Two initiatives seek to standardise approaches to carbon accounting and provide a blueprint for investors to help achieve net zero global emissions by 2050.
On 3 August 2020, the Partnership for Carbon Accounting Financials (PCAF), a global collaboration of 70 financial institutions with total financial assets of more than US$10 trillion, released its proposed Global Carbon Accounting Standard (GCAS), aiming to provide financial institutions with a common set of robust carbon accounting methods. The proposed standard will help institutions assess and track the greenhouse gas (GHG) emissions financed by their loans and investments.
Subsequently, on 5 August 2020, the Institutional Investors Group on Climate Change (IIGCC), a 240-member group of mainly pension funds and asset managers across 15 countries, with more than US$39 trillion in assets under management, published a proposed Net Zero Investment Framework (the Framework) to guide investors in decarbonising their portfolios by 2050.
A Harmonised Approach Across Financial Institutions
Carbon accounting enables financial institutions to disclose GHG emissions at a fixed point in time, in line with financial accounting periods. Such disclosures are important to ensure stakeholders understand how a financial institution’s loans and investments either contribute to, or inhibit, the transition to a low-carbon economy.
So far, a lack of harmonised methodologies for disclosing emissions at fixed points in time and a lack of reporting rules has hindered the adoption of carbon accounting of financed emissions. Without guidelines for carbon accounting methods, there is a risk of inconsistent disclosures across financial institutions. However, as Giel Linthorst (Executive Director of PCAF) noted, because of the release of the GCAS, now “banks and investors across the globe have access to a standardized approach to measure the climate impact of lending and investment portfolios”.
Scope of PCAF Methodology
The GCAS provides guidance for six asset classes:
- Listed equity and bonds
- Business loans
- Commercial real estate
- Motor vehicle loans
- Project finance
For each asset class, the GCAS provides a detailed methodology to calculate the GHG emissions resulting from activities in the real economy that are financed through lending and investment portfolios.
The PCAF acknowledges that limited data often presents a challenge in calculating financed emissions, and therefore suggest that financial institutions should begin with estimated or proxy data in order to identify carbon-intensive areas in their portfolios. Accordingly, the GCAS also provides guidance on data quality scoring per asset class, aiming to facilitate data transparency and improve data quality in the medium to long term.
The GCAS additionally provides recommendations and requirements for disclosures, including a minimum disclosure threshold on a “comply or explain” basis (meaning any requirements not fulfilled must be accompanied by an explanation).
The PCAF are holding a public consultation on the GCAS from 3 August to 30 September 2020, seeking feedback from financial institutions, policy makers, regulators, data providers, NGOs, consultants, and other interested parties, on both the robustness and applicability of the GCAS. The PCAF intend to publish the final version of the GCAS in November 2020.
The Net Zero Investment Framework
The Net Zero Investment Framework is the first output of the IIGCC’s Paris Aligned Investment Initiative, launched in May 2019. The Framework was developed by more than 70 investor IIGCC members.
The IIGCC states the Framework provides the first-ever “practical blueprint” for investors to maximise their contribution to tackling climate change and achieving net zero global GHG emissions by 2050, aiming to translate the Paris Agreement goals into an actionable plan for investors.
The Framework outlines that, in order to meet net zero GHG emissions by 2050, investors must both decarbonise their investment portfolios and increase investment in “climate solutions”, such as renewable energy, low-carbon buildings, and energy efficient technology.
Portfolio/Fund Level Recommendations
The Framework sets out several “top-down” components at the portfolio or fund level, which set the direction, portfolio structure, and strategy to achieve alignment with Paris Agreement goals. An important component is “governance and strategy”, under which investors should: set a commitment to a net zero investment strategy; outline beliefs, strategy, and mandates designed to cut emissions; and monitor and report on the strategy’s implementation. The Framework additionally proposes setting portfolio level targets on emissions reductions, as well as investing in climate solutions consistent with the net zero goal.
Next, the Framework recommends investors implement a strategic asset collection process. This process should take into account scenario analyses in order to inform risk and return expectations, optimise portfolios for climate as well as risk/return metrics, and select asset class variants that enable investment in lower-carbon options. Finally, investors should review any constraints that could hinder the goal of limiting carbon emissions.
Asset Class Level Recommendations
At the asset class level, the Framework recommends shifting the alignment of assets towards the net zero goal, which should be the key strategy for achieving portfolio-level targets. This shift should involve setting targets for asset class alignment, assessing the alignment of assets using recommended methodologies, and undertaking alignment actions. Alignment actions might include using portfolio construction to allocate capital to invest in climate solutions, allocating capital towards engagement and stewardship, or directing management to influence the alignment and performance of assets. The Framework also recommends selective divestment, if alignment goals cannot be achieved.
The Framework additionally notes that investors should help create an environment that encourages alignment with net zero global emissions goals through stakeholder and market engagement, and through policy advocacy.
The Framework is open for feedback via the IIGCC’s consultation platform until 25 September 2020.
Taken together, the GCAS and Net Zero Investment Framework have the potential to promote more harmonised, clearer reporting of climate action across the financial services sector.
Latham & Watkins will continue to monitor developments in this area.
This post was prepared with the assistance of Emilie Cornelis in the London office of Latham & Watkins.