What’s the Deal with the 2-Degree Scenario?

Under the 2015 Paris Agreement, nearly 200 countries agreed to limit global warming to no more than 2 degrees Celsius by 2100, and to aim for a no more than 1.5 degrees Celsius increase. The 2-degree scenario is widely seen as the global community’s accepted limitation of temperature growth to avoid significant and potentially catastrophic changes to the planet. Under this framework, companies and countries around the world have acknowledged that action is needed to combat climate change, and in response are increasingly recording and disclosing their carbon emissions under growing recommendations and regulation.

The future financial and social consequences of climate change are becoming increasingly apparent to companies, investors, and policy makers. Strong action to reduce emissions and limit climate change may avoid the worst physical impacts of climate change but presents significant market, technology, and regulatory transition risks for market participants. Conversely, failure to adequately reduce greenhouse gas emissions may limit transition risks but will accelerate climate change and associated physical risks. While corporations and sovereigns are taking some necessary steps to abide by the 2-degree scenario framework, research shows that global efforts may not be aggressive enough to slow climate change.

Of the eight major economies that account for 67% of the world's greenhouse gas emissions, only Europe is gearing up to extend its Paris Agreement commitment after the European Parliament announced a climate emergency in December 2019. The world will need to reduce greenhouse gas emissions by 7.6% a year for the next decade in order to meet the Paris Agreement’s goals on climate change, according to a November 2019 U.N. report.  

Best practices across corporate climate disclosure and risk management continue to improve but appear to fall far short of the actions needed to meet global climate goals or mitigate a company’s financial risk. By reviewing how 2,500 of the world’s largest companies are reporting on their carbon emissions and managing the climate‑related risks that may have material implications, Trucost, part of S&P Global Market Intelligence, found that although the carbon reduction targets set by top global companies in 2016 seem quite large, they actually account for only 16% of the reduction needed to keep global temperatures from rising to 2 degrees Celsius. Over 90% of companies in 2018 have active carbon reporting targets, but only 14% have adopted science-based targets.

In 2015, the Financial Stability Board (FSB) established the Task Force on Climate-related Financial Disclosures (TCFD) as a voluntary framework to monitor vulnerabilities in the global financial system due to climate change. The TCFD developed recommendations for more effective and standardized disclosure of financially material climate-related risks and opportunities, with the goal to promote more informed investment and sustainable markets. In 2017, the FSB then raised the bar with the TCFD, building out additional recommendations for companies to identify and disclose the financial implications of climate-related risks and opportunities on their businesses. Using four core elements — governance, strategy, risk management, and metrics and targets — the TCFD assessment shows how an organization accounts for climate-related risks and opportunities, as well as strategies for mitigating risks and realizing opportunities.

These climate disclosures help investors, lenders, and insurers make assessments about the sustainability of potential investments and provide a global standard for climate disclosure and reporting. Initiatives like the TCFD highlight the importance of using 2-degree alignment assessments. In 2018, S&P Global assessed climate-related risks and opportunities according to the TCFD's recommendations. S&P Global’s TCFD report was published in August 2019.

With global efforts converging to reduce carbon-intensive activities and incentivize low-carbon technologies, investors are increasingly demanding forward-looking metrics to assess portfolio risk beyond traditional financial measures and simple carbon footprints. S&P Global’s S&P 500 ESG Index, Risk Atlas, and ESG Evaluations, among other environmental, social, and governance (ESG) solutions, provide investors with the essential intelligence they need to better understand the risks and opportunities related to the energy transition and environmental risk.

Policy interventions for climate risk disclosure are part of a larger regulatory effort to develop a low-carbon economy that meets the Paris Agreement's goals. Just as carbon pricing can stimulate economic incentives to move countries and companies away from high-carbon activities by placing financial responsibility for the social cost of climate change on the polluter, additional policy interventions can incentivize greater contributions. For example, the U.K. government has considered mandatory climate risk disclosure for listed companies and large asset owners, setting the foundation for mandatory climate risk reporting that could constrain financing for companies facing higher climate risk and increase financing for sustainable investments.

In light of this greater emphasis on the risks of climate change and the global push toward the 2-degree scenario, a plethora of companies are making plans to cut their carbon emissions accordingly. Other organizations have made missteps in their actions around environmental risks.

Utilities like Xcel have stated plans to reach an 80% emissions reduction  by 2030 by using more renewable energy generation, reducing coal-fired generation, electrification of transportation, and investments in transmission and advanced grid technology. Additionally, the banking sector regards climate change as a financial risk in part because of the potential exposure to stranded assets, which can put the entire economy at risk.

Banks having come under scrutiny for underwriting the IPO of Aramco amid climate change concerns — the Saudi oil corporation is the world's largest carbon and methane emitter, accounting for 4.38% of emissions between 1965 and 2017. Meanwhile, lenders like the French bank Société Générale SA have been changing their financing policies to comply with the 2-degree scenario, seeing climate change as a full-blown financial risk. Coming together to sign the Principles for Responsible Banking, the banking sector is uniting under this framework to bring their strategies in line with the Paris Agreement and work toward the UN's Sustainable Development Goals.

To account for the additional costs and benefits of pursing the 2-degree scenario, S&P Dow Jones Indices launched the S&P Carbon Price Risk Adjusted Index Series to allow investors to consider 2030 carbon price risk exposures in addition to company earnings in investment decisions. The index series takes into account a company's carbon emissions, operating geographies, and its ability to pass on carbon costs to consumers or purchasers at a time when the global economy doubles down on its efforts to reduce carbon dioxide emission. As countries, companies, and investors continue to align their actions in with climate risk disclosure and low-carbon activity, the importance of importance of ESG criteria in investing will continue to grow.