Financial institutions are pledging to lower carbon footprints. Here’s what you need to know about financed emissions.

Financial institutions are rapidly engaging to support and lead the transition to a low-carbon world. Not surprisingly, the evolving approaches, technologies and methods they’ll use to quantify the emissions intensity of their lending and investment activities are drawing keen attention. Quantifying financed emissions is a tangible first step toward building trust that financial institutions are integrating climate change into their core business of providing capital.

Greenhouse gas emissions (GHG) associated with lending, underwriting and investment activities are more than 700 times higher*, on average, than a financial institution’s direct emissions. Thus this is where a financial institution will probably go first to form a baseline view of its carbon footprint. For those making commitments like net zero by 2050 or other carbon reduction goals, such as those proposed by the various net zero alliances, the current level of financed emissions will set the foundation for measuring progress and allocating capital toward their climate goals.

Still, financial services organizations that are ready to determine a baseline of their emissions face a number of challenges. Emissions data is often incomplete or inconsistent in some areas of the business, and it may be entirely missing in others. Additionally, certain asset types have no carbon accounting standard and others have a limited conceptual relationship to emissions (for example, student loans). From this rough base, they’ll fold in projections around rates of future global decarbonization to help develop portfolio selection and management strategies that align to company climate targets while balancing overall growth and risk objectives. 

This isn’t a once-and-done exercise. As a firm progresses toward its own goals, it should expect to work closely with the companies it does business with—both lending to and investing in—to help manage shifts to lower emissions.

* Source: "Finance sector’s funded emissions over 700 times greater than its own." CDP Worldwide, April 2021.

What are financed emissions?

In current carbon accounting models, ownership of GHGs associated with investments and lending activities is considered part of a financial institution’s carbon footprint. Specifically, GHG protocol accounting standards define these GHGs as Scope 3 Category 15 emissions, or financed emissions. Lending and investment are not the only sources of carbon in financing. Insurance underwriting, for example, is another source that some regulators and industry groups recommend considering when assessing and mitigating climate risks. There’s no established emissions quantification methodology for these activities at this time, but that could change as several potential methodologies are currently under development.

Who is disclosing financed emissions?

These are early days. Thus far in 2021, seven US banks have committed to climate action with the Net-Zero Banking Alliance, including some of the largest in the US. The work to calculate financed emissions is taking place now. At least one of the alliance members  released sources of its financed emissions in four categories as well as plans to baseline and mitigate emissions in late October 2021. At the COP26 climate conference in November 2021, the Glasgow Financial Alliance for Net Zero (GFANZ) announced a global group of firms with $70 trillion in assets committed to Paris Agreement goals.

Disclosure of financed emissions is currently primarily voluntary in the US. At the same time, regulators are signaling expectations for enhanced climate risk disclosures, which for some financial institutions will likely include an analysis of carbon exposures in their portfolios. The European Banking Authority, for instance, has already proposed requiring that all banks under its jurisdiction measure and disclose financed emissions by June 2024 at the latest.

How are financed emissions considered within the broader context of risks driven by climate change?

Leading firms are considering financed emissions in the context of the overall level of climate change risk to the business. Climate change risk can manifest itself not only in the increasing frequency and severity of extreme weather events but through increasing transition risks as we move to a low-carbon economy. The potential imposition of a carbon tax is an example of a transition risk that could have a direct financial impact due to the emissions in a company’s portfolio. Another example would be the impact on a firm’s sustainability rating from external rating agencies that consider emissions levels as one of their rating factors.

What do firms do to develop a view of financed emissions?

Firms are digging into their entire portfolios, asset by asset, to build a full picture of their emissions intensity, a measure of emissions relative to the intensity of a specific activity or asset class that they support. Some portfolio companies may have already disclosed the emissions data required to complete the picture, but it’s likely that many have not.

To fill in the gaps, firms can engage a third-party data provider to acquire Scope 1 and Scope 2 emissions by sector and asset class as well as production-related data (emissions per kilowatt) of corporate securities and loans companies. Companies may also need to supplement this external data with estimates using industry emissions factors provided by sources such as the International Energy Agency (IEA). In practice, such industry estimates may diverge materially from emissions actually calculated by a company.

There are guidelines and industry alliances to help. The GHG protocol sets the foundation for measuring Scope 1 and 2 emissions and in some instances Scope 3, while the Partnership for Carbon Accounting Financials (PCAF) offers a methodology to assess and allocate GHG emissions associated with investments and loans, such as mortgages or car loans. In general, emissions allocated to financial institutions under PCAF methodology are based on the ratio of the investment in a company made by the financial institution divided by the enterprise value, including debt, equity, and cash, of the company.  This generally straightforward allocation principle can be difficult to implement in practice; company ownership structure, market price fluctuations, and  limited data are examples of challenges financial institutions may face when calculating their financed emissions.   In late 2021, the PCAF released new draft guidance covering additional asset classes (sovereign debt and green bonds), highlighting how quickly the financed emissions landscape can change.

