It’s Not Just Emissions: Other Metrics Evaluating EU Companies and Their Decarbonization Pathway

The first article in our series shed light on the quality and completeness of companies’ climate disclosures as they related to governance, strategy, risk management, and metrics and targets. In this article, we’ll examine how well companies are prepared to address the risks of a low-carbon economy. That is, do they have sound plans, strategies, and governance to achieve their emission reduction and climate targets. Let's find out.

Considering Metrics Beyond Emission Reduction Targets  

As noted in our previous article, across the four reporting areas recommended by the TCFD framework, companies have the highest management quality in the areas of metrics and targets. This is typically the first area to be addressed by companies when preparing a TCFD report. 

However, targets alone are not indicative of strong practices for managing transition risk.¹ Higher quality management is also needed in the areas of strategy and risk management. Indeed, it is important for a company to have decarbonization targets approved by external standard setters like the Science Based Targets initiative (SBTi), but it is equally important to examine whether the company has the management policies, including strong climate governance, in place to achieve those targets. Below are additional metrics investors can consider when evaluating whether a company is prepared for the low-carbon transition.

Metric One: Low Carbon Transition Rating Management Score

To assess companies’ alignment with decarbonization pathways, Morningstar Sustainalytics’ Low Carbon Transition Ratings (LCTR) looks beyond a company’s stated targets to assess its actions and governance. This information is captured in the LCTR management score. A score of 50 is considered neutral, meaning the company is likely to maintain GHG emissions at levels consistent with its historical emissions under a business-as-usual scenario (i.e., there is no significant effort to reduce emissions, but there are sufficient measures in place to prevent further increases).² A management score below 45 is considered weak and indicates that a company’s management is contributing to increasing emissions. 

Our analysis found that across our research universe of 10,447 companies, the global mean management score is 44.5, confirming that not enough action is being taken to reduce GHG emissions across industries and geographies, and so emissions will continue to rise. Only a handful of sectors have a mean management score that tracks to neutral or better, including telecommunications, with a mean management score of 51.8, consumer staples (47.14), materials (45.91), real estate (45.61), and utilities (49.10).  This highlights the need for substantial changes in how companies plan to manage climate risk. Across the entire research universe, only about 16% of the companies we assessed have strong management, with scores above 55 points. 

Metric Two: Implied Temperature Rise Score

Investors can also look to a company’s Implied Temperature Rise (ITR) score. The LCTR performance ITR methodology used for this research avoids a narrow focus on only using company-stated emissions reduction targets. It instead forecasts a company’s emissions trajectory based on both the International Energy Agency’s (IEA) Stated Policies Scenario³ and a comprehensive assessment of management actions to reduce GHG emissions across the entire value chain. The ITR is calculated by translating the GHG emissions gap between the company’s expected emissions trajectory and its allocated regional and sector-specific net zero budget (see Figure 1). Note that the scenario used for this analysis – the Inevitable Policy Response’s Required Policy Scenario (IPR RPS)⁴ – adheres to the just transition principle, allocating lower emissions budgets to companies operating in developed markets. 

Figure 1. Example of GHG Emission Gap Calculation

^{Source: Morningstar Sustainalytics. For informational purposes only.}

Metric Three: Value at Risk Signals

Another metric investors can consider is the company’s Value at Risk (VaR) signal. The transition VaR is a financial metric that demonstrates the potential loss in value that a company may experience from a transition to a low-carbon economy and can be calculated for different decarbonization pathways. VaR is measured based on the policy costs of expected emissions for all companies and the impact of reduced market demand for oil and gas companies. It is a cumulative value based on a discounted cash flow model in years, from now until 2050. For more insight into how Sustainalytics incorporates VaR in the LCTR, read Value at Risk - Quantifying the Impacts of a Low Carbon Transition.