Eva Cairns, Head of Sustainability Insights and Climate Strategy at abrdn, explains how investors can identify climate transition leaders across an APAC region characterised by diverse levels of policy support and technology readiness.
An increasing number of companies are setting net zero targets to combat the rise in global greenhouse gas (GHG) emissions. Equally, over 90% of global GDP is now covered by a net zero pledge. Supporting the transition to net zero requires investors to allocate capital to companies that not only set ambitious targets but, more importantly, take action to decarbonise.
Identifying credible transition leaders is key for investors because a company that successfully transitions has the potential to gain a competitive advantage relative to its peers. Companies that innovate and take action to decarbonise can expect to face lower carbon costs and be better positioned to benefit from increased demand in green segments of the economy. Investors are also likely to have more real-world impact on advancing the energy transition by investing in credible leaders, rather than just divesting from carbon intensive companies to decarbonise portfolios.
Critically, it is not just a firm’s carbon emissions today that matter, but what they are likely to be in the future.
abrdn has developed a framework to assess the credibility of net zero targets set by 1,200 companies around the world, based on six pillars reflecting four aspects of company action (Emissions Target Design, Emissions Performance, Climate Governance and Green Market Penetration) as well as two enabling factors: Technology Readiness and Policy Supportiveness.
Just as government net zero statements cannot be taken at face value, since most commitments aren’t yet backed by concrete policies, it shouldn’t be assumed that a firm’s decarbonisation strategy will be implemented. Short-term business decisions sometimes conflict with the longer-term behaviour needed to realise decarbonising ambitions, resulting in a credibility gap between pledges and action.
abrdn’s Credibility Scores help investors understand whether companies are likely to deliver on pledges and can help identify credible transition leaders within sectors and regions. The insights can also help investors engage with ‘climate laggards’ that are often at an early stage of their decarbonisation journey. They can also aid collaboration by identifying weaknesses in transition plans and supporting discussions on how to address these issues.
The Asia Pacific (APAC) region will play a central role in the transition to net zero as it accounts for more than half of global energy consumption, and is projected to be the fastest-growing region by GDP by 2050. Changes in APAC energy usage and emissions will significantly affect climate change.
abrdn has analysed1the credibility of more than 300 APAC company targets, using the components of its credibility framework at regional, sector and company level, comparing APAC to non-APAC peers.
On average, APAC companies have a credibility score below their non-APAC peers, but a deeper dive into the factors is required to understand strengths and weaknesses as well as the enabling factors.
Does this mean major APAC firms are less committed? Not necessarily. One important reason for the region’s underperformance in credibility scores is that many companies operate in a policy environment that provides weaker incentives to decarbonise. That may be a reason why a lower proportion of APAC companies have reduced their emissions intensity over the last two years. While data coverage is not as comprehensive across the APAC sample compared with, say, Europe, the former still underperforms when only including firms for which emissions intensity data is available.
Conversely, more APAC sample companies operate in industries with more mature low-carbon technologies, such as semiconductors and other IT sub-sectors, versus the non-APAC universe. This indicates that they are in a better position to achieve targets based on the maturity of technologies they rely on, a key enabling factor. It underlines the fact that APAC can incubate attractive investment opportunities during the net zero transition, with firms well-placed to pursue green revenues and drive climate-positive business models. Additionally, various companies with a strong credibility score have been identified in the region. Another challenge for the region is data gaps, which may result in lower scores due to more limited disclosures or coverage.
Regions, policies and sectors
Perhaps more than any other region, APAC shows diversity, with companies in several countries demonstrating transition leadership today, while elsewhere there are future opportunities for improvement.
Some of the most developed economies in the region rank well above the APAC and global average. On average, companies in the sample from South Korea, Taiwan and Japan have credibility scores of 49%, 47% and 45% – above the 44% credibility score of non-APAC companies and the 40% score registered by companies in the APAC region.
In contrast, companies in Asian emerging economies like India (34%), China (31%) and Thailand (26%) have credibility scores more that 10% below the global mean. Every country in APAC has significant scope to enhance its credibility score, offering future opportunity to investors.
Analysing the four countries in the region for which abrdn has the largest data coverage, it found:
Japanese businesses outperform global peers on most indicators. Japan scores highly on Emission Target Design, with more than three-quarters of Japanese companies in the sample having set targets, and most are on track to meet them. It is one of the top performers in Technology Readiness, partly due to its strong presence in the railroad and auto sector where green technologies are already viable, but scores lower than non-APAC peers on its Emissions Performance (only 54% of businesses have reduced their emissions intensity), and Green Market Penetration.