Recognizing that there can be incomplete data available on emissions at a company or issuer level, it’s critical to first form a broad view of the firm’s financed emissions by calculating its share of emissions from lending or investing activities at the sector level. These are generally based on industry/sector-wide emissions factors. 

Expect to encounter gaps in emissions data and consider how to handle concerns that may arise on the quality of the data. The PCAF has developed a data hierarchy and scorecard that firms can use to understand the overall quality of their emissions data and to develop strategies for improvement. Financial institutions should continually strive to improve the quality of their financed emissions data. Engaging with portfolio companies to disclose emissions can support this goal.

How can a firm determine the level of action required to achieve its decarbonization targets?

This is the looming question. Once a financial services firm commits to decarbonize and develops an emissions baseline, there’s a range of portfolio management strategies they may deploy on the path to achieving their decarbonization ambition.

By applying the emissions data in the portfolio to projections of a decarbonization curve by sector and asset class, for instance, it’s possible to develop a view into the pace at which adjustments are needed to meet climate goals. Some sectors and asset classes are expected to decarbonize more quickly than others. For net-zero targets specifically, guidance developed by the Science Based Targets initiative (SBTi) outlines plausible trajectories for emissions reductions by sector over time to 2050. 

Expect to encounter gaps in projections that have been developed thus far for decarbonization rates. For example, SBTi has developed trajectories for six sectors, but oil and gas, one of the top GHG emitting sectors, is not included in those six.

The climate goal is set: What next?

After a firm’s financial institution has developed its baseline and set a decarbonization target for its financed emissions, it’s time to begin management of financed emissions.

It will be important to periodically refine the baseline emissions inventory as more portfolio companies report emissions data and as industry estimates refine. Portfolio managers steering a portfolio toward decarbonization will need to manage and monitor metrics and progress against targets. Getting buy-in from investment teams at the outset of the net-zero project can help with developing an execution framework that can meet the long-term goals. Perhaps most critically, financial institutions should ensure that the investment and credit professionals ultimately charged with managing financed emissions have the training and tools to consider these concepts in their day-to-day activities. With a decarbonization target set, a trained and engaged investment team, and an achievement plan in place, any firm can embark on the road to net zero.

Decarbonization through portfolio management

Strategy example

Potential impact on risk and return

(Re)invest in low-emissions assets

Greater diversification of climate risk within the portfolio

Allocate capital to sectors or companies decarbonizing at a faster pace

Lower risk of stranded assets

Engage with portfolio companies to help support their transitions

Improved prospects for long-term returns. More companies decarbonizing should equate to a lower risk of GDP contraction from climate disruptions


Higher short-term transactions costs

Four considerations for portfolio managers on reaching company climate goals

1. Attach a financial outcome to the emissions targets

Consider optimizing the emissions-reduction target against relevant financial indicators like risk adjusted return or duration matching. By doing so, managers can effectively attach a financial outcome to portfolio actions and gain insights into the embedded costs of reaching the decarbonization goals—and find ways to balance the trade-offs with traditional financial management objectives.

2. Establish growth rate and runoff assumptions

Expect portfolio growth and runoff rates to play an important part in achieving a decarbonization goal. Each can have an outsized impact on inventories of financed emissions. Managers may find that, with careful analysis, growth in high-emitting sectors can still fit within an overall decarbonization objective when balanced with growth in carbon-neutral assets. Similarly, for fixed term assets, decarbonization gains from the natural runoff of assets should factor in strategies.

3. Prepare to adjust strategies to rates of decarbonization

Assumptions about the rate at which the world (and the securities and loans of portfolio companies) decarbonize also factor in the drive toward a financed emissions target. Portfolio managers can assess various decarbonization trajectories to develop strategies that track actual emissions experienced against the target. Developing a plan for a variety of emissions pathways clears the way to act quickly when faced with the reality of progress against stated commitments.

4. Engage with portfolio companies

Working directly with customers and portfolio companies is one of the most effective ways that a financial institution can reduce its financed emissions footprint. The approach is championed by many organizations, including the SBTi. Engagement could allow for a lower level of portfolio management to achieve emissions goals.

How PwC can help

Standards for estimating financed emissions in pursuit of a carbon-reduction target within an investment portfolio are in their infancy. While we expect recent guidance from investor-led initiatives and net-zero projects to evolve in the coming months, there are processes and tools available today that provide resources for financial institutions to use in moving toward net-zero financed emissions.

PwC’s team of professionals with expertise in the emerging standards, methodologies and technologies can help firms move from ambition to action.

Contact us

Steve Bochanski

Climate Risk Modeling Leader, PwC US

Donald Reed

Managing Director, Finance Transformation, PwC US

Graham Hall

Director, Risk Modeling Services, PwC US

Adam Kallin

Senior Manager, Climate Change, PwC US

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