Green Finance Briefing: GFANZ moves a step ahead on net zero portfolio alignment
- GFANZ issued a report to provide guidance, clear definitions and case studies for financial institutions looking to develop and use portfolio alignment metrics to start decarbonizing their portfolios.
- We deep dive into what climate metrics financial practitioners use today, as well as the key sectors to watch when it comes to Scope 3 emissions.
Financial services need to decarbonize, but the banks and FIs looking to start this journey or deliver on their net-zero commitments are looking at a tricky road ahead.
It all sounds good in theory, but in practice, the whole endeavor is tremendously complicated.
Financial firms, investors, data providers and public bodies are investing time and money on a range of initiatives, according to EY. They’re looking at developing global carbon accounting standards; tackling challenging areas such as whether and how to include Scope 3 emissions; increasing the granularity of net-zero scenarios that can be used to set targets; and enhancing accreditation methodologies such as science-based targets.
Aiming to provide guidance for the above, the Glasgow Financial Alliance for Net Zero (GFANZ) is moving the conversation forward by introducing a draft report on measuring portfolio alignment.
Last year at COP26, more than 450 financial institutions joined GFANZ and committed to align more than $130 trillion of capital in order to reach Paris Agreement targets. But after commitments comes execution, and for this to happen, there needs to be comparable and consistent data. After all, we can't mitigate what we can't measure.
To measure the alignment of their investment, lending, and underwriting activities with the goal of net zero, GFANZ members have expressed the need for sound and forward-looking portfolio alignment methods.
“If financial institutions are to deploy the capital required to usher in the net-zero transition, they need a way to measure whether their financing activities align to their ambition,” said Mary Schapiro, Vice Chair of GFANZ.
Portfolio alignment metrics help financial institutions assess and identify companies that are 1.5 degrees C-aligned versus those that need to transition to become 1.5 degrees C-aligned.
The draft report released by GFANZ provides guidance and clear definitions, and also offers case studies for financial institutions looking to develop and use portfolio alignment metrics, drawing on extensive engagement with financial experts and other key stakeholders.
The aim is to encourage better convergence on best-practice methods when it comes to aligning an investment portfolio with net zero targets. The need for increased transparency on underlying assumptions and methodologies is key for an effective decarbonization of the financial sector.
For a quick overview of portfolio alignment metrics, there are four main categories that are being used by financial practitioners today:
- Binary metrics: measuring alignment using the percentage of the portfolio companies with net-zero aligned emission reduction targets
- Maturity scale metrics: categorizing companies based on different stages of alignment
- Benchmark divergence metrics provide the cumulative over or undershoot from a net-zero aligned benchmark
- Implied temperature rise (ITR) metrics go one step further and translate the over/undershoot into a science-based, end-of-century global warming outcome
But there are drawbacks:
- Binary metrics: easy to use, but doesn’t provide insights for companies without emission reduction targets
- Maturity scale metrics provide a comprehensive picture, but the lack of standards comes with the risk of diverging data sources and definitions used
- Benchmark divergence metrics are complex to use and interpret but are good at identifying sectoral climate leaders and laggards in an investment portfolio
- Implied temperature rise (ITR) metrics prove challenging to determine and implement
Scope 3 emissions: What should be included?
The report also provided some guidance over Scope 3 emissions. First, a quick overview:
- Scope 1 — emissions directly generated by owned or controlled assets
- Scope 2 — emissions indirectly associated with generation of purchased energy
- Scope 3 — indirect emissions from upstream and downstream activities in the value chain
Scope 3 emissions are the most significant across many sectors, accounting for more than 90% of total emissions in some industries. But it’s also the most challenging scope to report, with few companies currently disclosing or even trying to quantify how many emissions their businesses are enabling.
Few companies report Scope 3 emissions today, and financial practitioners often need to use a mix of reported data where available and estimated data to fill in the gaps.
Plus, there is no global standard for what scope of emissions should be included in portfolio alignment practices. The Science Based Targets initiative (SBTi) requires a company to set a Scope 3 emissions target if these emissions represent more than 40% of the company’s overall emissions. Meanwhile, the PCAF Standard requires that Scope 3 emissions should be disclosed for the sectors with the largest emissions impact.
GFANZ looked at both the magnitude of emissions and percentage of total emissions in different sectors and identified priority sectors such as oil and gas, automotive, electric utilities and chemical sectors.
Source: GFANZ
The report is accompanied by a five-week public consultation, running until September 12, 2022. Those who would like to provide feedback can respond to the survey here.
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“The better the data gets, the more granular the data gets, the more democratized the data gets, the more forceful the reduction will be able to be, and the more precise individual as well as institutional activities will be able to be. And I think this is all about shaping a new relationship between the clients and the financial institutions that are data-based and insight-driven, substantiated by data.”
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