photography of white smoke

Can we rely on financed emissions to reduce C02 by increasing the cost of capital for polluters?

Published: 19 Jul 2022

The financial industry is getting serious about financed emissions

Financed emissions are starting to be taken very seriously by the investment management industry. In a prior blog, we discussed Financed Carbon Emissions, which conceptually arose out of the Paris Agreement in 2015 and the G20 leaders stated intention to scale “green finance.”

All companies emit greenhouse gases.  Most public companies rely on financial services to support their business, such as loans, equity investments, or insurance.  A company’s financed emissions are a company’s greenhouse gases associated with a loan, equity investment, or insurance contract.  In other words, financial service companies measure and report how many carbon emissions they have financed or supported.

To this end, the UN has established two consortiums: the Net Zero Asset Owner Alliance and the Net Zero Asset Management (NZAM) initiative. As of January 2022, NZAOA had 69 asset owners and USD10.4 trillion in assets.  NZAM is an international group of asset managers committed to supporting the goal of net zero greenhouse gas emissions and investing aligned with net zero emissions by 2050 or sooner. As of May 2022, NZAM is comprised of 273 firms representing over $61.3 trillion in assets under management.

Yet in 2021, CDP, an international not-for-profit focused on carbon disclosure, reported that greenhouse gas emissions (GHG) associated with lending, underwriting, and investment activities are more than 700 times higher, on average than a financial institution’s direct emissions.  As we previously noted, the UN’s Net Zero Asset Owner and Net Zero Asset Manager initiatives are using financed carbon emissions as a mechanism for bringing down company-level emissions within their investment portfolios.  The first progress report is encouraging, but will it be enough? 

Well, the Net Zero groups have gotten some further support from the Glasgow Financial Alliance for Net Zero, which is a broad financial industry alliance with similar goals. The Network for Greening the Financial System, a group of central banks and industry supervisors, is further lending a hand by developing climate and environmental risk management guides for the financial sector with an aim to mobilize finance to support the green transition.

Simpler would be better

Despite the significant push toward aligning financial services with long-term emissions targets through financed emissions; without measurable, comparable and verifiable data no one can estimate, let alone manage against targets or risks.  In November 2021, the IFRS Foundation established the International Sustainability Standards Board (ISSB) to establish comprehensive, global sustainability-related disclosure standards on which capital market participants can rely in taking decisions.

The G20 Leaders support the ISSB’s work and the standards are being developed to work along with local reporting requirements.  Further, the ISSB integrates the work of several disparate pre-existing disclosure groups into one place to further ensure consistency and completeness.  The International Organization for Securities Commissions (IOSCO) supports the ISSB’s work, which lends further support to local regulatory and firm adoption. 

To have a greater impact

financed emissions

Collectively, these initiatives offer investors measurable and comparable ways to understand their environmental, fiscal and risk impacts.  Importantly, these groups are putting emissions into a context that is consistent with historical decision-making tools and methods.  These approaches are more easily integrated into existing business models and align with how investors and institutions view their portfolios today.  

Further, connecting dollars or euros or pounds to financed emissions removes the dubious process of pricing carbon, while also helping companies connect the cost of emissions dots more easily.  To the extent that companies understand their financial services providers are taking decisions based on how much of their portfolio funds emissions, internal project decision-making will increasingly consider these aspects in assessing costs of capital and rates of return.