Mandatory climate-related financial disclosure is becoming a universal reality, with more governments around the world adopting the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) and the International Sustainability Standards Board. In parallel, more companies are setting targets and developing strategies to do their part in meeting the global objective of minimizing global warming to 1.5°C by 2050. Climate transition plans and greenhouse gas (GHG) emissions disclosures are challenging for investors to understand and compare across industries and geographies. Investors acknowledge that to meaningfully assess transition risks, it is important to look beyond stated commitments to evaluate the actions companies are taking to manage climate risks and opportunities.
Morningstar Sustainalytics’ Low Carbon Transition Ratings provide investors with a top-level implied temperature rise and value-at-risk, assessing companies’ current alignment to a net-zero pathway. The ratings are supported by robust research and a transparent dataset, including annual expected emissions trajectories for different climate change scenarios.
Leveraging our Low Carbon Transition Ratings, investors can respond to regulatory initiatives, implement net-zero strategies, fulfill client net-zero mandates, conduct scenario analysis, and obtain transparency into company actions by integrating climate research into their investment decision-making processes.
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Policy Responses to Climate Change: The EU’s Fit for 55 Package and Its Implications for Companies and Investors
The effects of climate change are no longer a distant threat. The latest report from The Intergovernmental Panel on Climate Change tells us that urgent and more ambitious action is needed. Consequently, governments, companies, institutional investors, and financial institutions are focused on developing strategies to effectively reduce greenhouse gas (GHG) emissions, slow down environmental degradation, and mitigate climate transition risks.
In this blog, I highlight how global policy responses to the climate crisis and the targets set within them could affect business strategy and operations. I also outline what investors can do to evaluate this transition risk among portfolio companies. We’ll delve into the European Union’s Fit for 55 package, as it provides examples of the most ambitious policy response to the climate crisis thus far, and has far-reaching implications for companies supplying goods and services to the EU market.
How Investors Can Assess Climate Transition Risk
As part of their response to the current climate crisis, institutional investors and financial institutions are assessing the climate transition risks in their portfolios. To do that, they need to understand the GHG emissions budgets for the companies they invest in. The emissions budget is the amount of GHG emissions a company is allowed each year until 2050, if its activities are aligned to a 1.5-degree Celsius global temperature rise.1 The budget is dependent on the pace of climate policy implementations in the coming years.
To help prepare institutional investors for the risks and opportunities related to an acceleration of policy responses to climate change, the United Nations Principles for Responsible Investment commissioned a consortium called Inevitable Policy Response (IPR) to develop the Required Policy Response (RPR) scenario. The IPR forecasts that, to address the climate crisis, “governments will be forced to act more decisively than they have thus far, leaving financial portfolios exposed to significant transition risk.”2 This scenario may seem questionable, given the uncertainty on whether governments will actually become more decisive. However, there are already several examples of climate laws implemented just as the IPR presumed.
The Fit for 55 Regulation
The Fit For 55 regulation package is a real-world example of the required policy response. Legislation has also been passed outside of the EU, such as the coal capacity market reforms in India,3 the announced end of fossil-fueled cars and vans sales in China4 and South Korea5 by 2035, and the 100% clean power standard in several states of the U.S.6
The Fit for 55 legislative package explicitly aims to set the EU on a decarbonization path reducing carbon emissions by 55% by 2030 compared to 1990 levels. Several key pieces of the package, including the revision of the Emission Trading Scheme, the Carbon Border Adjustment Mechanism, and the Social Climate Fund, were adopted by the European Council in April 2023.7
The Fit for 55 legislative package, along with new requirements for renewable energy use and energy efficiency, has the potential to transform the economy. The most ambitious Fit for 55 measures target industries with high energy consumption: buildings, heavy industry and transport. Most measures will come into effect in 2024 and 2025, with a planned surge in energy efficiency and low-carbon fuel use targets in the years leading up to 2030 and 2050.
For instance, planes flying from EU airports will have to use a minimum of 2% sustainable aviation fuel (SAF) starting in 2025, increasing the minimum uptake in small increments until 2030. The minimum target for SAF use will then ramp up to 70% by 2050, which is an ambitious target, given the current state of airplane fleets and existing technologies (current maximum certified SAF blending percentages are between 10% and 50%).8 Similarly, the carbon reduction target for shipping moves from 2% in 2025 to 80% in 2050, despite no definitive low-carbon alternative fuel for large container ships.
