Navigating the Climate Challenge: Understanding Financed Emissions

The global economy, driven by financial institutions, is seeing a marked move towards sustainability. Key to this transition is tackling "financed emissions" – the greenhouse gases tied to investment and lending decisions – understanding the many emissions financing challenges faced by business, and discovering the innovative tools they can use to address them.

Understanding financed emissions

Financed emissions stands at the intersection of finance and sustainability – it encompasses the emissions financial institutions indirectly generate through their portfolios. Financed emissions fall under Scope 3 emissions for financial institutions. The Carbon Disclosure Project (CDP) suggests that such emissions dwarf operational emissions by a factor of 700. This stark contrast underscores the critical influence these institutions exert over our climate's future.

The regulatory trigger

The financial sector's indirect climate impact, captured by financed emissions, is being scrutinized now more than ever. Regulatory frameworks are demanding greater transparency, with the Task Force on Climate-related Financial Disclosures (TCFD) at the forefront. TCFD mandates the disclosure of material scope 3 emissions — those linked to investments and loans — alongside targets and the methodologies used for their calculation. Tailored for investors, TCFD's framework centers on the financial risks and opportunities arising from the transition to a low-carbon economy.

The Corporate Sustainability Reporting Directive (CSRD) takes this a step further, enforcing the reporting of financed emissions and adherence to a 1.5°C global warming trajectory. It not only aligns with TCFD but also intensifies the requirements.

Building on TCFD's foundation, the European Banking Authority's ESG Pillar 3 introduces stringent reporting obligations. It specifies the format and methods for disclosures, ensuring consistency and comparability across institutions. These include both quantitative details on transition and physical climate risks, and qualitative insights on how ESG principles are integrated into business models, strategy, risk management and governance.

Measuring financed emissions: PCAF and beyond

As we look into quantifying financed emissions, we encounter significant complexity. The Partnership for Carbon Accounting Financials (PCAF) is important here, guiding institutions in setting emissions baselines and tracking progress. It provides a standardized framework for banks and investors to calculate and report their financed emissions, thereby offering a uniform baseline from which progress can be assessed. The real power of PCAF, however, is in its recognition of the importance of data quality.

PCAF's approach goes beyond mere calculation; it enables scenario analysis, using emissions data to represent potential climate risks. This analysis is vital as it reveals the most carbon-intensive segments within a portfolio, empowering financial institutions (FIs) to engage with clients on mitigating these risks. As FIs embark on this journey, PCAF’s data scoring guidelines offer a way to measure their progress, emphasizing the need for data accuracy and consistency. This is a foundational aspect of climate-related financial disclosures, as reliable data is the bedrock of credible emissions tracking and meaningful progress.

A balancing act

Financial institutions must walk a tightrope, balancing immediate shareholder expectations against potential reputational damage (if they are seen not to be taking action) and the long-term demands of a warming planet. Investments that once seemed secure now face becoming "stranded assets" in a low-carbon economy. But, while existing long-term commitments pose significant challenges, they also present opportunities for institutions to lead the way in the transition to green assets.

Technology and data: Identifying the right tools

The development and implementation of a solid technological and data infrastructure is at the heart of managing financed emissions.

There are three pivotal data-related challenges related to ESG and financed emissions:

1. Suitability – the relevance and applicability of ESG data to specific institutional needs.
2. Accessibility – ensuring that this data is readily obtainable and usable by institutions of all sizes and capacities.
3. Consistency – the standardization of data across the board, allowing for reliable comparison and analysis.

For institutions to effectively monitor, disclose, and mitigate the impact of financed emissions, they must be equipped with capable systems and tools.

At Synechron, our mantra has always been to “walk the walk and talk the talk.” Over the past six years, we’ve made substantial investments in ESG-data focused accelerators. These accelerators empower institutions to both navigate and to lead in the ESG realm:

• ESG Booster: This tool aids in performing detailed portfolio analysis, evaluating ESG performance while being agnostic to ESG data providers. It empowers institutions to harness various data sources and gain a comprehensive view of their ESG standings.
• ESG Navigator: Designed for SMEs, this tool provides a risk and performance assessment to help achieve overall sustainability. It allows smaller enterprises to chart their sustainability journeys in alignment with broader financial markets.
• CRISTAL (Climate Risk Stress Test & Analysis Tool): Developed in collaboration with Amalthea, CRISTAL measures integrated risk, both physical and transitional. It’s a forward-looking instrument that helps institutions understand and prepare for future climate risks.

“Through our ESG-focused accelerators, we’re charting a course for our clients that is both sustainable and innovative,” says Sandeep Kumar, Head of Synechron FinLabs.

Conclusion: strategy, investment and a bold approach

As we confront the urgency of the climate crisis, the focus on financed emissions will only intensify. This will require strategic foresight, investment in cutting-edge tools, and bold decision-making.

“The move to a low-carbon economy is fraught with challenges, but it’s one that financial institutions must undertake. It is not just a responsibility but an opportunity to redefine what success looks like," concludes Janet Chung, Senior Manager, ESG, at Synechron.