It comes as no surprise that fossil fuel companies are the highest emitters in the world, but it can be argued that these companies would not have such a significant climate impact without the financing provided to them by other companies and people.
As a result, financial services companies are facing increasing pressure to recognise the role that their capital plays in facilitating climate change, a concept often dubbed ‘financed emissions’.
What are financed emissions?
Financed emissions are GHG emissions linked to a company’s investment and lending activities. The purpose of measuring and reporting financed emissions is for financial services companies to understand, assess, and take accountability for a portion of the environmental impact of their investment and lending portfolios.
What is the PCAF?
Launched in 2015, the Partnership for Carbon Accounting Financials (PCAF) is a global partnership of financial services companies that work together to develop and implement a harmonised approach to assess and disclose the greenhouse gas (GHG) emissions associated with loans and investments. The Carbon Trust’s GHG Protocol included a fifteenth Scope 3 category entitled “Investments” that aims to provide a framework for disclosing emissions associated with financing activity.
However, its guidance is unclear, and as a result, financial services companies initially used differing approaches, accounting methodologies, and reporting metrics to measure category 15, which led to inconsistent assessments of the industry’s climate impact.
This was until November 2022, when the PCAF published guidance on disclosed financed emissions. The PCAF’s reporting standard stipulates that financed emissions should be calculated as a financial services company’s invested proportion of a client’s value multiplied by that client’s absolute emissions. The standard is now the most widely adopted in the industry.
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While insurance companies can report on financed emissions, this only covers the asset side of their balance sheet. The PCAF has also therefore developed a methodology for insurance companies to calculate emissions associated with their liabilities—known as insurance-associated emissions. These emissions are linked to the reinsurance and underwriting portfolio of insurers.
The metric is calculated by multiplying a client’s absolute emissions by its attribution factor. The PCAF has currently only published guidance on attribution factors for commercial lines and personal motor lines of insurance.
Disclosure is bleak
A GlobalData study of 18 leading financed services companies found that seven of the eight leading banking companies had set at least three sectoral financed emissions reduction targets for 2030. These were cantered on high-emitting sectors like automotive, power, and aviation.
On insurance, only two out of 10 leading insurers had committed to sectoral financed emissions reduction targets and had only set them for one or two sectors. While some of the 10 leading insurers had published guidance on insurance-associated emissions, only three had set reduction targets. Some other insurers instead committed to no new underwriting for companies that generate more than a specific percentage of their revenue from thermal coal and oil & gas.
Roadblocks in the net zero financed emissions journey
Data measurement and disclosure are key challenges in measuring financed and insurance-associated emissions. Client emission disclosure varies widely, and where data is not available, estimations are used, which reduces accuracy. Market fluctuations in company value can also reduce accuracy. Financial services companies are legally required to report emissions associated with investments they have made with their own capital (i.e. assets that the company owns).
However, reporting for assets on behalf of clients is optional. This can lead to the issue of double counting if both the asset owner and the asset manager report financed emissions.
Client engagement is imperative for reducing financed and insurance-associated emissions
While the exclusionary policies implemented by many leading insurers address the issue of financed and insurance-associated emissions, they do not create long-term value for the broader economy. Financial services firms are better off engaging with high-emitting clients to facilitate their energy transition plans, rather than phasing out their financing altogether. Failure to do so will result in continued political pushback.
Suneet Muru is an Associate Analyst, GlobalData