Financial institutions are pledging to lower carbon footprints. Here’s what you need to know about financed emissions.
Financial institutions are facing pressure from regulators, civil society and clients for increased transparency about their role in climate change and other sustainability-related issues. An increasing number of financial institutions believe that they have to play an active role in the sustainability transition of the real economy, particularly when it comes to climate change1. Many have pledged to reduce the carbon emissions of their operations, and more importantly, to reduce the emissions associated with their financing and investment activities, known as their “financed emissions”.
Quantifying financed emissions is a tangible first step toward building trust that financial institutions are integrating climate change into their core business of providing and allocating capital. Additionally, financed emissions could be used as a proxy for transition risk from climate change.
Disclosure of financed emissions is currently voluntary in the US, though already mandatory in the European Union; though US regulators are signaling expectations for enhanced climate risk disclosures.
1 Source: Glasgow Financial Alliance for Net Zero “more than 550 firms in the global financial sector have independently committed to the goal of net zero by 2050, in addition to setting interim targets for 2030 or earlier and reporting transparently on progress along the way.”
Why should you measure financed emissions?
- Foster compliance with mandatory disclosure rules in some jurisdictions
- Enhance transparency to investors through voluntary disclosures
- Assist in target setting
- As a key pillar of your risk management profile
What challenges should you be prepared to tackle?
- Understanding the application of accounting standards - many of which are still evolving
- Preparing for enhanced climate risk disclosures, which for some financial institutions will likely include an analysis of carbon exposures in their portfolios
- Gathering emissions data - which is often incomplete or inconsistent in some asset classes; entirely missing in others
- Addressing technological challenges in processing and computing financed emissions data
- Properly folding in projections around rates of future global decarbonization to help develop portfolio selection and management strategies that align to company climate targets while balancing overall growth and risk objectives
Key updates to PCAF Financed Emissions Standard
In late 2022, PCAF released version 2.0 of its financed emissions standard, an update from the standard originally published in 2020. Significant updates in the new standard include:
- Methodology for attribution of sovereign emissions to holders of sovereign debt instruments
- Methodology and disclosure requirements for carbon emissions removals associated with investment activities
- Methodology to improve comparability of attributed emissions between reporting dates by adjusting for the impact of market value fluctuations on emissions attribution.
The addition of a methodology for sovereign debt instruments represents a significant addition for carbon accounting: as of year-end 2021, global outstanding central government debt totaled more than $30 trillion, making this asset class one of the largest sources of institutional investment worldwide.
Addressing financed emissions challenges: Getting started
Calculating financed emissions is not a once-and-done exercise. As you progress towards your own organizational goals, you should expect to update baseline emissions estimates on a regular basis. Work closely with the companies your firm conducts business with—both lending to and investing in—to encourage transparency of its GHG emissions and activities promoting lower emissions in the real economy.
- Accounting
- Data
- Technology
- Target Setting
Accounting
- Understand existing and evolving accounting standards around measuring financed emissions.
- Consider how you will address Scope 3, Category 15 emissions. These Insurance Associated Emissions are defined as GHG emissions in the real economy associated with specific (re)insurance policies.
- Understand reporting architecture required, leveraging existing financial reporting architectures to the greatest degree possible.
Data
- Find ways to source the data, dependent upon investment type and relationship with the investee entity.
- Assess reliability and availability of the data and consider how to handle data quality concerns.
- Look to established data scorecards (e.g., PCAF) to understand emissions data quality, track data over time, and develop strategies for improvement.
- Establish a sustainable, repeatable process and internal controls to collect and aggregate data and remediate data quality issues.
- Maintain and store ESG data in accordance with regulatory requirements and company policies.
Technology
- Assess reporting capabilities of your current technology stack.
- Determine if you can leverage existing IT systems or need to phase in new technology.
- Understand how to make technology systems ready to consume and process different types of financed emissions data.
- Consider other key technology features including compatibility with company IT strategic vision; integration and automation; reporting and dashboards; and user experience.
Target Setting
- Take steps to update your baseline emissions inventory on a periodic basis.
- Manage and monitor metrics and progress against decarbonization targets.
- Get buy-in from investment teams at the outset to help develop execution frameworks.
- Look to implement necessary training and tools.
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