Demystifying “Financed Emissions”: Understanding Scope 3 Category 15

As climate accounting standards rapidly evolve, financial services companies face intensifying scrutiny into the downstream emissions enabled through capital allocation activities. Quantifying these large-scale “financed emissions” represents the cutting edge of comprehensive environmental performance transparency.

Under the Greenhouse Gas Protocol’s Scope 3 reporting framework, Category 15 uniquely covers emissions driven by external companies as a result of financial capital provision from banks, asset managers and other funding facilitators. This pivotal category accounts for emissions impacts beyond direct operations or procedural value chains within typical Scope 1, 2 and 3 analyses.

While those classifications capture procedural impacts, Category 15 recognizes that financial services processes inherently enable tangible outcomes at scale by empowering entire enterprises through capital access. Recently standardized, this groundbreaking emissions classification framework sits separate from the prior 14 categories by acknowledging that emissions predominantly arise from recipients of funds rather than by financial institutions themselves.

By supporting the economic advancement of secondary corporations, banks and investors inherently contribute to international emissions footprints regardless of lacking operational control. Fund recipients utilize raised capital for potentially environmentally detrimental programs. Category 15 progress locks quantifying and disclosing these “financed emissions” as central to comprehensively assessing finance sector climate impacts.

Segmenting Portfolio Climate Impact – Types of Financed Emissions

While entire enterprises benefit from capital market access, discrete segments of corporate financing and investment drive specific environmental outcomes. Recognizing these differences allows more targeted quantification under the Scope 3 Category 15 umbrella spanning three key areas:

  1. Debt

There are two broad categories of debt in category 15.

Project finance fuels specific identifiable assets while general corporate debt provides unrestricted operational funding. This key delineation dramatically impacts data accessibility for financial institutions calculating attributable emissions.

In project finance scenarios, banks can isolate assets like manufacturing plants or mines as directly tied to capital deployment. By securing debt against singular tangible properties rather than entire multifaceted corporations, lenders trace localized inventory data or efficiency benchmarks to estimate impacts.

Conversely, general operational lending lacks tracing capital to defined usages across complex multinational recipients. Without transparency into how flexible funding gets utilized internally, financial institutions struggle to calculate precise climate impacts enabled through open-ended cash infusions. Absent asset-level tracking, extrapolating top-down proprietary emissions data across vast international conglomerates becomes the recourse. However methodological rigor suffers given data gaps.

Ultimately while project finance emissions get derived straight from isolated assets’ activities, general lending requires imperfect approximations across opaque but wide-reaching business enterprises. Improving visibility through client engagement is key to optimizing precision.

  1. Equity Investments

Two primary equity investment approaches exist across the financial spectrum: acquiring minority interests or controlling privately-held enterprises. This bifurcation leads to dramatically differing visibility capacities around operational emissions when quantifying proportional financed impacts.

On public exchanges, investors typically purchase fractional percentage stakes averaging 1-2% concentrated ownership in specific companies. Lacking major influence, accessing granular emissions inventory information from partly owned public entities often proves impossible notwithstanding mathematical liability crossing minor ownership thresholds.

Conversely, private equity funds fully acquiring or controlling sizable interests in private companies can mandate climate data disclosures through extensive shareholder rights. Majority investments provide direct access enabling rigorous carbon accounting.

Yet despite both public minority and private controlling scenarios bearing clear proportional responsibility for some percentage of operational emissions enabled through capital allocation, actual data deficiencies can severely inhibit credible disclosure without assertive engagement mandates across partially owned enterprises.

  1. Client Services

Beyond direct investing institutions, the wider financial ecosystem including client servicers and deal advisors contributes to portfolio emissions while navigating data overlaps. Asset managers investing on behalf of client organizations double-count the impacts of identical holdings. Meanwhile, financial sponsors like consultants and advisors facilitate transactions and deals that ultimately fund carbon-emitting growth, even though they do not directly contribute capital.

These intermediaries represent pivotal stakeholders with influence over capital flows, albeit through advisory rather than deployment. Hence industry standards now encourage expansive accountability across the investment value web. Asset managers, consultants and other service facilitators should transparently measure some share of clients’ portfolio impacts.

However, this well-intentioned pursuit of comprehensiveness raises acute double counting challenges. Asset owners, asset managers and investees report matching equity stakes’ emissions as individual specialties. Yet despite appearing additive, the duplications trace to a singular investing chain with interconnected reporting among principals and agents.

Untangling these interlinked data redundancies across financial ecosystem touchpoints remains an evolving methodological pursuit as disclosure expectations rise. However, maintaining broad accountability helps ensure cooperative advancement of portfolio decarbonization efforts through unified commitments to emissions transparency.

