Exploring the Role of Financed Emissions in Climate Action

All across the world individuals, organisations, and economies are striving towards better economic growth. In the process, environmental ecosystems are taking on larger burdens to sustain our economic activity. However, there comes a tipping point at which our environmental systems can no longer sustain our livelihoods. It is precisely in scenarios like these that business leaders must recognise the importance of driving sustainable change within their business practices - to ensure the long-term viability of their organisations. 

Over the past few years efforts towards sustainable development have increased, with many organisations and economies committing to net-zero targets and taking active steps towards their goals. This has meant that the regulatory environment in which we operate is constantly evolving, and business leaders are witnessing a monumental change of priorities. Those leaders with foresight are preparing for the risks and opportunities that lay with the times ahead. 

One significant and exciting development in climate action over the past few years has been uncovering the roles played by our financial institutions. Previously, climate action was mostly directed toward industries that had measurable and fairly obvious signs of disproportionate impacts on climate change. For example, companies involved in industrial activity were burning enormous amounts of fuel and energy to conduct operations, such as those involved in manufacturing cement, iron, or refined petroleum products. However, as our understanding of climate change has developed, so have our systems. Today, we have reached a level of technological maturity that we can now focus on unveiling a significant, and so far invisible stakeholder in the fight against climate change: financial institutions. 

Contrary to our prior understanding, financial institutions play an equally significant role in our decarbonization efforts as those companies involved in manufacturing. We are starting to understand this via the concept of financed emissions. Simply put, financed emissions is a broad methodology that aims to measure the environmental impact of a financial institution’s lending practices. While the act of lending is not very carbon-intensive itself, financial institutions can drive growth in industries based on the ones they choose to prioritise. In short, the flow of capital from financial institutions enables the emissions of other companies. A lender who releases significant loans to companies involved in the manufacture of plastic materials has enabled said companies to grow, and with their growth enabled the emissions that would have otherwise not existed. 

Measuring Financed Emissions:

Measuring financed emissions is not a cane that governments hope to use so that financial institutions learn to obey some new order, in fact, it is quite the contrary. In recent years, our economic activity has led our environmental ecosystem to behave a certain way. This change is becoming more erratic, with each progressing year being increasingly threatened by changing weather patterns, resource constraints, and so on. These real-world catastrophes will surely find a way to creep into our economic livelihoods. Leaders who learn to adapt to this change, and work with it rather than against, stand to identify opportunities that allow their businesses to not just survive but also thrive. For financial institutions, measuring financed emissions is an opportunity, and here’s why: 

1. Changing regulatory landscape 

By quantifying and disclosing their carbon footprints, institutions can demonstrate compliance with emerging climate-related mandates. This includes reporting requirements, stress testing for climate risks, and integrating sustainability considerations into investment decisions. For instance, regulations such as the European Union's Sustainable Finance Disclosure Regulation (SFDR) and the Task Force on Climate-related Financial Disclosures (TCFD) recommendations are driving institutions to disclose their climate-related risks and opportunities.

Furthermore, measuring financed emissions allows institutions to stay ahead of regulatory changes. By proactively adapting their strategies to meet evolving standards, they reduce the risk of non-compliance penalties and reputation damage. Ultimately, this approach positions them as responsible stewards of capital in a climate-conscious regulatory environment.

2. Risk identification and divestment 

Effective risk management is a cornerstone of financial success, and measuring financed emissions plays a crucial role in identifying and mitigating climate-related risks.

Financial institutions that assess their carbon exposures gain valuable insights into the vulnerability of their portfolios to climate change impacts. This includes physical risks such as extreme weather events and transitional risks like policy changes and market shifts towards renewable energy.

By understanding these risks, institutions can make informed decisions on divestment from high-carbon assets. This not only reduces exposure to potential losses associated with stranded assets but also aligns their portfolios with the transition to a low-carbon economy. Divesting from carbon-intensive industries can also mitigate reputational risks, as investors increasingly scrutinise the environmental impact of their investments.

Moreover, measuring financed emissions enables institutions to engage with high-emission companies in their portfolios. Through dialogue and active ownership, they can encourage these companies to adopt sustainable practices, reducing long-term risks and enhancing value for investors.

