Emissions Measurement for Financial Institutions - What You Need to Know About PCAF
What you can expect in the financial services industry when it comes to measuring your Scope 3 emissions.
While we all stand to lose something to climate change, it’s clear that the financial sector is exposed to significant climate-related risks. Research shows that a 3.2°C rise in global temperatures could devastate the global economy, potentially wiping out up to 18% of GDP by 20501, and significantly impacting investment portfolios and loan repayments.
As financial institutions begin to grapple with this harsh reality, there is much that can be done starting today to de-risk their investments and set themselves up for long-term, green success. Measuring emissions related to their investments and lending activities is a key first step toward managing climate-related risks and capitalizing on the opportunities of a low-carbon economy.2
A Brief Primer: Carbon Accounting Essentials
Carbon accounting is an accounting method to count, inventory, track, and report your organization's greenhouse gas (GHG) emissions. This is also known as your carbon footprint. For most companies, the established, global accounting unit for carbon is the greenhouse gas carbon dioxide (CO2), and "carbon equivalents" (CO2e) - the sum of carbon plus other emissions like methane converted into carbon.
If you're familiar with financial accounting, which adds up income and expenses into a budget, carbon accounting works in a similar way. Common practice in carbon accounting is categorizing CO2 as Scope 1, Scope 2, or Scope 3 GHG.
Scope 3 emissions are all of a company's "indirect" or value chain emissions. Scope 3 is broken down into 15 different categories, spanning upstream activities like business travel to downstream emissions from investments.
The Birth of PCAF: Partnership for Carbon Accounting Financials
When it comes to measuring your carbon footprint in the financial services industry, chances are a significant percentage of your Scope 3 will fall under category 15 “investments.” When the Greenhouse Gas (GHG) Protocol developed its framework for carbon accounting, it provided little guidance around the suggested methodology to measure a company’s investments and loans.
In an effort to support financial institutions in their work to measure their GHG emissions and assess ESG risks from their investments and loans, the Dutch-led Partnership for Carbon Accounting Financials (PCAF) was born. Since 2015, PCAF has brought together leaders in the financial services industry to develop an open-source global GHG accounting standard for financial institutions.3
PCAF’s development marked a significant step in addressing the gap in standardized carbon accounting for financial institutions. In 2020, PCAF's standard became part of the broader climate disclosure frameworks supported by international organizations like the Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD).
Breaking Down the Standard
There are 3 main sections to the Standard developed by PCAF. We’ll break down each section to help you understand what they are and when they apply.
Financed emissions are GHG emissions associated with the lending and investment activities of financial institutions.
There are currently 7 different asset classes:
Listed equity and corporate bonds - bonds issued by General Electric
Business loans and unlisted equity - loans provided by banks for private companies or VC investments in a startup
Project finance - financing a wind farm or the construction of an airport
Commercial real estate - investing in shopping malls
Mortgages - home loans
Motor vehicle loans - financing the purchase of delivery trucks
Sovereign bonds - U.S. treasury bonds or government bonds issued by other countries
Specifically, these emissions are categorized into the following:
Scope 1 and 2 Emissions: For investments, this involves direct emissions from the operations of the investee companies or projects. For loans, it involves direct emissions of the borrower.
Scope 3 Emissions: Indirect emissions that occur in the value chain of the entities financed by the institution. For example, if a financial institution provides a loan to a company that produces goods, the emissions from the production and transportation of those goods would fall under Scope 3 emissions.
Facilitated emissions are GHG emissions associated with primary capital market transactions.
Different from financed emissions, facilitated emissions apply to “those who facilitate and enable complex multi-party transactions, i.e., facilitators” and not investors.4 Facilitators (e.g., large international banks) helping companies raise money in the capital markets fall into this category of emissions measurement.
The main factors to consider are:
Annual emissions: What is the time period over which the facilitation activity is captured?
Attribution factor (facilitated amount/company value): How are emissions allocated between the different facilitators of an issuance?
Weighting factor: How is the responsibility of a facilitator for the issuer's emissions valued?
Facilitators have the ability to use their influence to encourage companies to become more sustainable and attract investors who prioritize green investments. By doing so, banks can help shift trillions of dollars towards companies that are actively working to reduce emissions and build a cleaner future.5
Insurance-associated emissions are GHG emissions associated with re/insurance underwriting.
Insurance-associated emissions are separated into two categories:
Commercial Lines: this covers insurance for businesses (e.g., property, liability). Consider attribution factors like Gross Written Premiums (the total premiums received for the policy) or Sum Insured (the total value of the insured assets).
Personal Motor Lines: this covers car insurance. Consider attribution factors such as Gross Written Premiums or the Number of Insured Vehicles (the total number of vehicles covered under the policy).
The Bottom Line and Next Steps
Understanding the emissions linked to financial activities is crucial for financial institutions. By measuring Scope 3 emissions, financial institutions can identify sectors and companies with high exposure to climate risks, allowing them to adjust their investment strategies accordingly.
If your company is thinking about addressing Scope 3 emissions, consider joining PCAF. There are currently 524 financial institutions taking part in PCAF, working together to address industry challenges and develop best practices. Disclosing your emissions in line with PCAF ensures consistency and comparability across institutions.
There is still much work to do to continue developing the Standard; join your peers and become a leader in the transition to sustainable investing.
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1 https://www.weforum.org/agenda/2021/06/impact-climate-change-global-gdp/
2 https://www.weforum.org/agenda/2023/02/low-carbon-investment-record-2022/
3 https://carbonaccountingfinancials.com/standard
4 https://carbonaccountingfinancials.com/standard
5 https://www.thebanker.com/Explainer-how-HSBC-is-expected-to-disclose-facilitated-emissions-1708077273