The introduction of facilitated emissions will have profound implications for the financial sector

For several years now, the big banks have been under pressure to do more – a lot more – to finance the world in a way that will help it get to net zero.

And over the last few months, the pressure seems to have ramped up – an international climate summit, new industry agreements, shareholder rebellions at the oil and gas majors, even an eye-catching display of public discontent when protestors gathered outside HSBC’s London HQ and used hammers to shatter its glass façade. It all creates a whiff that maybe, just maybe, the walls are finally closing in on the powerful institutions that oversee the all-important flow of global capital.

For now though, the numbers say otherwise. A recent report on fossil fuel financing found the 60 largest banks worldwide have pumped over $3.8 trillion into the industry since the Paris Agreement. It found that, despite the rhetoric, despite the pressure, the promises and the apparently endless acronyms used to represent new commitments to net zero, investment in fossil fuels still appears to be going in the wrong direction; higher in 2020 than it was in 2016.

But while that makes for sobering reading, there are also signs it’s a trend that won’t – and indeed can’t – continue. One of these is proposed new guidance on carbon accounting for the financial sector. Consultation papers from The Partnership for Carbon Accounting Financials (PCAF) consultation, published at the end of last year, seem to set out a vision of not just harmonising the quality of carbon reporting, but also broadening its scope.  Combined with all those industry net zero commitments, it could have profound implications for the whole sector.

Capturing emissions is not straightforward and entails careful boundary setting

PCAF’s new consultation highlighted why capital markets are essential to the climate transition, introducing new methodologies, guidelines and indeed concepts for carbon accounting. It’s worth noting at this point that PCAF standards already carry weight – the organisation first published its Global GHG Accounting and Reporting Standard for the Financial Industry in November 2020, and a year later over 170 financial institutions across 45 countries, representing $54 trillion in assets, had committed to measuring and disclosing emissions associated with their financial activities. Some 43 countries have already published aligned reports. Which is why PCAF’s introduction of a fairly new concept – facilitated emissions – has raised a few eyebrows in the ESG world.

Facilitated emissions cover the provision of services rather than funding by financial institutions, which therefore do not result in a year-end balance sheet liability for the reporting entity. This would seem to be positive development for anyone sustainably-minded, leaving one less place for financers of fossil fuels to hide.

But it’s also one that raises several issues. For starters, capturing emissions for this type of activity is not necessarily straightforward. It entails careful boundary setting – timeframe of capture, apportioning liability for the issuance to be accounted for by the facilitator’s of the transaction, splitting responsibility across multiple facilitators, then allocating the emissions themselves and designing appropriate treatment for issues around equity versus debt on the issuers’ balance sheet. PCAF also acknowledges the potential for double counting. Its chief executive has suggested “a more criteria-based target-setting approach” might work, but breaths will be bated when the group announces the actual methodology, due by the end of the year.

Unaccounted emissions will have implications beyond the financial world

“It’s a very interesting workstream which is starting to cause us some anxiety,” a senior ESG banker reportedly said recently when asked about facilitated emissions. It’s easy to see why. First there is the question of compliance. The industry has written a lot of cheques by signing up to all those net zero commitments, and eventually, the world will expect them to be cashed in – some sooner than others. At COP26, the Glasgow Financial Alliance for Net Zero (GFANZ) asked its members to reduce their emissions by 50 per cent by 2030, while the Net Zero Banking Alliance (NZBA) wants banks to set 2030 targets within 18 months of joining, with further targets set within 36 months.

Then there are implications beyond the financial world. While PCAF’s standards are aimed at banks, it’s easy to imagine the type of thinking underpinning them being applied elsewhere, where professional services firms are providing services, but not financing to high-emitting industries. And if that happened, it might not be enough for companies to consider themselves net zero only according to their own operations, upstream and downstream. Suddenly, might find they are having to look at everything, from the lawyers and accountants they use to their shippers and advertisers. This might in turn spark a change in those very companies if they started to see their client base start to shrivel up. And so on and so forth.

Such a trend already appears to be taking hold in the corporate world. The Science Based Targets Initiative (SBTi) is another robust organisation, holding companies accountable for their ambitious carbon reduction targets – and one that proudly claims any approved targets and plans will be rooted in climate science. At the latest count, some 2,392 corporations have made commitments, with roughly half already fully vetted and approved. A group of over 200 were recently singled out for being the most ambitious – and it included the likes of Microsoft, IKEA and Walmart.

What happens next?

Some believe all this can only lead to a shift towards green financing. Again, there are numbers to support the theory. For all the sobering figures around fossil fuel financing up to 2020, more recent ones paint a different picture.

According to research by Autonomous, renewables and other climate-friendly ventures received more bank-issued bonds and loans than the fossil fuel sector for the first time ever in 2021. They said that Deutsche Bank, JPMorgan Chase and HSBC are among more than a dozen banks whose annual green financing commitments now outstrip their 2020 support for fossil fuels. They also believe the market is moving that way too, predicting that any loss of brown financing could be completely offset by green growth when rising demand for loans and other banking services from a swelling green sector becomes worth up to $2.3 trillion a year.

At the same time, where the flow of capital fails to encourage behavioural change, one suspects the long arm of regulation is likely to force one. More and more national governments are setting out a path to mandatory climate disclosures in line with recommendations by the Taskforce for Climate-related Financial Disclosures (TCFD). Then there are the recommendations from the International Energy Agency’s 1.5C Net Zero scenario, which concluded there could be no more fossil fuel supply beyond what is already committed as of 2021 to ensure, the plant stays on track to limit global warming below the critical 1.5 degrees. Already some of the IEA’s sector-specific warnings – such as those against sales of new internal combustion passenger cars by 2035 at the latest – have been taken forward by the EU, the UK Government, and others.

It would appear then that all the signs are pointing in one direction where sustainability is concerned. Yes, there might be at least one more oil hoorah before its day is done. And yes, if things continue as they are, it might be opaque private finance that shares the spoils of financing it.

But taking everything into account, it’s a good bet that any advantage gained would be a short-lived one. In the longer term, those who seek to build a reputation that aligns with the needs and demands of their clients, those who sense the shifting landscape, and plan for it and adapt to it, would seem to be much better placed to get the lasting competitive edge.

In any case, a new hoorah for renewables might be around the corner too.

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