Table 1. Select List of Regulations Included in Fit for 55
Regulations Pending | Adopted Regulations |
| ReFuel Aviation Directive | Carbon Border Adjustment Mechanism (CBAM) |
| Fuel EU Maritime | Social Climate Fund (SCF) |
| Revision of Alternative Fuels Infrastructure Regulation | Revision of the Emissions Trading Scheme (ETS) |
| Energy Taxation Directive | Amending the regulation on greenhouse gas emissions and removals from land use, land use change and forestry (LULUCF) |
| Energy Efficiency Directive | Revision of CO2 emission performance standards for cars and vans |
| Renewable Energy Directive | Review of Effort-Sharing Regulation (ESR) |
| Methane Emissions reduction | Notification of the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) |
| Buildings Energy Performance |
Source: Fit for 55 package Under the European Green Deal. For informational purposes only.
How Companies Can Prepare for Increasingly Ambitious Carbon Reduction Targets
1. Prepare Assets for Efficiency
Given the increasingly ambitious energy efficiency and sustainable fuel use targets set out in the Fit for 55 package, we must acknowledge the time it will take for companies to implement the necessary changes in their businesses and supply chains. Take the ReFuelEU Aviation regulation, setting gradually progressive targets on SAF and e-kerosine uptake for aircraft departing from EU airports. Most aircraft can already run on a mix of SAF and kerosene. The challenge to come is in building aircraft that run mostly or solely on SAF. This will require airline companies to renew their airline fleets; a major investment that cannot be done overnight. At the same time, the supply chain needs to prepare to assure sufficient SAF supply and the infrastructure to deliver it.
2. Coordinate Across the Business Ecosystem
Having targets that accelerate towards 2050 will give industries a shared trajectory so that interlinked production processes can shift together. For instance, the Alternative Fuels Regulation targets airports, highways, and marine ports to ensure sufficient electric charging points and hydrogen refueling points. This has major consequences for energy suppliers, contracted building and construction companies, the airlines and shipping companies operating at airports and marine ports, and, ultimately, the capacity of the electricity grid.
Since these measures will be dependent on an entire business ecosystem — an ecosystem that will need to deliver on technological innovation, suppliers shifting production processes to different materials, the development of existing production sites and technology, as well as different skills within the workforce — a common point on the horizon is necessary to move all businesses in a supply chain in the same direction.
3. Account for Future Measures in Current Business Planning
Furthermore, businesses will need to account for future policy measures in their current planning. Car manufacturers that will no longer be able to sell combustion engine vehicles after 2035 will need to start investing today in building the factories to manufacture electric vehicles, training their workforce on these technologies, and setting up supplier relations for a completely different set of materials. Additionally, car manufacturers will need to consider the change in pricing and the taxation of raw materials like steel and aluminum as a result of the Carbon Border Adjustment Mechanism.9
Considering the system-wide transitions required for carbon reduction, it is understandable that the measures in the Fit for 55 package will need to be implemented gradually. This should help to avoid economic shock, widespread unemployment, price instability, and immediate supply shortages. These policy measures and associated economic shifts require careful planning at the micro and macro level. If companies do not start making changes today, they could experience larger implementation shocks closer to 2050.
Measuring Climate Transition Risk in Investment Portfolios
When assessing the climate transition risks of portfolio companies, investors need to assess companies’ management. Does the company have management structures in place to adopt the measures needed to meet their net-zero commitments and keep the global temperature rise to 1.5 degrees by 2050?
Most companies will have to drastically change their business models, supplier relations, technical know-how, employee skill sets, infrastructure, and factories today if they want to be aligned with that objective a few years from now. Investors can use assessments like the Low Carbon Transition Rating (LCTR) to determine company readiness and align their portfolios accordingly. The LCTR shows how well-prepared companies are for the 1.5 degrees scenario and the required policy response. Our analysis finds that most companies are misaligned with the 1.5 degrees scenario, but companies that are most severely misaligned could face the highest risks to their business continuity when regulatory targets accelerate.
Ambitious climate policies and targets are a welcome invitation to companies to start planning their alignment with these measures. However, the longer companies wait to act, the more stringent, destabilizing and financially impactful the transition will be.
References
- Sussams, L. 2018. “Carbon Budgets Explained.” February 6, 2018. Carbon Tracker. https://carbontracker.org/carbon-budgets-explained/.