Australian companies are in line with the APAC average when it comes to credibility but underperform their developed economy peers globally. Australia’s economy is dominated by emission-intensive industries, such as materials and energy, and the country exports significant energy resources to other APAC countries, which makes it more difficult for companies to decarbonise. Nevertheless, Australia has one of the best policy environments in the region, benefits from stable institutions, and legislation in place to reduce emissions by 43% from 2005 levels by 2030, which provides strengthening incentives for businesses to decarbonise.
Indian firms score below the regional average on every indicator, which offers potentially significant future scope for progress in terms of setting transition targets, as the country makes good on its commitments. While India has set a net zero goal by 2070 and has ambitious interim renewables targets, stronger policies are required to incentivise business decarbonisation. However, given that utilities occupy a larger share of the MSCI India than the MSCI ACWI and APAC indices, considerable investment opportunities could become available if the utilities sector successfully switches to renewables sources. Companies could take advantage of the government target of 500GW from renewable energy by 2030, versus 163GW in 2022.
In China, many companies are playing a central role on the path to net zero, but most businesses have room to raise the ambition of their targets. Companies score low on Emissions Performance, due to operating in an environment where country GHG emissions continue to increase. More than three-quarters of Chinese companies are not covered in the Emissions Target Design indicator, partly reflecting a lack of targets, or targets that cover only some emissions. Significantly, China outpaces other economies on Green Market Penetration and Technology Readiness, with Chinese companies dominant in renewable energy technologies, notably solar PV and mineral processing. Such segments already have viable technologies, which contributes to the high ranking of China on Technology Readiness.
Caution is required in assessing Chinese companies, because of significant data gaps. In addition, various emission-intensive companies are state-owned, which could bias the Green Market Penetration score by overweighting low emissions-intensive companies operating in renewables and other green industries.
Variations across sectors
All APAC sectors score below 50% of the possible maximum, but there are wide gaps between them. Some companies with the highest credibility scores are auto manufacturers, semiconductors and power producers, while utilities, materials and industrials companies are present both in the top and bottom sections, indicating wide performance differences between laggards and leading companies in these sectors.
Energy firms have some of the lowest credibility scores, and energy is also the sector with the weakest technology maturity score.
The average APAC score for energy, however, is in line with the non-APAC score since the sector as a whole faces significant uphill credibility challenges. Transition plans are often based on technologies such as carbon capture and storage which are at early maturity stages.
Information technology (IT) is one sector where APAC firms outperform their non-APAC peers. The sector contains numerous semiconductor companies operating with mature technologies that can be deployed into net zero solutions. Most corporates have already set net zero targets and successfully reduced emissions intensity, making it one of the fastest decarbonising sectors.
APAC IT businesses provide components for net zero technologies and are well positioned to take advantage of climate opportunities.
A substantial credibility gap exists for utilities, the best scoring sector globally, but positioned in the lower half of the ranking in APAC. This is due to the sample bias towards emerging economies; over 35% of companies in the sample are based in either India or Thailand, where most energy is generated from fossil fuels and policy support is lagging behind many other APAC economies. Such companies have fewer incentives to set targets or reduce emissions intensity.
Only 19% of electricity comes from renewables in India and 15% in Thailand (versus 28% globally).
These companies have significant opportunities to transform their existing businesses by switching to cleaner energy sources, particularly as mature technologies enable decarbonisation.
Most of the consumer staples sector is related to food production, a major contributor to global GHG emissions and biodiversity loss. The sector in APAC receives a low credibility score mainly because of weak Emissions Target Design – a lower share of emissions is covered by targets or includes Scope 3 emissions – and Emissions Performance.
For investors, one of the most important takeaways from abrdn’s credibility gap framework is the large dispersion in corporate performance within sectors.
Looking at the score for each of the six indicators helps assess companies’ specific strengths and weaknesses.
Emissions Performance: Most companies have reduced their emissions intensity, but standards of living are rapidly developing in many Asian countries, translating into increased energy demand and emissions (CO2 emissions in Asia increased by 22% between 2011 and 2021, versus 8% globally). More effort is needed to decarbonise, especially where decarbonising technologies are already available and cost competitive.
