Measuring what matters

We know that climate-related risks and opportunities are financially material. Where energy transition leadership is currently underappreciated by the market, there could be an opportunity for outperformance as investors increasingly price in the transition. However, in some cases it may be appropriate for us to avoid companies that are particularly exposed to climate risk, while in other cases we may want to proactively engage with ‘laggards’ with the aim of driving better outcomes for the company and potentially the broader industry. In practice, this approach combines systematic use of metrics across a broad investment universe with more detailed, company-level analysis where most material. Ultimately, tackling climate risk requires nuance, judgement and a willingness to engage with complexity.

Whatever the approach, the first challenge is identification. How do you tell apart companies which are doing a relatively good job of managing climate-related risks and opportunities and those which are not? There are many methods that look to do this, each with pros and cons. We cannot solely take companies at their word – for example, many companies in the same industry may claim to be a leader, when this cannot be true for all. The thousands of different off-the-shelf ESG metrics and ratings, each with differing methodologies and coverage, can also only be thought of as a starting point.[1]

Metrics vs. judgement: discipline and nuance

To form a more well-rounded assessment of how companies are addressing climate-related risks and opportunities, investors must rely on a combination of quantitative metrics and qualitative judgement. Metrics play a vital role in grounding climate commitments in observable evidence, holding companies to account, and providing a simplified framework for comparison. Without them, there is a real risk that company climate strategies, even if well-intentioned, ultimately remain vague and unfalsifiable.

We rely on metrics to establish baselines, track progress and identify inconsistencies between ambition and action. In combination, quantitative indicators allow us to assess direction of travel over time, support consistent assessment, and to prioritise engagement across a large investment universe where deep-dive analysis is not always applicable or appropriate. They provide a common language through which investors can compare firms, interrogate disclosures and hold management teams accountable.

However, metrics alone are not always sufficient to assess risk and opportunities. These are shaped by complex and evolving interactions between policy, technology, economics and behaviour. No single figure can capture this complexity, and when taken out of context, even widely used metrics can lead to misleading conclusions. This is particularly true when assessing industries with lumpy capex cycles and the banks that provide credit for them, where exposures vary significantly in structure, duration and underlying economics.

For this reason, we look to triangulate our analysis across multiple dimensions, particularly when considering ‘dial-mover’ companies.[2] For example, in our Climate Action Strategy, our engagement-led investing approach combines quantitative indicators with detailed analysis of disclosures, governance frameworks and risk management processes, alongside direct and sustained dialogue with senior management teams. This helps us understand how these issues are embedded within strategic decision-making.

Assessing transition risk in practice

These challenges are particularly relevant in the banking sector. Continued financing of misaligned fossil fuel activities is rightly seen as creating real financial and environmental risks. But how should investors assess how banks are managing these risks through the energy transition – balancing system-wide dynamics and firm-level exposures? And how can they distinguish those institutions that are well positioned relative to peers to manage transition-related risks?

Banks play a key role as intermediaries financing fossil fuel activities, but their exposures are fundamentally different from those companies producing or consuming fossil fuels directly. In this context, aggregate fossil fuel lending is often used as a simple proxy. While such headline metrics offer a clear and intuitive lens, we believe relying on them in isolation can obscure important nuances in how risks and opportunities are identified and managed in practice – and therefore where real transition risk lies.

In our next blog, we will explore this question in more detail.

 
[1] https://www.fca.org.uk/news/press-releases/fca-proposals-esg-ratings

[2] Large companies we have identified as having the potential to galvanise action in their sectors.