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Sustainalytics develops corporate net-zero action analysis tool

Low Carbon Transition Ratings is designed for investors interested in climate transparency

Morningstar Sustainalytics' Low Carbon Transition Ratings is designed to provide investors with transparency into corporate climate actions and assess their legitimacy. (Courtesy Morningstar Sustainalytics)

Corporate ESG research firm Morningstar Sustainalytics has released a rating product to track whether companies are following through on their net-zero commitments with actions, to provide transparency for investors.

Morningstar Sustainalytics was formed by a merger with Chicago-based financial services company Morningstar, Inc. and corporate sustainability rater Sustainalytics, which itself was founded via a merger with Toronto-based Jantzi Research and a European company.

Its latest product, Low Carbon Transition Ratings (LCTR), is designed to provide investors with a window into a company’s alignment with a 1.5 Celsius pathway and to assess the credibility of its climate actions.

Anya Solovieva, Morningstar Sustainalytics’ global commercial lead for climate solutions, told SustainableBiz the LCTR provides “investors with insights in terms of the actions companies are taking and to really be able to provide a transparent and comparable way so that investors can broadly compare companies on their actions and progress toward meeting net-zero goals.”

The ratings find only about one-in-six companies have the strong policies and strategies in place to confidently meet the Science Based Targets initiative (SBTI), despite their pledges. Morningstar Sustainalytics says this illustrates the importance of corporate transparency.

How the LCTR works

The LCTR assesses a company’s exposure to carbon risks and opportunities, and its management of those risks.

Solovieva said the exposure rating starts by determining a company’s baseline emissions. The emissions are projected into the future with assumptions like market share constancy and a policy scenario from the International Energy Association. It subtracts emissions based on the company's decarbonization programs, strategy and governance, known as managed emissions.

The score for managed emissions, or the management score, is derived from transition preparedness based on the company’s level of disclosure of key management indicators. These can include greenhouse gas emissions targets, carbon price integration, climate policy engagement and investment alignment, dependent on the company’s disclosure of climate investment plans.

If a company does not have available information regarding management indicators, Morningstar Sustainalytics will give a score of zero, but make it apparent it is due to absence of evidence, not because it failed to meet best practices.

The ratings give a management score from one to 100, which is used to deduct from baseline emissions and develop an assessment of where Morningstar Sustainalytics believes the company can achieve emissions reduction over next 27 years. 

The expected emissions calculation is subject to the company’s 'net-zero budget,’ which is an idea of the sector- and region-specific emissions cut the company needs to reach to adhere to a 1.5 Celsius pathway by 2050.

LCTR forms a rating expressed through an expected emissions gap, which is a calculation of the “gap in emissions in their expected emissions trajectory and their expected net-zero budget, which is then translated into an implied temperature rise,” according to a blog post by the company.

The implied temperature rise is the temperature by “which the Earth would warm if the global economy were on a similar pathway as the company being rated.

“Poor management results in a company’s exposure increasing and a higher ITR, while strong management leads to a lower exposure assessment and lower ITR.”

What the LCTR found

The LCTR covers approximately 4,000 large public companies, with plans to expand coverage to over 12,500 companies by 2024.

From the initial research that looked at public companies with an SBTI-approved target, only 17 per cent have “strong policies and strategies” in place to provide confidence in meeting those targets.

Other findings were: Only 25 per cent of assessed companies have strong emissions reduction targets and only eight per cent have strong greenhouse gas performance incentive plans.

Morningstar Sustainalytics expects the world to warm by 2.9 Celsius, almost double the 1.5 Celsius target under the Paris Agreement.

“I think it speaks to the importance of what we are doing,” Solovieva said. “You can have an approved, science-based target, but you actually need to have evidence of actions toward meeting that target.”

What the LCTR can be used for

The product was devised in response to market demand, Solovieva said. Investors are increasingly asking for ways to better assess climate transition risk in their portfolios, and want tools that assess a company’s climate action.

The ratings are meant to help investors such as institutional asset managers and owners, and hedge funds. Those insights can be applied to an investment process, corporate reporting and company engagement.

Solovieva said investors can see a company that has a poor incentivization plan, for example, and spark a conversation about why it does not link executive compensation to carbon dioxide emissions reductions.

Investors have already subscribed to LCTR and are using its research, she said. Though Solovieva cannot disclose names, she did say large asset managers and hedge funds, U.S. city and state pension funds, and pension funds in Europe have expressed interest.

Sustainalytics plans to continue enhancements to LTCR such as additional indicators and providing outcomes compared to different climate scenarios.

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