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 expect an entity's economic activities will be once the entity's planned transition changes are realized and potential material implementation risks are considered. We express our opinion using a single Shade of Green ranging from Dark green to Red consistent with the principles associated with each Shade of Green described in "Analytical Approach: Shades of Green Assessments", published on July 27, 2023.

Our CTA analysis follows three steps. First, under current activity we consider the entity's current activities and determine how consistent they are with a low carbon, climate resilient future.

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

Finally, we assign a single Shade of Green to the entity based on the likely mix of future activities. The Shade of Green conveys our opinion on how consistent with a low carbon, climate resilient future we expect an entity's economic activities will be once its planned transition changes are realized. To produce this single Shade of Green, we apply principles associated with each Shade of Green.

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 of this data.   Our opinions are based on an entity's individual transition plan and its own time frame 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 non-financial 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 and other frameworks based on the World Federation of Exchanges Green Equity Principles.

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 a track record of reasonable assurance across an entity's emissions reporting 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 Activity

Our current activity analysis displays 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 activity analysis and subsequent shades assigned does not reflect an activity's social risks or benefits.

We express the current activity as a percentage breakdown of the chosen financial metric by shade.   For example, a pure play renewables company with all its revenue derived from the sale of electricity generated by its solar power plants would likely have 100% of its revenue shaded as Dark green.

For most nonfinancial corporations, we typically use the latest reported revenues to describe the entity's mix of economic activities and apply Shades of Green to each of the activities. We may use alternative metrics where we believe the alternative metric is more representative of the mix of activities. For entities in financial services, we may focus more on investment, lending, or underwriting exposures. For services businesses in general we can look at the policies used to manage an entity's mix of exposures to customers and suppliers and how they are managing climate risks.

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 plan? 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 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.

Metrics and Targets

We consider the entity's stated metrics and targets and any forward-looking objectives that are relevant to its climate transition.   The targets typically include green revenue targets, greenhouse gas emission targets, or renewable energy targets.

When relevant to the targets, 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.
• 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 the targets address the most impactful climate activities, have robust interim targets rather than long-term targets in isolation, and the metrics are calculated and reported according to leading standards.

A CTA report would illustrate the climate-related targets, when relevant.

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, 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 impact their transition plans. When relevant, we consider whether an entity is comprehensively assessing the sustainability 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. However, just because a product is recyclable or compostable, does not mean the end user will ultimately recycle or compost it. Therefore, in addition to considering the action of sustainable product design, we may consider, when relevant, how the entity is engaging with external stakeholders to ensure those benefits will be realized. For example, for a consumer products company that has developed a fully recyclable product and packaging, we would consider how the entity is educating customers to ensure they are disposing of it in ways most compatible with a low carbon, climate resilient future, and ensuring those options are available to them.

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 impact its consistency 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 what might derail or block the entity from implementing its climate transition.

Organizational Alignment

We consider a company's organizational alignment because we believe the climate transition plan will likely only be successfully implemented if there are management structures and processes fit for the purpose of delivering the plan and a management team that is incentivized to enact 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;
• Commensurate resourcing and personnel allocation planning; and
• Track record of achieving previous climate transition targets where relevant.

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.

Climate Transition Assessment

The single Shade of Green builds on our understanding of the entity's current activity and climate transition plan and reflects 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 use a principles-based approach to assign a single Shade of Green based on the definitions of each Shade of Green. The single Shade of Green is anchored on the Shade of Green where the majority of the expected future activities will be after the effects of the Actions and Investments are realized, and after considering the impact of potential material Implementation Drivers. Below is a list of the high-level principles we apply to arrive at a single Shade of Green.

• Red activities are never considered aligned with a low carbon, climate resilient future. A Light green and Medium green single Shade therefore requires mainly green activities and only negligible Red activities. A Dark green Shade requires mainly Dark green activities and would allow for some Yellow activities and no Orange or Red activities.
• Given the limitations on Red activities, a non-green single Shade may include mainly green activities, and the share of Red and Orange activities are likely to determine which non-green Shade is assigned.

For example, a Dark green Shade would reflect our expectation that an entity will eliminate all Red and Orange activities from its operations and transition to mainly Dark green activities with limited unmitigated implementation risks. If an entity's current activity mix already meets these requirements, a Dark green shade would reflect our expectation that the entity's economic activities will remain consistent in future.

Other Optional Assessments

Green equity add-on

We can also provide a CTA Green Equity add-on, which is an opinion as to whether there is alignment with Green Equity Principles used by various stock exchanges. The CTA Green Equity add-on is our assessment for the exchanges where we are an approved reviewer. It is offered at the client's request.

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. For companies seeking green equity designations we use our Shades of Green applied to the most recently reported revenue, capex, and operating expenditure (opex) for a full financial year. We associate activities assigned a Dark, Medium, or Light Shade of Green 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.

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.

Related Research

• FAQ: Applying Our Integrated Analytical Approach For Climate Transition Assessments, July 18, 2024
• Analytical Approach: Shades of Green Assessments, July 27, 2023

Other contacts: Harald Lund, Global Head of Sustainability Methodology & Research, Oslo, harald.lund@spglobal.com; Kristina Alnes, Oslo, Kristina.alnes@spglobal.com