The climate transition is progressing unevenly, from company to company and region to region. S&P Global Ratings' Christa Clapp and Alexandra Dimitrijevic explain how investors can get a consistent picture
Environmental Finance: What impact do you see geopolitical headwinds having on companies' progress towards climate transition and resilience?
There is also a link here to artificial intelligence. AI is not only critical in terms of technological competition, it is also critical for security. It also brings additional demand for energy to power data centres. Meanwhile, there is enormous need in emerging markets for more energy, and for that energy to be affordable.
This focus on the need for secure, additional and affordable energy means the energy transition is going to take longer. But it is also important to note that climate change isn't going away. Companies recognise this, and are placing an increased focus on adaptation and resilience in the face of growing physical risks.
EF: Transition financing has, thus far, lagged behind other parts of the sustainable debt market. Why do you think that has been the case?
In response, we have developed a Climate Transition Assessment (CTA) that applies our Shades of Green approach to offer a globally consistent picture. Our scale runs from dark green, for activities aligned with net zero by the middle of the century, down to red, for activities that are inconsistent with or likely to impede the net-zero transition, such as direct fossil fuel investment.
The Shades of Green scale also addresses regional differentiation. For example, we assessed Rwanda's Sustainable Finance Framework last year. We shaded its financing for the use of liquified petroleum gas for cooking as light green. In other regions, we wouldn't have judged the use of fossil fuel for cooking as light green but, in Rwanda, it delivers carbon reductions compared with the current practice of using wood, as well as significant improvements in indoor air quality. The Shades of Green scale thus allows global comparisons of regionally specific progress towards transition.
EF: How does your Climate Transition Assessment address issues with credibility and transparency?
CC: A lot of companies have long-term net-zero targets, but investors find it difficult to understand how credible those targets are. In addition to companies' long-term targets, the CTA focuses on the specific near-term actions, over the next five to 10 years, that companies are taking to put themselves on a pathway to meet their ambitions. What policies are they implementing? How are they engaging with their supply chains? Are they relying on developments, such as in sustainable aviation fuel, that might not deliver at the scale necessary?
We then apply our shading to look at companies' existing revenues and business models – it might be a carbon-intensive firm shaded yellow or orange, for example.
We examine their near-term actions and investment plans to project that shading forward to the future, to consider whether they are credibly moving to greener business models. Again, that provides a globally consistent assessment of a company's planned transition.
EF: How are market participants applying the CTA?
CC: Every investor has its own mandate, risk tolerance and approach to managing sustainability in its portfolio. When an investor is looking at the early stages of the transition of heavy emitting industries, for example, it might be comfortable holding yellow or orange companies, whereas another might be focused on the greener part of the spectrum: the CTA provides them with the transparency and lets them decide how to apply it.
We're also seeing some companies use the CTA in their annual reports, to publicly share our assessment of the progress of their transition, while we are seeing lenders use the CTA as an element in their lending assessments.
The CTA is also being used in green equity designation programmes at three exchanges – NASDAQ, B3 in Brazil and SIX Swiss Exchange. These programmes identify listed companies that meet green criteria, largely based on the World Federation of Exchanges' Green Equity Principles, but with local specificities. If one of their listed companies is interested in having a green label, we apply our shading to their revenues and investment plans, and provide a CTA report – and, if it meets the requirements, the exchange can give it greater visibility.
It's an interesting space to watch. It's a pretty nascent market, but I can see parallels with how the green bond market started, in that it provided a very visible way of identifying a green company. It began slowly but soon snowballed. We're very interested in contributing to transparency in this emerging area.
Christa Clapp is global head of sustainable finance market analytics, in Oslo, and Alexandra Dimitrijevic is global head of research and development, in London, at S&P Global Ratings.
For more information on Second Party Opinions, see:
https://www.spglobal.com/ratings/en/products-benefits/products/second-party-opinions
On the Climate Transition Assessment, see:
https://www.spglobal.com/ratings/en/products-benefits/products/climate-transition-assessment
On the Shades of Green approach, see:
