Overview And Scope

This article describes S&P Global Ratings' analytical approach for providing a Climate Transition Assessment (CTA). A CTA is our qualitative opinion of how consistent with a low carbon, climate resilient future we believe an entity's current economic activities and expected future economic activities will be once the entity's planned transition changes are realized, and potential material implementation risks are considered. We use two single Shades of Green to express our view of the entity's current status and future status ranging from Dark green to Red as described in "Analytical Approach: Shades of Green Assessments", published on July 27, 2023. We also assign a Transition Progress score to express our opinion on the extent to which we expect an entity will change its underlying economic activities to align with a low carbon climate resilient future between the current and future time horizon.

Our CTA analysis follows the following steps. First, we assign a current status in the form of a single Shade of Green based on how consistent the entity's current economic activities are with a low carbon, climate resilient future.

Second, we review the entity's climate transition plan, which covers the entity's key climate targets and metrics, and the actions and investments the entity is making to transition toward a low carbon, climate resilient future. We also consider major implementation drivers, including the identification of potential blockers and enablers that are important for the entity in delivering its plan.

We assign a future status in the form of a single Shade of Green, based on how consistent with a low-carbon, climate resilient future we believe the entity's likely mix of future economic activities will be.

We also assign a transition progress score, which communicates our opinion of the likely extent of change between the entity's current mix and future mix of economic activities, and their alignment with a low carbon, climate resilient future.

A CTA is a point-in-time qualitative analysis. Our review relies on the accuracy, timeliness, and completeness of the financial data and information provided by the company, and we do not provide any assurance on this data.   We base our opinions on an entity's transition plan and its own timeframe to realize that plan.

CTAs are not credit ratings, do not assess credit quality, and do not factor into our credit ratings. Our CTA analysis is applicable to public and private sector financial and nonfinancial corporate entities and cannot be applied to any sovereign, regional, or local governments.

In addition, and upon request from the entity, we can assess consistency with Nasdaq's Green Equity Designation Requirements, the SIX 1.5°C Climate Equity Flag, B3 Ações Verdes (BAV), and any green equity framework for which we are an approved reviewer.

Our CTA reports include an analytical summary expressed as the strengths, weaknesses, and areas to watch.   Strengths and weaknesses highlight our analysis of the entity's preparedness for a low carbon, climate resilient future. Areas to watch highlight risks that we believe could undermine the entity's climate transition.

• We consider a strength to be a feature that stands out as positive in the context of our view of the entity's climate transition. For example, we could consider an entity's commitments to retire fossil assets well ahead of the end of their useful life and regulatory requirements a strength.
• We consider a weakness to be a significant limitation, identified in our analysis, that could prevent the entity from being aligned with a low carbon, climate resilient future. For example, we could consider a transition plan's failure to address an entity's primary source of climate risk a weakness.
• We consider an area to watch to be a potential problem or risk that we believe could undermine the entity's transition plan. In general, areas to watch are risks that the entity plans to mitigate or residual risks that will likely remain after the entity has taken mitigating actions. For example, we could consider an entity's exposure to increasing levels of physical risk as an area to watch. If other environmental or social factors are more material for the entity than climate transition, we might highlight that as an area to watch.

Current Status

Our current status analysis represents our qualitative opinion of how consistent an entity's current economic activities are with a low carbon, climate resilient future.   We use our "Analytical Approach: Shades of Green Assessments" to assign Shades of Green to the entity's current economic activities. We determine Shades based on our analysis of climate and nonclimate environmental factors. Our analysis of activities and subsequent shades assigned does not reflect an activity's social risks or benefits.

We express our view of an entity's current activity as a single Shade of Green based on the principles enumerated in the "Single Shade Roll Up Principles" section.   We also disclose the percent breakdown of activity by shade which underpins the single Shade of Green.

For assessing an entity's mix of economic activities, we select a metric we believe is most indicative of its environmental and operational footprint and apply Shades of Green to each of the activities. For most nonfinancial corporations, we typically use the latest reported revenues to describe the entity's mix of economic activities. We use alternative metrics where we believe the alternative metric is more representative of the mix of activities. For entities in financial services, we will primarily focus on metrics related to lending, underwriting, and assets under management, assigning shades to both balance sheet and off-balance-sheet equivalent exposures where relevant and possible.

