from Grant Bremner
Founder & CEO, Easier Levels Limited
22 April 2020
I hope this letter finds you and your loved ones well. As I write this the pandemic is raging and playing havoc with our lives, our firms and the economy. With the abrupt halt in commuting, travel and industry, consumption of coal, oil and gas has plummeted, along with associated emissions. It’s quieter. The streets and skies are clearer, the stars are brighter… Eventually when the economy roars back into action, will we have gained any useful insights from this shock on the new normal?
We could use this extraordinary disruption to innovate on sustainable value creation. The coronavirus is not the only thing in the air; climate-related financial impacts are also upon us. Firms will either create or destroy value in their positioning for market and technology shifts, physical climate events, carbon pricing, and Government actions. Fast-emerging climate-related factors are causing ambiguities, information asymmetries and inefficiencies in capital asset pricing. Investors are seeking transparent and reliable financial reporting, essential to the operation of efficient markets. Today, marking the 50th anniversary of Earth Day, is a golden opportunity for me to share with you our climate ratings for firms and their value.
Easier Levels Limited developed climate ratings to crystallise the net effects of climate impacts on firms. Companies can reposition and integrate climate-related financial disclosures into annual reporting to improve climate ratings.
Adoption of Easier Levels climate ratings helps firms create sustainable value.
A short section on each point follows. To download the letter, click the link below.
Easier Levels pre-assessed over one thousand equities, covering $50 trillion or almost two thirds of the world’s total market capitalization.
Climate-related financial impacts have random timing and materiality, and the aim is to correlate climate ratings with shifts in firm value.
Our climate rating algorithm models these uncertainties under future scenarios. The two medium-term scenarios presented evoke the choice between adapting to climate impacts and mitigating climate risk.
An overall BB rating is low quality and is concerning as it indicates the Overshoot pathway leads to large-scale disruption to asset values in the medium-term.
Companies will either survive or be threatened by climate risk, to varying degrees. Companies rated in the first four levels are likely survivors while those in the final three are threatened — comprising the Red List of Threatened Companies. 63% of the world's market capitalisation is threatened in the Overshoot Scenario, reducing to 27% in Net-Zero.
Our coverage of stock market indexes in the US, Canada, the UK, Australia and New Zealand shows: the ASX and NZX are BB, US market indices are higher at BB+/BBB, and the FTSE and TSX have lower B climate ratings.
Our climate ratings of sectors and industries vary, and there may be a wide spread of climate ratings within a sector or even within an industry between companies from the highest to lowest climate quality.
The top-rated sectors are tech, healthcare and communications while the lower rated sectors are energy and materials which have higher proportions of threatened companies.
Tech and communications companies have many climate solutions which translates into carbon value driving up their ratings. Whereas energy and materials have high carbon risk and physical asset risk driving down their ratings. The world’s energy system is primarily based on coal, oil and gas, and the Net-Zero Scenario results in stranded assets, disrupting energy companies.
Our climate algorithm enables ratings of equity portfolios such as ETFs and mutual funds. Portfolio climate ratings for existing funds yield some surprising aggregate results due to information asymmetries, take for example an ESG ETF, a climate aware fund and a portfolio of CDP A List companies:
Environmental Social and Governance (ESG) investors have a broader focus. BlackRock’s iShares ETF ESGU for example has high ESG quality but low climate quality.
In the UBS Climate Aware World Equity Fund, many of the top 10 holdings are threatened with one quarter of the market cap on the red list, and a further 13% near threatened.
The Easier Levels climate rating for the portfolio of CDP A List companies is A+ (Balanced) in the Net-Zero Scenario however in Overshoot our rating is BB+ (Vulnerable).
Easier Levels can benchmark your climate quality against other companies in the industry and beyond. Companies can improve climate ratings by integrating business strategy with effective climate mitigation and adaptation strategies, and by providing climate-related financial disclosures in annual reports.
Auditors can apply Easier Level climate ratings to identify degrees of climate risk for audit clients. Climate ratings help determine likelihood of financial statement impacts, the need for climate-related financial disclosures, and scrutiny on adherence with the going concern principle. Accounting standards already require climate-related disclosures of infrequent and unusual events on the income statement and their effect before income taxes.
Climate-integrated funds are coming soon. Financial services industry experts integrate climate ratings with fundamentals to aid in portfolio construction and in advising customers on their investment choices.
Investment Advisors can de-risk climate risk, by rebalancing/tilting constituent weightings, and by divesting threatened companies on the Red List, to raise the climate rating of a given portfolio.
Portfolio Construction Specialists can create new climate funds by applying Easier Levels climate ratings and metrics either to rebalance or to disaggregate funds or to create new funds with higher climate ratings.