Destination 1.5C Engagement and stewardship on the road to net zero

Destination 1.5°C

Engagement and stewardship on the road to net zero

Destination 1.5°C

With the 26th UN Climate Change Conference of the Parties (COP 26) now upon us, the world stands at a critical juncture in confronting the climate crisis. The threats facing the planet from rising temperatures are enormous: weather patterns are becoming extreme, polar ice caps and glaciers are melting, and sea levels are rising. The impacts are felt everywhere. Human health and livelihoods, wildlife, entire economies and societies, lie exposed to the consequences of climate inaction.

Global temperatures have already risen by approximately 1.2°C above pre-industrial levels. The margin for limiting temperature rises to 1.5°C, the limit agreed at COP 21 in Paris, is narrowing. The Intergovernmental Panel on Climate Change (IPCC) estimates that the world has emitted 2,400bn tonnes of CO2 since the mid-1800s, and that we have a carbon budget of just 400bn tonnes left to emit in order to have a 66% chance of keeping to 1.5°C. The IPCC believes that this target can remain within reach provided "there are immediate, rapid and large-scale reductions in greenhouse gas emissions".1

In quantitative terms, in order to ensure that the 1.5°C threshold is not passed, global greenhouse gas emissions need

The climate emergency is a race we are losing, but it is a race we can win

A. Guterres

- UN Secretary General

Derek Traynor, CFA

Chief ESG Analyst

Danske Bank Asset Management

Carla Steuer

First Year Analyst

Danske Bank Asset Management

to be cut in half by 2030 with net zero emissions achieved by 2050. This is a tall order and requires a global economic restructuring many magnitudes of order greater than anything attempted before. Companies, and especially those from the highest emitting sectors, have a crucial role to play in this transition. As do we as investors, through our engagement and stewardship activities and through the clear expectations we set our investee companies. As Antonio Guterres, Secretary-­General of the United Nations notes, although "the climate emergency is a race we are losing, but it is a race we can win".

1 See: https://www.ipcc.ch/2021/08/09/ar6-wg1-20210809-pr/

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Our 1.5°C Commitment with the Net Zero Asset Managers Initiative

As part of our determination to play a part in supporting goals of limiting global warming to 1.5°C and achieving corresponding net zero emissions by 2050, Danske Bank Asset Management has joined the Net Zero Asset Managers Initiative. By joining this initiative, Danske Bank Asset Management aims to work in partnership with asset owner clients on decarbonisation goals, consistent with an ambition to reach net zero emissions by 2050 or sooner across all assets under management (AUM). Furthermore, we will set an interim (2030) target for the proportion of assets managed in line with the net zero goal and commit to review our interim target at least every two years, with a view to ratcheting up the proportion of AUM covered until 100% of assets are included.

This is a considerable commitment and requires - in addition to governments following through their own pledges to ensure the objectives of the Paris Agreement are met - that we both engage and partner with our investee companies to help them achieve real economy emissions reductions. As part of our commitment as one of the largest asset managers in the Nordics, we will implement a stewardship and engagement strategy, with a clear escalation and voting policy that is consistent with the scale of these ambitions.

The purpose of this white paper is to analyse the current 'state of play' of 35 large Nordic companies from some of the

By understanding where companies currently stand on carbon policies and processes, and most importantly, where they are lacking, we can better formulate and target our stewardship and engagement strategy

highest-emitting industry sectors. It focuses on management quality and governance of company carbon practices, in order to assess both their approach to greenhouse gas emissions reductions and their adaptability to the risks and opportunities stemming from the low-carbon transition. By understanding where companies currently stand on carbon policies and processes, and most importantly, where they are lacking, we can better formulate and target our stewardship and engagement strategy to align their ambitions with ours on the net zero targets.

Addressing the commitment-action gaps for the largest Nordic companies

The importance of developing a coherent climate transition strategy

Of the 192 countries that are Parties to the Paris Agreement, more than 130 countries have set or are considering a target of reducing emissions to net zero by 2050. However, according to the United Nations, their planned combined emissions reductions, as stated by their National Defined Contributions (NDCs), still fall far below what is required in terms of ambition to achieve the 1.5 °C goal2. The UN Environment Programme's Emissions Gap Report 20213 finds that NDCs only take 7.5% off predicted 2030 emissions, while 55%

is needed to meet the 1.5 °C goal. In other words, countries need to increase decarbonisation comittments to more than seven-fold from current levels.

