Beyond 1.5 Degrees: What the LCTR Tells Us About Companies Managing Their Climate Risk

In April 2023, Morningstar Sustainalytics launched its Low Carbon Transition Rating (LCTR), with ratings for about 4,000 companies. The ratings assessed how these companies were doing on identifying and managing their climate risk and their progress toward addressing the Paris Agreement’s goal of limiting global warming to 1.5 degrees Celsius. This initial assessment of 4,000 companies showed that the average implied temperature rise was tracking towards 2.9 degrees.

Through the latter half of 2023, we have added more companies to our universe and refreshed the companies previously assessed on the basis of their latest reports. Now, in assessing over 8,000 companies across the same industries, we have a more detailed picture of how companies around the world are doing on managing their climate risk. If all companies and countries in the world continue to operate similar to the over 8,000 companies assessed under the LCTR, global temperatures are likely to rise to 3.1 degrees Celsius over pre-industrial averages.¹ 

In this article, we look at the overall performance of companies in the LCTR and which industries are leading on managing their climate risk.

Companies Are Not Managing Their Climate Risk Well Enough

The LCTR considers a management score of 50 to be neutral and anything below 45 as weak. The mean management score of 35.5 shows that companies are not doing well in managing their climate risk (see Figure 1 below). This is compounded by the fact that most companies continue to have a high exposure to high carbon emitting products, processes and activities.

No industries, on average, track to a neutral or better score, highlighting the need for substantial changes in how they plan to manage climate risk. The best performing industries have a mean management score of around 45, with only three industries – containers and packaging (47.2), telecommunication services (46.4) and household products (45.9) – belonging to our category of average management.

Figure 1: Average Overall LCTR Score by Industry

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

The majority of low management scores illustrates the need for companies to set out and disclose plans and structures that will allow them to manage climate transition risks, such as policy driven carbon prices (e.g., taxes or compulsory cap and trade mechanisms), changes in what products and services can be provided to customers, and customer preferences as they become more aware of how their decisions affect the climate.

It also highlights that most companies continue to treat climate as a matter of public relations or something good to do as part of their social responsibilities and not a real risk to their business’s financial success. If this trend continues, we may see many companies losing value and falling behind competitors in a very short period of time, as more climate technologies become viable and early adopters disrupt the market.

An Overview of the Better Performing Industries on Climate

Only about 11% of companies in the LCTR research universe have verified targets approved by the Science Based Targets initiative (SBTi) (see Figure 2 below). But just having targets is not enough. Companies need to have the governance structures, product/service and operational strategies, and data and progress tracking mechanisms in place if they want to demonstrate real, credible commitments to managing climate risk. As things currently stand, companies’ plans, or lack there of, will still cause global emissions to rise well beyond 2030.

Figure 2. Industries With Strong Management and Verified SBTi Targets

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

Companies with better management over their climate risks have higher rates of disclosure on their transition plans and on how they’re aligning their own governance and operational processes with these transition plans. Typically, leading companies set a comprehensive emissions reduction target that covers all of its operations. To add credibility to these targets, these leading companies highlight how their targets contribute to reducing global emissions, in line with 1.5 degrees; or they get independent verification of their targets to that affect.

As well, leading companies typically align their CEO’s, board’s and senior management’s remuneration with achieving their emissions reductions goals, while incorporating carbon prices in their decision-making. This ensures that transition matters are considered in all strategic and operational considerations. To further strengthen the management of climate risks, companies can take other important actions, such as conducting an assessment of the product’s emissions during use and setting pathways for the reduction of these emissions. 

About 10% of the companies we’ve assessed have strong management, with scores above 55 points. The top performing industries in terms of management score also have a higher proportion of companies with strong management. For example, nearly 30% of companies in the telecommunication services industry have strong management scores. This is mostly driven by these companies doing very well on the GHG reduction target indicator. Further, nearly all of the strong management companies under telecommunication services have verified science based targets for emissions reductions. These companies have identified their climate risk, have set a path to manage these risks, and are more likely to take the necessary steps to align their businesses with achieving these targets.

Now Is the Time to Act on Climate Disclosures

While the coverage of the LCTR universe has expanded since last year, the mean management score of the universe has decreased, primarily because the companies added have much lower disclosures than companies in the original universe. It is imperative that companies set clearer decarbonization plans and targets and improve their disclosure levels – at the very least – to match the levels of their leading global peers. 

With time running out on limiting warming to 1.5 degrees, we see only a few industries and regions that are performing much better than the others. But, on average, very few companies are performing adequately. With each year that passes, the emissions gap that a company’s management needs to overcome will get larger. 

Learn how Sustainalytics’ Low Carbon Transition Ratings can help you assess transition risks within your portfolio. Contact our team or your client advisor.

---

References

1. This in line with representative concentration pathway (RCP) 6.0, in which the increase in GHG emissions stabilizes shortly after 2100.