Carl Prins
Amid the global push to meet net zero targets, regulators are increasingly looking towards investors to put positive downward pressure on greenhouse gas emissions. Voluntarily or in response to “soft” or “hard” regulations, financial institutions have started to tackle “financed emissions.”
Carbon accounting is coming of age
Early adopters are already working hard to reduce their carbon footprint. From favouring renewable energy sources to reducing waste, organisations in all sectors are embracing initiatives designed to reduce their direct impact on the environment.
While tackling such greenhouse emissions is important, they only account for a small percentage of an organisation’s total environmental impact. To understand an organisation’s true impact on global efforts to meet net zero targets, it must look further afield, across its value chain.
A sophisticated carbon accounting system has been devised to account for such emissions. Total emissions can be divided into three broad categories:
Scope 1 covers direct emissions from owned or controlled sources, such as property portfolios and vehicle fleets.
Scope 2 covers indirect emissions from the generation of purchased energy.
Scope 3 emissions are all the rest, i.e. indirect emissions across the value chain (including supply chain) that are not already accounted for in Scope 2. This is because a company has various levels of influence over its value chain.
For financial institutions, a specific category of Scope 3 emissions is called “financed emissions”. Investment firms, banks and insurance companies should consider the emissions of the companies which they lend to or invest in as “financed emissions” because they effectively facilitate such activities by providing them with the financial resources they need to operate.
Taking responsibility for financed emissions
A financial institution’s “financed emissions” is the total of the greenhouse gas emissions from all the companies in an investor’s portfolio or a bank’s lending book. The total is calculated as a proportion of how much each company’s activities are financed by that financial institution.
When taken into account, financed emissions can cast a financial institution’s or a fund’s sustainability credentials in a very different light.
Total financed emissions from financial institutions are, on average, more than 700 times greater than their operational emissions, based on data from 84 organisations collectively managing $27 trillion in assets, according to a report from the non-profit Carbon Disclosure Project. As a specific example in the sector, CBA’s recent climate report pegged their Scope 3 emissions (for the first time including financed emissions) as 2300 times larger than their Scope 1.
Investors have become more conscious of the importance of total financed emissions, sometimes under the pressure of various stakeholders. Across Australia and New Zealand, 40 per cent of institutional investors had made portfolio-wide commitments to net zero by 2050, according to a report from the Investor Group on Climate Change.
The same report reveals that 55 per cent of investors are now reporting in line with the Task Force on Climate-Related Financial Disclosures (TCFD) recommendations, up from 38 per cent the previous year.
Regulators turn their eye to financed emissions
Around the world, regulators are also beginning to hold financial institutions accountable for their significant indirect impact on climate change.
Such issues were once considered non-financial issues, offering the flexibility to ignore them or gloss over them. Yet, in the past decade, there has been a considerable shift in the legal recognition of investors’ fiduciary duty to consider climate risk in their decision-making.
With this has come specific guidance notes issued by Australian regulators APRA and ASIC, as well as the RBA. Then ASIC Commissioner, Cathie Armour, said disclosing and managing climate-related risk is a “key director responsibility.”
Meanwhile in the US, the SEC has proposed rules around the disclosure of emissions, climate-related risks and net-zero transition plans for listed companies. It also proposed requirements for investors and lenders to disclose Scope 3 emissions, if material, which includes financed emissions.
“If adopted, it would provide investors with consistent, comparable, and decision-useful information for making their investment decisions, and it would provide consistent and clear reporting obligations for issuers,” said SEC Chair Gary Gensler.
“Today, investors representing literally tens of trillions of dollars support climate-related disclosures because they recognise that climate risks can pose significant financial risks to companies, and investors need reliable information about climate risks to make informed investment decisions.”
The SEC indicated these rules would operate in alignment with the emerging international climate accounting regime from the International Sustainability Standards Board (ISSB), part of International Financial Reporting Standards (IFRS).
This, in turn, draws on principles set by the TCFD, and the more industry-specific framework of the Sustainability Accounting Standards Board (SASB), which the IFRS has now subsumed.
In Australia, ASIC has expressed support for the objectives of the ISSB and encourages listed companies to use the TCFD recommendations as the key framework for voluntary disclosures.
Preparing for legislative change
What are currently recommendations from Australian regulators look set to become law, based on international trends. So far, the United Kingdom and New Zealand have passed laws requiring the disclosure of risks inherent to financed emissions.
The UK imposed rules in April 2022, requiring more than 1,300 of the largest companies and financial institutions to report climate-related risks in line with TCFD recommendations. Similarly, New Zealand passed legislation this year which mandates climate-related disclosures for around 200 of the country’s largest financial institutions. As a result, banks, insurers and large listed issuers in New Zealand will now be required to follow TCFD reporting requirements.
The writing is on the wall and financial institutions should not wait until the last minute and scramble to manage their financed emissions. Now is the time to get on the front foot and address financed emissions before regulators come knocking.
By Carl Prins, Co-founder and CEO