Single Shade Roll Up Principles

As part of our CTA analysis, we derive a single Shade of Green to express our view on the entity's current mix of activities in the current status, and its expected future activities mix in the future status.

To do this, we use a three-step process:

Step 1:   We derive a weighted average indicative score to determine the Preliminary Overall Shade. First, we assign a shade to each of the entity's economic activities following our "Analytical Approach: Shades of Green Assessments". This results in a breakdown of economic activities by shade. Then, we apply a multiplier to the proportion of activities in each shade, as shown in the second column of Table 1. We aggregate the results to produce a weighted average indicative score between 1 and 6, rounded to the nearest hundredth. We translate this indicative score to a Preliminary Overall Shade based on the thresholds shown in the third column of Table 1.

For example, if an entity's economic activity was labeled 55% Dark green and 45% Yellow, we would compute the following formula: Indicative score = 6x55% + 3x45%.

This yields an indicative score of 4.65, to which we would assign a Medium green.

Table 1

Step 2:   When applicable, we apply adjustments, which may override the Preliminary Overall Shade, to determine the Overall Shade of Green. If multiple conditions are triggered, the lower of the indicated outcomes applies.

• If the Preliminary Overall Shade is Dark green, are there any Orange or Red activities? If yes, we cap the outcome at Medium green.
• Is the share of Green activities at least 50% and the share of Red is less than 5%? If yes, the outcome is at least Light green.
• Is the share of Red activities 5% or more? If yes, we cap the outcome at Yellow.

Step 3:   We may also adjust the Overall Shade of Green to reflect factors not fully captured in our shade analysis, so that the final outcome reflects our holistic view. For example, we may adjust the Overall Shade of Green when data limitations affect our ability to form a comprehensive view of the breakdown of future economic activities.

Climate Transition Plan

To understand the entity's climate transition plan we consider the entity's targets and metrics, planned actions and investments, and implementation drivers.   Given the unique characteristics of each entity's transition plan, we combine these analytical elements holistically to form an opinion on the likely future mix of economic activities. Examples of the topics we aim to understand are:

• What is the entity's plan to transition? How has the entity set targets?
• What is the timeline of the entity's transition plans? What is the lead time to execute on the plan actions and for those actions to deliver change in the entity's mix of activities?
• What do the quality of target setting, monitoring, and reporting tell us about the entity's commitment to deliver?
• What investment decisions is the entity committed to making to transition?
• What activities will the entity stop doing, start doing, or continue doing and when?
• How is the entity organized to implement the plan?
• How much is the transition likely to cost and how does the entity expect to fund the plan?
• What obstacles or blockers can we identify that could constrain the entity's ability to implement?

What we learn from understanding the entity's climate transition plan informs our expectation of the likely future mix of economic activities, to which we apply a single Shade of Green in the next step of our analysis. We anchor our analysis on the time horizon over which the entity's current and committed plans and actions are expected to unfold. For example, this can be in the next five years if the entity expects to have transformed its activity mix through mergers, acquisitions, disposals, or via new and decommissioned business lines. Alternatively, it could be over a longer time horizon if the lead time and realization of impact for some of the planned actions and investments being made is longer than five years.

The CTA explains the amount of time over which we understand the entity's activity mix will change and why we have anchored our analysis on that time frame.   If we do not expect the activity mix to change, we anchor our analysis on the entity's current activities and its commitments to maintain its current consistency with a low carbon, climate resilient future.

Metrics And Targets

We consider the entity's metrics and targets and any forward-looking objectives that are relevant to its climate transition.   We focus on the metrics and targets we believe to be most material. These targets typically include green revenue targets, greenhouse gas emission targets, or renewable energy targets.

When relevant, we look at the comprehensiveness of the targets by reviewing whether:

• The targets address the entity's activities that have the greatest climate risk, which may exist outside its direct operational control, including scope 3 emissions.
• The entity has interim and long-term targets that represent continued progress toward a low carbon, climate resilient future.
• The entity's targets are consistent with appropriate decarbonization pathways if a relevant pathway exists.

We typically view an entity's metrics and targets as more comprehensive when they address climate activities with the most impact, have robust interim targets rather than long-term targets in isolation, and the metrics are calculated and reported according to leading standards.

