What are financed emissions?

Financial organizations have a key role to play in the transition to a low carbon economy. Here’s what you need to know about financed emissions.

Financed emissions are the carbon emissions associated with the investments made by an organization or individual. As climate change continues to be a growing concern, attention has shifted to the financial sector and the role it plays in contributing to the problem. Many financial institutions invest in companies that have significant carbon emissions (such as those in the energy and power sectors), and as a result, they are indirectly responsible for the greenhouse gas emissions associated with these companies. In this blog post, we will take a closer look at what financed emissions are, why they matter, and what can be done to address them.

Why do financed emissions matter?

When a financial institution invests in a company, it provides the company with capital to fund its operations and growth. In return, the investor expects to receive a return on their investment. However, the company being invested may be a significant emitter of greenhouse gases – and the financial institution is indirectly responsible for the carbon emissions associated with the company's operations. These carbon emissions are referred to as financed emissions.

Categories of greenhouse gas emissions

Financed emissions can be broken down into two categories: operational and value chain emissions. Operational emissions are the direct emissions associated with a company's operations, such as emissions from factories, transportation, and energy use. Value chain emissions are the indirect emissions associated with a company's supply chain, including the production of materials and components, transportation of goods, and disposal of waste. Both types of emissions contribute to the carbon footprint of a company and are included in the calculation of financed emissions.

The Global GHG Accounting and Reporting Standard for the Financial Industry outlines six significant asset classes within the wider context of financed emissions. These asset classes encompass listed equity and corporate bonds, business loans and unlisted equity, project finance, commercial real estate mortgages, and motor vehicle loans.

By providing clarity and guidance on these specific asset classes, the standard enables financial institutions to accurately account for and report their emissions associated with these financing activities, contributing to a comprehensive understanding of their overall impact on greenhouse gas emissions.

What is the impact of financed emissions?

The impact of financed emissions is significant. A recent study found that the world's 60 largest banks have provided over $3.8 trillion in financing for fossil fuel companies since the signing of the Paris Agreement in 2015. This financing has resulted in over 2.7 billion metric tons of CO2 emissions, which is equivalent to the emissions of over 580 million cars on the road for a year. The financial sector's role in financing fossil fuels has made it a major contributor to climate change and has raised concerns about the industry's lack of action to address the issue.

Who needs to disclose financed emissions?

Companies that provide financial services, such as banks, insurance companies, and asset managers, are typically required to disclose their financed emissions. This is because they provide capital to other companies, and the emissions associated with those investments can be attributed to the financial service provider. Additionally, many investors are increasingly interested in understanding the carbon footprint of their investments, and are therefore calling for greater transparency from financial institutions.

A shared responsibility between investors and investees

The responsibility to address financed emissions does not fall solely on the financial sector. Companies that receive investments also have a responsibility to reduce emissions. The task of reducing emissions can be daunting, but it is essential for the long-term sustainability of the planet. Companies can start by identifying their carbon footprint and setting targets to reduce their emissions. This requires collecting data on operational and value chain emissions and identifying areas where emissions can be reduced. In addition to emissions targets, companies should consider implementing sustainability initiatives, such as using renewable energy, improving energy efficiency, and reducing waste.

What are the reporting requirements around financed emissions?

The reporting requirements around financed emissions vary across jurisdictions and regulatory frameworks. In the European Union, the EU Taxonomy Regulation, as part of the Sustainable Finance Disclosure Regulation (SFDR), requires financial market participants and financial advisors to disclose information on how their activities align with environmental objectives, including climate change mitigation. This includes reporting on the carbon footprint of their investments and the extent to which their activities are associated with environmentally sustainable economic activities. Similarly, the Task Force on Climate-related Financial Disclosures (TCFD), a global initiative, provides recommendations for companies to disclose climate-related financial information, which encompasses considerations of financed emissions. These reporting requirements aim to enhance transparency, promote sustainable investments, and enable stakeholders to assess the climate-related financial risks and opportunities associated with financial institutions.

What is the Net Zero Finance Alliance?

The Net Zero Finance Alliance plays a pivotal role in driving the global transition to a net zero economy. This alliance brings together financial institutions committed to achieving net zero emissions by aligning their portfolios and investments with climate goals. By joining this alliance, financial institutions demonstrate their commitment to addressing climate change and contributing to a sustainable future. The Net Zero Finance Alliance serves as a platform for collaboration, knowledge sharing, and best practices in implementing net zero strategies. It provides guidance and resources to help institutions develop robust net zero targets, track progress, and report on their efforts. Through the collective action of the Net Zero Finance Alliance, financial institutions can leverage their influence and resources to accelerate the shift towards a net zero economy, driving transformative change and reducing greenhouse gas emissions on a global scale.

How can you address your organization's financed emissions?

As a CSO or sustainability leader, it is your responsibility to ensure that your organization complies with regulations related to sustainability issues. This includes addressing financed emissions. One way to do this is by integrating environmental, social, and governance (ESG) considerations into your organization's investment decisions. This involves analyzing the impact of investments on the environment, society, and governance. By considering ESG issues, financial institutions can identify high-carbon investments and reduce their exposure to these types of investments.

Another way to address financed emissions is by engaging with internal and external stakeholders. This includes engaging with investors, clients, and employees to raise awareness of the financial sector's role in climate change and the importance of reducing emissions. By educating stakeholders, financial institutions can build support for initiatives to reduce financed emissions and demonstrate their commitment to addressing the issue.

