Scope 3 Financed Emissions - The Next Frontier In Responsible Business
Financial institutions, embodying the essence of kaitiakitanga, play a crucial role accelerating carbon emission reductions. They serve as guardians, managing the complex area of scope 3 financed emissions and insured emissions.
Scope 3 Financed and Insured Emissions
Banks play a pivotal role in driving sustainable outcomes as business enablers, through their role as lenders. Banks can influence both business (as business lenders) and individual's emissions (as mortgage holders) through their focus on measuring and reducing scope 3 financed emissions. Ultimately fossil fuel intensive industries are likely to be cut off to lending altogether while green loans will drive sustainable businesses and activities going forward. Equally Insurers are key business enablers and must also measure and reduce their insured emissions.
Banking scope 3 financed emissions are typically a staggering 90-95% of a bank’s emissions profile. Quantifying financed emissions is a challenging first step that enables financial institutions to understand their emissions profiles. Data analytics, insights and dashboards help banks and insurers track and deeply understand their financed emissions sources.
Banks and Insurers will need to focus on reduction plans as well as disclosures. They can enable this through green loans, and increasingly we are likely to see them developing AI-driven digital tools to help enable borrowers to measure and reduce carbon emissions.
The background - where did this come from?
We are now all very familiar with the Paris Agreement, and the global movement to limit global temperature increase to well below 2℃, while pursuing efforts to limit the increase to 1.5℃. Alongside this, many other global initiatives were underway, including the Taskforce on Climate-Related Financial Disclosures (TCFD). This taskforce came about to tackle concerns that investors did not have sufficient good quality information about the climate-related exposure of their investments, and that this could pose a major threat to global financial stability.
Many jurisdictions began the process of making climate-related disclosures mandatory by law. Aotearoa New Zealand was first in the world to do this, and in 2021 the Financial Sector (Climate-related Disclosures and Other Matters) Amendment Act 2021 was passed. This new law requires around 200 large financial institutions to start making climate-related disclosures, and to publish these from financial years starting on or after 1 January 2023.
At first glance this might not seem like a big deal. But it is.
What are Financed Emissions?
Financed emissions form a crucial component of climate-related financial disclosure. Financed emissions are the indirect greenhouse gas emissions associated with the lending, investing, or underwriting activities of financial institutions. For example, if a bank provides a loan to a homeowner the bank must measure and disclose the emissions generated as a result.
Scope 3 Category 15 - Investments
Financed emissions are categorised by the Greenhouse Gas Protocol (GHG Protocol) as Category 15: Investments within Scope 3. They can arise through lending activities (e.g. bank loan), investment activities (e.g. equity investment), or underwriting activities (e.g. providing insurance).
How to measure Financed Emissions
The Partnership for Carbon Accounting Financials (PCAF) has issued guidance for calculating financed emissions, and this guidance is being adopted widely, including in Generate Zero’s Financed Emissions platform. The guidance is aligned with the GHG Protocol’s Scope 3 Accounting and Reporting Standard for Category 15: Investments.
Financed emissions are calculated by taking the proportion of the entity’s enterprise, project, or asset value that is being financed by a financial institution’s activity (loan, investment, or underwriting) and applying this proportion to the GHG emissions associated with that entity, project, or asset. In the early years only absolute Scope 1 and 2 emissions were reported, with Scope 3 being phased in over subsequent years.
The PCAF guidance provides methodologies for calculating financed emissions for different asset classes, including:
- Listed equity and corporate bonds
- Business loans and unlisted equity
- Project finance
- Commercial real estate
- Residential mortgages
- Motor vehicle loans
Data is a Massive Challenge
PCAF acknowledges that one of the primary barriers to accurate measurement of financed emissions lies in the availability and quality of data. The methodologies include specific guidance about data sources and how to improve the quality of data over time.
Generate Zero is an expert in leveraging data expertise to improve quality and transparency of decision-making and reporting, so we have brought this expertise to the challenge of financed emissions. We are helping banks to establish a baseline financed emissions measurement, and then build a plan to enhance that over time.
Whilst PCAF and the GHG protocol have provided the starting point (with the methodology to calculate financed and insurance emissions) there is still a significant challenge sitting within organizations to gain visibility of their financed emissions and data quality remains a challenge.
The role of digital tools and AI
At Generate Zero we enable financial institutions to measure and reduce their financed emissions through our proprietary data models and platform. We see technology and AI playing a crucial role in measurement accuracy (improving data quality) not to mention its role in the future - enabling emissions reduction.
How AI and Technology improve data quality
At present floor area-based models are used to estimate residential emissions, but the move towards customer integrated data will enable banks to have much better estimates using AI or even actual consumption based financed emission inventories. The move to higher quality models will also enable targeted reduction efforts.
The time to act is now!
Data and technology are powerful tools we can leverage to deliver the scale of change necessary, transforming data into actionable insights for a sustainable future. To learn more about how Generate Zero is helping Financial Institutions to scale up their scope 3 financed emissions measurement, reporting and reduction get in touch with our team today.