- Principles for Responsible Investment. “What is the Inevitable Policy Response?” n.d. https://www.unpri.org/inevitable-policy-response/what-is-the-inevitable-policy-response/4787.article.
- Chaganti Singh, S. and Varadhan, S. 2023. “India amends power policy draft to halt new coal-fired capacity.” May 5, 2023. Reuters. https://www.reuters.com/business/energy/india-amends-power-policy-draft-halt-new-coal-fired-capacity-sources-2023-05-04/.
- Reuters. 2021. “China targets 1.8% cut in average coal use at power plants by 2025.“ November 3, 2021. https://www.reuters.com/business/cop/china-cut-coal-use-power-plants-300gkwh-by-2025-2021-11-03/.
- World Economic Forum. “China joins list of nations banning the sale of old-style fossil-fuelled vehicles” November 2020. https://www.weforum.org/agenda/2020/11/china-bans-fossil-fuel-vehicles-electric/.
- CBS News. “Chinese Province Plans to ban the sale of Gasoline Powered cars”. August 2022. https://www.cbsnews.com/news/chinese-province-plans-to-ban-the-sale-of-gasoline-powered-cars/.
- Just Auto. 2022. “South Korea to phase out ICE vehicles by 2035.” March 2022. https://www.just-auto.com/news/south-korea-to-phase-out-ice-vehicles-by-2035/#:~:text=South%20Korea's%20president%2Delect%20Yoon,2035%2C%20according%20to%20local%20reports.
- Clean Energy States Alliance. Table of 100% Clean Energy States. n.d. https://www.cesa.org/projects/100-clean-energy-collaborative/guide/table-of-100-clean-energy-states/.
- Council of the EU. 2023. “’Fit for 55’: Council adopts key pieces of legislation delivering on 2030 climate targets.” April 15, 2023. Press release. https://www.consilium.europa.eu/en/press/press-releases/2023/04/25/fit-for-55-council-adopts-key-pieces-of-legislation-delivering-on-2030-climate-targets/#:~:text=Presented%20by%20the%20European%20Commission,achieve%20climate%20neutrality%20in%202050.
- Destination 2050. 2021. A Route to Net Zero European Aviation. February 2021. https://www.destination2050.eu/wp-content/uploads/2021/03/Destination2050_Report.pdf.
- European Parliament. 2023. “Carbon border adjustment mechanism as part of the European Green Deal.” May 20, 2023. Legislative Train Schedule web site. https://www.europarl.europa.eu/legislative-train/package-fit-for-55/file-carbon-border-adjustment-mechanism.
Overview of Sustainalytics’ Low Carbon Transition Ratings
Our comprehensive framework measures the degree to which a company’s projected GHG emissions differ from various decarbonization policy scenarios between now and the year 2050. The ratings leverage a two-dimensional framework that measures an issuer’s exposure from their expected emissions, while also accounting for management actions. They assess the company’s progress toward their stated net-zero commitments by evaluating the quality and ambition of their GHG reduction targets, as well as any demonstrated short-term investment plans, policies and programs such as Climate Transition Resilience Program, Product Decarbonization Strategy and a GHG Emissions Reduction Policy – Supply Chain. The ratings also provide a Climate Transition Value-at-Risk signal that demonstrates the potential loss in value that a company may experience from a transition to a low carbon economy, calculated for different decarbonization pathways.
Comprehensive Measure of Low Carbon Transition Alignment
Analyze low carbon transition exposure and management preparedness across a business’ value chain for each scope of emissions. Our assessment delivers more than just an Implied Temperature Rise rating, going beyond by looking at a company’s ambitions and targets. Investors can identify areas where each issuer is performing well and opportunities for improvement.
Analyze Expected Issuer Emissions Against Various Net-Zero Climate Scenario
Our Low Carbon Transition Ratings are driven by a bottom-up scenario analysis, evaluating companies’ emission trajectories against expected regional policy and technology pathways required to meet the Paris Agreement and net-zero ambitions by the year 2050. This currently includes orderly scenarios like the UN PRI IPR Required Policy Scenario (RPS)*, and IEA Net Zero 2050 Scenario (NZE), a disorderly scenario with the IPR Forecast Policy Scenario (FPS), and a hot-house scenario with IEA Stated Policies Scenario (STEPS).
