Financial services companies are well represented in the journey to net-zero carbon emissions. According to the United Nations,1 more than 160 firms with $70 trillion in assets are now committed to achieving net zero by 2050. This group, the Glasgow Financial Alliance for Net Zero,2 includes 43 banks from 23 countries with assets of more than $28 trillion.
For these companies, however, making the commitment is just the beginning of a more demanding journey. At some point, they will have to tackle their biggest data collection challenge since the Dodd-Frank Act was enacted in 2010. Not only do firms need to track and measure the Scope 1 and Scope 2 emissions from their own business operations, they also need to account for Scope 3, which means measuring and reporting the emissions and climate impact of many of the activities they help to finance for their customers.
This emissions category, known as “financed emissions,” is extraordinarily large and complex, as it touches almost every asset class and financing activity, from simple small business loans to the financing for carbon-intensive factories and construction projects. Complicating things further, the data that companies need is extremely difficult to obtain, and the quality is questionable.
Currently, there are five primary limitations that the industry needs to overcome to accurately report on financed emissions:
- Data from counterparties is not readily available.
- Available data is not audited and the quality is often substandard.
- There is no single, agreed industry standard for accounting and reporting on financed emissions.
- Most Environmental, Social & Governance (ESG) reporting is done manually and cannot generate the volume of data that is needed.
- Closer engagement with the Chief Data Officer is needed to get better access to quality data and eventually upgrade the ESG reporting process.
Fortunately, leading firms are forging ahead despite the obstacles, teaming with industry groups and standard setters such as Partnership for Carbon Accounting Financials (PCAF) and Science Based Target Institute (SBTi). PCAF developed the Global GHG Accounting and Reporting Standard for the Financial Industry3 to provide detailed methodological guidance to measure and disclose greenhouse gas (GHG) emissions associated with six asset classes. SBTi provides science-based principles and metrics for financial institutions to set quantitative net-zero targets linked with emissions reductions in the real economy.
At a minimum, these organizations are beginning to conduct internal analyses of their financed emissions. Some are disclosing it externally for certain products and industry types, acknowledging any data limitations or quality shortfalls through proxy and other assumption-driven reporting. Clearly, conservative assumptions should be used for these early disclosures. However, the need for this will ease over time as counterparties increase and improve their carbon disclosures.
We believe every financial services company can at least begin to plan for and participate in the journey to net zero. It’s critical that firms take action now to uphold the objectives of the Paris Accord, reducing GHG emissions and addressing climate change responsibly.
A four-phase approach
We recommend a four-phase approach to measuring and disclosing your financed emissions.
- Understand and analyze your scope. That means you need to identify and evaluate which of your asset classes will be included, as well as the industries and geographies your customers, or counterparties, operate in. Some asset class groups might be descoped for various reasons. For example, retail mortgages might be removed as this could negatively impact your community reinvestment activities.
- Develop a transparent set of assumptions. Using a waterfall logic approach, you can develop a set of assumptions for measuring your financed emission for specific assets and industries. Initially, it’s not necessary to cover every asset and industry. We recommend that you start by prioritizing the most carbon-intensive industries.
- Source the available data. Gathering the data you need to perform your calculations starts by engaging with clients. But you will also need to evaluate available third-party data consolidators and build proxy assumptions to fill data gaps.
- Enable your calculation engine. There is a standard equation for calculating financed emissions:
General approach to financed emissions calculation
Financed emmisions = Attribution Factor X Scope 1 & 2 Emission Per Loan or Investment
Attribution Factor = % Share of Loan or Investment (e.g., Total Loan / Total Debt + Equity)
To do the math, you must know your percentage share of the financing of the business or project and assume an equal-share responsibility for the resulting GHG emissions from the business or project. First, however, you must gather your data, enable your “calculation engine,” and engage with your counterparties to validate the results.
As you work through these phases, it’s important to openly explain your goals and objectives to your external stakeholders. Make your assumptions known and acknowledge they will change over time. However, the long-term business benefits far outweigh the short-term costs of launching your financed emission journey.
- United Nations: “Biggest financial players back net zero,” April 21, 2021
- Glasgow Financial Alliance For Net Zero Web site, “Amount of finance committed to achieving 1.5°C now at scale needed to deliver the transition,” new release November 3, 2021
- Partnership for Carbon Accounting Financials: Global GHG Accounting and Reporting Standard for the Financial Industry: https://carbonaccountingfinancials.com/standard