The Invisible Carbon Footprint: Unveiling Financed Emissions

1. What is meant by Financed Emissions?

Financed emissions is the general term for the indirect GHG emissions that are attributable to financial investments due to their involvement in providing capital or financing to a company that emits GHGs. 

There are varying types of financing activities which are can contribute to financed emissions under the GHG Protocol’s definition:

• Lending activities, which are most relevant to the banking and lending sectors.
• Investment activities, which are most relevant to the insurance, fund management and asset-owning sectors, and some banks.
• Underwriting activities, which are most relevant to the insurance sector

2. Why are financed emissions important?

• provide insights into the carbon footprint of financial institution portfolios
• helping them assess exposure to carbon-intensive industries and identify low-carbon investment opportunities
• transparency in reporting meets investor and stakeholder expectations
• supports compliance with evolving regulations across jurisdictions
• contributes to the growth of sustainable finance and impact investing 

3. Challenges reporting on financed emissions:

• gathering accurate, reliable and standardized information or data provided by investee companies or external sources
• measurement and calculation complexities of determining which exact emissions are linked to specific financial activities
• defining scope and boundaries on what types of activities and investments should be included in their reporting
• attribution and aggregation of emissions when multiple investors/financiers are involved in a single project or investment
• Ensuring the accuracy and reliability of the reported data by setting up processes for collection, validation, and verification 

4. Who Needs To Disclose Financed Emissions?

While reporting on financed emissions is currently voluntary in the U.S, UK. and most other regions, there is a growing trend towards mandatory reporting due to changing legislation and regulations. For ex. New Zealand has implemented requirements for insurers, banks, and other financial institutions to disclose their climate-related impact.

Various alliances, collectives, and organizations have voluntarily committed to reporting on their financed emissions.

The United Nations Framework Convention on Climate Change (UNFCCC) manages the global Race To Zero campaign. It rallies support from all levels and leads net zero initiatives. 

The Glasgow Financial Alliance for Net Zero (GFANZ) aligns its goals with the Race To Zero. Its goal is to unify net zero worldwide financial industry-specific alliances (like Net-Zero Banking Alliance, Net Zero Asset Managers Initiative, Net-Zero Insurance Alliance, etc.) into one. 

5. Resources to measure, reduce and disclose financed emissions:

• GHG Protocol (GHGP): As the first standard developed in 1998, the GHGP is the most well-known and widely used. Under the GHGP scope 3, category 15 is the section that pertains to financed emissions. However, from a financed emissions perspective, the level of detail remains slightly underdeveloped.
• Initiative Climat International (iCI): the iCI has developed specific guidance for GHG emissions measurement and reporting for private equity investors. It combines industry-specific knowledge, with existing best practices, to help private market investors overcome the unique challenges of measuring and reporting emissions data. 
• Glasgow Financial Alliance for Net Zero (GFANZ): The GFANZ Progress Report gives annual updates on the progress of the alliance. They’ve since made strides toward building commitment in the industry to lower emissions and creating actionable guidance for specific sectors.
• Science-Based Targets Initiative (SBTi): SBTi has guidance for the financial sector to set science-based targets (SBTs). SBTs are targets in line with what the latest research finds is necessary to meet the Paris Agreement’s goals.
• Partnership for Carbon Accounting Financials (PCAF): The PCAF is a global collaboration of financial institutions that have developed a framework to help firms measure financed emissions. It was created in 2015 in response to a growing need for fully accountable and comparable financed emissions calculations. Scope 3, category 15 was a precursor to PCAF.  PCAF also aligns with the CDP, Science Based Targets Initiative (SBTi), and the Task Force on Climate-Related Financial Disclosures (TCFD) to streamline reporting and complement guidelines from those respective initiatives. 
• Paris Agreement Capital Transition Assessment (PACTA): Banks can also turn to the (PACTA) to see how their portfolios align with different climate scenarios. This can help banks quantify potential risks and their effects.

6. Calculation of financed emissions (PCAF framework):

Calculating financed emissions involves assessing the carbon footprint of an activity and attributing it to the relevant financial institution. The accounting process consists of two steps:

• Estimating the carbon footprint of activities associated with loans, investments, or financial services.
• Allocating the carbon footprint to the financial institution using a shared attribution calculation.

In cases where reporting standards are unclear or data is limited, estimates and assumptions may be required.

Fortunately, various organizations and initiatives are working on developing tools to streamline this process and address data gaps. For instance, the International Energy Agency (IEA) provides scenarios that aid in the analysis of such situations.

As more institutions report their emissions and data quality improves, the reliance on proxy data will decrease over time. PCAF developed the Global GHG Accounting and Reporting Standard for the Financial Industry to give firms more guidance on reporting on financed emissions.

Mentioned below are the formulae for calculating financed emissions of the asset classes prescribed by PCAF:

Listed equity and corporate bonds calculation

=(Outstanding amount/(total equity + Debt))*Company Emissions

Commercial real estate calculation

=(Outstanding amount/(total equity + Debt))*Building Emissions

Business loans and unlisted equity calculation

=(Outstanding amount/(total equity + Debt))*Company Emissions

Mortgages calculation calculation

=(Outstanding amount/(total equity + Debt))*Building Emissions

Motor vehicle loans calculation

=(Outstanding amount/(total equity + Debt))*Vehicle Emissions

Project finance calculation

=(Outstanding amount/(total equity + Debt))*Building Emissions

Limitations to PCAF :

• PCAF provides guidance for calculating emissions from investments in specific asset classes. However, there are ongoing efforts to expand the coverage of asset classes, such as green bonds and sovereign bonds. 
• PCAF standard does not currently account for emissions-negative actions like forest regeneration, and it does not address benefits from transition finance or general decarbonization solutions.