Where relevant, we may benchmark the entity's performance against metrics we believe address its most important climate risks. We may also compare its performance with other entities to provide further context on the progress the entity has already made or planned.

Actions And Investments

The entity's committed climate transition actions and investments affect its transition and the consistency of its activities with a low carbon, climate resilient future.   Commitments may include stopping certain activities by a given date or investing in green technologies, a new supplier, and customer relationships. We assess whether the entity intends to expand activities consistent with a low carbon, climate resilient future and phase out activities that are inconsistent with or will likely impede the transition, in its direct operations and when relevant in its value chain. When capital expenditure (capex) mix helps assess our opinion of the future mix of activities, our CTA analysis will include applying Shades of Green to the capex activities.

Examples of actions and investments

We consider the actions an entity may take to align itself with a low carbon, climate resilient future, including its investment planning activities. Actions in areas such as research and development (R&D), mergers & acquisitions (M&A), capex, asset retirement plans, carbon removal technologies, lending and investment policies, and changes in upstream and downstream activities and other areas may be relevant to the climate transition plan.

When analyzing an entity's climate transition plan, including its investment plans, we consider the plan's time horizon, the likely magnitude of impact on the entity's future mix of economic activities, and the entity's track record of execution.

Many entities will rely on R&D for new green technologies or M&A for green technologies or sources of revenue. While it is not always possible for an entity to know how much it will spend on R&D for a particular technology or the extent of future M&A, we consider how comprehensively an entity incorporates these actions into its climate transition and investment plans, and if they are consistent with achieving the stated targets within its plan. For example, a transportation company intending to adopt green hydrogen technology may consider the costs of developing the technology and infrastructure itself or acquiring it in the coming years. Our view would be more favorable if the company demonstrates its investment decision-making process and the assumptions that underpin its plan to transition to green hydrogen.

Many entities are exposed to climate risk from purchased goods and services that can affect their transition plans. When relevant, we consider whether an entity is comprehensively assessing the environmental impacts of its supply chain, what types of commitments to change it is securing from its suppliers (including how and what time frame it expects those commitments to deliver change and across what proportion of suppliers), and the consistency of those commitments with a low carbon, climate resilient future. We also consider the entity's monitoring and enforcement of supplier commitments, including its willingness and ability to change suppliers if environmental commitments are not met.

Some entities may also be exposed to material climate risk associated with transporting their products. We consider the steps an entity is taking to improve the sustainability of its logistics and transportation, when relevant.

Entities may also incorporate sustainability into product design, focusing on stemming climate risk over the product's lifecycle, including reducing emissions from energy use and the product's end-of-life phase. For example, we may consider the extent to which a consumer products company's processes to source its raw materials, manufacture its products, and deliver the products to customers have been decarbonized, and how well it manages other environmental impacts like waste from the products' end of life phase.

Some entities, for example financial services, are exposed to climate risk from their clients' actions, which can affect their transition plans. When relevant, we consider whether an entity is comprehensively assessing the transition progress of its clients, what types of transition commitments it is securing from its clients, the consistency of those commitments with a low carbon, climate resilient future, and the timeframe over which it expects those commitments to occur.

Financial institutions may rely on lending and investment policy to scale up green activities and support the transition process of their clients to phase out Red activities. These actions could take the form of environmental risk management policies which require heightened diligence on potentially environmentally intensive financing activities, exclusionary policies which prohibit financing certain activities, or any other policy intended to affect the climate impacts associated with the entity's financing activities.

Implementation Drivers

In this section of our analysis, we consider how likely the entity is to implement its climate transition plan successfully. This helps us take a view on how the entity's planned transition actions will affect the consistency of its economic activity mix with a low carbon, climate resilient future. Our analysis focuses on how aligned the entity is to its climate transition plan from organizational and financial perspectives. Finally, we also consider external or macroeconomic factors which might derail or block the entity from implementing its transition plans.

Organizational Alignment

We believe an entity will successfully implement its climate transition plan only if there are management incentives and structures fit for the purpose of delivering the plan. When considering how effectively the entity's organizational alignment supports its transition, we consider a variety of characteristics such as:

• Leadership structure and lines of accountability;
• Incentives, financial or nonfinancial, for senior management to deliver; and
• Commensurate resourcing and personnel allocation planning

Financial Management

We assess the entity's financial management for its transition plan by understanding how the entity estimates the cost of managing the transition and how it plans to fund this investment. Typical areas to understand include:

• The estimated cost of the plan; and
• Expectations for funding these costs, for example, with cash flow, debt, asset disposal sales, equity investment or government support.

