Managing ‘Financed Emissions’: How Investors Can Support the Low-Carbon Economy Transition

by | Mar 31, 2024

When people talk about the negative actions of companies contributing to the climate crisis, what often resonates in their minds are carbon-intensive industries or fossil fuel producers and consumers. But can we truly put all the blame on fossil fuel dealers?

Even though this assertion may not be debunked in its entirety, it is still correct to say that a sharper lens is yet to be adopted to examine this issue. Interestingly, a 2022 report revealed that from 2015-2021, the 60 largest banks in the world financed up to $4.6 trillion in fossil fuels.

Image by Catazul via Pixabay

According to a report by the Carbon Disclosure Project (CDP) in 2017, only about 100 companies in the world have been responsible for 71% of the industrial global greenhouse gas emissions (GHG) since 1988. This data further suggests that much attention is paid to companies that produce direct carbon emissions. Unfortunately, other agents supporting this cause might have yet to be addressed.

This article will explore the role of financial actors in combatting the climate change crisis and transitioning towards a low-carbon economy.

Demystifying Financed Emissions

Financed emissions are emissions that come about as a result of a financial service. When financial services contribute to carbon emissions, this kind of financial services is referred to as financed emission. An investment or loan in a carbon-producing portfolio or business can be described as a financed emission.

For example, if an investor invests in an oil-producing company, this investor would not be directly involved in oil production, contributing to carbon emissions. However, the investor has supported carbon emissions through its funding. Financed emission is categorized under scope 3 of the Greenhouse Gas Protocol (GHGP). This category addresses greenhouse gas emissions that are indirectly related to a company.

Assuming the investor in the example above has a 10% equity in the oil-producing company, if the investee company has a total emission that equals 100 tonnes of C02e, the investor’s financed emission will be calculated as 10% of the 100 tonnes of C02e, which is 10 tonnes of C02e.

Due to the operational nature of financial institutions, they are expected to have fewer carbon emissions from their direct activities compared to other industries. However, the volume of emissions from their indirect activities can have devastating impacts. According to CDP, It was reported that in financial institutions, financed emissions account for emissions that are 700 times more than the institutions’ directly generated emissions.

Managing Financed Emission

For many individual investors, their financed emission is like a green snake under green grass- making it barely noticeable. This means that investors must make an intentional effort and strategy to ensure their investment decisions do not intensify the climate change chaos.

Since the popularisation of the climate change crisis narrative, the financial industry has produced different initiatives to show its alliance and support for global climate actions. For instance, The Glasgow Financial Alliance for Net Zero (GFANZ) birthed many climate-friendly financial alliances like the Net Zero Asset Manager Initiative (NZAM), Net-Zero Asset Owner Alliance (NZAOA), and the Net-Zero Banking Alliance (NZBA). The core objective of these initiatives is to support the mainstreaming of climate-related risks in financial decisions.

Meanwhile, consumers (including financial institutions’ clients) are applying pressure or shifting their capital elsewhere. Research has suggested a considerable rise in ethical investors among younger generations. For example, a 2022 study conducted by Stanford University shows that 70% of investors between the ages of 18 and 41 were interested in considering the environmental implications of their investments. Contrarily, only 35% of investors in the older group express the same. The “Great Wealth Transfer” from Baby Boomers to Gen X, Millennials, and Gen Z will exacerbate the shifting consumer preference.

Challenges of Managing Financed Emissions

Everything worth doing is inseparable from challenges; unsurprisingly, managing financed emissions is no exception to this reality. Some of the difficulties that investors might encounter while trying to manage their financed emissions include the following;

    • The availability of reliable data needed to make accurate financed emissions calculations
    • Greenwashing: managers might provide misleading information to deceive investors about the environmental friendliness of their business.
    • The complicated nature of investment funds might make it difficult for investors to determine their financed emissions accurately.
    • The feeling of considering possible economic tradeoffs and the chaos of balancing between financial gains and responsible investment.

    Strategies for Managing Financed Emission

    There is a need to provide practical guides that investors can adopt in making ethical investment decisions. The following approaches can help investors manage financed emissions and ease their path toward ethical investing.

      • Prioritise Ethical Investment Portfolios: Ethical investing is often adjudged as an investment strategy guided by principles that consider stakeholders’ welfare in investment activities. An ethical investor will always consider the social and environmental questions that might be raised regarding a prospective investment opportunity before embarking on it. Investors can reduce the carbon footprint of their funds by investing with asset managers that support impact and ethical investments.

      Image by Eko Pramono via Pixabay

      • Calculate Financed Emissions: This approach will allow investors to assess the carbon emission of their investment decisions. The partnership for Carbon Accounting Financials (PCAF) provides a standard methodology investors can adopt to measure their financed emissions. To provide a summarized explanation of how it works, the financed emission is calculated under PCAF by considering the emissions of the company the investor has invested in and then assigning the right amount of the emission to the investor based on how much of the company it has financed.
      • Engage with Companies: Investors, like shareholders, can reduce their financed emissions by expressing their environmental concerns to the company’s management to decarbonise their activities and embrace carbon-friendly alternatives. Investors-activism can play a significant positive role in corporate sustainability. They can utilize their statutory rights to influence a positive change.
      • Consider the Benefits of Decarbonising Your Investment: The benefits of managing the emissions of your investment might be too numerous to highlight in this post. However, financial actors can have peace of mind knowing that their investment decisions are not exacerbating problems in the world, especially for vulnerable groups and communities. For instance, greater awareness and engagement with climate refugees who are forced to relocate due to the effect of the climate change crisis on their primary habitats and suffering as a result of severe famines caused by a loss of agricultural resources could enhance interest in addressing financed emissions.

      The transition towards a carbon-friendly economy is a systematic change requiring stakeholders’ cooperation. Investors represent an essential group among these stakeholders. They can help influence the direction of capital by providing the resources needed to fund carbon-friendly investments and withholding their funds from carbon-heavy investments.

      References

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