Quantifying climate transition risk

Overview

A rapid transition to net zero emissions is required to avert the worst climate scenarios and build resilience against harmful climate impacts.

Companies need to adapt or face significant challenges. Investors need to be aware of the effects that this transition will have on companies through changes to policy, technology and the consumer landscape. The transition has the potential to create value, but can also cause significant losses.

Willis Towers Watson is bringing together best-in-class solution providers to launch a new type of equity index that assesses the anticipated impact of a climate transition on company valuations. The STOXX Willis Towers Watson Climate Transition Indices, and any subsequent strategies tracking them, will enable investors to manage climate transition risk. By tilting toward companies expected to benefit from the transition, and tilting away from companies expected to face significant challenges, investors can capitalise on opportunities and manage risks as we move into a net-zero economy.

We’ve developed the STOXX Willis Towers Watson Climate Transition Index (CTI) in partnership with STOXX – a systematic, transparent way for investors to incorporate climate transition risk into their investment decisions.

Using our proprietary Climate Transition Value at Risk (CTVaR) methodology , we quantify transition risk by integrating forward-looking company assessments with traditional risk and return models. The index allows investors to reduce carbon emissions but does so only where it makes financial sense and on a forward-looking basis.

STOXX Willis Towers Watson Climate Transition Index (CTI)

1. 01

   Beyond carbon

   CTI uses a more granular analytical approach that addresses 100s of transition impacts on asset prices that go beyond carbon exposure or a carbon price as a proxy for climate risk.

2. 02

   Deeper data

   For companies most impacted by climate transition, CTI curates asset level data from multiple sources to build a higher resolution view of climate transition risks and opportunities.

3. 03

   Forward, not backward

   Forward-looking company transition risk is refreshed over time, rather than using historic carbon emissions data.

4. 04

   Whole economy

   The CTI is focused on the wide range of changes needed at system level – to different goods, services and commodities – in order to drive down GHG emissions consistent with the goals of the Paris Agreement.

Transition risk is defined as the loss or gain in value due to the transition to the net zero economy from changes to policy, regulation, technology, and consumer preferences. It is measured by the expected change in today’s prices as a result of the transition – we call this measurement Climate Transition Value at Risk (CTVaR).

• CTVaR offers a bottom-up granular approach to measuring the effect that changes to the global economy (driven by climate change mitigation) will have on a company’s valuation.
• CTVaR focuses on the effect of climate on individual companies by integrating a forward-looking assessment of climate transition risk into the traditional risk/return framework, aligning climate transition risk with investors’ fiduciary duty.
• This approach looks beyond top-down issues such as the implementation of carbon prices to consider a wide range of underlying climate-related issues that are expected to influence the drivers of company cashflows.
• We take a deeper analysis of scenarios and each company’s business model to determine how they are positioned for the transition. It is this analysis that determines the weight of each stock in the index.

“

Less than 10% of the impact of the transition is a result of the carbon footprint. So, we’ve built an index that starts from the bottom up. Our methodology looks at all of the changes that will happen to each part of a company’s business, across each and every industry, to see the effects on the value of assets, of companies and ultimately investment portfolios.”

David Nelson | Senior Director of Climate Transition Analytics

Many institutional investors have made progress on setting climate objectives (net zero commitments/carbon journey planning discussions) but have struggled to find simple implementation routes for making immediate progress.

To offer investors a cost-effective way of tracking the index, AMX has launched a smart implementation solution.

“

The CTI leads to lower portfolio emissions, but only where it makes financial sense to do so. It increases your expected return and reduces your risk from the climate transition. We believe it is appropriate for consideration by all institutional investors as it aligns with fiduciary duty, is forward-looking, simple to implement and low cost.”

Craig Baker | Global Chief Investment Officer