Implementation Blockers

There may be other risks that could impede an entity's ability to execute its plan including opposition from stakeholders, reliance on new technology, or regional variations in regulations and government policy.   Examples of implementation blockers could include:

• Significant stakeholder opposition (for example, if community pushback could prevent an energy company from acquiring land on which to build new wind farms).
• Over-reliance on unproven or undeveloped technological innovations (for example, if an airline is relying on the development of electric airplanes to achieve its plan where there are none currently existing that could support the airline's capacity and range requirements).
• Unfavorable regulatory environment (for example, if an electric utility operates in a coal-friendly region and has difficulty obtaining regulatory approval to close its coal plants before the end of their economically useful lives).

While social considerations do not influence the Shades of Green we assign, there could be climate-related social factors that constrain an entity's ability to successfully implement its plan, which can influence the CTA outcome; for example, if a company is facing significant community opposition to the development of renewable assets it is relying on to execute its transition plan.

Future Status And Transition Progress

The future status and transition progress build on our understanding of an entity's current status and climate transition plan and reflect our opinion of how consistent with a low carbon, climate resilient future we expect an entity's economic activities will be once the planned transition changes are realized and implementation risks are considered.

We express the future status as a single Shade of Green, following the same principles we use to come to the entity's current status and enumerated in the "Single Shade Roll Up Principles" section. A future status that is any Shade of Green higher on the scale than the current status would signal that we expect the entity's future mix of economic activities will be more consistent with a low-carbon, climate resilient future than it currently is. The inverse is also true: a future status that is lower on the scale than the current status signals that we expect the entity's expected future mix of economic activities is less consistent with a low-carbon climate resilient future than its current mix.

However, there are situations in which we would expect an entity's economic activities to improve between current status and future status, but not to the extent it results in a difference in shade. This could be due to change in the activity mix or improvement in the characteristics of underlying activities. Therefore, we assign a transition progress score, which reflects our opinion of the likely extent of change between the entity's current economic activities and expected future economic activities in a more granular way. The score is generally guided by calculating the difference in the indicative scores underpinning the current Shade of Green and future Shade of Green, per the table in the section "Single Shade Roll Up Principles."

We express the transition progress as one of five outcomes, illustrated in table 2 below.

Table 2

Other Optional Assessments

Green equity

Upon request from the entity, we can provide an opinion as to whether there is alignment with the Green Equity Principles used by various stock exchanges. This assessment is applicable for the exchanges where we are an approved reviewer.

This opinion leverages the same underlying analysis that we use in our CTA. We use our analysis of the consistency of activities with a low carbon, climate resilient future to determine what qualifies as green. When the designating set criteria for the share of green activities, we use our Shades of Green applied to the most recently reported revenue, capex and operational expenditure (opex), or other metrics determined by the exchange for a full financial year. We associate activities assigned a Dark, Medium, or Light green shade as green for the purpose of this assessment. For example, a Nasdaq green designation is, at the time of writing, attainable for a company that derives more than 50% of its turnover from activities considered green and more than 50% of investments allocated to activities considered green. For further information about all the designation requirements see Nasdaq Green Equity principles.

Stock exchanges may include exclusion criteria in their Green Equity Principles, for example in the form of thresholds for fossil fuel activities. We assess against the specific activity thresholds of the relevant principles and the financial data and information disclosed by the company.

Our review relies on the information presented by the company, and we do not provide any assurance of this data, including for any taxonomy alignment. For example, when assessing companies against the B3 Ações Verdes (BAV) we consider if the company's green activities are listed in the "Sectors" and "Activities" items in the EU Taxonomy for Sustainable Activities without providing any assurance on EU taxonomy alignment. As per the requirement by B3 Ações Verdes only activities that are eligible for the EU taxonomy can be counted towards the green activities' thresholds. For further information about the designation requirements see B3 Ofício Circular on B3 Ações Verdes.

Related Research

• Analytical Approach: Shades of Green Assessments, July 27, 2023