Banks are working hard to analyse their emissions to meet their net-zero commitments and the sector's pledges under the Glasgow Financial Alliance for Net Zero, and the results will likely reshape both lending and overall strategies.
Banks are looking in particular at "financed emissions" – the financing that they provide on their balance sheets – starting with the highest emitting sectors, and are getting ready to start publishing targets in early 2022 that will define their focus and appetite.
“We’re moving to more and more financed emissions reporting,” said Giel Linthorst, executive director at the Partnership for Carbon Accounting Financials, which is setting the standard on how banks calculate financed emissions.
Calculating financed emissions provides a missing link between the financing that banks give to companies to their clients’ activity in the real economy, and ties the CO2 generated back to the financing. But it is not an easy or straightforward exercise.
“If you want to scale your whole portfolio to net zero, then you have to measure your whole portfolio and also connect it to potential emission removals. A long-term net-zero target should also have short-term sector-level targets because sector pathways differ. And in my opinion, those targets, especially for heavy-emitting industries should be expressed in emission intensities, using a physical unit,” Linthorst said.
Although complex, following that model will enable banks to calculate their indirect Scope 3 emissions, which is where the bulk of their emissions lie. It is also the area where banks face most pressure and where there is least visibility.
HSBC certainly buys into that ambition. “The concept of financed emissions needs to be embedded into how we manage our businesses. We all have a role to play in making that happen," said Peter Kanning, global head of sustainable finance strategy and implementation at the bank.
Financed emissions data is expected to prompt a rash of pledges early next year to reduce emissions in oil and gas and energy portfolios similar to SEB’s recent commitment to cut fossil fuel exposure in its energy portfolio by 45%–60% by 2030 from a 2019 baseline.
The issue has been pushed forward by the Sustainable Markets Initiative’s Financial Services Taskforce and the Net Zero Banking Alliance, which is part of GFANZ. GFANZ is asking members to reduce their emissions by 50% by 2030 and the NZBA wants banks to set 2030 targets within 18 months of joining, starting with the highest emitting sectors, with further targets to be set in 36 months.
"Communicating financed emissions is part of our commitment to NZBA. We regard financed emissions as a form of standardisation concerning financial institutions' communication of their impact, which is a positive development," said Hans Beyer, SEB's chief sustainability officer.
‘Facilitated emissions’
Banks are using similar metrics to calculate "facilitated emissions" which are off-balance-sheet services other than financing that banks provide to clients. This covers capital markets activity and underwriting for debt, equity and syndicated loans, and is a potential game-changer for the banking industry and dealmaking.
It will attribute facilitated emissions to different financing products and the associated carbon emissions could be shared between underwriters, issuers and lenders. That could prompt banks to adopt a portfolio coverage approach using criteria that could limit financing only to companies with science-based targets, or approved targets, potentially with tighter criteria for high-emitting companies.
PCAF launched a consultation paper in November for capital markets instruments that explains the hard choices necessary to develop guidelines for facilitated emissions and the complex challenges that it represents.
“That is a very interesting workstream which is starting to cause us some anxiety,” a senior ESG banker said.
PCAF is aiming to develop a clear methodology for financed and facilitated emissions by the fourth quarter of 2022 in time for the UN’s COP27 climate meeting in Sharm El-Sheikh, Egypt.
“A more criteria-based target-setting approach would probably work for capital market instruments facilitation, while for on-balance-sheet activities and thus financed emissions, you would probably go with the sectoral pathway type of approach or absolute emissions reductions,” Linthorst said.
Best practice is still being defined, but industry-leading standards are expected to cover both approaches and use additional tools such as the International Energy Agency's net-zero pathway, which gives a roadmap to net-zero CO2 emissions for the energy sector and industrial processes by 2050, in addition to PCAF's guidance.
Challenges ahead
Banks are adopting a range of approaches to the proposals and cite data and evolving methodologies as the two key challenges to overcome as they work to produce their first sets of numbers and develop flexible and adaptable methodologies. Bank data is heavily dependent on clients' reporting and methodologies are evolving.
“Assessing financed emissions has required us to source and map data that has not previously been part of our systems or processes. In terms of methodology, many of the tools and references applied to assessing portfolio alignment have been developed in the past one to two years and will continue to evolve," Kanning said.
The metrics for financed and facilitated emissions are continuing to develop and standards vary, but the ability to see how portfolios are changing annually will transform banking and arm relationship managers with information in readiness to have difficult conversations with clients about their transition plans.
"We see indeed that there are very good reports being published by some banks and also others where there are still a lot of questions about how they got to the numbers and why they use a certain metric. It's also very new to many financial institutions," Linthorst said.