Inconsistencies between long-term commitments and shorter -term actions and targets on decarbonisation are not a prob-

lem unique to countries or governments however. Companies are often just as inconsistent when it comes to aligning words with actions, and the association with greenwashing often looms over corporate climate policies. A lack of incentives can drive this gap. The transition to a greener and more sustainable future requires significant investment, and adequate incentives need to be in place to drive change.

Risks extend beyond greenwashing and reputational damage. By failing to fully integrate a coherent climate transition strategy into their businesses, these companies stand ill prepared to manage a broad range of financially material risks and opportunities related to the low carbon transition. Once such risk surrounds carbon pricing. Through implementing a carbon

1. https://www.un.org/en/climatechange/net-zero-coalition
2. https://www.unep.org/resources/emissions-gap-report-2021

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price, the EU hopes to incentivise businesses to use less carbon while placing a premium on decarbonisation in order to stimulate innovation and adaption. This can serve as a key mechanism to translate company inaction into financial risk and therefore companies need to factor such developments into their climate strategy.

Lastly, and most crucially, companies have a critical role to play in helping the world avoid a climate catastrophe and all relevant stakeholders - investors, governments, society - expect them to act.

A framework for understanding company management of carbon transition risks and opportunities

While it is not feasible nor credible to assess a company's climate journey using a single number, the Transition Pathway Initiative's (TPI) Management Quality framework, which we leverage in this white paper, is amongst the stronger forward-looking methods of assessment4. This strength was recognised by Environmental Finance which awarded TPI 'ESG Assessment Tool of the Year 2020' at the Sustainable Investment Awards, crediting TPI with having been "instrumental in enabling asset owners to understand what the transition to a low carbon economy means for their major holdings in energy intensive sectors. It has simplified the message around climate change and has made it easier for asset owners to take action."

This paper applies the framework to 35 large Nordic companies transcending some of the highest emitting sectors including oil and gas, shipping, autos, electricity utilities, aluminium, industrials, consumer goods, chemicals, construction, paper, mining and steel. We have grouped these sectors into broader categories of energy, industrials and materials, transport and

buildings and consumer goods. The Management Quality assessment evaluates and tracks the quality of companies' governance and management of their greenhouse gas emissions as well as the risks and opportunities they face related to the low-carbon transition, in line with the Taskforce on Climate-related Financial Disclosures (see Box 1 and 2).

Long-term ambition from companies is worthless without credible short-term action plans and targets

Enabling strong net zero stewardship and engagement TPI's framework helps to align our obligations as members of the Net Zero Asset Managers Initiative by providing a tool that guides our stewardship of the companies that we invest in, focusing on real world change and accountability. Long-termambition from companies is worthless without credible short- term action plans and targets. By assessing the management quality of a company's climate plan, using publicly disclosed data mapped to the TPI's Management Quality framework, we can better gauge the credibility of their action plans and the likelihood of meeting their long-termambitions.

4 The Transition Pathway Initiative is a global initiative led by asset owners and supported by investors globally. It seeks to support efforts to get companies to align themselves with the transition to a low carbon economy. See https://www.transitionpathwayinitiative.org for more information.

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Box 1: TPI Management Quality Assessment

The TPI's Management Quality assessment framework utilises 19 indicators that seek to determine whether a company has implemented a particular carbon practice, each assessed through a binary yes / no question. Each of these questions are mapped to five levels - from Level 0 through to Level 4 - reflecting a company's level of progress with respect to implementation of carbon management systems and processes. The assessment covers areas such as emissions disclosures, setting targets and strategic policy commitments. The questions begin at a high level, such as 'does the company acknowledge climate change as an issue for the business?', becoming more targeted and strategy specific as they progress up the ladder. A company that achieves a perfect score across all 19 questions is provided a 4 Star categorisation.

