Practical application of SDA on financial portfolios

Hi there,

It’s been a long time since I posted this question and have not received a response. Re-linking it here and would appreciate a view as it is a fundamental question on FIs ability to actually use the SDA in the same way corporates do.

Many thanks,

Anahttps://community.sciencebasedtargets.org/t/practical-application-of-the-sda-on-corporate-loans-portfolios/1113

Hi Ana,
Thanks for re-posting this. The time-lag is indeed a function of using the SDA at the portfolio level, and also a function of current disclosure systems which tend to be annual and only reporting corporate data with a one year time lag.

SDA targets ultimately given a target year intensity that FIs need to reach within a given sector, and this will be achieved via a combination of both companies setting reduction targets and reducing their intensity in addition to reallocation to better performers (lower intensity). Therefore the FI should engage those portfolio companies as well assess its own portfolio composition to ensure that they will be able to be at the given intensity by the target year.

The lag between the FI engagement and the company setting targets should not be relevant as the SDA is designed so that delayed action by a corporate will mean they will have to set a more ambitious target anyway. Therefore even if there is a lag between the FI setting the target, and the corporate setting the target, it would be compensated by the corporate having to potentially set a more ambitious target to be aligned with a well-below 2C or 1.5C pathway. This is built into all SBT methods, where delayed action by any company has to be compensated by more ambitious targets.

We see the primary issue being the FI having good enough quality and timely data to accurately report progress across the time period (from base year to target year) and the in the target year to determine f the target has actually been achieved.

Hope this helps, but do follow up if anything you would like to discuss further.

Hi Eoin,

Thank you for the comprehensive response. Can I please double check this? The SDA allows a company to set a target for e.g. 2030 but 2050 is the convergence. This means that a delayed target still converges to 2050 at a steeper slope but it doesn’t necessarily get you to the same number in 2030.

When we model a portfolio of say 5 companies, with an aggregate SDA target for 2030 from 2020, if these companies have a 2030 target using the same 2020 base year then by meeting their target, the aggregate portfolio meets its target. But if these clients set their targets in 2023 (reasonable if an FI has just published a target and is engaging companies around this), then while the slope will be steeper and the 2050 endpoint will be the same, the 2030 intensity for each client will be different compared to a 2020 base year (higher).

This means that the portfolio in aggregate doesn’t meet its target. This would apply for all FI targets using the SDA, where there is a time lag between the FI’s base year and the base year clients set SBTs from.

Many thanks,

Ana

Thanks Ana,
I see your point on the delayed target leading to different 2030 intensity for the companies. The only way the FI target will be compatible with the company targets if the same base year is used. Therefore, if the FI sets their sector target with a base year of 2020 (taking into account the 2020 intensity of all the portfolio companies), the companies will also need to use 2020 as their base-year in order for the targets to achieve the desired intensity in the target year of 2030. The question is, if they choose a later base-year, wouldnt that still mean that they reach at least the desired intensity for the company, if not a lower intensity? Therefore the FI target intensity should set the upper bound, and any companies who delay target setting would still have to meet at least that intensity, but may have to have an even lower intensity?

The SBTi protocol has a criteria on “forward-looking ambition” (https://sciencebasedtargets.org/resources/files/Target-Validation-Protocol.pdf) p33, which highlights that delayed action after 2020 will mean that companies need to set even more ambitious targets to be compatible with a given temperature outcome. This then should ensure that the company targets, regardless of the base-year will achieve the desired intensity even if their base-year is different from the FIs.

Please let me know if that makes sense?
Best,Eoin

Hi Eoin,

Thank you for the speedy response. I think ultimately the issue is the maths. My concern is that FI would be reluctant to publish a target in 2023 and ask their counterparties to set targets with a base year that’s 3 years in the past just so that the equation adds up. Similarly, they would not ask clients to go beyond 1.5 degree ambition, when 1.5 degrees is already so challenging to convert to. The key lever employed is to engage the counterparties to set targets in line with science by x year or consider divesting.

This is why I am raising this as an issue. Because by 2024, a sector portfolio may be made up exclusively by companies that have approved SBTs; and the FI will still not be on track to meet their own 2030 target, that they set using the SDA. The premise of the SDA is convergence to net zero and if a counterparty is converging, what ground would the FI have to say they need to go further just based on the FI’s own decision on base year and intensity? Ultimately, the decarbonisation gold standard for FIs is to be financing companies that are transitioning to net zero in a credible way and counterparties with approved SBTs, set later, would be meeting this criterion. I would really value some further discussion on how this issue can be addressed in e.g. transition plan narrative where FIs will have to show how levers add up to the targets they have set.

Many thanks once again for your clarifications and for all the useful guidance you are providing in this forum!

Ana