Financial institutions are learning to protect investors–and themselves–from investments exposed to risk from climate change.
As the country reflects on the anniversary of the fall of Lehman Brothers and the subsequent bailouts of major banks, pressure is mounting for financial institutions and companies to more fully disclose their investment risks, especially those risks from climate change.
Investments in carbon-intensive projects are no longer a safe bet. Companies, under pressure from shareholders, have been pulling support and cancelling plans to construct new coal plants. Two years ago, in a move that showed increasing concern for investments in heavily polluting industries, top investment banks participated in a leveraged environmental buyout of TXU, a major Texas power company, which meant dropping 8 out of 11 planned coal plants. New York has required energy companies to disclose their climate change risk exposure to investors, and The National Association of Insurance Commissioners has adopted new mandatory requirements that insurance companies disclose the financial risks they face from climate change as well. And in the U.K. banks are under pressure to report their emissions from investments after revelations that taxpayer dollars were potentially bankrolling highly polluting projects.
As WRI’s new issue brief Accounting for Risk shows, there are powerful incentives for financial institutions to manage their environmental risk, whether it’s for reputational reasons or to insulate their shareholders from climate change risks.
But before a company can reduce its greenhouse gas (GHG) emissions, it must first know what those emissions are and where they come from. That’s the idea behind the Greenhouse Gas Protocol, the most widely used accounting tool for companies to track, quantify, and then manage their GHG emissions.
The GHG Protocol has become the international standard, used by top corporations, NGO’s, government agencies, and other organizations. However there is one sector that can fall through the cracks: financial institutions.
Here’s how it happens. Per the GHG Protocol Corporate Accounting and Reporting Standard, companies can choose whether to report emissions (1) based on their ownership in a company or project, or (2) based on companies that they financially or operationally control. Most financial institutions choose to report emissions only from entities or projects that they operationally control, including emissions from sources like purchased energy for building operations or company-owned cars. For a typical financial institution these emissions are relatively insignificant.
For financial institutions using “operational control” as the institution’s boundary for measuring its emissions could be problematic or even misleading. For example, by using this reporting method, emissions from investments in coal plants, or lending to oil and gas companies would not be reported, giving investors an incomplete understanding of the institution’s carbon impact.
Citigroup, one of the few companies that reports on emissions from some project financing, gives us a rare glimpse into just how much other companies could be underreporting. In 2007, Citi reported its total environmental footprint (scope 1 and 2) at about 1.4 million metric tons of CO2, but estimated its share of CO2 emissions from financing just two thermal power plants to be almost 200 million metric tons of CO2 (~3.3 million metric tons on an annual basis based on a 60 year life). That’s a big difference, and, like Citigroup, most other financial institutions’ traditionally reported scope 1 and 2 emissions will be tiny when compared to their share of emissions from investments.
These discrepancies show why it’s necessary to develop specific guidelines to help financial institutions report their full GHG emissions consistently and accurately. The World Resources Institute has taken the first steps with Accounting for Risk, a new issue brief that gives an overview of options for companies looking for better reporting options.
The report makes a strong case for why financial institutions should both measure and report the GHG emissions in their investment portfolios. One is the matter of reputation. Institutions can get a lot of mileage from being leaders in GHG accounting, and proactively branding themselves as transparent and eco-conscious. In general, stakeholders have applauded institutions that allocate less capital to dirty sectors and more capital to clean sectors. In a conversation with representatives from Citigroup, Valerie Smith, Vice President of Corporate Sustainability, told us that their decision to report “really came out of stakeholder requests, and there has only been positive feedback.”
Better accounting is also smart for business. By fully tracking “investment related emissions,” these institutions can manage their climate-risk exposure and become more aware of carbon-intensive holdings and potentially bad investments. It’s important for an institution to have a clear picture of its total emissions, especially if pending legislation puts a price on carbon. According to Courtney Lowrance, Vice President of Environmental and Social Risk Management at Citi, “A big business case for [reporting] is that it really gets the institution thinking about carbon risk. And the first step in doing that is understanding how to calculate it.”
“Standard guidelines would absolutely help,” adds Eliza Eubank, Assistant Vice President of Environmental and Social Risk at Citi. “It always helps to be able to make apples to apples comparisons. If everyone is finding their own way and designing their own methodology, then you really don’t know how to compare different numbers that different people are putting out there.” Without guidelines, deciding what and how to report, “can be a very dicey issue.”
As consensus grows for the need for updated guidelines, WRI’s next step is to convene stakeholders (including banks, accounting firms, consultants, NGOs, and funders) and develop a strategy for implementing more specific GHG reporting standards. The success of the GHG Protocol shows that this approach can work, and WRI hopes these next steps will keep the GHG Protocol tools and standards relevant and effective for a broader range of organizations.
In 2007, Citi changed its reporting methodology from reporting based on a proportion of the total debt capitalization of a project, to reporting based on a proportion of the total capitalization of the project. The 192.8 million metric tons of CO2 reported in 2007 is based on the Citi’s proportion of total debt capitalization over the 60 year lifespan of the projects. Based on the new methodology, the proportional share of total capitalization is 79.5 million metric tons, or ~1.3 million metric tons annually. While lower, this is still close to Citi’s reported operational emissions for the entire year.
Shally Venogopal is a Research Analyst in the Capital Markets team at WRI.