Why is PCAF Important?
Financial institutions have a huge role to play in funding the global transition to a low carbon economy. As banks, asset managers and other financial entities attempt to decarbonize their operations under commitments such as the Glasgow Financial Alliance for Net Zero (GFANZ) and The Net Zero Asset Managers Initiative. They are under increasing pressure to accurately measure not only their direct and indirect operational emissions (Scope 1, 2 & 3) but their financed emissions as well (Scope 3).
Considering financed emissions account for over 99% of financial institutions' emissions, accurately measuring them will be integral for financial institutions to meet these goals. To measure financed emissions, financial entities take attribution of the emissions from a proportion of their loans, debts, and investments. Large financial institutions often have millions of loans, investments, or debt holdings, which make the collection and calculation of data a complex process.
To ensure the correct data is collected and calculated, the Greenhouse Gas Protocol created the “Scope 3: category 15 investments” category, which is a calculation methodology for measuring financed emissions. However, this calculation method had an underdeveloped level of detail for financed emissions calculations, which is why in 2019 the Partnership for Carbon Accounting Financials (PCAF) was adopted as a global standard calculation methodology for financed emissions.
PCAF Asset Classes
The PCAF initiative introduced a globally accepted standard for the measurement and disclosure of financed emissions and currently provides in-depth methodological guidance to measure and disclose the GHG emissions of the following seven asset classes:
Listed Equity & Corporate Bonds - This asset class is defined as all listed corporate bonds and all listed equity for general corporate purposes (i.e., unknown use of proceeds) that are traded on a market and are on the balance sheet of the financial institution. Including:
- All types of corporate bonds for general corporate purposes
- Common stock
- Preferred stock
Business Loans and Unlisted Equity - This asset class is defined as all business loans and equity investments in private companies (i.e., unlisted equity). Business loans include all loans and lines of credit for general corporate purposes (i.e., unknown use of proceeds) to businesses, nonprofits, and any other structure of an organization that is not traded on a market and is on the balance sheet of the financial institution. Unlisted equity includes all equity investments for general corporate purposes (i.e., unknown use of proceeds) to businesses, nonprofits, and any other structure of an organization that is not traded on a market and is on the balance sheet of the financial institution.
Project Finance - This asset class is defined as loans or equities to projects for specific purposes (i.e., with known use of proceeds) that are on the balance sheet of the financial institution. The financing is designated for a defined activity or set of activities, such as the construction and operation of a gas-fired power plant, wind or solar project, or energy efficiency projects.
Commercial Real Estate - This asset class is defined as on-balance sheet loans for the purchase and refinance of commercial real estate (CRE), and on-balance sheet investments in CRE. This implies the properties are used for income-generating activities, and commercial activities, such as retail, hotels, office space, industrial, or large multifamily rentals.
Mortgages - This asset class is defined as on-balance sheet loans for specific consumer purposes (i.e., the purchase and refinance of the residential property), including individual homes and multifamily housing with a small number of units. This definition implies that the property is used only for residential purposes and not for income-generating activities. Mortgages used to construct or renovate a house are not required at this point given that the homeowner does not directly account for construction emissions.
Motor Vehicle Loans - On-balance sheet loans and lines of credit for specific (corporate or consumer) purposes to businesses and consumers that are used to finance one or several motor vehicles. This methodology does not prescribe a specific list of vehicle types falling within this asset class; instead, it leaves it open for financial institutions to decide and define what vehicle types to include in their inventory of financed emissions.
Sovereign Debt: This asset class is defined as sovereign bonds and sovereign loans of all maturities issued in domestic or foreign currencies. Both sovereign loans and bonds lead to the transfer of funds to the country, which in turn creates a debt obligation to be repaid by the borrowing country.
Asset Class Calculation Methodology
Each asset class has a specific methodology to accurately measure emissions. All of these consider different scopes, require different data sets that have different levels of validity, and have different calculation methods.
To illustrate the extent of the data needed for each asset class, an overview of the process for Listed Equity and Corporate Bonds is featured below:
Financial institutions shall report borrowers’ and investees’ absolute scope 1 and scope 2 emissions across all sectors. Reporting borrowers’ and investees’ scope 3 emissions will be phased in as a requirement, starting with sectors anticipated to have significant emissions (e.g., oil & gas). When scope 3 emissions are reported, they shall be reported separately.
Financial institutions should use the highest quality data available for calculations and improve the quality of the data over time. There are 3 options for calculating emissions for this asset class and 7 potential data sources:
As a basic attribution principle, the financial institution accounts for a portion of the annual emissions of the financed company determined by the ratio between the institution’s outstanding amount (numerator) and the value of the financed company (denominator).
As the global transition to a low carbon economy picks up speed, financial institutions accurately measuring financed emissions will give them a better idea of where their emissions are coming from, enabling them to make better decisions in reducing them.
Keen to learn more? Check out our new guide on the PBAF Standard.