A new take on the energy transition
MSCI’s new Energy Transition Framework helps investors and other capital market participants understand how technology and policy are expected to affect transition risk and opportunity. Environmental Finance talks to the firm’s Chris Cote
Environmental Finance: You just launched MSCI’s Energy Transition Framework. What does the framework set out to do, and what insights does it provide to help investors understand the energy transition?
Chris Cote: We built this framework based on demand from clients who are looking for something more nuanced in how to measure and assess the risks and opportunities of the energy transition. It sets out to understand, aligning with MSCI ACWI Investable Markets Index universe, where the hotspots of transition risks are, where the opportunities are, and how to measure them – not just in a top-level way, but also in a way that has nuance across every company, with the ability to drill down and get into the details.
It is not designed to measure how green a company is – we have other metrics that help understand the impact that companies have on the world. This model is designed to assess financially material risks and opportunities over the next five to seven years – an actionable, investible time horizon.
EF: What, specifically, does the model assess?
CC: There are two main components to the model. One establishes the level of risk, to identify transition high-exposure areas. Does a company have high emissions intensity? What technologies are available to reduce those emissions and how much pressure will companies face to adopt them? Are they at cost parity? What barriers might exist to making them commercially adoptable?
We also look at the policy environment across the countries that the company operates in or sells its products into. What is the extent of carbon pricing measures? Are fossil fuel subsidies distorting the playing field? What are the ambitions of these countries in terms of the energy transition? We call this the transition pressure that the company faces.
The other component is understanding company readiness to transition its business model or operations. What is management doing to position the company to navigate these potential risks? Here, we’re looking at corporate strategy and governance, and emissions performance, both forward-looking targets and performance to date. We also look at opportunities, which considers the extent to which the company is providing products and services that will facilitate the transition, and how commercially viable those are. So, solar panels might position a company better than hydrogen fuel cells, for example, although of course there are regional policy dynamics to consider as well.
EF: What outputs does the model produce?
CC: At a high level, it generates a score from zero to 10 to indicate, based on our calculations, how prepared the company is for the energy transition, given its level of risk. That balances the pressures that it faces versus the level of readiness it has. But the model is hierarchical in nature: there are many levels to it, and we built into the design the ability to drill down through these different levels, to investigate and understand the quality of the targets or corporate strategy, for example, and trace them all the way back to the underlying data that informs the assessment. It is based on our transparent process, which is publicly available.
EF: What would you say differentiates this framework’s approach?
CC: How it incorporates technology and policy is a big differentiator from traditional approaches. Emissions on their own may not create financial risks, but when you instrumentalise them through the levers of technology and policy that are creating pressure, these are the things that drive risk. By emphasising those components, we developed something new.
EF: What use cases do you expect investors to apply the framework to?
CC: A common starting point for investors is that they want to know where the risks and opportunities are in their portfolios. One of the initial questions that a sustainability team is going to be asked by the investment team on a due diligence level is, “is this something that we need to pay attention to?” Then, for investment teams, the model allows for a general portfolio evaluation to help them understand where those risks and opportunities are.
The second question investors will ask is, given the level of risk, who’s leading and who’s lagging? Who's doing well and is well positioned? Then, finally, it can be used to look for opportunities and to understand which companies are maybe better positioned for the energy transition.
EF: You say it can be used to communicate allocation decisions and exposures to stakeholders. How so?
CC: A lot of communication right now about the energy transition is around the carbon footprint of portfolios. What is less communicated about is the level of risk or the quality of management and therefore the readiness that companies are exhibiting. We think that this framework could offer a step forward in communicating between fund managers and capital allocators, to help the latter better understand transition strategies and understand the nuance behind the allocation decisions that fund managers are making that go beyond emissions footprints.
Chris Cote is an executive director, and energy transition R&D lead at MSCI ESG Research, based in Boston, Massachusetts.
For more information on MSCI’s Energy Transition Framework, see https://www.msci.com/data-and-analytics/climate-solutions/energy-transition-framework
