate-conscious investment strategies. To access the recording, click here.
1 United Nations Framework Convention on Climate Change. 2022. “Nationally Determined Contributions under the Paris Agreement, Synthesis Report by the Secretariat.” October 26, 2022. https://unfccc.int/documents/619180.
2 Norges Bank Investment Management. 2022. “Climate Action Plan 2025: Leading Our Portfolio Companies to the Next Zero by 2050.” https://www.nbim.no/en/the-fund/responsible-investment/2025-climate-action-plan/#:~:text=We%20will%20set%20a%20net,acquisition%20and%20asset% 20management%20practices.
3 Quinio, A. 2022. “Norwegian Oil Fund Votes Against Companies Without Net Zero Targets.” Financial times. December 7, 2022. https://www.ft.com/content/d681cabf-3189-442c-a9ed-2fd51b2f68fd.
4 Lo, J. 2022. “Science Bast Targets initiative accused of providing a ‘platform for greenwashing’.” Climate Home News. June 2, 2022. https://www.climatechangenews.com/2022/02/06/science-based-targets-initiative-accused-providing-platform-greenwashing/.
5 Glasgow Financial Alliance for Net Zero. 2022. “Measuring Portfolio Alignment.” August 2022. https://assets.bbhub.io/company/sites/63/2022/07/GFANZ-Portfolio-Alignment-Measurement-August2022.pdf.
6 Based on a test universe of 800 global companies.
7 2 Degree Investment Initiative. 2022. “Tracking Emissions Reductions in the Real World.” September 2022. https://2degrees-investing.org/wp-content/uploads/2022/10/2DII_Real_final.pdf
8 Based on a test universe of 800 global companies.