The new tool aims to provide investors with an evidence-based assessment of the extent to which companies are at net zero.
Morningstar Sustainalytics’ new launched Low Carbon Transition Ratings (LCTRs) help investors hold companies to account for the actions needed to decarbonize. Anya Solovieva, Global Commercial Lead, Climate Solutions at Morningstar Sustainalytics, explains ESG.
“There is now a standardized tool on the market that aims to assess the actions of companies,” Solovieva said. “That data is what we’re hearing from investors and is the next step in terms of the kind of insights they need.”
It took almost two years for the LCTRs to be developed and offered by SustainalyticsS investors a contextual signal that shows a company’s exposure to transition risks and opportunities based on its business model, emissions and management performance.
The signal is expressed by an implied temperature increase (ITR), which expresses what global temperatures could rise to if the entire economy had the same rate of misaligned emissions between now and the year 2050. Poor management results in an increase in a company’s exposure and a higher ITR, while strong management results in a lower exposure rating and lower ITR.
“ITR is a great metric to essentially do a temperature check on a portfolio or a company, to be able to use it as a screening tool to identify companies that are significantly aligned or out of alignment, and then take a deeper look to be able to dive into what makes that tick,” she said.
“From an external communications perspective, it is also a tangible and easy-to-understand signal that is very useful,” she added.
Scores on the doors
The LCTRs are the combined assessment of two components: a company’s exposure to specific carbon risks and opportunities, and the management of those risks.
The overall management score is a measure of how much of the company’s exposure can be managed, based on the alignment of investments with net income zero and our rating of the company preparation for the transition.
The management score of the LCTRs ranges from 1 to 100 and is normalized so that it can be compared between sectors. The management score consists of two equally weighted parts: transition preparation, which is assessed based on the company’s disclosure of key management indicators, and investment alignment, which is assessed based on the company’s disclosure company of its climate investment plans.
A company with a management score above 60 is categorized as having strong low-carbon transition risk management.
The assessments include more than 80 indicators – including greenhouse gas (GHG) emissions targets, carbon pricing integration and a GHG performance incentive plan – with each company rated out of 20 to 30, which are determined and weighted based on its subsector company.
“As investors have become more sophisticated, it is critical that they dive deeper and can validate commitments against the actions the company is taking,” Solovieva said.
A “clearly differentiated” instrument
According to Solovieva, existing tools focus on assessing commitments, while Sustainalytics’ new LCTRs aim to provide insights into corporate actions that are comparable and transparent. “I have spoken to investors worldwide and what we have heard unanimously is that what we have created is clearly different from what already exists in the market,” she said.
She also underlined that the new ratings will help strengthen the “engagement dialogue” between investors and companies, with the insights they provide serving as a starting point for conversations.
The ratings are supported by a holistic evaluation of a company’s strategy and actions to meet its net objectives –zero liabilities, which provide investors with a “clear and comparable view” of a company’s policies, governance practices and investment plans.
Sustainalytics currently provides LCTR coverage for approximately 4,000 of the largest publicly traded companies and plans to expand to more than 12,500 companies by 2024. Solovieva said the company’s goal is to include approximately 6,000 companies in its research universe by July 1 with Sustainalytics expecting new coverage every quarter.
Later this year, Morningstar Indexes will introduce a new set of global climate indexes powered by the Sustainalytics LCTRs. It looks to help investors who want to follow the net-zero trajectory of their portfolios, with the indices providing exposure to companies committed to delivering business model transformation and managing the risks of the climate transition.