A Detailed Look at Climate Transition Risk Data
- Assessing transition risk matters because it is one of the major components of climate risk for companies, alongside physical risk (see Physical Climate Risk Data: A Primer and Evaluation). The leading climate data vendors have varied approaches to transition risk.
- Even though vendors’ approaches to transition risk may be comparable, TVaR correlations between ISS and MSCI were moderate, and MSCI and Trucost arrived at significantly different conclusions about industry/geographic risk. Results vary substantially depending on which pathways, scenarios, horizons, and other criteria are selected.
- The majority of datasets and models related to the transition are closely aligned with the Task Force on Climate-related Financial Disclosures (TCFD) recommendations to perform scenario analysis on investment portfolios.
Vendors generate climate transition risk data in an assortment of ways — just as they do for many other types of ESG data. Different ESG vendors have adopted various proprietary methodologies and employed different climate pathways, criteria, and considerations to drive their transition risk models. Therefore, we believe that investors should take a closer look at the methodologies of each vendor. In this piece, we analyzed the current approaches to transition risk of three climate data vendors: MSCI, ISS, and S&P Trucost.
Analyzing Climate Transition Data
ESG data providers face several challenges in the generation of climate transition data in our view, including the sheer lack of history.
Transition Data Lacks Standardization: A Closer Look at Three Approaches
| ISS | MSCI | S&P Trucost | |
|---|---|---|---|
| Policy Risk | Y | Y | Y |
| Technology Opportunities | Y | Y | N |
| Emission Data | Only Scope 1 and 2 | Scope 1, 2, and 3 | Only Scope 1 and 2 |
| Coverage (# of Companies) | 11,000+ companies | 11,000+ companies | 17,000+ companies |
| History | Q4 2021 onwards | 2022 onwards | 2018 onwards |
| Numerical Outputs | TVaR (% and absolute values); Estimated change in sales due to transition risk (%); Carbon Risk Classification, Carbon Performance Score (1–4 scores); and Carbon Risk Ratings (0–100 scores). | Policy Risk Climate VaR (%); Technology Opportunities Climate VaR (%); Transition Climate VaR (%); Climate VaR (%); Low Carbon Transition Score (0–10 scores); Low Carbon Transition Category (5 qualitative brackets). | Unpriced carbon costs in $M, as well as percentages of earnings at risk due to carbon pricing. |
Sources: ISS, MSCI, and S&P Trucost, as of June 30, 2023.
MSCI
MSCI tackles transition risk by focusing on two key components:
- Policy Risk MSCI calculates the projected carbon emission reductions needed to meet the particular carbon price and temperature objectives for several future scenarios. The net present value of future additional costs is normalized by the company’s market value to attain a Policy Risk Climate Value-at-Risk (VaR) (see: Climate VaR and Financial Value: Assessing the Empirical Evidence).
- Technological Opportunities Similar to the policy risk model, this provides an estimate of future profits that a firm might derive thanks to its involvement in green or low-carbon technologies. MSCI identifies those technologies by evaluating companies’ estimated low-carbon revenues and analyzing a database of millions of patents. The net present value of future profits is then normalized by the firm’s market value in order to calculate the Technology Opportunity Climate VaR.
The Policy Risk and Technology Opportunity results are equally weighted to calculate an aggregated Transition VaR. The assessment of how climate change may affect investment returns for a particular company takes the form of a percentage change from a company’s current valuation.
MSCI also has a second distinct tool to identify transition risks and opportunities. MSCI designed this tool, named the “Low Carbon Transition Risk Assessment” (LCR), to identify potential leaders and laggards in transition risk by measuring companies’ exposure to and management of risks and opportunities related to the low carbon transition. The assumption behind this rating mechanism, which scores companies using a 0–10 scale, is that if a low-carbon transition takes place, demand for carbon-intensive products would decline in favor of low/net-zero carbon products.
ISS
ISS also has two main focuses:
- Carbon Risk ISS’s Carbon Risk Rating is a proprietary scoring system that is comparable to MSCI’s Low Carbon Transition Risk Assessment. ISS created the Carbon Risk Rating (CRR) to evaluate how well a particular company or portfolio is prepared to face the low-carbon economy of the future.
The CRR is split into two complementary sub-scores The first one is the Carbon Risk Classification, which aims at evaluating a company’s exposure to climate change risks, given its industry, products, and business lines. The second sub-score is the Carbon Performance Score, which quantifies how well the firm is able to capitalize on climate-related opportunities and manage risks. - Geographic-related Risk ISS’s transition VaR dataset is similar to MSCI’s Transition CVaR tool. However, ISS has created a more specialized Transition VaR model. This dataset leverages two available scenarios. Both scenarios take into account policy risks as well as market and technology risks. The ISS TVaR model links each company’s geographical exposure profile to each scenario’s carbon prices, and evaluates the impact of transition risks and opportunities1 on the valuation of each company. To do so, ISS employs its proprietary Economic Value Added methodology. ISS can calculate a total TVaR by estimating the change in share price resulting from the financial impact of transition risks and opportunities.
Separately, ISS calculates a final Risk Rating that is an aggregated score indicating a company’s overall climate-related risk. The final Risk Rating accounts for transition risk, as it indicates how a particular firm’s baseline risks may impact how it can mitigate transition risk.
S&P TRUCOST
S&P Trucost has focused its approach on the development of its Carbon Earnings at Risk (CEaR) dataset. The dataset assesses the potential impact of the global carbon transition on a company’s current earnings. To quantify a company’s potential exposure to carbon price increases, Trucost identifies sectors that would be particularly impacted by that risk. In addition, Trucost considers the countries or jurisdictions in which those companies operate to estimate the percentage of unpriced carbon cost that an investor is exposed to.