The challenge of measuring financed CO₂ emissions
The measurement of financed CO₂ emissions at banks and investment companies has become increasingly important and makes it possible to record the climate-neutral transformation in the financial sector. International standards are already quite advanced, but have so far only been applied by a few large banks and investment companies. However, smaller banks are now also beginning to use them as a measurement and control parameter for their loan and investment portfolios, as pressure from stakeholders and supervisory authorities is increasing for the progress of the transformation to be documented.
The measurement of financed greenhouse gas emissions in loan and investment portfolios begins with the recording of individual emissions in the financed asset classes. The Partnership for Carbon Accounting Financials (PCAF) categorises these into companies, real estate, vehicles or infrastructure projects, for example. Their greenhouse gas emissions are further divided into three classes at company level:
- Scope 1 emissions: These are direct emissions that occur at the reporting company or investees controlled by it. These are emissions that arise during the production of goods and services. The respective company can reduce this type of emission by investing in new technologies or improving processes.
- Scope 2 emissions: These are indirect emissions caused by the purchase of electricity, steam, heat or cooling required for production. These upstream emissions are not generated by the reporting company, but by other companies whose electricity, steam, heat or cooling the reporting company needs for its production and has therefore purchased. However, they are attributed to the producing company. A company can save on this type of emission, for example, by purchasing climate-neutral electricity from renewable energy sources.
- Scope 3 emissions: These are indirect emissions that are not included in Scope 2. Scope 3 emissions can arise as upstream emissions (e.g. from the production of materials purchased by the reporting company) or as downstream emissions (e.g. in the logistics of products and services produced by the reporting company). Financed emissions, i.e. emissions generated by a company that is financed by banks or investment companies, are downstream emissions and are measured at the Scope 3 level of the financing banks or the financing investment company.
In the case of a bank or investment company in particular, the financed issues can be a multiple of its Scope 1 and Scope 2 issues.
Measuring the financed issues of the asset classes
PCAF has created a metric for financed issues for the following asset classes:
- Listed shares: financed emissions for listed companies are calculated by dividing the volume of shares in such a company that a bank or investment company has acquired by the enterprise value excluding cash (EVIC). This ratio is then multiplied by the listed company’s greenhouse gas emissions.
- Non-listed shares: For non-listed companies, the share held by the bank or investment company in this company is divided by the volume of equity in this company. This ratio is then multiplied by the company’s greenhouse gas emissions.
- Corporate bonds: To measure the financed issues in this asset class, the volume of the company’s bonds held by a bank or investment company is divided by the volume of the company’s equity and debt financing instruments and this ratio is then multiplied by the company’s greenhouse gas emissions.
- Corporate loans: The calculation for this asset class is analogous to the calculation for corporate bonds. The loan volume granted to the company is divided by the volume of equity and debt financing instruments and multiplied by the greenhouse gas emissions of the financed company.
- Project financing: Here, the investment share or the loan share of the financed project is divided by the equity and debt instruments of the project. This ratio is then multiplied by the project’s greenhouse gas emissions.
- Commercial property: The volume invested in the commercial property or the volume of the property loan is divided by the value of the property. This ratio is then multiplied by the greenhouse gas emissions of the building.
- Mortgages: The volume of the mortgage loan is divided by the value of the property and this ratio is multiplied by the greenhouse gas emissions of the property.
- Car financing: This involves dividing the volume of finance by the value of the vehicle and multiplying this ratio by the vehicle’s greenhouse gas emissions.
- Government bonds: To calculate the financed emissions of a state, the volume of government bonds purchased is divided by the gross domestic product of the country, adjusted for purchasing power, and this ratio is multiplied by the greenhouse gas emissions of the public sector.
PCAF proposes the following metrics for reporting financed emissions:
- Absolute emissions: These are the total financed greenhouse gas emissions of a portfolio or a financed company. They are measured in tonnes of CO₂ equivalents.
- Economic emissions intensity: These are the absolute emissions of a financed company divided by the volume of financing for this company. This indicator is measured in tonnes of CO₂ equivalents per million euros. This figure can be calculated for the entire portfolio as the sum of absolute emissions divided by the assets under management.
- Physical emissions intensity: These are the absolute emissions of a financed company divided by the company’s energy consumption. They are measured in tonnes of CO₂ equivalents per megawatt hour.
- Weighted average emissions intensity: This key figure measures the exposure of a portfolio to emissions-intensive companies. This key figure is measured by the ratio of the absolute emissions of a financed company and the company’s turnover.
Aim of measuring financed greenhouse gas emissions
Banks and investment companies can use these indicators to fulfil the following tasks:
- They can determine climate risks in their balance sheets that are in line with the guidelines of the Task Force for Climate-related Financial Disclosures stehen (TCFD).
- The Financial Stability Board has established the TCFD to improve and expand the reporting of climate-related financial information.
- They can set so-called science-based targets of the Science-based Targets Initiave (SBTi) for their transformation strategy. These targets offer companies a transformation pathway to reduce emissions in line with the goals of the Paris Agreement. More than 4,000 companies around the world are already working with the SBTi and providing data to it, which is then used for benchmark analyses.
- They can report to stakeholders such as the Carbon Disclosure Project (CDP): The CDP is a non-profit organisation that operates a global disclosure system for investors, companies, cities, states and regions to measure and therefore manage their environmental impact. CDP’s Corporate Environmental Action Tracker (CEAT) is a tool that makes aggregated CDP data available to the public to track the status of companies‘ climate disclosures and actions.
- They can develop innovative financial products that support the transformation to a net-zero economy.
How do these metrics relate to the Green Asset Ratio?
The Green Asset Ratio is not based on the PCAF standard, but on the EU taxonomy. It indicates which part of a bank’s balance sheet fulfils environmental sustainability criteria. Unlike the PCAF, project financing, government bonds, European Investment Bank (EIB) bonds and SME loans are not included here. The latter are not taken into account, as only assets of companies that are subject to sustainability reporting requirements may be included in the green asset ratio. This means that banks cannot generally improve their green asset ratio, e.g. by financing wind turbines or climate-neutral SMEs. This could lead to banks adjusting their portfolios in order to improve their green asset ratio and therefore withdrawing from SME financing or the financing of wind power plants, for example.
What does this development mean for borrowers?
For small and medium-sized enterprises (SMEs), this means that they will have to disclose their Scope 1, Scope 2 and probably also Scope 3 issues to financial institutions. Only very few large banks have used the PCAF standard to date. However, it can also be expected that smaller banks will follow suit as part of the Green Asset Ratio, as they are also in a transformation process and report their progress in the transformation to their stakeholders as well as signalling to the supervisory authorities that their balance sheet is not exposed to any significant climate risk. The level of effort required by SMEs depends on how they record and report the key figures in their company.
In the case of standardised key figures that have to be disclosed regularly, the effort involved is less than if non-standardisable information has to be recorded and transmitted on a case-by-case basis.
Specialist article by Markus Demary,
Institut der deutschen Wirtschaft Köln e.V. (German Economic Institute)