In his blog titled, “Has the backlash against financed emissions begun?”, author Louie Woodall remarks that “Financed emissions” are no longer in vogue. He goes on to explain why “financed emissions” were all the rage in 2021, but is increasingly viewed with skepticism and concerns and why “financed emissions” might not be enough to solve real world decarbonisation. This article presents the basics of “financed emissions”, which has quickly become the metric used by the financial services industry to measure portfolio level carbon intensity and track the portfolio decarbonisation performance against targets. (Louie’s article can be found here.)
Definition of Financed Emissions
According to the WWF, financed emissions are “the greenhouse gas emissions(GHG) associated with a financial institutions’ loans and investments in a reporting year” (Source). The GHG emissions financed by the financial institutions are also called portfolio climate impact (Source).
Purpose of measuring and reporting Financed Emissions
GHG accounting is intended to help financial institutions achieve several objectives, including
- creating transparency for stakeholders
- managing financial risks associated with climate policies and regulations
- creating new financial products to further the transition to net zero,
- aligning financial flows with the goals of the Paris Agreement
In order to have a common methodology for accounting GHG emissions in the portfolios of financial services companies, the Partnership for Carbon Accounting Financials (PCAF) was launched in 2019, and PCAF released “The Global GHG Accounting & Reporting Standard for the Financial Industry”(link). This standard was built on the GHG protocol’s Scope 3 emissions for financial services industry. (Read more on Scope 1, 2 and 3 emissions here.)
Scope 3 in GHG protocol and financed emissions.
GHG protocol has 15 Scope 3 emission categories, divided between upstream and downstream activities as given below.
- Purchased goods and services
- Capital goods
- Fuel- and energy-related activities (not included in scope 1 or scope 2)
- Upstream transportation and distribution
- Waste generated in operations
- Business travel
- Employee commuting
- Upstream leased assets
- Downstream transportation and distribution
- Processing of sold products
- Use of sold products
- End-of-life treatment of sold products
- Downstream leased assets
Financed emissions are related to the category 15 in Scope 3 above – Investments. (Click here to download the Scope 3 standards).
Accounting and Reporting Principles and Rules
In addition to the GHG Protocol’s five core principles of completeness, consistency, relevance, accuracy, and transparency, the PCAF requires financial institutions to follow five additional principles which accounting for GHG emissions in their portfolios. These The additional principles are recognition, measurement, attribution, data quality and disclosure, each of which is briefly touched upon below.
Financial institutions are required to use either of the two approaches to measure and report their GHG emissions.
- Financial control approach
- Operational control approach
The standard requires that the financed emissions for each asset class be measured and reported by financial institutions. Emission removals and avoided emissions are to be reported separately.
The allocation GHG emissions from loans and investments to a financial institution should be based on the proportional lending or investment in the borrower or investee based on an attribution factor. Double counting should be minimized.
4. Data quality
Availability of high quality and highly granular GHG emission data of portfolio companies is a challenge, and financial institutions have to incorporate the data quality into their estimation of GHG emissions. The PCAF provides a data quality score ranging from 1 to 5, with 1 being highest data quality and 5 being the lowest. The data quality score takes into account both the granularity and the specificity of emissions data.
The PCAF requires that financial institutions disclose absolute financed emissions as against reporting only emissions intensity.
Coverage – Asset Classes
The PCAF Standard provides methods to measure financed emissions of six asset classes:
- Listed equity and corporate bonds
- Business loans and unlisted equity
- Project finance
- Commercial real estate
- Motor vehicle loans
The PCAF provides detailed methodologies for reviewing and reporting the financed emissions for each asset class.
Financed emissions metrics
While measurement and reporting of absolute emissions are mandatory, other metrics are required for benchmarking or for facilitating comparability of companies, sectors or portfolios. The table below provides the details of some of those metrics.
|To understand the climate impact of loans and investments and set a baseline for climate action
|The total GHG emissions of an asset class or portfolio
|Economic emissions intensity
|To understand how the emissions intensity of different portfolios (or parts of portfolios) compare to each other per monetary unit
|Absolute emissions divided by the loan and investment volume, expressed as tCO2e/€M invested
|Physical emissions intensity
|To understand the efficiency of a portfolio (or parts of a portfolio) in terms of total carbon emissions per unit of a common output
|Absolute emissions divided by an output value, expressed as tCO2 e/ MWh, tCO2 e/ton product produced
|Weighted average carbon intensity (WACI)
|To understand exposure to carbon intensive companies
|Portfolio’s exposure to carbon intensive companies, expressed as tCO2e/€M company revenue
Several financial institutions have already started reporting their financed emissions using the PCAF standards. While some criticisms and concerns regarding these standards are arising, the “financed emissions” are very likely to continue as the gold standard for financial institutions.
Download the PCAF standards here.
Subscribe to this blog to get the forthcoming articles delivered to your email inbox.