Financed, facilitated, and insured emissions (collectively referred to as “financed emissions” in the rest of this article) are the emissions produced by a financial institution’s loan and investment portfolios, off-balance-sheet capital markets activities, and insurance services, respectively. Measuring and reporting these emissions enable financial institutions to manage and capitalize on climate-related risks and opportunities. With constantly evolving industry guidance and regulatory requirements, rising investor pressure, and increasing climate-related financial risks, financial institutions need to quickly establish or enhance their financed emissions programs to comply with heightened expectations.
Financial institutions’ interactions across industries multiply their exposure to the far-reaching economic impacts of climate change. At the same time, financial institutions play a key role in financing the transition to a low-carbon economy by facilitating the flow of capital needed to mitigate and adapt to climate change. In this capacity, the financial industry is subject to unique risks and opportunities from climate change, requiring new ways of measuring and reporting operations, including accounting for financed emissions.
Understanding Financed Emissions
Given the critical role financial institutions play in the transition to a greener economy, there is increasing scrutiny and criticism of funding high-polluting industries and companies. Stakeholders’ demands to hold financial organizations accountable for the carbon footprint related to their products and services have been gaining momentum. Proposed and approved regulatory requirements, maturing reporting standards, and intensifying investor pressure are driving financial institutions to account for financed emissions as part of their environmental disclosures and set corresponding, science-based emissions reduction targets.
The Greenhouse Gas (GHG) Protocol, an internationally recognized GHG accounting standard, categorizes financed emissions as Scope 3, Category 15: Investments. In addition, the Partnership for Carbon Accounting Financials (PCAF), a widely accepted and utilized industry-led initiative, provides guidance that enables financial institutions to measure and disclose GHG emissions for certain asset classes and activities. These, and other industry organizations, continue to refine guidance to encompass additional considerations, expand use cases, and assist in implementation.
Frequent Challenges
Despite the growing focus and guidance related to this topic, many financial institutions are only in the beginning stages of measuring financed emissions. This is in part because of the reputational risk related to publishing emissions baselines and reduction targets, amid many uncertainties on how to calculate and achieve them.
Beyond the reputational considerations, establishing a financed emissions program presents numerous challenges. Here are some of the most common ones institutions are grappling with and some practical considerations to tackle them:
Methodology
As methodologies and best practices continue to evolve, organizations will need to be strategic around the deployment of a financed emissions program and conduct periodic reviews to refine their approach to calculations. For instance, PCAF provided guidance on how to measure and disclose GHG emissions for loans and investments in 2019, updated this standard in 2022, and included guidance on facilitated emissions (for capital markets activities) in December 2023.
Financial institutions should prioritize significant business activities, consider developing interim solutions, and chart a staged approach to implementation given this ongoing development.
Data Availability & Quality
Financed emissions precision is dependent upon many factors, including client data availability and quality. Because emissions reporting is still voluntary in most jurisdictions, financial institutions struggle with the lack and quality of information. Currently, various combinations of client-reported emissions, revenue, or production data are used for calculations, but are often incomplete, incorrect, or inconsistent. This forces financial institutions to rely on estimates or averages, which may result in under- or overestimating emissions baselines, reliance on external data sourcing or manual efforts, inaccurate performance measurement, and errors in reported progress toward targets. Organizations should track and disclose data concerns, leverage results accordingly, and engage clients and service providers for ongoing improvements.
Resource Management
Building a robust financed emissions program requires substantial resources to interpret guidance, develop tools and technology to capture data, perform calculations, prepare reporting and disclosure, and develop an ongoing management strategy. The investment in staffing, hiring, or upskilling the workforce and developing new tools, such as technology infrastructure, should not be underestimated.
Companies will need to establish a multiyear plan to build or embed financed emissions calculations and ongoing management into existing operations.
Cross-Functional Collaboration
Establishing financed emissions expertise requires significant engagement from across the organization. Having stakeholders from each of the three lines of defense—business and support functions, risk, and audit—understand the calculations, unique data needs, and overall process can help provide the cohesiveness critical to an organization’s overall decarbonization strategy. Each group of stakeholders holds a unique lens and can provide insight into specific aspects of the process. This may include discussion regarding the population measured for financed emissions, the approach to data sourcing and how to weave in unique data inputs, technical understanding of critical levers, and final reasonableness checks of calculation outputs. Particularly challenging, and yet critical, is finding the right balance and focus of engagement of business teams.
Measuring financed emissions cannot be done in a silo. Engaging cross-functional stakeholders from each of the three lines of defense, including early and meaningful engagement of the business teams, can help improve measurement accuracy and organizational cohesion toward target management and net zero.
Controls & Governance
It is essential to establish appropriate controls and governance for financed emissions’ calculation and management, especially given the complex, evolving nature of this space and the upcoming regulatory expectations of producing verified data to be disclosed in a company’s regulatory reports. This may be difficult, as many organizations are still developing the necessary tools and talent related to financed emissions.
Borrowing concepts from other disciplines and engaging team members with control function expertise from other parts of the organization, specifically accounting professionals, can provide insight into best practices that can be leveraged for financed emissions management. In addition, organizations must help ensure appropriate oversight of these activities with executive leadership’s active engagement and ownership of these efforts, understanding the challenges, and providing guidance and assistance to build a robust program.
Target Management & Strategy
Financed emissions are necessary to demonstrate progress toward net zero reduction targets, which are increasingly expected of all organizations. Moving beyond measurement to performance management requires a defined strategy, which should tie into the larger organizational strategy. This can result in trade-offs, as organizations balance a variety of objectives, such as reducing emissions, engaging clients in the transition to a low-carbon economy, facilitating a just transition, and meeting financial targets.
It is critical to understand the impact of financed emissions and seek the appropriate collaboration to develop a comprehensive organizational strategy, inclusive of net zero targets’ management.
Finding the Path Forward
Calculating and managing financed emissions will become a more pressing expectation for financial institutions going forward. Effective financed emissions programs can help identify and manage climate-related risks and opportunities and focus on strategic decarbonization opportunities through targeted service offerings. While it will take time to address the challenges associated with establishing a credible program, regulatory and industry expectations—as well as climate change impacts—are expected to hit much faster. Organizations ahead of the curve in this space will have a definitive advantage.
If you have any questions or need assistance, feel free to reach out to our team at Forvis Mazars.