In order to progress from one level to the next, companies need to answer 'yes' to all questions relevant to that level. Ultimately, the higher a company places on the ladder, the more anchored and more credible their climate transition plan is, meaning the likelihood of a company actually delivering on the required emissions reductions is higher.

Level 0

Unaware

Company does not recognise climate change as a significant issue for the business

Level 1

Awareness

Company recognises climate change as a relevant risk / opportunity for the business

Company has a policy (or equivalent) commitment to action on climate change

Level 2

Building capacity

Company has set GHG* emissions reductions targets

Company has published information on its operational GHG emissions

Level 3

Intergrated into oprational decision-making

Company has nominated a board member / committee with explicit responsibility for oversight of the climate change policy

Company has set quantitative targets for reducing its GHG emissions

Company reports on its Scope 3 GHG emissions

Company has had its operational GHG emissions data veried

Company supports domestic and international eforts to mitigate climate change

Company discloses membership and involvement in trade associations engaged on climate

Company has a process to manage climaterelated risks

Company discloses Scope 3 GHG emissions from use of sold products (selected sectors only)

Level 4

Strategic assessment

Company has set long-term quantitative targets (>5 years) for reducing its GHG emissions

Company has incorporated climate change performance into executive remuneration

Company has incorporated climate change risks and opportunities in its strategy

Company undertakes climate scenario planning

Company discloses an internal carbon price

Company ensures consistency between its climate change policy and position of trade associations of which it is a member

Source: Transition Pathway Initiative . *GHG: Greenhouse Gas

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Box 2: TPI Management Quality Assessment

Level 0: Unaware of Climate Change as a Business Issue

1. Does the company acknowledge climate change as a significant issue for the business?

Level 1: Acknowledging Climate Change as a Business Issue

1. Does the company recognise climate change as a relevant risk and/or opportunity for the business?
2. Does the company have a policy (or equivalent) commitment to action on climate change?

Level 2: Building Capacity

1. Has the company set greenhouse gas emission reduction targets?
2. Has the company published information on its Scope 1 and 2 greenhouse gas emissions?

Level 3: Integrating into Operational Decision Making

1. Has the company nominated a board member or board committee with explicit responsibility for oversight of the climate change policy?
2. Has the company set quantitative targets for reducing its greenhouse gas emissions?
3. Does the company report on Scope 3 emissions?
4. Has the company had its operational (Scope 1 and/or 2) greenhouse gas emissions data verified?
5. Does the company support domestic and international efforts to mitigate climate change?
6. Does the company disclose its membership and involvement in trade associations engaged in climate issues?
7. Does the company have a process to manage climate-related risks?
8. Does the company disclose Scope 3 use of product emissions?

Level 4: Strategic Assessment

1. Has the company set long-term quantitative targets for reducing its greenhouse gas emissions?
2. Does the company's remuneration for senior executives incorporate climate change performance?
3. Does the company incorporate climate change risks and opportunities in their strategy?
4. Does the company undertake climate scenario planning?
5. Does the company disclose an internal price of carbon?
6. Does the company ensure consistency between its climate change policy and the positions taken by trade associations of which it is a member?

Source: Transition Pathway Initiative

Companies face unique sector-specific decarbonisation pathways

The importance of understanding sector dynamics The International Energy Agency (IEA) has produced the "world's first comprehensive study of how to transition to a net zero energy system by 2050 while ensuring stable and affordable energy supplies, providing universal energy access, and enabling robust economic growth". As the report makes clear5, to reach the goal of limiting warming to 1.5°C and achieving net zero emissions by 2050, each sector is expected to transition, while pathways to net zero emissions differ considerably depending on sector. Each company faces its own unique sector-specificdecarbonisation challenges that vary across many dimensions such cost implications and

the distribution of emissions concentrations across the value chain.

Figure 1 outlines the expected transition paths for different sectors according the IEA's Net Zero Emissions (NZE) scenario and serves as frame with which to understand the individual sector dynamics required to facilitate the transition. The heat and electricity utilities sector, for example, is expected to

5 The IEA published its Net Zero by 2050 - A Roadmap for the Global Energy Sector paper in May 2021. It is the world's first comprehensive study of how to transition to a net zero energy system by 2050. The report can be accessed here: https://www.iea.org/reports/ net-zero-by-2050

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