*The 1.5°C Required Policy Scenario (RPS) is from the UN PRI commissioned Inevitable Policy Response (IPR).
Support Investor TCFD Reporting and Assess Issuer Disclosure
Paired with our Physical Climate Risk Metrics and Carbon Emissions Data solutions, our Low Carbon Transition Ratings enable investors to meet most TCFD recommendations. Additionally, investors receive a detailed assessment of issuer TCFD disclosure with respect to their quality of management across each thematic area of the TCFD.
Access our Transparent Methodology and Granular Data
Our Low Carbon Transition Ratings are underpinned by a transparent methodology, multiple levels of data and clear indicator guidance, which allows for validation and customization of the weighted data points to generate unique insights that align to investors’ objectives.
Holistic Integration of Management Preparedness
With more than 85 general and subindustry-specific management indicators – weighted by a company’s distribution of GHG emissions across Scopes 1, 2, 3 upstream, and 3 downstream – investors gain transparency into the credibility of company’s transition plans and management preparedness and can integrate granular climate insights into their company assessments and valuation models.
Ratings Expressed as Implied Temperature Rise
The top-level ratings are expressed as a simple contextualized signal, estimating the Implied Temperature Rise of issuers’ current low carbon transition performance. This expresses what global temperatures could rise to if the whole economy had the same percentage of misaligned emissions between now and the year 2050. This output enables investors to seamlessly categorize and compare different levels of performance across issuers.
Dedicated Module to Assess Issuer Disclosure with TCFD
A TCFD module module is included in the rating to assess and track the completeness of issuer reporting and translate our assessment of issuers’ managerial preparedness across the four thematic areas recommended by the TCFD (governance, strategy, risk management, and metrics and targets).
Integrated Asset Impact Data
More accurately assess how companies are managing their net-zero transition. Estimate the impact of current CapEx on future investment alignment among the 9 highest emitting sectors including utilities, construction materials, and transportation.
8,000+ Companies Covered
Sustainalytics' Low Carbon Transition Ratings span more than 8,000 companies and encompass most major global indices. Future expansion of the company database will align with the coverage of our ESG Risk Ratings.
Flexible Accessibility
The Low Carbon Transition Ratings are available through Global Access with screening and reporting tools, data-feeds, and application programming interface (API). They will be made available for several third-party distribution platforms in the future.
Analysis of Issuer's Transition Value at Risk
Value at Risk (VaR) is a financial metric that demonstrates the expected future impact on a company’s bottom line due to the transition to a low carbon economy. VaR is measured based on the policy costs of expected emissions and the impact of reduced market demand, where applicable. It is a cumulative value based on a discounted cash flow model for the years from now until 2050 that allows users to complete regulatory reporting, stress testing, scenario analysis, and portfolio optimization.
Learn more about our Low Carbon Transition Ratings
To learn more about our Low Carbon Transition Ratings, view the video message from our Senior Vice President of Climate Solutions, Azadeh Sabour.
About Our Framework
We start with a baseline projection, which is based on corporate reporting and estimation modelling across all 3 scopes of emissions, including both the upstream and downstream segments of scope 3.
Next, we consider how the quality of the company's policies and programs, strategy, governance, and financial position affect the baseline emissions.
This emissions projection is based on a company's baseline emissions in combination with their managed emissions.
This is the company's sector- and region-specific budget required to align to a net-zero emissions pathway by 2050.
The expected emissions gap reflects the emissions that are not managed and indicates the severity of misaligned emissions.
The Expected Emissions Gap reflects the emissions that are not managed and indicates the severity of misaligned emissions.
Expected Emissions Gap Calculation
| Cumulative Emissions to 2050 (CO2) | |
|---|---|
| Expected Emissions | 765 Mt |
| Net-Zero Budget | 211 Mt |
| Expected Emissions Gap | 553 Mt (+261%) |
| Implied Temperature Rise Score | 2.4ºC |
| Implied Temperature Rise Category | Significantly Misaligned |
Use Cases
Climate Research Integration
- Measure alignment of companies against a 1.5°C scenario
- Deepen insights into transition risk and opportunities for portfolio management
- Conduct scenario analysis – compare value at risk for different decarbonization pathways
Implement Net-Zero Strategies
- Assess forward-looking carbon emissions of companies, portfolios, funds, and benchmarks with net-zero pathways.
