Companies need to do more work on carbon transition

Sustainalytics launches new Low Carbon Transition Ratings and finds companies are falling behind.

Morningstar's Sustainalytics has just launched its Low Carbon Transition Ratings - a research intensive ratings designed to provide investors with a forward-looking assessment of a company's alignment to a net-zero pathway. Currently there are no global companies that Sustainalytics looked at that are aligned to this path but Sustainalytics senior director, client relations APAC (ex-Japan) Chris Terzis is confident companies will do the work in time. He sat down with Industry Moves to explain some of the reasoning behind the research.

What are the ranges that you identify for companies?

So, it's alignment to a net-zero pathway that limits global warming to 1.5 degrees, and we've got aligned, moderately misaligned, significantly misaligned, highly misalignment and severely misaligned.

How did Australian companies go in this research?

The makeup of the market does lean towards companies that are high producers of greenhouse gas emissions, but nevertheless, there are industries - real estate investment trusts, banks, etc - where their alignment is a lot closer to net zero than other industries.

There are no companies that we're currently covering within Australia that are aligned to net zero as of right now. And the way we're phasing in the research is at the moment within the Australian context, we're covering the S&P/ASX 200, and then phase two by quarter one of next year, we'll be covering the S&P/ASX 300.

How does that compare with the rest of the world?

If we look at the global universe at the moment, there are no companies that are aligned to net zero.

So, Australia doesn't seem so bad?

That's right. Within the global universe there are 17% of global companies that are moderately misaligned.

The implied temperature rise that we're looking at is an overshoot or undershoot compared to net zero and right now most of them are overshooting the net zero target. So moderately misaligned means that the company's pathway is above one and a half degrees but less than two degrees temperature rise. So, it implies that if all the global companies were on the same path as this particular company, then that's what the greenhouse gas emission temperature rise impact would be.

The majority of companies are significantly misaligned at this point, which is sitting within that 2 to 3 per cent range, so there's some work to be done by those companies.

Do you have confidence that the companies will do the work?

Yes. There are risks associated with not doing anything and some of those risks are things like regulatory risk. If companies decide not to do anything, they could face things like higher taxes. Even though there's the Paris agreement where governments have signed up to it and companies have control over how they manage their greenhouse gas emission exposure, you've got the view that if they don't do it themselves, the regulators will start requesting for reporting first and then start pushing for action.

Companies will be at risk of new technology and product substitution as well. So, there's a commercial impact for them too as renewables and other technologies emerge, or businesses emerge, that that are focused on low carbon transition. Stakeholder expectations - so we've already got institutional investors focused on this. As more institutional investors become focused on this globally, you'll find that listed companies are also focused on ensuring that they are they are actively looking at this.

And then lastly revenues. There's the risk of reduced revenues when it comes to changing consumer demands and preferences as well. Consumers will increasingly want to deal with companies that are doing the right thing by the environment and society.

Why did you launch these ratings?

Clients of ours have been asking for a solution like this for quite some time. I've been here since September 2020, and ever since that time existing clients and then prospective clients have always asked us for what type of low carbon transition solution we had. It was a gap in in our offering, and so the team went on this journey of allocating an executive to run this project. And here we are two years later with a team of about 150 climate-dedicated specialists globally and of those 80 are research dedicated to the research itself. It was in order to meet client demand on the institutional side, asset owners, institutional investors, sovereign wealth funds, insurance companies and the like.

So, investors are just expecting it now?

You've got groups like the UNPRI, as well, that require investors to determine how their portfolios are exposed to climate risk and the climate temperature rise, which is the measure that we take, is one of those risk assessments that the UNPRI asks investors to undertake. It's one of a couple.

Were these ratings difficult to put together?

It's always a challenge to source talent. And then secondly, you need the capital to invest in a solution like this. For us, it reinforces the strength of being part of Morningstar. Morningstar were able to allocate and invest in this initiative. And then, given the brand that Sustainalytics has and its reputation in its association with ESG since 1992, we've been able to attract some high-quality talent to be part of this team. So yes, it's taken time, but we believe, based on the research we undertook in terms of what we wanted to deliver, and the feedback we've had from the market, we've got a really good, differentiated solution out there in the marketplace and something that's market leading.

Currently these ratings are for institutional clients, are there plans for a retail launch?

Yes, definitely, watch this space. Being a fully owned part of Morningstar, the underlying company research that we produce and make available to institutional investors, will inevitably feed up through the Morningstar platforms and become available to advisors and the wealth management community more broadly. So, it's quite powerful, in that it will empower advisors to have information at their fingertips to have those detailed discussions with their clients when they have their review meetings.

There are a number of adviser groups who have been focused in this area - environmental, social and governance investing or responsible investing - for quite some time, as there are on the institutional side, and then there are those who are reacting to the commercial opportunity because their clients are walking into meetings requesting this type of information or not wanting to be exposed to companies that are harming the environment or society.