Two emissions reporting cycles have passed since Investors for Paris Compliance started scrutinizing the climate plans of Canada’s largest banks. During that time, a major issue surfaced: how the industry calculates and reports its financed emissions.
This past year saw banks reporting year-over-year absolute emissions changes of 20% to 40% that were unrelated to changes in financing or real-world emissions. In addition, we are seeing inconsistencies in the way banks are defining sectors, what years of data, and what complementary metrics are being reported. All this makes it challenging, if not impossible to track and compare bank progress towards net zero.
Before anyone panics, this doesn’t mean it’s a fool’s errand and we should all simply give up the ghost. But, it does mean we need to stop, try to understand the issue, learn from it, and pivot. The Canadian financial regulator needs to step in and provide more guidance. The Office of the Superintendent of Financial Institutions (OSFI) should do so via its Climate Risk Management Guideline B-15, which requires federally regulated financial institutions (e.g. banks and insurance companies) to report their financed emissions, but for now offers insufficient guidance.
First, why does this issue matter? Because measuring, reporting, and tracking financed emissions is critical for reducing exposure to climate transition risk (i.e. exposure to assets that will lose value as governments transition away from the unabated combustion of fossil fuels). It’s a way for financial institutions to measure their exposure to climate transition risk and set targets to reduce that exposure in line with the absolute global emissions reductions required by science.
A simple example of financed emissions would be as follows: a bank lends $1 million to an oil and gas company. The bank would then become responsible for $1 million worth of the company’s emissions. This involves double counting on purpose. Both the company and the bank now share the same financial risk. Seems simple, right? Except, how do we calculate the bank’s proportion of a company’s emissions? The Partnership for Carbon Accounting Financials (or PCAF) sets the industry standard. For publicly listed companies, the share would be calculated based on the company’s enterprise value including cash. However, if that company’s value changes significantly, then that $1 million could represent a lot more or a lot less emissions without real-world emissions or financing changes.
Our experience has led us to conclude that the volatility of absolute financed emissions isn’t necessarily a problem if we embrace the fact that company value will inevitably swing, particularly in certain industries, like oil and gas. What is necessary is being able to interpret the causes of the swings, which requires additional data points, in particular: financing value (e.g. committed loans) and the company’s physical emissions intensity (e.g. emissions per unit of energy). These extra data points make it possible to understand what is driving changes in emissions: increased or decreased financing activity, or, the investee company’s decarbonization efforts.
So long as all three data points are as accurate as possible, standardized, reported for all available years (and that reporting for a year is truly based on emissions data from the year indicated), reflect the financial institution’s full financial risk (i.e. committed, not just outstanding loans), and based on transparent methodology, then we’re getting somewhere. Ideally, the reporting company also provides associated analysis to explain trends over time. This information will help shareholders better understand their transition risk and track progress toward emissions reduction targets.
As we continue to push for improved net zero plans from Canada’s largest emitters, we need to see the quality and comparability of absolute emissions data, as well as the necessary complementary metrics, improve. So far, it seems PCAF guidance and best efforts from financial institutions aren’t cutting it. OSFI has the duty to step in and ensure this is the case.