- Meet commitments of global alliances and member groups such as the Net Zero Asset Manager Initiative and the Institutional Investors Group on Climate Change (IIGCC).
Screening and Benchmarking
- Set decarbonization targets and monitor performance.
- Screen investable universe based on company exposure to, and/or management of, transition risks.
- Conduct credibility assessments of company transition plans and assess SBTi Readiness
Reporting & Client Communication
- Support TCFD-aligned regulatory reporting.
- Report to clients on how portfolios are aligned with global climate goals.
- Respond to client net-zero mandates.
Engagement and Voting
- Evaluate company management of transition risks and opportunities.
- Obtain transparency on corporate’s disclosure sufficiency to current TCFD recommendations.
Thematic Investing
- Create climate-aware investment products.
Report Insights
A company’s top-level rating is expressed as an Implied Temperature Rise signifying the expected level of global warming if the global economy had the same proportion of emissions misaligned to the net-zero budget. The absolute emissions gap across each scope of the company’s business activity are summarized through time series graphs, with the underlying components of the assessment illustrated in decomposition charts.
The degree of overall alignment to the net-zero budget is summarized for each scope of emissions across an issuer’s value-chain, providing transparency into how much each scope of emissions is contributing to the overall rating. A separate value-chain analysis for each of the exposure and management components is also provided.
The issuer’s rating is analyzed in context of their peers in global public equity and bond markets, as well as industry and sub-industry specific peers. The issuer’s top peers by market capitalization are summarized with a view of their overall rating, Exposure and Management scores.
An overall management score out of 100 is provided, as well as an analysis identifying where action may be needed across the issuer's business activities. This is communicated through a breakdown of their management scores and contribution of key management indicators for each scope of emissions across the issuer’s value chain.
An overall score of the comprehensiveness of issuers’ climate related disclosures, and a detailed analysis across the key TCFD thematic areas of governance, strategy, risk management and metrics & targets provides transparency into quality of their management.
Low Carbon Transition Value at Risk (VaR) informs investors about potential future losses their portfolio companies may face due to their exposure and management of the transition to a low carbon economy. By taking into account the policy costs of expected emissions, and the impact of reduced market demand for fossil fuels, VaR enables investors to respond to regulatory requirements, perform stress testing, and optimize their portfolio for transition scenarios.
Why Sustainalytics?
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Related Products
Carbon Emissions Data
Evaluate and analyze companies’ GHG emissions across scope 1, 2, and 3 emissions.
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Morningstar Low Carbon Transition Leaders Indexes
Gain diversified broad market exposure to companies leading their sector peers in their readiness for — and action towards — climate transition.
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Physical Climate Risk Metrics
Assess and disclose the direct and indirect physical climate risks of climate change related exposure.
Learn MoreRelated Insights and Resources
Policy Responses to Climate Change: The EU’s Fit for 55 Package and Its Implications for Companies and Investors
The effects of climate change are no longer a distant threat. The latest report from The Intergovernmental Panel on Climate Change tells us that urgent and more ambitious action is needed. Consequently, governments, companies, institutional investors, and financial institutions are focused on developing strategies to effectively reduce greenhouse gas (GHG) emissions, slow down environmental degradation, and mitigate climate transition risks.
In this blog, I highlight how global policy responses to the climate crisis and the targets set within them could affect business strategy and operations. I also outline what investors can do to evaluate this transition risk among portfolio companies. We’ll delve into the European Union’s Fit for 55 package, as it provides examples of the most ambitious policy response to the climate crisis thus far, and has far-reaching implications for companies supplying goods and services to the EU market.
How Investors Can Assess Climate Transition Risk
As part of their response to the current climate crisis, institutional investors and financial institutions are assessing the climate transition risks in their portfolios. To do that, they need to understand the GHG emissions budgets for the companies they invest in. The emissions budget is the amount of GHG emissions a company is allowed each year until 2050, if its activities are aligned to a 1.5-degree Celsius global temperature rise.1 The budget is dependent on the pace of climate policy implementations in the coming years.
To help prepare institutional investors for the risks and opportunities related to an acceleration of policy responses to climate change, the United Nations Principles for Responsible Investment commissioned a consortium called Inevitable Policy Response (IPR) to develop the Required Policy Response (RPR) scenario. The IPR forecasts that, to address the climate crisis, “governments will be forced to act more decisively than they have thus far, leaving financial portfolios exposed to significant transition risk.”2 This scenario may seem questionable, given the uncertainty on whether governments will actually become more decisive. However, there are already several examples of climate laws implemented just as the IPR presumed.
