Financed emissions are the indirect greenhouse gas (GHG) emissions that result from a financial institution’s lending, investing, and underwriting activities. These emissions are critical for banks, financial services, and insurance companies because they reflect the environmental impact of the businesses they support financially. When financial institutions provide capital to high-carbon-emitting entities, they indirectly contribute to climate change. This connection places significant responsibility on financial institutions to monitor, measure, and manage their financed emissions.
According to the Greenhouse Gas (GHG) Protocol, financed emissions are classified as indirect emissions. While direct emissions come from a company’s own operations, indirect emissions are the result of activities that occur outside the organization’s direct control but are influenced by its financial support. This distinction underscores the importance of financial institutions in addressing climate change by influencing the behaviours and practices of the companies they finance.
Importance of Measuring Financed Emissions
Regulators and civil society are increasingly pressuring financial institutions to demonstrate transparency in their environmental impact. By tracking and measuring their financed emissions, these institutions can implement better control measures and build trust with regulatory bodies. Here are additional reasons why measuring financed emissions is crucial:
- Enhanced Climate Reporting and Environmental Impact Assessment
For businesses aiming to refine their climate reporting and evaluate downstream environmental impacts, tracking financed emissions is indispensable. This process ensures that financial institutions can accurately report their environmental footprint, leading to improved transparency and accountability.
- Critical Insights for Risk Management
Measuring financed emissions provides essential insights into climate-related transition risks and opportunities. Understanding the carbon intensity of their investments enables institutions to identify potential risks associated with climate change and make informed decisions to mitigate these risks.
- Alignment with Net Zero Ambitions
For financial institutions and investors, measuring financed emissions is fundamental to aligning portfolios with Net Zero ambitions. Accurate emissions measurement allows for the setting of science-based targets and the execution of strategic actions aimed at reducing carbon footprints. This alignment is crucial for meeting global climate goals and maintaining the institution’s credibility and market position.
Financed Emissions Measurement Techniques
The Partnership for Carbon Accounting Financials (PCAF) developed the Global GHG Accounting and Reporting Standard for the Financial Industry in response to the industry’s demand for a standardized global approach to measure and report financed emissions. According to the PCAF methodology, financial institution investments can be categorized into various types, including but not limited to equity (listed and unlisted), corporate bonds, project finance, business loans, vehicle loans, mortgages, and real estate. The primary methodologies for calculating financed emissions include:
- Reported Emissions Methodology
This method estimates the greenhouse gas (GHG) emissions of an investment by accounting for the reported emissions of the invested company and allocating those emissions based on the share of the investment. For example, if Company B reports an annual GHG emission of 60,000 tCO2eq and Company A holds a 15% equity stake in Company B, then Company A’s emission related to this investment would be 60,000 X 15% = 9,000 tCO2eq. This method relies on the transparency and accuracy of the investee company’s emissions reporting.
- Physical Intensity-Based Methodology
This approach focuses on collecting the investee company’s energy consumption data (scope 1 & 2 emissions) to derive the overall emissions using the GHG protocol. Alternatively, production data can be used to estimate emissions. The emissions are then allocated based on the share of the investment. For instance, if Company A has an 8% stake in Company B, which produces 800,000 MWh from coal power plants (with an emission factor of 0.4 tons/MWh), Company B’s emissions would be 320,000 tCO2eq. Company A’s share of these emissions would be 320,000 X 8% = 25,600 tCO2eq. This method provides a more specific and tangible measure of emissions based on actual energy consumption and production data.
- Economic Intensity-Based Methodology
In this method, GHG calculations are done using revenue data along with relevant emission factors for the specific sector. For example, if Company A holds an 8% equity stake in Company B, and Company B’s total revenue from the power supply is $180,000 with an emission factor of 20 tCO2eq per $1,000, Company B’s total emissions would be 3,600 tCO2eq. Company A’s share of these emissions would be 3,600 X 8% = 288 tCO2eq. This approach uses economic data to estimate emissions, providing a different perspective compared to the physical data method.
- Data and Tools
Accurate data collection is crucial for measuring and managing financed emissions. Without reliable data, financial institutions cannot accurately assess their carbon footprint or set realistic Net Zero targets. Advanced tracking tools, such as Olive Gaea’s Zero, play a vital role in this process. These tools facilitate the comprehensive collection and analysis of emissions data, enabling organizations to track progress, identify trends, and make informed decisions. By employing sophisticated tracking tools, banks and investors can ensure their investments align with Net Zero goals and support the transition to a low-carbon economy.
Strategic Actions for Managing Financed Emissions
To manage and reduce financed emissions, financial institutions can adopt several strategic actions, including:
- Investment Strategies
Financial institutions can prioritize investments in low-carbon and sustainable projects. By directing capital towards renewable energy, energy efficiency, and other environmentally friendly initiatives, they can reduce their financed emissions and support the broader transition to a low-carbon economy.
- Portfolio Adjustments
Institutions should regularly assess and adjust their portfolios to minimize exposure to high-carbon assets. This involves divesting from companies with poor environmental performance and increasing investments in businesses with strong sustainability practices. Portfolio adjustments should be guided by science-based targets and aligned with the institution’s overall climate goals.
- Engagement and Advocacy
Financial institutions can engage with the companies they finance to encourage better environmental practices. By setting clear expectations and providing support for sustainability initiatives, they can influence positive change and reduce overall emissions. Additionally, institutions can advocate for stronger climate policies and collaborate with industry peers to drive collective action.
Conclusion
Financed emissions represent a significant aspect of a financial institution’s overall environmental impact. By understanding and managing these emissions, financial institutions can play a crucial role in addressing climate change.
Utilizing accurate measurement methodologies, advanced tracking tools like Olive Gaea’s Zero, and strategic actions, institutions can align their portfolios with Net Zero ambitions and contribute to a sustainable future.