Raising the Bar on Portfolio Climate Accountability – Emergence of Specialized Finance Standards

With Scope 3’s Category 15 covering high-impact yet methodologically ambiguous financed emissions, financial sector institutions have proactively self-organized to fill accounting guidance gaps present within current greenhouse gas protocol frameworks aimed more at tangible industrial value chains.

Given intensifying expectations for banks and investors to quantify enabled emissions, these players have spearheaded development of targeted field standards through a dedicated organization purely focused on financially material climate impacts – the Partnership for Carbon Accounting Financials (PCAF).

Alongside providing general recommendations on approaching often opaque emission factor data gathering and proportional calculations, PCAF has moved the needle by publishing tailored supporters with granular advice for banking, investment management and insurance subsectors.

This industry-led supplement to overarching but less sector-specific existing protocols promises to accelerate adoption by clearing compliance hurdles. With financed emissions representing a ballooning disclosure area filled with nuance, establishing actionable best practices through global cooperation allows more institutions to meet rising climate leadership demands.

Modeling Decarbonization in the Dark – Leveraging Economic Proxies

When financial institutions deposit immense capital across thousands of firms lacking climate transparency, calculating precise proportional portfolio impacts appears impossible without sweeping disclosure mandates. This data deficiency dilemma has prompted embracing modeled approximations.

By extending traditional economic input-output tables mapping product flows across industries with carbon coefficients per revenue dollar, resulting Environmentally-Extended EEIO databases generate intensity factors estimating average emissions for various business activities based on monetary value.

So while unable to trace actual tonnes without direct company data access, banks can impute intensity ratios against client revenues to derive reasonable footprint estimates. Despite methodological limitations, EEIO tools represent the sole pragmatic path forward for financial services giants facing political pressure to account for financed emissions at portfolio scale despite staggering data gaps.

However, serious reservations exist around relying on proprietary third-party black box databases. Questionable input quality and completeness plague results. The model can only stretch so far absent transparency. Plus coverage gaps where intensity ratios remain unassigned fully for many niche sectors exacerbate uncertainties.

Still for all their imperfections, current EEIO methodologies distinctly progress climate accountability by mandating reasonable estimates given roadblocks. However, improving integrity, expanding completeness and pursuing primary data access represent parallel imperatives if financiers genuinely intend to drive influence over downstream decarbonization.

Legacy Systems Complicate Capital Attribution

Even armed with reasonable estimates of portfolio entities’ emissions, allocating accurate proportional responsibility back to the financing party gets compounded by data deficiencies and antiquated systems according to experts.

As an example, while loan officers negotiate terms with individual companies based on financial factors like existing leverage and assets, distilling what percentage of the total debt or equity a bank itself financed falls to disconnected backend systems, hindering computing precise ratable impacts at collective portfolio scale.

Many global banks rely on fragmented legacy infrastructure from generations of mergers that never integrated various lending data trails into accessible central repositories suitable for enterprise climate accounting. Without dependable visibility, rough assumptions around never lending over 60% of an asset’s value often substitute where precision proves impossible.

Ultimately driving accountability requires modernizing siloed reporting so emissions proportions trace back to specific banking relationships rather than average approximations. Integrating climate considerations into client onboarding and internal data flows promises to resolve these lingering attribution barriers.

Inherent Inaccuracies Should Not Deter Strategic Orientation

Despite profound data deficiencies currently inhibiting precision, financial institutions must maintain perspective regarding the cardinal purpose underpinning financed emissions estimates. Quantification intends not to derive flawless inventories but rather directionally identify priority decarbonization areas.

Understanding the highest and lowest carbon sectors offers strategic clarity even if specific tonnage gets disputed. Lending exposure concentrations become apparent notwithstanding volatility around precise cumulative totals. Tracking emissions factors and modeled outputs annually spotlights trajectory rather than absolute accuracy in any given year.

So, while scope for improvement remains, especially as disclosure practices and coordination with clients and data providers matures, imperfect progress still enables targeting the most carbon-intensive relationships. Finance fuels transformation across economies, and even moderately consistent emissions quantification guides capital toward ethical reallocation.

Rather than resigning themselves to paralysis given accuracy constraints, banks and investors should leverage the environmental intelligence gleaned through existing methodologies, working diligently to systematically refine integrity over the coming years of standardization. However, hesitation only hinders collaborative advancement of disclosure practices that promise immense influence over global emissions through engagement.

Alyasar Holou
Business Development Manager

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