New tool aims to provide investors with science-based assessment of companies’ alignment to net zero.
Morningstar Sustainalytics’ newly launched Low Carbon Transition Ratings (LCTRs) looks to help investors hold companies to account on the actions required to decarbonise, Anya Solovieva, Global Commercial Lead, Climate Solutions at Morningstar Sustainalytics, told ESG Investor.
“There is now a standardised tool in the market that aims to make an assessment of company actions,” Solovieva said. “That data is what we’re hearing from investors is the next step in terms of the type of insights that they need.”
The LCTRs have taken nearly two years to be developed by Sustainalytics and offers 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 rise (ITR), which expresses what global temperatures could rise to if the whole economy had the same percentage of misaligned emissions between now and the year 2050. 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.
“ITR is a great metric to essentially take a temperature check of a portfolio or a company, to be able to use it as a screening tool to identify companies that are significantly aligned or misaligned and then be able to take a deeper dive into what’s driving that,” she said.
“From an external communication perspective, it’s also a tangible and easy to understand signal that’s very helpful,” 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 its management of those risks.
The overall management score is a measure of how much of the company’s exposure can be managed, based on its investment alignment to net zero and our assessment of the company’s transition preparedness.
The management score of the LCTRs ranges from 1 to 100 and is normalised so that it can be compared across industries. The management score is comprised of two parts with equal weighting: transition preparedness which is scored based on the company’s level of disclosure of key management indicators, and investment alignment which is scored based on the company’s disclosure of its climate investment plans.
A company with a management score over 60 is categorised as one with strong management of low carbon transition risk.
The ratings have over 80 indicators – including greenhouse gas (GHG) emissions targets, carbon price integration, GHG performance incentive plan, among others – with each company being assessed on 20 to 30 that are determined and weighted based on the company’s subindustry.
“As investors have become more sophisticated, it is critical they dive deeper and be able to validate commitments in comparison to actions that the company is taking,” Solovieva said.
A “clearly differentiated” tool
According to Solovieva, existing tools focus on assessing commitments, while Sustainalytics new LCTRs aims to provide insights on company actions which are comparable and transparent. “I have been speaking to investors globally and what we have heard unanimously is that what we have created is clearly differentiated from what already exists in the market,” she said.
She also underlined that the new ratings will help to strengthen the “engagement dialogue” between investors and companies, with the insights it offers serving as a starting point for conversations.
The ratings are underpinned by a holistic evaluation of a company’s strategy and actions toward meeting its net –zero commitments, which offers investors a “clear and comparable view” of a company’s policies, governance practices, and investment plans.
Sustainalytics currently provides LCTRs coverage for approximately 4,000 of the largest public companies and plans to expand to include more than 12,500 companies by 2024. Solovieva said the firm’s target is to have approximately 6,000 companies in its research universe by July 1, with Sustainalytics expecting to roll out new coverage every quarter.
Later this year, Morningstar Indexes will introduce a new suite of global climate indexes underpinned by the Sustainalytics LCTRs. It looks to assist investors that are aiming to track the net zero trajectory of their portfolios, with the indexes providing exposure to companies committed to delivering business model transformation and managing climate transition risks.