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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 decarbonization today are ahead of the game in a rapidly evolving sector.
There are several reasons for this fundamental trend, starting with the desire to limit exposure to the various risks induced by climate change and the company's low-carbon transition; but also the choice to differentiate ourselves from our competitors, and to respond to the demands of our stakeholders (employees, regulators, civil society...).
What does a financial fund for the low-carbon transition entail?
1. Regulatory constraints: climate reporting
Regulations on ESG criteria in finance have become increasingly complex since the beginning of the decade: the French TECV, the European SFDR, the Green Taxonomy... What are the obligations for financial companies today?
SFDR regulation (since March 2021):
The SFDR asks financial market players to publish how risks and "principal adverse impacts" - the main negative effects of their investments on sustainability - 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 features (article 8)
- With the aim of sustainable investment, i.e. investment in economic activities that contribute to an environmental or social objective (article 9).
This applies not only to financial market players, but also to all institutional investors, including credit institutions (banks, finance companies, etc.) and investment firms, which are covered by Article 29 of the French Climate and Energy Act, which reinforces the provisions of the SFDR.
The French Climate and Energy Act also stipulates that financial players with more than €500 million in assets or balance sheets must publish full information on :
- internal resources deployed
- climate alignment strategy
- ESG governance
For financial players below this threshold of 500 million euros, only general information on the inclusion of ESG criteria and the overall approach is expected in their 2022 reporting on the year 2021.
This information must be summarized in an annual report sent to ADEME and published on the company's website.
To date, there are no sanctions for companies providing incomplete information, but the prevailing rule is "comply or explain", i.e., for any element that is not explained, the reason must be given. In addition, the entity will be required to publish a continuous improvement plan setting out its plans for improvement and the associated timetable for implementation.
2. Measuring the portfolio's impact 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, concern 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?
- Measure the carbon footprint of scopes 1, 2 and 3 companies.
By knowing the emissions over the entire value chain of the companies held, the investor can know the emissions that can be attributed to him. The aim is to measure the emissions financed by 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, in the case of real estate, the emissions of the building are calculated, multiplied by the ratio between the outstanding amount and the original value of the property:
Building emissions x Amount outstandingOriginal value of the asset
The 6 PCAF calculation methods are shown below:
The Global GHG Accounting & Reporting for the Financial Industry Standard - Partnership for Carbon Accounting Financials (2020)
https://carbonaccountingfinancials.com/files/downloads/PCAF-Global-GHG-Standard.pdf
- And what if all the companies we invest in haven't yet carried out a carbon assessment?
Some companies have not yet drawn up a carbon balance sheet for all three scopes, making it 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 covering all 3 scopes.
However, as a first approximation, if you don't yet have precise 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 organization to obtain details on the nature of physical flows. These 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 include them in your carbon footprint?
These "avoided" emissions refer to emission reductions made possible by the activity, products or services provided by an organization. These emissions are compared with a reference scenario if they enable reductions outside the scope of their activity. For example, if you finance an electric bicycle start-up that will enable its users to do without a car and thus avoid emitting CO2 during their daily commute. Your funding will have effectively reduced emissions outside the organization's direct perimeter.
While you can measure these emissions, the carbon balance methodology specifies that these emissions cannot be accounted for in the carbon balance, i.e. avoided emissions cannot be subtracted from emitted emissions.
3. Developing a low-carbon strategy
- Set a target in line with the commitments of the Paris Agreements
SBTi, the reference player for low-carbon objectives published a Guide for the financial sector in February 2022, which you can find on their website.
To develop a credible target and keep your commitments, readour article on how to reach your SBTi target.
- Deploying your strategy within your portfolio
- Redirecting flows. One way of decarbonizing investments is to redirect financial flows towards low-carbon or even decarbonizing activities, which help to reduce society's emissions. The parallel is "divestment" of highly polluting activities, such as fossil fuels.
This approach aims to make access to capital for the most polluting sectors more difficult, and by applying it, investors participate in the overall transformation of society towards less carbon-intensive activities.
- Condition access to financing. Many financial players already require due diligence specific to ESG criteria. Financial players can go further by including a climate clause in the Term Sheet, and making access to funding conditional on the publication of a carbon footprint and climate strategy by the organization.
By developing your own climate analysis grid, you can differentiate between possible sources of financing and choose only those that correspond to your climate ambitions: does the organization have a business that is compatible with a +1.5°C world? Does it have a lower physical and economic carbon intensity than its competitors?
- Engaging with funded organizations. Investor engagement is an important lever for decarbonization, and investors can be key players in a company's low-carbon transition. By being a driving force behind a company's carbon strategy, and demanding monitoring and results in terms of climate performance, investors can make climate a central issue for organizations.
Conclusion
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 decarbonization, 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 organizations it finances.
Please don't hesitate to contact us if you have any questions about low-carbon finance!
