By Mogens Pedersen
Head of ESG Risk and Defence Centre of Excellence,
LC&I Sustainable Finance Denmark, Danske Bank
In my role as Head of ESG Risk in LC&I Sustainable Finance, I’ve seen how many companies value the transparency and overview our transition risk assessment brings, often integrating it as a tool for internal use.
By providing a structured framework, the risk assessment can help create clarity and thereby drive momentum and important discussions about your company’s transition, no matter how far you have come in your journey.
Transitioning in a high-emission sector is undoubtedly challenging. Expectations to transition are rising from customers, lenders and employees.
At the same time, regulatory demands are shifting, and investors want to be sure that you don’t risk too much, go too fast or too slow and stay on the path to delivering the right financial results. And the needed technologies do not always exist at scale - yet.
There is always a risk assessment associated with credit. What is new in this transition risk assessment is that the climate transition is systematically incorporated as forward-looking risk dimension in the credit assessment.
This type of risk assessment has been introduced because traditional credit models do not, on their own, capture the structural and long-term risks associated with the transition - particularly not for large companies in high emitting sectors. The transition risk assessment therefore serves as a supplement, combining an evaluation of the company’s climate ambitions with an assessment of its ability to execute them in practice.
The purpose of this analysis is not to eliminate all transition risks in our overall portfolio but to ensure we understand the transition risks associated with each client in the high emitting sectors.
A key principle of this approach is that the assessment is conducted at entity level rather than project level. A successful investment with social and environmental characteristics may be relevant, but it does not necessarily alter the overall risk profile if the rest of the business remains exposed to high transition risk.
By assessing strategy, governance, investment priorities and execution capability at entity level, a more accurate picture emerges of how the transition affects the company’s long-term creditworthiness — and, ultimately, the bank’s risk-taking.
But what exactly do we examine when assessing your transition risk?
The two key elements you are assessed on:
Your company is evaluated based on two main aspects: net-zero alignment and execution risk.
These two elements – net-zero alignment and execution risk - are then brought together in a combined assessment that can be integrated directly into our credit process.
Your company is evaluated based on two main aspects: net-zero alignment and execution risk.
Mogens Pedersen
Head of ESG Risk and Defence Centre of Excellence, Danske Bank
The net-zero alignment analysis evaluates how clearly and credibly your company has defined a pathway toward reaching net-zero by 2050, and here our focus is on evidence and decision making.
Key elements in Danske Bank’s assessment of your company’s net-zero alignment include:
Whether your company has set science backed long term commitments supported by short and medium-term targets that reflect meaningful emissions reductions
The level of detail in your transition strategy including the technologies and measures you intend to deploy
How your current emissions compare to the trajectory your company has outlined
The degree to which your capital allocation for the coming years supports the decarbonisation pathway you have defined.
A high level of alignment indicates that your company is building a transition plan that is coherent and supported by investment choices that match your company’s stated ambitions.
The score does not stand alone but supports a holistic evaluation of the company’s long-term creditworthiness at entity level.
Mogens Pedersen
Head of ESG Risk and Defence Centre of Excellence, Danske Bank
Execution risk
Policies shift, and technologies might or might not evolve as predicted . The second part of the assessment investigates the practical limits that can impact your progress to get a realistic view of how actionable your company’s transition roadmap is; and how it can be impacted negatively by external factors outside of your control.
Your execution risk is assessed by reviewing:
- The maturity and availability of the technologies your company relies on to achieve emissions reductions. Carbon capture and storage (CCS), for instance, carries a high execution risk, as the technology is not yet mature for all industries, but converting a coal‑fired power plant into a biomass plant is low‑risk, because it’s a well-known process.
- Operational readiness and the strength of your mitigation strategies for delays, cost pressures or supply chain risks.
- External factors that may slow progress such as regulatory changes and timelines, access to renewable energy or infrastructure constraints: Tax credits, public subsidies on settlement prices, and grid connection can all be influenced by changing political winds.
More on transition risk assessment
The net-zero alignment assessment and the execution risk assessment scores are combined to give a final transition risk assessment score. This provides a structured view of how transition-related factors contribute to your company’s overall risk profile and is used as an input to the broader credit assessment.
As such, the score does not stand alone but supports a holistic evaluation of the company’s long-term creditworthiness at entity level.
By enabling a clear view of the inherent risks and possibilities in your company’s transition, the finalized transition risk assessment is a great foundation for understanding credit risk and for a well-grounded dialogue.
