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Part 1 mainly discussed the background of carbon accounting and the calculation approaches of physical carbon accounting. In this part, the article will continue the topic of carbon accounting from the disclosure and financed emission perspective.
Carbon accounting information disclosure methods can be divided into disclosures of on-balance sheets and off-balance sheets. On-balance sheet disclosures record corporate carbon accounting elements, including carbon assets, carbon liabilities, carbon equity, carbon costs, and carbon profits. Information disclosures of off-balance sheets refer to carbon accounting information in other parts of financial reports rather than in balance sheets. Users can obtain a clear picture of a company’s current operating conditions and future development in carbon management.
Financial institutions play a crucial role in decarbonization as they can provide and allocate monetary sources for financing the required transformation towards a decarbonized economy. Also, commitments to the Paris Agreement also contribute to the growing demand for transparency of its indirect impact on climate change, or financed emissions. However, it is confused for financial institutions to choose a proper standard among various disclosure frameworks, like the TCFD recommendations report, the GHG Protocol, the Carbon Information Disclosure Project (CDP), etc. Unharmonized standards have become the main obstacle for the finance sector to deal with financed carbon information.
Partnership for Carbon Accounting for Financials (PCAF)
In view of the increasing demand for transparency of greenhouse gas (GHG) emission data and a harmonized assessment and reporting standard for financed carbon, the Partnership for Carbon Accounting for Financials (PCAF) launched globally in 2019. PCAF recognized the power of banks and investors to facilitate the net-zero carbon transition, which in turn, are the signatories of PCAF. Hence, it allowed its participants to jointly develop a bottom-up approach, called the Global GHG Accounting and Reporting Standard for the Financial Industry (the Standard), to measure and disclose the GHG emissions of their loans and investments. Since financial institutions led the development of the standard by themselves, it is more easily for a wider range of financial firms to adopt the Standard. Currently, it is working in five regions: Africa, Asia-Pacific, Europe, Latin America, and North America.
Global GHG Accounting & Reporting Standard for the Financial Industry (the Standard)
The Standard provides detailed guidance and assists in the measurement and disclosures of the GHG emissions related to six asset classes. It covers listed equity and corporate bonds, unlisted business loans and equity, project finance, commercial real estate, mortgages, and motor vehicle loans. The Standard defines financing types, uses of proceeds, and activity sectors to assist in classifying users’ assets and following the corresponding measuring and disclosing guidelines. However, the current version does not include the explicit methodologies for financial instruments beyond the six categories, such as green bonds, sovereign bonds, and initial public offering (IPO) underwriting.
Three Steps to Report Financed Emissions
The general PCAF approach contains three main steps: emission scopes covered, attribution of emissions, and equation and data required for calculating financed emissions.
Emission Scopes Covered
The Standard requires all financial institutions to report borrowers’ and investees’ absolute scope 1 and scope 2 GHG emissions across all sectors. In terms of scope 3 emissions, PCAF applies a phased-in approach, which requires financial institutions to disclose absolute scope 3 emissions based on the sectors their investments or loans attributed to. PCAF acknowledges the potential problems that scope 3 emissions reported may overlap with those in scope 1 and/or scope 2, but it promotes the transparency in financed emission disclosures by adopting the approach. According to the Standard, financial organizations shall report on the scope 3 emissions for the oil, gas, and mining sectors from 2021 onward. By 2024, PCAF plans to add at least transportation, construction, buildings, materials, and industrial sectors. Finally, PCAF members shall be responsible for scope 3 emissions reporting on all the sectors in their portfolios.
Attribution of Emissions
At this stage, the key indicator is the attribution factor, which separates the emissions related to a financial institution from the total GHGs emitted by its investees. The attribution factor is the ratio between the institution’s outstanding amount (numerator) and the value of the financed company or project (denominator). The calculation varies among different types of asset classes.
With regard to denominators, the Standard defined three methods for different asset holders to determine the value of the investees. The first one is the property values at origination, which applies to commercial real estate, mortgages, and motor vehicle loans. Financial institutions shall use the latest value from the first year of GHG accounting and remain constant until the property is replaced. This value is unfeasible to obtain as it involves complicated calculations. The second method is to calculate the sum of total equity and debts, which pertains to private corporate bonds, unlisted business loans, and equities, and project finance. The third method is to calculate the Enterprise Value Including Cash (EVIC) of the respective client, which is suitable for the rest of the asset classes. EVIC refers to the sum of the market capitalization of ordinary and preferred shares at the first fiscal-year end and book value of total debt and minorities’ interests.
In terms of the outstanding amount (numerator), it refers to the total amount of funds invested in the corporates, used to finance the projects, or lent to the borrowers. Financial institutions normally could extract the amounts related to the corresponding items on their financial statements.
Calculation Equation and Data Required
The total financed emissions is generally calculated as follows:
Overall, PCAF distinguishes three different options to calculate the financed emissions of the respective clients depending on the emissions data used. These options are reported emissions, physical activity-based emissions, and economic activity-based emissions.
Options 1 and 2 are based on company-specific reported emissions or primary physical activity data provided by the borrower or investee companies or third-party data providers, while Option 3 is from a data source on regional or sector specific average emissions or financial data. Since Options 1 and 2 present a more accurate result on GHG emissions, the Standard recommends financial institutions to use more data from Option 1 and/or 2 than that from Option 3.
Implications of PCAF
The Standard helps the financial sector assess climate-related risks in line with TCFD and set their own science-based targets aligned to SBTi. Financial institutions can also report to stakeholders like CDP and inform climate strategies and actions to develop innovative products that support the transition toward a net-zero emissions economy.
By now, 166 institutions joined PCAF with total assets under management (AUM) of USD53.7tr. The majority of the PCAF signatories are banks, which also represent most of the available capital globally. Apart from banks and financial service providers, PCAF declared its collaboration with the UN-convened Net-Zero Insurance Alliance (NZIA), signalling a step to fill a major gap in accounting for the total attributable emissions from the financial sector. Through this move, PCAF can offer deeper insights and innovative assessments of GHG emissions in insurance and re-insurance firms.
The application of the PCAF Standard remains challenging for many investors because this process demands a large knowledge pool and diversified skillsets. Seneca ESG provides a SaaS platform targeting problem settlements during the reporting and other aspects to sustainable investment for companies. Our experienced team will provide professional services to help companies with PCAF, decarbonization, and sustainable investment. Contact us at info@senecaesg.com to get customized solutions for you.
Sources:
https://carbonaccountingfinancials.com/standard
https://carbonaccountingfinancials.com/financial-institutions-taking-action
http://theijbmt.com/archive/0939/2098339675.pdf
https://mp.weixin.qq.com/s/9kWI7PwyUxWZFwMzIGxs7Q
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