Finally, it is essential to collaborate with other organizations to find innovative ways to reduce emissions. This includes collaborating with other financial institutions to develop industry-wide standards and initiatives for addressing financed emissions. It also includes working with companies to identify areas where emissions can be reduced and supporting them in implementing sustainability initiatives. By collaborating with others, financial institutions can drive change and accelerate progress towards a sustainable future.

What challenges do firms face when measuring financed emissions?

Measuring financed emissions presents several challenges for firms.

The data challenge

Obtaining comprehensive and accurate data on the emissions associated with their investments can be complex. Financial institutions often have diverse portfolios with numerous investments across different asset classes, sectors and geographies, making it challenging to collect data from various sources. Limited data availability and inconsistencies in reporting standards among investee companies can further complicate the measurement process.

The attribution challenge

Attributing emissions to specific financial activities or investments can be difficult. Financial institutions may have indirect exposure to emissions through equity holdings, bonds, or loans, making it challenging to allocate emissions accurately. Additionally, the complex network of intermediaries, such as investment funds or syndicated loans, adds another layer of complexity in tracing emissions to specific investments.

The methodology challenge

Thirdly, calculating financed emissions requires applying appropriate methodologies and emission factors. Different sectors have different methodologies for measuring emissions, and financial institutions need to ensure consistency and comparability in their calculations. This requires access to reliable emission factors and the expertise to apply them correctly.

The reporting challenge

Another challenge is the lack of standardized reporting frameworks and guidelines specific to managing financed emissions. While initiatives like the Partnership for Carbon Accounting Financials (PCAF) and TCFD provide guidance, there is no universal framework for measuring and disclosing financed emissions. This can lead to inconsistencies in methodologies, metrics, and reporting formats across different financial institutions, making it challenging for stakeholders to compare and assess their environmental impacts.

The engagement challenge

Furthermore, engaging investee companies and obtaining their emissions data can be a significant hurdle. Companies may have varying levels of environmental disclosure practices, and not all may be willing to share detailed emissions data with their investors. This creates obstacles in collecting complete and reliable information for measuring financed emissions accurately.

How are financed emissions calculated?

When it comes to measuring and managing financed emissions, there are several steps you need to go through.

Portfolio mapping: Begin by mapping out the financial institution's portfolio, encompassing equity holdings, bonds, loans, and other investments, taking into account the emissions generated by each investee company or project that relate to the calculation of emissions.

Emissions factors: Determine the appropriate emission factors for each sector or industry in which the investee companies operate. Emission factors indicate the average emissions per unit of activity or output. These factors are typically obtained from reputable sources such as government agencies, industry associations, or international standards bodies.

Data collection: Gather the necessary company emissions data, including data from investee companies to calculate their emissions. This data may include details on energy consumption, fuel usage, production volumes, or other relevant parameters specific to the sector. Engage with investee companies to ensure data quality.

Financed emissions calculations: Apply the emission factors to the relevant data collected from investee companies. Multiply the activity or output of each investee company by the corresponding emission factor to determine their emissions intensity. Aggregate the emissions across the portfolio to obtain the total emissions financed.

Adjustments and allocations: Consider any necessary adjustments or allocations to accurately attribute emissions. For instance, if the financial institution holds a minority stake in a company, the emissions associated with that investment may require adjustment. Similarly, if there are shared investments or syndicated loans, appropriate allocations must be made to prevent double counting.

Reporting and disclosure: Clearly and transparently present the calculated financed emissions. This may involve reporting on total emissions, emissions by sector or investment type, or other relevant breakdowns. Adhere to applicable reporting frameworks and guidelines, such as those provided by initiatives like the Partnership for Carbon Accounting Financials (PCAF) or the Task Force on Climate-related Financial Disclosures (TCFD). These reporting practices contribute to addressing global climate concerns, climate risks, emerging regulatory requirements, reduced emissions, and the transition to a low carbon economy, aligning with climate goals set by the institution and its portfolio companies.

How can you reduce financed emissions?

To effectively reduce financed emissions across your portfolio companies, you can adopt several strategies. Start by aligning your investments with science-based targets, as outlined by the Science Based Targets initiative, which ensures that your emissions reductions goals are in line with global climate objectives. Setting clear interim targets will help you track progress and take necessary actions to achieve long-term emission reductions. By actively engaging with your investee companies, promoting sustainable practices, and directing investments towards low-carbon and sustainable projects, you can play a significant role in reducing your total carbon footprint. This not only contributes to addressing climate goals but also supports the transition to a greener and more sustainable global economy.

Why is climate action beneficial to financial institutions?

Addressing your financed emissions demonstrates your commitment to environmental sustainability and responsible investing, which can enhance your brand reputation and attract environmentally conscious investors and clients. It showcases your firm as a responsible player in the financial sector, contributing to a positive image and strengthening stakeholder relationships.

Furthermore, by actively managing and reducing your financed emissions, you can mitigate climate risks and potential regulatory uncertainties. As governments and international bodies increasingly focus on climate change, there is a growing likelihood of stricter regulations and reporting requirements. Proactively addressing your financed emissions positions your firm ahead of emerging regulatory requirements, ensuring compliance and minimizing potential financial and reputational risks.

Reducing financed emissions can also lead to long-term cost savings and operational efficiencies. By directing investments towards low-carbon and sustainable projects, you can support companies that are well-positioned to thrive in a low-carbon economy. This can result in better financial performance and returns on investment, aligning with the long-term interests of your firm and your clients.

Ready to start addressing your financed emissions? Find out how Sweep can help. Contact us today.