To manage climate-related risks and opportunities, financial institutions must first measure the carbon impact of their investment portfolios to meet the expectations of all stakeholders. The carbon emissions generated by a company’s investment activities are measured by so-called portfolio carbon footprinting.
This provides a useful tool for understanding a company’s exposure to climate change, which is useful for both internal and external stakeholders. It can be used as a baseline against which you can set net-zero decarbonisation targets that are aligned with climate science. Proper analysis is critical to ensure that you have the right targets and investment strategies to mitigate climate risks.
Effects on the financial sector
The awareness of the negative effects of climate change on our financial system is growing. Financial institutions are under increasing pressure to disclose the financial risk of climate change in their investment portfolios and to disclose how they intend to finance a carbon-free future.
Recent developments send a clear signal to financial institutions to act now and start building up capacity and knowledge on how to quantify and manage climate-related risks and opportunities. There are three leading initiatives:
- The Carbon Disclosure Project CDP introduced a sector-specific questionnaire for financial institutions in 2020. For the first time, companies are required to disclose their portfolio carbon footprint data at a granular level to investors and customers as part of their Scope 3 emissions reporting.
- The Science Based Targets Initiative (SBTi) is expected to publish a methodology for financial institutions to set science-based carbon reduction targets in the summer. The targets must be compared to a credible, robust basis for the carbon footprint of a portfolio.
- The recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) are due to become binding in the UK by 2022. The TCFD provides users with a framework for quantifying and disclosing the financial impact of climate on the company. For financial institutions, this includes an obligation to disclose portfolio carbon footprint metrics.
Principle of operation
A portfolio carbon footprint is based on collecting the right data and then measuring the carbon impact of investment portfolios. In summary, you collect the data, calculate the emissions using standard emission factors, normalise the data to make it comparable across the portfolio, allocate the emissions based on your investment level, and aggregate the results to calculate the portfolio’s overall carbon footprint.
However, complexity arises when trying to deal with large data sets and different methods for different asset classes. Other challenges that need to be considered are the limits of emissions, which will be included in the assessment. Scopes 1 & 2 should be included as a minimum, but Scope 3 data, if available, should be included as climate risks are often hidden in the broader value chain. Companies should also be transparent about the estimation methods they have used to fill data gaps in establishing the Portfolio Impact Footprint.