ESG is a broad topic. Whilst theoretically, it may seem simple: environmental, social and governance – the reality of it is the opposite. There is an abundance of disclosure standards designed to help companies measure and report the carbon footprint and other sustainability impacts. Some have called this the ‘alphabet soup’ of ESG standards, referring to the confusion stemming from the abbreviations and acronyms of the standards organisations. However, despite the confusion to those who are unfamiliar with the landscape, change must take place now.
Tim Mohin is the chief sustainability officer for Persefoni. Formerly, Mohin served as chief executive of the Global Reporting Initiative; he also held sustainability leadership roles with Intel, Apple, and AMD and worked on environmental policy within the US Senate and Environmental Protection Agency. He is the author of ‘Changing Business From the Inside Out: A Treehugger’s Guide to Working in Corporations’.
Mohin argues that there is no time to lose whilst companies try and work out how their ESG standards either are or are not effective in helping climate change. He argues that a new coalition, PCAF will simplify things enabling transparency, comparability, and accountability for the carbon impacts of financial transactions for over 100 financial institutions:
Anyone following the ascendent world of ESG (environmental, social and governance – also known as sustainability) is aware of the abundance of disclosure standards out there designed to help companies measure and report the carbon footprint and other sustainability impacts. Some have called this the ‘alphabet soup’ of ESG standards, referring to the confusion stemming from the abbreviations and acronyms of the standards organisations. As the former CEO of the Global Reporting Initiative (GRI) — the most widely adopted sustainability disclosure standard — I used to bristle at this characterisation. But, unless you are a true insider, it is natural to be confused by the crowded landscape.
While the world waits for the inevitable consolidation of ESG reporting frameworks, a new standard has arrived: Partnership for Carbon Accounting Financials (PCAF) — and it might just be the most important one yet in the fight against global climate change.
PCAF is a coalition of more than 100 large financial institutions, including Bank of America, Citibank, and Morgan Stanley, collectively managing more than $38trillion in total assets. Working with climate-oriented nonprofits, PCAF developed a consensus approach to assess and disclose the carbon impacts associated with loans and investments. As an open-source accounting standard, it enables transparency, comparability, and accountability for the carbon impacts of financial transactions.
For example, when an investor buys shares in a company, they are essentially buying a portion of their carbon footprint. The PCAF standard provides a method for that investor to measure – and importantly, manage – the carbon impacts associated with its portfolio of investments. And the standard covers more than just one kind of investment; it includes formulas to allocate the carbon associated with transactions in six asset classes: listed equity and bonds, mortgages, business loans, motor vehicle loans, project finance, and commercial real estate.
The potential of PCAF
The implications of this standard are monumental. Because the financial community essentially manages the flow of capital through the economy, they can fund the transition to a low-carbon economy. But they can only do this if they have visibility of the climate impacts of their financial transactions – also known as their “financed emissions.”
A recent report from the climate nonprofit CDP (formerly the Climate Disclosure Project) revealed that the carbon emissions associated with financial institution’s investing, lending, and underwriting activities are more than 700 times higher than the emissions from their own operations. Yet only one in four financial services firms report on these financed emissions, in part because they don’t yet have the tools, frameworks and technology necessary to do so. That’s changing thanks to PCAF.
The Organisation for Economic Co-operation and Development (OECD) estimates that $6.9trillion of infrastructure investment is needed each year until 2030 to meet the goals of the Paris Agreement. Applying the PCAF standard to financial transactions will shine a light on the investments needed to fund the low-carbon transition.
Unleashing the power of PCAF
Ultimately, it’s a data problem. While the PCAF standard provides an accepted formula to calculate financed emissions, financial services firms can make millions of transactions per year involving a myriad of companies across all industrial sectors. In many cases, the transactions are made by computers and the investment can be quite short-term.
State of the art information technology is needed to integrate the PCAF standard into the data engines used by the world’s largest finance companies. That’s part of what drew me personally to join the team at Persefoni, a carbon accounting software firm that has encoded the entire PCAF standard. With this kind of information technology, portfolio managers can incorporate carbon risks into their investment algorithms. And, as carbon risk is priced into the models, the follow of capital will be diverted to a low carbon economy. This is huge; it can literally change the world.
Funding the transition
Will this change be enough? Climate scientists warn that we have about ten years to take action to avoid the worst effects of climate change.
With the US back in the Paris Climate Accord, and the G7 inching toward mandatory climate disclosure, governments are poised to act. This year’s climate meeting (COP26) in November is shaping up to be a turning-point for new, more stringent policy in the climate area.
Even without new government mandates, investors will continue to pressure their portfolio companies to reduce their climate-related risks. Pressure is one thing, divestment is another. With the PCAF standard integrated into their investment decisions, financial firms will begin to put their money where their mouth is. But there is a lot of work to be done: since the Paris Agreement was signed in 2015, banks like JP Morgan Chase, CITI and Wells Fargo have pumped more than $3.8trillion into the fossil fuel industry.
Complex, global problems like climate change require complex, global solutions. Government mandates, better standards and carbon-aware investment are three of the most important levers in the fight against climate change. And, while the PCAF standard may be flying under the radar, it could be the most important tool in the toolbox to fund the transition to the low carbon economy we need to sustain this planet.