Emissions Target Design: Some 44% of companies in APAC don’t have data on Emissions Targets. Even where firms have targets, the region scores below the global average, implying targets are less ambitious. Also, a higher proportion of reports are based on intensity targets, whereas absolute reduction targets are required to achieve net zero.
Technology Readiness: The region outperforms, as it is host to a larger share of consumer discretionary and information technology companies where technologies to decarbonise industries are already available (e.g., electric vehicles, semiconductors). It also has a lower proportion of energy firms, where most technologies are only at a prototype, or demonstration, stage.
Policy Environment: Asian countries typically score below Europe due to the latter’s status as a pioneer in key policy areas such as carbon pricing and development of its green taxonomy, as well as legally binding commitments, but several countries, like Japan and Australia, have a stronger policy environment than the US. Firms with a large presence globally are often ranked higher than domestically or regionally focused peers due to the regulatory developments in major jurisdictions.
Green Market Penetration: APAC and non-APAC companies score similarly, partly due to the fact that regulations and frameworks for aligning revenues with sustainability objectives, e.g. green taxonomies, are in the early stages of development in most markets. Scores are expected to increase in coming years as reporting requirements transition towards greener segments.
Climate Governance: More than two-thirds of companies in abrdn’s APAC sample aren’t covered by the TPI Management Quality set, a key data source for corporate climate performance data globally. Its 2021 report showed that most companies in Japan, Australia and New Zealand score relatively well, with a Management Quality Level of 3 (climate change is integrated into operational decision-making) or 4 (climate change is integrated into strategic assessments).
The framework can be used to identify firms that set ambitious emissions-reduction targets, actively transform their businesses and lead by example within their sector. For instance, Taiwan Semiconductor is one of the best performing companies. It has absolute targets that cover the entire spectrum of corporate emissions (Scopes 1, 2 and 3), and has also reduced its emissions intensity, and operates in a sector where low-carbon technologies are already mature. Similarly, LG Chem scores well partly due to its strong ‘climate governance’. It integrates climate change into its strategic assessment, and a board member has explicit responsibility over climate policy implementation.
abrdn’s framework can also help identify companies that may not have a high score overall, but stand out on particular factors that could be key to transform their business or make a significant contribution. This includes Sungrow Power Supply, which has a close to perfect green market penetration score as it provides equipment for solar and wind projects.
For investors, understanding the credibility gaps in corporate net zero strategies can play a significant role in their assessment of portfolio companies. Credible transition leaders can be identified, but there are caveats, especially in APAC where data gaps hamper analysis.
Integrating transition plans into abrdn’s climate scenario analysis quantifies the extent to which company valuations would be affected by successfully implementing targets. Combining the impacts of targets on asset valuations with abrdn’s credibility assessment framework better captures the likely impact of the energy transition on firms.
Transition targets significantly improve company valuations. While APAC companies would be negatively impacted by the energy transition, assuming current business models are maintained, the valuation impact becomes positive for over half the companies in the sample if they fully commit to their targets.
Most of the upside is lost, however, once accounting for the credibility of transition plans and APAC companies will miss significant climate opportunities by not backing transition plans with concrete actions. A significant proportion of companies in emerging APAC economies have no or weak transition targets and will continue to face climate risks.
The effects of transition plans on valuations vary across sectors. The impact is limited in the IT sector while the energy sector is the most negatively impaired. The average energy corporate valuation would be positively impacted to a small extent if targets were fully implemented, but most of the uplift would be erased as energy firms have some of the weakest credibility scores.
Materials and emissions-intensive industrials such as airlines would obtain some of the largest uplifts but they also risk losing most of these because of weakly credible transition plans.
Although many APAC utilities have no or weak transition targets, continuing to use emissions-intensive energy sources rather than switching to renewables, the companies that set up ambitious and credible targets could obtain significant valuation uplifts.
abrdn’s credibility gap framework clearly demonstrates that there are climate leaders within sectors, obliging investors to look carefully at the specific approaches being taken by management to integrating net zero objectives into their business strategies.
Like their portfolio companies, many investors may also be in the early stages of deciding how best to incorporate climate considerations into company-level assessments, particularly understanding the credibility of a growing number of climate targets. However, the differences and drivers highlighted here show that robust methodologies are being developed which can assist investors in this critical task.
1. This link directs you to the abrdn UK Institutional Investor site.