By Dhruba Purkayastha and Labanya Prakash Jena

Post COVID19, Indian financial regulators, particularly the Reserve Bank of India (RBI) and the Securities & Exchange Board of India (SEBI), developed a slew of climate change guidelines and norms focusing on Disclosure as a means to help attain the transparency required for market incentives to operate efficiently.

Financed emissions, and why is it critical?

A critical point on Disclosure is ‘financed emissions’ which, in essence, represents greenhouse gas (GHG) emissions produced as an end result of the investments or loans provided by banks and financial institutions. This is a pre-requisite to understanding the climate-related transition risk of loans and investments; in other words, how loans and investments by banks and FIs contribute to GHG emissions. The Greenhouse Gas Protocol classifies financed emissions under the Scope 3 emissions category meant for banks and financial institutions. Scope 3 includes indirect emissions of an organization excluding the purchase and use of electricity, steam, heating, and cooling.

SEBI’s Business Responsibility and Sustainability Reporting (BRSR) on climate-related regulation is restricted to the top 1,000 companies by market capitalization, and by Scope 1 and Scope 2 emissions. Although several banks and financial institutions come in the top 1,000 list, this regulation mandates companies to disclose only their Scope 1 and Scope 2 emissions, leaving out Scope 3 where their real emissions are. Scope 3 emissions contribute an average of 95% of the total financed emissions of banks and financial institutions—a staggering indicator of its significance in climate change.

To add to this, RBI’s recent Report on Currency and Finance suggests that the exposure of Indian banks to high energy-intensive sectors like generation and distribution of energy (utility sector) and industrial sector (steel, cement, and chemicals) is relatively high. Besides this, Non-Banking Financial Companies (NBFCs) provide approximately 50% of their gross credit to carbon-intensive power and automobile segments. Moreover, around 6% of NBFC credit is exposed to Micro, Small, and Medium Enterprises (MSMEs) that typically depend on conventional fuel.

Since it is not mandatory for banks and financial institutions to disclose Scope 3 emissions, it is challenging to quantify financed emissions in the financial system. Also, borrowers or investee companies do not disclose Scope 3 emissions even if they are bound to follow the BRSR framework. MSMEs that do not come under BRSR, are also not mandated to disclose GHG emissions. Effectively, it becomes extremely difficult for banks and FIs to assess financed emissions. This, despite the fact that climate change is considered a systemic risk to the financial system. Moreover, it is not possible for equity investors and bondholders or even regulators of these institutions to differentiate among financiers on the basis of the carbon intensity of loans and investments.

The need of the hour

Mandatory financed-emissions disclosure by banks and FIs is the need of the hour. A light format of BRSR for MSMEs, at least limited to GHG emissions, could be followed. Another method to assess GHG emissions could be to consider an industry average of GHG emissions, multiplied by the capacity or revenue of the borrower. These changes will bring about greater transparency on the role of banks and FIs in GHG emissions, and how it has changed over time. It will help policymakers, regulators, and the public have a better understanding of how capital is contributing to GHG emissions. Financial regulators can also better assess the transition risks of banks and FIs through their financed emissions disclosures. This in turn will nudge banks and FIs to reduce their exposure to carbon-intensive sectors and divert their capital to low-carbon businesses. It would also help banks and FIs measure the carbon intensity of their portfolios, and use it as a baseline to set carbon reduction targets.

The Partnership for Carbon Accounting Financials (PCAF)—an international coalition of financial institutions—has developed a harmonised accounting approach for FIs to assess and disclose the GHG emissions associated with their loans and investments.

The PCAF standard is considered the de facto standard for measuring GHG emissions associated with financing activities; it is endorsed by the GHG Protocol and is referenced in the Task Force on Climate-related Financial Disclosure (TCFD) supplementary guidance (now a part of the International Sustainability Standards Board formed by IFRS Foundation) for the financial industry. The first step of the methodology is calculating the absolute emissions of the entity being lent to or invested in. The financed emissions can be calculated by multiplying an attribution factor. The attribution factor represents the financial institution’s proportional share of lending or investment in the borrower or investee. For example, A bank has lent to a company with a total enterprise value (total equity +debt) of 100 crore and the company is generating 1,000 GHG tons. The bank’s outstanding loan amount is5 crore. The financed emissions of the bank will be 200 GHG tons (attribution factor – 20%).

Reporting and disclosure of financed emissions is of critical importance to enable financial regulators and policymakers to assess the quantum of financial assets exposed to climate change risk, thereby allowing them to make informed and appropriate climate-friendly decisions.

The authors Dhruba Purkayastha, India Director, Climate Policy Initiative, and Labanya Prakash Jena, head, Centre for Sustainable Finance, Climate Policy Initiative

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