.The aim is to control the adverse impact of climate change and ensure a livable planet. To achieve this, emissions must be cut to net zero by 2050. Financial institutions have the opportunity to play a pivotal role in driving the systemic change needed to realize the goals of the Paris Agreement. This will entail directing their business activities toward sustainable investments, funding green technologies and innovation, and prioritizing lending to companies focused on net zero.
Nonetheless, financial institutions have historically financed economic activities that emit large volumes of greenhouse gases (GHGs) and contribute to climate change. Consequently, there is growing pressure on financial institutions from regulators, the general public, and other stakeholders, including the scientific community, to align their investment portfolios and lending activities with decarbonization pathways consistent with achieving net zero by 2050 or earlier.
However, some financial institutions have taken a different approach and prioritized short-term financial gains. They have brownwashed or transferred their ‘dirty’ loans to avoid addressing financed emissions and the associated sustainability risks. Brownwashing involves transferring high-carbon loans to other financial institutions or selling them off to investors who are less concerned about sustainability. This reduces exposure to high-carbon industries, avoids the need to address the issue of financed emissions, and helps financial institutions maintain their reputation as sustainable investors, while still earning profits from high-carbon industries. This practice has been criticized as a form of greenwashing as it does not actually reduce carbon emissions or address the environmental impact of these industries. It also raises questions about the ethical responsibilities of financial institutions in promoting sustainability and mitigating climate change
In response to growing criticism of greenwashing and intense pressure to address the negative environmental impact of their business activities, financial institutions are now moving toward sustainable finance and the development of sustainable frameworks and reporting standards that align with net zero objectives. And the first step in this journey is to accurately calculate their financed emissions (the GHG emissions associated with financial institutions’ business activities) because typically, what doesn’t get measured, can’t be managed.
 For a livable climate: Net-zero commitments must be backed by credible action, Climate Action, ©United Nations, https://www.un.org/en/climatechange/net-zero-coalition, May 2023
Calculating financed emissions will facilitate a transition to net zero.
In addition, it can be beneficial to financial institutions in the following ways:
Risk management: Accurate measurement of financed emissions helps identify potential climate risks associated with investments in and lending to high-emitting industries. This information can be leveraged to inform future investment and lending decisions and reduce exposure to climate-related risks in existing portfolios.
Compliance: Financial institutions are required to report their carbon footprint and climate-related risks to regulatory bodies. For example, the UK has become the first G20 nation to enforce mandatory reporting aligned with the Task Force on Climate-Related Financial Disclosures (TCFD) for public companies and large private companies, including financial institutions. Calculating financed emissions can help facilitate compliance with new regulations and avoid potential penalties.
Reputation management: Consumers, investors, and other stakeholders are increasingly concerned about the environmental impact of their investments. By disclosing their financed emissions, financial institutions can demonstrate their commitment to sustainability and gain a competitive advantage.
Innovation and opportunity: As the world transitions to a low-carbon economy, there will be opportunities for financial institutions to invest in innovative technologies and industries aligned with climate goals. By understanding their financed emissions, financial institutions can identify green financing opportunities, seize investment options that actively contribute to mitigating climate change and other sustainability-related challenges, and position themselves as leaders in sustainable finance.
Financial institutions face several challenges in efficiently calculating financed emissions.
Data availability and quality: Financial institutions often rely on data from third-party sources, which can be incomplete, outdated, or inaccurate. This can lead to errors and uncertainties in calculations and make it difficult for financial institutions to gain a complete picture of their financed emissions.
Scope and boundaries: Defining the scope and boundaries of financed emissions can be challenging, as it requires identifying emissions that are directly and indirectly financed by an institution's investments. This requires a detailed understanding of the supply and value chains of the companies that the financial institution lends to or invests in.
Complexity of investments: Complex investment portfolios with multiple asset classes, geographies, and sectors make it difficult to track the emissions associated with each individual investment and aggregate them into a meaningful total.
Lack of transparency: Financial institutions face challenges in obtaining complete and accurate emissions data from companies they lend to or invest in. This lack of transparency hinders accurate calculation of financed emissions and can lead to incomplete or inaccurate reporting.
Accurate calculation of financed emissions is the bedrock for more insightful and complex climate risk analytics.
Our approach will help financial institutions calculate additional climate risk metrics such as warming potential and transition disruption. It will also help ascertain the alignment of a given investment option or credit proposal with Paris Agreement objectives. This will facilitate engagement with customers that are high emitters or slow to decarbonize. Financial institutions can advise customers on how their business activities contribute to climate change and the potential risks of failing to keep pace with climate transition benchmarks applicable to their industry.
In our view, financial institutions must draw up a step-by-step strategy to calculate financed emissions covering the five components of CO2 equivalent, weighted average carbon intensity (WACI), economic emission intensity, physical emission intensity, and financial impact. This will entail the following actions:
Figure 1 illustrates the conceptualization of the financed emissions value chain.
Adopting such an approach will enable financial institutions to perform more accurate and insightful calculation of financed emissions. Based on the calculation, they can identify loans and investment portfolios, where calculating and reporting emissions is essential as per PCAF norms. Furthermore, financial institutions can set targets to gradually reduce lending to and investments in emission-heavy projects across sectors such as automobiles and components and energy and utilities.