Many financial institutions don’t measure or report the vast majority of their emissions footprint

• CDP analysis finds that financial institutions’ financed emissions, which most don’t report, are 700 times larger than their operational emissions
• CDP highlights the importance of financed emissions as a source of risk that isn’t adequately measured or managed
• RFI Foundation has an ongoing series of reports focused on Islamic markets looking at where the financial sector’s emissions are concentrated

A new analysis from CDP has found that many financial institutions — banks, insurers, asset managers and asset owners — are failing to fully report on their financed greenhouse gas emissions. Where financial institutions reported full Scope 3 emissions, including financed emissions, these emissions were 700 times larger than operational emissions alone. The critical aspect of this reporting gap is that more financial institutions report primarily on their opportunities to provide green finance rather than the risks they face.

Financial institutions are providing green finance but they are not greening finance in a way that would reasonably address the credit and market risks they face from climate change. CDP has estimated these risks at more than $1 trillion. This is a major issue that RFI has dug into quite deeply over the past year.

RFI’s research brought us to the same conclusion as CDP’s — that financial institutions haven’t done enough yet to analyze and report on their financed emissions risks. In November 2020, RFI released the first report covering Malaysia in a series focused on Islamic markets, which was followed by a report on Indonesia, and we have several reports planned for launch over the coming months.

These reports get to one specific element of the credit and market risks that financial institutions and investors will face. We analyze quantitatively the size of emissions financed by different parts of financial sectors in Islamic markets. We also analyze from different angles, such as directly financed emissions, indirectly financed emissions (those induced by economic activities, especially in sectors with lower direct emissions intensity), and those generated by household purchases financed by banks.

RFI was motivated by a similar concern that drove CDP’s Climate Change Disclosure Questionnaire in 2020. There was a significant gap in what financial institutions were reporting. The gap is even more relevant to Islamic markets, most of which are considered emerging markets. The disclosure regimes aren’t always as rigorous as in developed markets and data that would be a key input to disclosures by financial institutions are not always available.

That lack of data, however, doesn’t mean there is a lack of risk from these financed emissions. The cost of future climate risk is being pushed forward by the mechanics of the Paris Agreement. Between now and 2030, the ambition of each country is supposed to ratchet up. Countries are setting new national targets this year, there will be a global stock take of emissions in 2023, and there will be a final national target update in 2025.

Within the next 2–3 years, there will be a much clearer picture emerging of the likelihood of having an orderly transition to meet the Paris Agreement targets or whether the transition will become disorderly. The policy response — or lack of response — will be increasingly factored into investors’, banks’ and insurers’ valuations of different businesses and assets. The policy ratchet will make the cost of emissions rise from (in many countries) zero through direct policies, stronger regulation of emissions, or in some cases imported through other countries’ carbon border adjustments.

The insight that the CDP has highlighted is that financial institutions aren’t recognizing that challenge. Half (49%) of the financial institutions responding to CDP’s questionnaire said they “do not conduct any analysis of how their portfolio impacts the climate at all” and only 25% of disclosing financial institutions report their financed emissions. There are many ESG issues that need attention from the financial sector and many of them are impacted by climate change or climate change mitigation. For financial institutions that are among those not factoring in their financed emissions to their overall risk management, as well as those not disclosing these emissions, the time for action is now.

Want to learn more about how RFI Foundation can help you identify your biggest opportunities in responsible finance? Contact us for more information through our Membership Page or by email at info@rfi-foundation.org.

Republished from the RFI Foundation’s weekly newsletter. Subscribe for free here!