Addressing climate change is an urgent imperative and it has various problems associated. One critical but often overlooked obstacle is financed emissions.
Despite growing awareness of the environmental impacts associated with investments in fossil fuels and other high-emission industries, financed emissions persist as formidable barriers to achieving our climate goals.
But what exactly are these emissions that pose such a significant threat to our efforts to combat climate change?
What are financed emissions?
Financed emissions, in simple words, encompass the greenhouse gas (GHG) emissions stemming from financial activities, investments, and lending conducted by investors and financial service providers.
These emissions encompass the carbon footprint of a firm’s entire investment portfolio or lending book, attributing emissions based on the activities financed by the institution.
These emissions enter the atmosphere through investments in fossil fuel projects, industries, and infrastructure. Despite growing awareness of their environmental toll, financed emissions persist as formidable barriers to achieving our climate aspirations.
According to the Greenhouse Gas Protocol, financed emissions are classified as Scope 3 emissions.
Why are these emissions important?
Financed emissions are important because they contribute significantly to global greenhouse gas emissions. If left unattended or neglected, even with other mechanisms in place to tackle climate change, these emissions can dent the efforts.
For instance, a study found that the portfolio emissions of global financial institutions are, on average, over 700 times larger than direct emissions, according to the emissions disclosed by the companies.
Financial institutions are overlooking the most critical climate-related risks linked to financing.
The report also mentioned that the majority of companies considered for the study fail to disclose credit risks (65%), including borrower defaults on loan repayments, and a significant percentage (74%) neglect market risks, such as stranded assets and devaluation of financial assets.
However, the financial impacts of these financing-related risks are significantly greater than those associated with operational risks, amounting to a combined US$1 trillion versus just US$34 billion, as per the study.
Although financial institutions are increasingly setting net zero targets, the study uncovered that fewer than half of disclosure financial institutions and only 27% of insurers are taking action to align their portfolios with the goal of limiting global warming to well below 2 ° C.
But how are these measured?
A consistent standard is required to measure greenhouse gas emissions and maintain accuracy and comparability across companies, portfolios, and industries.
For this reason, prominent European banks established the Partnership for Carbon Accounting Financials (PCAF). It has emerged as the global leader in setting standards for measuring and reporting financed emissions.
The PCAF is endorsed by the GHG Protocol, which is the most renowned framework for GHG accounting. The PCAF defines financed emissions under the Corporate Value Chain (Scope 3) standard, specifically within Category 15 for investment activities.
Who needs to disclose these emissions?
Entities such as banks, insurance companies, and asset managers are increasingly obligated to disclose their financed emissions since the emissions originate from their investments in other companies, directly linking them to the carbon footprint associated with those investments.
While reporting on financed emissions remains voluntary in the U.S. and many other global regions, regulatory trends indicate a shift toward mandatory disclosure. Notably, New Zealand has already implemented requirements for insurers, banks, and other financial entities to disclose their climate-related impacts.
Several alliances, collectives, and organizations have also committed to reporting on financed emissions, highlighting a broader industry movement toward accountability and transparency in environmental impact reporting.
The choice to contribute to sustainability is not the only factor that creates a reluctance in the company’s actions regarding financed emissions. Other challenges make it difficult for organizations to report their financed emissions.
What are the challenges faced by firms when reporting financed emissions?
Data Collection and Standardization: Gathering comprehensive and accurate data across diverse portfolios is complex and time-consuming. Standardizing methodologies and metrics for reporting remains a significant hurdle.
Regulatory and Policy Limitations: A lack of standardized regulations and policies globally complicates consistent and comparable reporting practices. This can lead to variations in reporting quality and transparency.
Risk of Greenwashing: Without clear standards, there is a risk of overstating or misrepresenting environmental impacts, leading to accusations of greenwashing.
What can companies do to report their financed emissions better?
- Identify key stakeholders and define their roles in emission reduction efforts.
- Set interim emission reduction targets with regular progress checkpoints.
- Educate employees and stakeholders on emission reduction strategies.
- Provide targeted training for financial advisors and asset managers.
- Engage with high-emission portfolio companies and clients to encourage emissions measurement and reduction.
- Prioritize actions targeting the largest emission sources
- Explore sustainable investment opportunities such as renewable energy projects and transition bonds.
- Regularly review and adjust targets based on evolving data and disclosure standards.
- Establish feedback mechanisms to refine strategies and improve outcomes.
- Monitor and adapt to changing legislation affecting portfolio companies and clients.