Financial players are destined to become major players in the low-carbon transition, and while European and French regulations are gradually framing this transition, funds that commit to a decarbonisation approach today are ahead of a rapidly evolving sector.
There are several reasons for this underlying trend, starting with the desire to limit its exposure to the various risks induced by climate change and the company's low-carbon transition; but also the choice to differentiate itself from its competitors and to respond to the demands of stakeholders (employees, regulators, civil society, etc.).
What is the commitment of a financial fund for the low-carbon transition?
1. Regulatory constraints: climate reporting
The regulations on ESG criteria in finance have become increasingly complex since the beginning of the decade: French TECV, European SFDR, Green Taxonomy... What are the obligations for financial companies today?
The SFDR Regulation (since March 2021) :
The SFDR asks financial market players to publish how risks and "principal adverse impacts", i.e. the main negative sustainability impacts of their investments, are taken into account.
With this new regulation, financial products are classified into three categories that determine their sustainability objective:
- Without sustainability objective (Article 6)
- With environmental or social characteristics (Article 8)
- With the objective of sustainable investment, i.e. investment in economic activities that contribute to an environmental or social objective (Article 9)
This concerns not only financial market players, but also all institutional investors, including credit institutions (banks, finance companies, etc.) and investment firms, which are covered by Article 29 of the Climate and Energy Act, which reinforces the provisions of the SFDR.
The French Climate and Energy Law also specifies that financial actors with more than €500 million in assets or balance sheet must publish full information on :
- the internal resources deployed
- the climate alignment strategy
- ESG governance
For financial actors below this threshold of 500 million euros, only general information on the consideration of ESG criteria and the overall approach is expected in their 2022 reporting for the year 2021.
This information must be summarised in an annual report sent to ADEME and published on the company's website.
No sanctions are currently planned for companies that provide incomplete information, but the prevailing rule is "comply or explain", i.e. for any element that is not explained, it is necessary to give the reason. In addition, the entity will have to publish a continuous improvement plan to present its avenues for improvement and the associated implementation schedule.
2. Measuring the impact of the portfolio on climate change
When we think of measuring climate impact, we think of the carbon footprint, i.e. the measurement of greenhouse gas emissions resulting from an entity's activity. In the case of funds, there are of course emissions that can be linked directly to operational activities: energy consumption for offices, fuel consumption for employee travel, etc. However, the bulk of these emissions, and the most important part of climate impact measurement, concerns financial flows. It is therefore necessary to measure the emissions associated with the portfolio in order to take stock of the current situation and make informed decisions. How to measure the emissions of securities held?
- Measuring the carbon footprint of companies held in scopes 1, 2 and 3.
By knowing the emissions across the value chain of the companies owned, the investor can know the emissions that can be attributed to him. The aim is to measure the emissions financed from the share of capital held.
If you own 20% of a company that emits 100,000 tCO2e per year (scope 1, 2 and 3), the emissions associated with this investment will be 20,000 tCO2e.
Depending on the type of financial product involved, the Partnership for Carbon Accounting Financials(PCAF) has identified different types of calculation elements. For example, for real estate, the emissions from the building are calculated, multiplied by the ratio between the outstanding amount and the original value of the property:
Emissions from the building x Outstanding amountOriginal value of the asset
Below are the 6 methods of calculating the PCAF:
The Global GHG Accounting & Reporting for the Financial Industry Standard - Partnership for Carbon Accounting Financials (2020)
- What if all the companies invested have not yet carried out a carbon assessment?
Some companies have not yet completed a carbon footprint on all three scopes, and it is therefore difficult to estimate the emissions attributable to the investor. As an investor, you can ask the company to carry out a carbon assessment, or even make your new investments conditional on the completion of a carbon assessment on all three scopes.
However, as a first approximation, if you do not yet have accurate carbon footprint information, the company's main physical data can be used to estimate the order of magnitude of emissions. A questionnaire can be sent to the organisation to obtain details of the nature of the physical flows. This data can be supplemented by an estimate based on accounting data, but this approach is no substitute for a full carbon footprint.
- Can we account for avoided emissions, or "positive carbon impact"?
Do you invest in green energy, finance projects with an environmental impact, and would like to count them in your carbon impact?
These "avoided" emissions are the emission reductions enabled by the activity, products or services provided by an organisation. These emissions are compared to a baseline scenario if they enable reductions outside the scope of their activity. For example, if you fund a start-up that provides electric bicycles that allow users to avoid using a car and therefore avoid emitting CO2 during their daily commute. Your funding will have effectively reduced emissions outside the direct scope of the organisation.
While you can measure these emissions, the carbon footprint methodology specifies that you cannot count these emissions in the carbon footprint, i.e. you cannot subtract avoided emissions from emitted emissions.
3. Developing a low carbon strategy
- Set a target in line with the commitments of the Paris Agreements
The SBTi, the leading actor for low carbon objectives, published a Guide for the financial sector in February 2022, which you can find on their website.
In order to develop a credible target and keep your commitments, you can readour article on how to reach your SBTi target.
- Deploying your strategy within your portfolio
- Redirecting flows. One way to decarbonise investments is to redirect financial flows to low-carbon or even decarbonising activities that help reduce society's emissions. The parallel is "divestment" of highly polluting activities, such as fossil fuels.
This approach aims to make it more difficult for the most polluting sectors to access capital, and by applying it, investors participate in the overall transformation of society towards less carbon intensive activities.
- Condition access to financing. Many financial actors already require specific due diligence on ESG criteria. Financial actors can go further by using a climate clause in the Term Sheet, and by making access to funds conditional on the publication of a carbon footprint and a climate strategy by the organisation.
Developing your own climate analysis grid makes it possible to differentiate between possible financing and to choose only those that correspond to your climate ambitions: does the organisation have a business that is compatible with a world at +1.5°C? Does it have a lower physical and economic carbon intensity than its competitors?
- Engaging with funded organisations. Investor engagement is an important lever for decarbonisation, and investors can be key players in the low-carbon transition of companies. By making proposals on the company's carbon strategy and requesting monitoring and results on the evolution of climate performance, investors can make climate a central issue for organisations.
Green finance is at the heart of the debate with the advent of new tools at its service, green bonds, green funds, labelled funds... And in this structural trend towards decarbonisation, investors can anticipate regulatory changes by relying on investment strategies that fully integrate climate issues, like Blackrock, which uses its shareholder rights to assert its climate ambitionswith the organisations it finances.
Do not hesitate to contact us if you have any questions about low-carbon finance!