3. Foster trust, and attract conscious investors and stakeholders 

Transparency and accountability are crucial factors in building trust with investors, customers, and other stakeholders. Measuring financed emissions demonstrates a commitment to sustainability and responsible investing, fostering trust in the institution's operations and decision-making processes.

When financial institutions disclose their carbon footprints and sustainable investment practices, they attract a growing segment of conscious investors. These investors prioritise environmental, social, and governance (ESG) factors in their investment decisions and seek opportunities aligned with their values.

By catering to this demand, institutions can access a pool of capital dedicated to driving positive social and environmental change. This not only diversifies their investor base but also enhances their reputation as leaders in sustainable finance.

Additionally, measuring financed emissions strengthens relationships with stakeholders such as regulators, NGOs, and communities. It shows a willingness to engage in dialogue on climate-related issues and collaborate on solutions for a more sustainable future. This collaborative approach builds goodwill and enhances the institution's social licence to operate.

4. Identify undervalued assets 

In the transition to a low-carbon economy, some assets may be undervalued due to their carbon intensity or exposure to climate risks. Measuring financed emissions allows financial institutions to identify these undervalued assets and capitalise on opportunities for value creation.

By assessing the carbon footprint of companies and projects in their portfolios, institutions can uncover hidden risks and potential for growth. This includes recognizing companies with strong sustainability practices that may be undervalued by traditional metrics.

Furthermore, institutions can actively seek out investments in sectors poised for growth in the green economy. This strategic approach not only enhances the institution's returns but also contributes to the shift towards a more sustainable financial system.

In conclusion, measuring financed emissions has far-reaching implications for financial institutions, influencing their strategies, risk management practices, and stakeholder relationships. By embracing transparency, sustainability, and innovation, institutions can navigate the evolving regulatory landscape, mitigate risks, build trust, and capitalise on opportunities for a greener and more prosperous future.

How StepChange helps financial institutions adapt to a dynamic, and changing landscape

Despite the clear benefits, measuring financed emissions comes with its share of challenges. One significant hurdle is the lack of standardised methodologies. Different institutions may use varying approaches, making it difficult to compare and benchmark emissions data. While many institutions try to develop their own frameworks for measuring financed emissions, StepChange’s platform is aligned with the Partnership for Carbon Accounting Financials (PCAF), which emerges as the global leader for standardising methodology regarding financed emissions. Today, over 466 of the world’s leading financial institutions that account for nearly $86.7 trillion in assets measure their financed emissions using the PCAF methodology.  

Additionally, data availability and quality pose challenges. Obtaining accurate emissions data from investee companies, particularly in sectors with complex supply chains, can be arduous. This highlights the need for better reporting standards and collaboration between financial institutions and the companies they invest in. StepChange has deep expertise in assisting financial institutions measure their emissions across the complexity of their portfolio. Our models incorporate many of the most significant asset classes, including, but not limited to: 

1. Listed Equity and Corporate Bonds 

2. Business Loans and Unlisted Equity 

3. Project Finance 

4. Commercial Real Estate 

5. Mortgages

6. Motor Vehicle Loans 

7. Sovereign Debt 

Moreover, the dynamic nature of financial markets adds complexity. Fluctuating asset valuations, changing investment strategies, and evolving regulatory landscapes require institutions to continuously adapt their emission measurement practices.

StepChange serves as an indispensable climate-tech partner, providing financial institutions in India with a comprehensive and sophisticated solution for navigating the intricacies of ESG reporting. Our platform, aligned with PCAF standards and developed by climate scientists, streamlines the process of measuring and reporting financed emissions. As financial entities in India seek a robust ally for their ESG journey, StepChange distinguishes itself through its commitment and adherence to global standards, ensuring accurate and reliable ESG reporting.

Our platform facilitates a seamless and automated approach to data management, benchmarking, and setting science-based net-zero objectives. Having accounted for more than 450 million tonnes of CO2e on our platform, our mission in assisting financial institutions has only begun. Get in touch to schedule a demo session today.