The Accounting Flaw at the Heart of ‘Financed Emissions’

Article content

(Bloomberg) — A frequent critique of carbon accounting is that Scope 3 emissions, those that arise from a company’s customers and supply chains, are essentially double-counted.

Since one company’s Scope 3 emissions are comprised of other companies’ Scope 1 emissions, which are those that occur from sources controlled or owned by an organization, by definition Scope 3 accounting involves multiple actors counting the same emissions.

Article content

And when it comes to the financial industry, it gets worse. The way in which investors calculate emissions they are responsible for having financed — the Scope 3 category most relevant to asset managers and banks — can allow for even more layers of duplication. So says Richard Manley, chief sustainability officer at CPP Investments, the $632 billion investment arm of the Canada Pension Plan. (Financed emissions cover the greenhouse gas pollution enabled by financial activity — namely lending and investing.)

“The emission is only emitted once, but by overlaying investments and loans to companies in the same value chain, you start to double, triple and even quintuple-count the same emission,” Manley said. But of course, investors also can use this dynamic to their own, greenwashing advantage — claiming multiple times their actual emissions reductions, he said.

To make his point, Manley poses this hypothetical:

• Imagine an investor that holds shares of Vinci SA, an owner and operator of airports; TotalEnergies SE, an energy company and jet-fuel supplier; airline Air France-KLM and aircraft manufacturer Airbus SE, plus a host of other big corporates who send their employees on overseas business trips.
• For every ton of carbon that’s emitted from an Air France A350 plane that takes off from Vinci’s Lyon-Saint Exupéry airport, that investor would count its share of Air France’s Scope 1 emissions (those generated from aircraft engines), TotalEnergies’s downstream Scope 3 (as Air France is its customer), Vinci’s Scope 3 (as it operates the airport), Airbus’ Scope 3 (as Air France is its customer) and the Scope 3 from business travel of all the companies that have passengers on the plane.
• Conversely, the day (if it ever comes) that a plane takes off from Lyon powered by a zero emissions fuel, the emissions of Air France, TotalEnergies, Vinci, Airbus and business travelers would all go away, meaning the investor could claim a fivefold reduction in financed emissions for each ton of emissions reduced in the real world.

Article content

Article content

Manley’s synopsis feeds into a broader discussion around the potential disconnect between the real economy and the financial economy. A question that’s increasingly being asked by financiers is what’s the utility of targets tied to and disclosures of financed emissions?

Although the financed emissions’ metric has become the primary yardstick for measuring the financial industry’s progress on climate goals, it’s been shown to be misleading, and even deeply flawed, due to its volatility and sometimes counterintuitive results.  

And Manley isn’t the only one raising the issue. When the Institutional Investors Group on Climate Change published its updated net zero guidance for fund managers last month, it said it aimed to “better support” an emphasis “on ‘financing reduced emissions’ rather than ‘reducing financed emissions.’”

That small change in wording reflects a big shift in world view.

“Fixating on a linear reduction of financed emissions is misguided at best, and at worst, it can starve climate solutions of funding, as they may come with an upfront short-term increase in emissions to enable a dramatically positive impact over time,” said Adrian Fenton, senior investor strategies program manager at IIGCC in London.

Article content

Manley’s aviation example is just a hypothetical. But similar examples in other sectors are already happening, allowing for the overstatement of emissions reduction, he said.

Take selling stuff on the Internet:

• An investor would report the Scope 1 emissions of the freight-forwarding companies they own, the downstream Scope 3 of the truck manufacturers in their portfolios that ship the goods, the downstream Scope 3 from the fuel consumed for shipping and the online retailer’s and the product manufacturer’s Scope 3 from transportation.
• But given the increasing electrification of the transportation industry, these emissions could all go away. That’s potentially another five-times reduction in financed emissions.

“There are many ways to optimize financed emissions” that do nothing to address actual emissions in the atmosphere, Manley said. What investors need to do is “focus on absolute emissions” so as “to reduce climate risk in the real economy.”

Sustainable finance in brief

There’s yet more evidence that the combined efforts of Big Oil, the industrial lobby and Republican politicians are successfully crushing ESG in America. And in Europe, now that companies are less able to greenwash their way to an ESG gold star, they’re backing away as well. At some of the world’s biggest asset managers, ESG fund launches are stalling. BlackRock Inc., Deutsche Bank AG’s DWS Group, Invesco Ltd. and the asset management arm of UBS Group AG are among firms that have cut the number of new funds with environmental, social and governance mandates. This year through the end of May, just over 100 ESG funds were launched globally, putting the industry on track to fall well short of levels seen in recent years, the data show. 

• US Vice President Kamala Harris may end up being tougher on the fossil fuel industry than President Joe Biden.
• Russia needs to ramp up liquefied natural gas exports to fund its war on Ukraine. Western pension funds may be helping.
• T. Rowe Price Group Inc. is targeting a corner of the sustainable debt market that it sees growing fast over the next decade: blue bonds.

Article content