The Fit for 55 Regulation
The Fit For 55 regulation package is a real-world example of the required policy response. Legislation has also been passed outside of the EU, such as the coal capacity market reforms in India,3 the announced end of fossil-fueled cars and vans sales in China4 and South Korea5 by 2035, and the 100% clean power standard in several states of the U.S.6
The Fit for 55 legislative package explicitly aims to set the EU on a decarbonization path reducing carbon emissions by 55% by 2030 compared to 1990 levels. Several key pieces of the package, including the revision of the Emission Trading Scheme, the Carbon Border Adjustment Mechanism, and the Social Climate Fund, were adopted by the European Council in April 2023.7
The Fit for 55 legislative package, along with new requirements for renewable energy use and energy efficiency, has the potential to transform the economy. The most ambitious Fit for 55 measures target industries with high energy consumption: buildings, heavy industry and transport. Most measures will come into effect in 2024 and 2025, with a planned surge in energy efficiency and low-carbon fuel use targets in the years leading up to 2030 and 2050.
For instance, planes flying from EU airports will have to use a minimum of 2% sustainable aviation fuel (SAF) starting in 2025, increasing the minimum uptake in small increments until 2030. The minimum target for SAF use will then ramp up to 70% by 2050, which is an ambitious target, given the current state of airplane fleets and existing technologies (current maximum certified SAF blending percentages are between 10% and 50%).8 Similarly, the carbon reduction target for shipping moves from 2% in 2025 to 80% in 2050, despite no definitive low-carbon alternative fuel for large container ships.
Table 1. Select List of Regulations Included in Fit for 55
Regulations Pending | Adopted Regulations |
| ReFuel Aviation Directive | Carbon Border Adjustment Mechanism (CBAM) |
| Fuel EU Maritime | Social Climate Fund (SCF) |
| Revision of Alternative Fuels Infrastructure Regulation | Revision of the Emissions Trading Scheme (ETS) |
| Energy Taxation Directive | Amending the regulation on greenhouse gas emissions and removals from land use, land use change and forestry (LULUCF) |
| Energy Efficiency Directive | Revision of CO2 emission performance standards for cars and vans |
| Renewable Energy Directive | Review of Effort-Sharing Regulation (ESR) |
| Methane Emissions reduction | Notification of the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) |
| Buildings Energy Performance |
Source: Fit for 55 package Under the European Green Deal. For informational purposes only.
How Companies Can Prepare for Increasingly Ambitious Carbon Reduction Targets
1. Prepare Assets for Efficiency
Given the increasingly ambitious energy efficiency and sustainable fuel use targets set out in the Fit for 55 package, we must acknowledge the time it will take for companies to implement the necessary changes in their businesses and supply chains. Take the ReFuelEU Aviation regulation, setting gradually progressive targets on SAF and e-kerosine uptake for aircraft departing from EU airports. Most aircraft can already run on a mix of SAF and kerosene. The challenge to come is in building aircraft that run mostly or solely on SAF. This will require airline companies to renew their airline fleets; a major investment that cannot be done overnight. At the same time, the supply chain needs to prepare to assure sufficient SAF supply and the infrastructure to deliver it.
2. Coordinate Across the Business Ecosystem
Having targets that accelerate towards 2050 will give industries a shared trajectory so that interlinked production processes can shift together. For instance, the Alternative Fuels Regulation targets airports, highways, and marine ports to ensure sufficient electric charging points and hydrogen refueling points. This has major consequences for energy suppliers, contracted building and construction companies, the airlines and shipping companies operating at airports and marine ports, and, ultimately, the capacity of the electricity grid.
Since these measures will be dependent on an entire business ecosystem — an ecosystem that will need to deliver on technological innovation, suppliers shifting production processes to different materials, the development of existing production sites and technology, as well as different skills within the workforce — a common point on the horizon is necessary to move all businesses in a supply chain in the same direction.
