Governance Financial Statements
Strategic Report
51
been confirmed as a government policy yet. Any impact would be incremental over a period of years as and when loans become repayable following the customer’s death or entry into long- term care. The impact may be mitigated by the extent to which government softens the blow for homeowners through grants and subsidies. The cost of transition risk could lead to a 1.3% reduction in property values under the net zero scenarios for our LTM portfolio. This is a material reduction of 52% from the figure previously reported, which is due to an enhancement to our methodology. This is now based on the assumption that the most cost effective solution for energy efficiency improvements are completed first, in place of using an average cost approach. Any reduction in property value would only affect Just in instances where it leads to the property sale price being lower than the loan balance. Our physical risk modelling estimates that they lead to at most a 0.2% reduction in property values by 2080 on our LTM portfolio. Of the physical risks to which we are exposed, increased flood risk due to climate change is expected to have the most material impact. CARBON FOOTPRINT – INVESTMENT PORTFOLIO The carbon footprint of our credit and LTM portfolios are shown in the table below. The metrics show our baseline year (2019) and our 2024 position. We acknowledge there is double counting in producing the carbon footprint data and have therefore split the data by scope of emissions. Our carbon footprint does not include cash/cash equivalents, derivatives and reinsurance assets.
The CVaR is purely illustrative as it projects far into the future based on assumptions about our existing investment portfolio. The longer the time period that data is projected into the future, the more uncertainty in the results. The carbon footprint metric reflects the financed emissions of our current portfolio. ITR gives an indication of the temperature alignment of the portfolio. We expect each of these metrics to reduce as the composition of our investment portfolio changes over the years through the application of our Responsible Investment Framework. ENHANCEMENTS As part of the scenario analysis, we have further enhanced our approach in the following ways: 1. Modelling and tools: • Improved modelling of carbon emissions on LTMs through refined assumptions. • Improved analysis of projected financed emissions on the investment portfolio. • Improved data integrity checks and controls on the credit portfolio. • Fully aligned to the NGFS scenarios following enhancements made by our third party data provider 1 . 2. Risk Exposure • Reduced exposure to high emissions intensity investments through portfolio optimisation. • Financed emissions are now considered as part of due diligence for all prospective investments. COMBINED ILLUSTRATIVE IMPACTS – CVAR AND PVAR PRE-MANAGEMENT ACTIONS The results of our quantitative analysis of CVaR relating to the credit portfolio and PVaR relating to the LTM portfolio are shown in the table below. The metrics show the illustrative impacts on our existing credit portfolio if it were to remain unchanged to 2100. The analysis assumes no changes in the Investment Portfolio and does not consider the Group’s cash/cash equivalent holdings, derivatives, reinsurance assets and sovereign bonds.
Investment Portfolio
2019
2024¹
Credit portfolio² (tCO 2 e/$m nominal invested)
Scope 1 and 2: 84 Scope 1 and 2: 89 Scope 3: 407 Scope 3: 180 Coverage: (Scope 1, 2 and 3): 99.8% Coverage: (Scope 1, 2 and 3): 99.2%³
Scope 3: 10.3 5
Scope 3: 10.4
LTM portfolio 4 (tCO 2 e/$m nominal)
Coverage (Scope 3): n/a
Coverage (Scope 3): 96%
Scope 1 and 2: 60 Scope 1 and 2: 72 Scope 3: 274 Scope 3: 143
Combined
Current Policies 1
Sub-Portfolio
Delayed Transition Net Zero 2050
Credit portfolio 1 -2.0% CVaR -5.7% CVaR -0.8% CVaR LTM portfolio -1.5% PVaR -1.5% PVaR -0.2% PVaR 1 Results as at 31 December 2024. Historically, all scenarios were required to select a physical risk (aggressive or average) alongside the NGFS scenario and Nationally Determined Contributions was the only available scenario, within the ‘Hot House World’ segment. In line with the NGFS Phase IV scenarios, the Delayed Transition scenario (well below 2 degree pathway) has replaced the Divergent Net Zero scenarios (1.5 degree pathway), our 3rd party provider updated their physical risk methodology, both of which have contributed to changes in CVaR. Across all scenarios we have seen a fall in the aggregate CVaR which is due to a number of factors including: • The previous base case scenario, Divergent Net Zero, being replaced with Delayed Transition. The transition risks in the latter are more pronounced in the longer term. • Updated methodology, where our third party data provider has incorporated more accurate physical risk data which has reduced the overall physical risk across each scenario. The modelling continues to suggest that transition risks represent a more material risk to our investment portfolio than physical risks. In the Net Zero 2050 and Delayed Transition scenarios, there is an assumed implementation of minimum EPC standards for residential properties (based on assumptions stated in the Climate Biennial Exploratory Scenario). 70% of the LTM portfolio has an EPC below C, which is the anticipated minimum standard. For LTMs, we have not made explicit allowance for transition risk within our reported numbers. The estimated potential impact of transition risk on property values is based on the UK government implementing a minimum EPC standard of C and this has not
1 Data as at 28 June 2024. 2 A combination of latest available reported and estimated data has been used to calculate the carbon footprint of the credit portfolio using nominal values; this includes our third party data provider aiming to apply the principles under version one of the PCAF Financed Emissions Standard. For asset classes where no approach has yet been identified by PCAF, our third party data provider has applied an appropriate approach that is similar to the PCAF standard. Where data was not available an unweighted sector average was applied to produce a full portfolio footprint. Sector averages cover c.30% of the 2019 data. In 2024, scope 1 data improved significantly with c.7% of data representing sector averages and c.25% for scope 2 and scope 3. Data could be subject to change due to improvements in data quality going forward. 3 Coverage of the portfolio in the carbon footprint data. Data coverage varies across individual scopes of emissions, lowest value shown for prudence. 4 The LTM portfolio’s carbon footprint is calculated using an updated method from prior years, which is more accurate. The actual emissions are from the EPC where it exists and is active, and is modelled for the rest of the portfolio. The EPCs are associated for those properties secured against a LTM. Electricity is based on a rolling 12 month average CO 2 intensity factor from the National Grid based on the Distribution Network Operator for the region where that property is located. For other sources, the most recently published intensity factors from the Department for Energy Security and Net Zero ‘Government conversion factors for company reporting of greenhouse gas emissions’ report is used in place of the SAP 2012 factors. For 38% of properties we use the rating on the record, and for 58% of properties we use an estimated rating. For the remaining 4% of properties, an estimated rating was not available, as the model had insufficient information about the property to produce an estimated rating. The results of the existing data were then extrapolated to represent the whole portfolio. There is not an emissions standard for LTMs. We have calculated the emissions intensity based on the PCAF residential mortgage standard. The contribution of an individual property to the carbon emissions of the overall portfolio is based on current loan-to-value ratio of the relevant LTM. We have used the current loan balance and property value to calculate the loan-to-value ratio. 5 We have updated our approach to calculating emissions on LTMs to use a more accurate approach than prior years. To avoid using an inconsistent baseline, we have restated the 2019 figure. The figures for 2019 and 2024 are now reported in $m/nominal in order that we can report an aggregate scope 3 carbon footprint.
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