Financed emissions refer to the carbon emissions tied to an individual’s or organization’s investments. With climate change becoming an urgent issue, the spotlight has turned to the financial sector and its influence on the problem. Many financial institutions back companies with substantial carbon footprints, especially in the energy and power sectors. As a result, these institutions bear indirect responsibility for the greenhouse gases released by the companies they invest in.

By redirecting investments, financial institutions can either accelerate or slow down global efforts to combat climate change.

Why is it Important to Take Note of Financed Emissions?

When a financial institution invests in a company, it powers that company’s growth and operations. The goal is simple: the investor expects a financial return. But if the company is a significant greenhouse gas emitter, the institution indirectly shares responsibility for those emissions.

These emissions, linked to the investment, are called financed emissions. They reveal the often-overlooked environmental costs of financial choices. Recognizing financed emissions is essential, as it determines how investment decisions shape the global climate. It brings into focus how our financial activities directly affect the rise in greenhouse gas levels, making investors part of the climate equation.

Emerging Regulations and Frameworks for Climate-Related Financial Disclosures

The EU Green Deal, SEBI’s BRSR Core in India, TCFD, and SBTi are driving a significant shift towards greater transparency and accountability for companies’ climate-related impacts. The EU Green Deal, for example, sets ambitious goals for climate neutrality, while SEBI’s BRSR Core mandates sustainability reporting for listed companies in India. The TCFD provides a framework for companies to disclose climate-related financial information, including governance, strategy, risk management, and metrics. Meanwhile, the SBTi helps companies set ambitious emissions reduction targets aligned with the Paris Agreement. These initiatives are collectively increasing regulatory pressure on companies to address climate change, enhancing transparency for investors, and driving a transition towards more sustainable business practices.

Classification of Financed Emissions

Financed emissions fall into two categories: operational and value chain emissions. Operational emissions include direct emissions from a company’s activities like factories, transportation, and energy use. Value chain emissions cover indirect emissions from the supply chain, such as material production, goods transportation, and waste disposal. Both types contribute to a company’s carbon footprint.

The Global GHG Accounting and Reporting Standard for the Financial Industry identifies six key asset classes within financed emissions. These include listed equity, corporate bonds, business loans, unlisted equity, project finance, real estate mortgages, and vehicle loans. This standard helps financial institutions accurately report emissions tied to their financing activities, ensuring a clear view of their greenhouse gas impact.

Sources of Financed Emissions

Financed emissions refer to the greenhouse gas (GHG) emissions linked to investments, loans, or insurance provided by various entities. The main sources include:

1. Financial Institutions: Banks, insurance companies, and asset managers are key players. They finance companies and projects that contribute to emissions, either through lending or investing. By funding fossil fuel projects or high-emission industries, they indirectly increase GHG emissions.
2. Governments: Governments also contribute to financed emissions by funding infrastructure projects or providing subsidies to industries with significant emissions, such as energy and transportation. State-backed banks or development funds play a role in supporting emission-heavy sectors.
3. Corporations: Large corporations, particularly in energy, mining, and manufacturing, finance emissions through their investments and supply chains. By supporting high-emission activities, they contribute to a company’s overall carbon footprint.

How Financed Emissions Contribute to Climate Change

1. Investing in Fossil Fuel Projects: Financial institutions often fund projects related to oil, gas, and coal. These projects release large amounts of carbon dioxide and other GHGs, accelerating global warming.
2. Lending Money to High-Emission Companies: Banks and investors provide capital to companies with high emissions. This financial support enables these companies to expand their operations, resulting in greater emissions and environmental harm.
3. Providing Insurance for Polluting Industries: Insurance companies protect industries like oil and gas from financial risks. By insuring polluting activities, they facilitate the continued operation of these industries, contributing to the release of harmful emissions.

These financial activities collectively exacerbate climate change by supporting industries that generate significant GHG emissions.

Why is Reporting Financed Emissions Challenging?

Organizations encounter several challenges when reporting their financed emissions. These issues arise from task complexity, lack of standard methods, and difficulties with data collection and analysis.

Data Collection and Management

• Incomplete or Inaccurate Data: Smaller companies or those in emerging markets may lack accurate emissions data.
• Data Quality Variations: Inconsistent data quality makes it hard to ensure reliability.
• Data Granularity: Firms often struggle to obtain detailed emissions data by product, region, or project.

Methodology and Standardization

• Lack of Consensus: No universal method for calculating financed emissions creates inconsistencies.
• Complex Financial Structures: Attributing emissions to specific investments is difficult with complex financial structures.
• Scope and Boundaries: Identifying all relevant assets and liabilities to define financed emissions can be challenging.

Resource Constraints

• Cost and Time: Reporting financed emissions is often expensive and time-consuming.
• Internal Capacity: Many firms lack the expertise or resources to handle these challenges effectively.

Regulatory and Policy Challenges

• Lack of Clear Guidance: Regulatory guidelines for reporting emissions are often unclear or inconsistent.
• Conflicting Requirements: Organizations may face conflicting regulations across jurisdictions.
• Evolving Landscape: Constant regulatory changes make it hard for firms to stay updated.

Transparency and Accountability

• Greenwashing Risks: Organizations may exaggerate their climate efforts or mislead stakeholders.
• Stakeholder Pressure: Investors and customers increasingly demand accurate emissions disclosures.

To overcome these challenges, firms need standardized methods, better data quality, and stronger internal resources. Collaboration with regulators and industry groups is crucial for accurate emissions reporting.

Who Needs to Report Financed Emissions?

Organizations involved in financing or insuring high-emission activities are increasingly expected to report their financed emissions. The key entities include:

1. Banks: Commercial and investment banks must report financed emissions from loans and investments tied to carbon-intensive industries. Regulatory frameworks and investor demands push banks to disclose how their financing contributes to climate change.
2. Asset Managers and Investors: Asset managers, pension funds, and institutional investors need to report emissions linked to their portfolios. This includes the carbon footprint of companies they invest in, especially in sectors like energy, manufacturing, and transportation.
3. Insurance Companies: Insurers must report emissions from the industries they underwrite. By insuring fossil fuel projects or high-emission industries, insurance companies play a role in enabling these activities, and disclosure helps track their climate impact.
4. Corporations with Financial Divisions: Companies with significant financial arms, such as automakers with financing subsidiaries, must report emissions generated by their loans or investments in carbon-intensive projects.

Reporting financed emissions is crucial for transparency and accountability, helping stakeholders understand the climate impact of financial decisions. Regulatory bodies and climate-focused initiatives, like the Task Force on Climate-related Financial Disclosures (TCFD), increasingly require such disclosures to align with global climate goals.

Conclusion

Reporting financed emissions is essential for fostering transparency and accountability in the financial sector’s role in climate change. As banks, insurers, asset managers, and corporations continue to fund high-emission activities, tracking and disclosing their impact becomes crucial for aligning with global climate goals. By reporting financed emissions, these entities can not only mitigate their environmental footprint but also contribute to a broader shift toward sustainable investments and responsible financial practices. This accountability is key to driving systemic change in the fight against climate change.