3. Account for Future Measures in Current Business Planning
Furthermore, businesses will need to account for future policy measures in their current planning. Car manufacturers that will no longer be able to sell combustion engine vehicles after 2035 will need to start investing today in building the factories to manufacture electric vehicles, training their workforce on these technologies, and setting up supplier relations for a completely different set of materials. Additionally, car manufacturers will need to consider the change in pricing and the taxation of raw materials like steel and aluminum as a result of the Carbon Border Adjustment Mechanism.9
Considering the system-wide transitions required for carbon reduction, it is understandable that the measures in the Fit for 55 package will need to be implemented gradually. This should help to avoid economic shock, widespread unemployment, price instability, and immediate supply shortages. These policy measures and associated economic shifts require careful planning at the micro and macro level. If companies do not start making changes today, they could experience larger implementation shocks closer to 2050.
Measuring Climate Transition Risk in Investment Portfolios
When assessing the climate transition risks of portfolio companies, investors need to assess companies’ management. Does the company have management structures in place to adopt the measures needed to meet their net-zero commitments and keep the global temperature rise to 1.5 degrees by 2050?
Most companies will have to drastically change their business models, supplier relations, technical know-how, employee skill sets, infrastructure, and factories today if they want to be aligned with that objective a few years from now. Investors can use assessments like the Low Carbon Transition Rating (LCTR) to determine company readiness and align their portfolios accordingly. The LCTR shows how well-prepared companies are for the 1.5 degrees scenario and the required policy response. Our analysis finds that most companies are misaligned with the 1.5 degrees scenario, but companies that are most severely misaligned could face the highest risks to their business continuity when regulatory targets accelerate.
Ambitious climate policies and targets are a welcome invitation to companies to start planning their alignment with these measures. However, the longer companies wait to act, the more stringent, destabilizing and financially impactful the transition will be.
References
- Sussams, L. 2018. “Carbon Budgets Explained.” February 6, 2018. Carbon Tracker. https://carbontracker.org/carbon-budgets-explained/.
- Principles for Responsible Investment. “What is the Inevitable Policy Response?” n.d. https://www.unpri.org/inevitable-policy-response/what-is-the-inevitable-policy-response/4787.article.
- Chaganti Singh, S. and Varadhan, S. 2023. “India amends power policy draft to halt new coal-fired capacity.” May 5, 2023. Reuters. https://www.reuters.com/business/energy/india-amends-power-policy-draft-halt-new-coal-fired-capacity-sources-2023-05-04/.
- Reuters. 2021. “China targets 1.8% cut in average coal use at power plants by 2025.“ November 3, 2021. https://www.reuters.com/business/cop/china-cut-coal-use-power-plants-300gkwh-by-2025-2021-11-03/.
- World Economic Forum. “China joins list of nations banning the sale of old-style fossil-fuelled vehicles” November 2020. https://www.weforum.org/agenda/2020/11/china-bans-fossil-fuel-vehicles-electric/.
- CBS News. “Chinese Province Plans to ban the sale of Gasoline Powered cars”. August 2022. https://www.cbsnews.com/news/chinese-province-plans-to-ban-the-sale-of-gasoline-powered-cars/.
- Just Auto. 2022. “South Korea to phase out ICE vehicles by 2035.” March 2022. https://www.just-auto.com/news/south-korea-to-phase-out-ice-vehicles-by-2035/#:~:text=South%20Korea's%20president%2Delect%20Yoon,2035%2C%20according%20to%20local%20reports.
- Clean Energy States Alliance. Table of 100% Clean Energy States. n.d. https://www.cesa.org/projects/100-clean-energy-collaborative/guide/table-of-100-clean-energy-states/.
- Council of the EU. 2023. “’Fit for 55’: Council adopts key pieces of legislation delivering on 2030 climate targets.” April 15, 2023. Press release. https://www.consilium.europa.eu/en/press/press-releases/2023/04/25/fit-for-55-council-adopts-key-pieces-of-legislation-delivering-on-2030-climate-targets/#:~:text=Presented%20by%20the%20European%20Commission,achieve%20climate%20neutrality%20in%202050.
- Destination 2050. 2021. A Route to Net Zero European Aviation. February 2021. https://www.destination2050.eu/wp-content/uploads/2021/03/Destination2050_Report.pdf.
- European Parliament. 2023. “Carbon border adjustment mechanism as part of the European Green Deal.” May 20, 2023. Legislative Train Schedule web site. https://www.europarl.europa.eu/legislative-train/package-fit-for-55/file-carbon-border-adjustment-mechanism.
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