Is It Possible To Define Criteria For Net Zero Credibility For Financial Institutions?

The Science Based Targets Initiative (SBTi) has released a new consultation document as it develops a standard for financial institutions that set Net Zero targets. The document lays out the process by which SBTi will release the first version of its Financial Institutions Net Zero (FINZ) Standard next year.

One of the most important elements of SBTi’s FINZ Standard will be defining the ‘fair share’ contribution that the financial sector can make in line with a global Net Zero by 2050 target. For non-financial companies, the role of Net Zero targets is for them to reduce direct and value chain emissions at a rapid enough pace to make a global Net Zero pathway achievable.

Financial institutions’ key difference in pursuing Net Zero targets is that they face tools that could reduce their emissions without impacting real economy decarbonization. For example, a bank with a loan portfolio that mirrored its national economy could reduce its financed emissions simply by divesting from high-emitting assets. However, it is likely that the financing it withdrew would be replaced by financing from other banks, leaving the economy’s emissions only slightly reduced.

The SBTi guidance makes a distinction between what it terms ‘ambition’ in the short-term, measured by the number of Net Zero targets by the financial institutions’ customers, and ‘performance’ in the longer-term picking up the amount of emissions reductions that actually occur. The view in the consultation document is that ‘ambition’ will be more important in coming years but will become less important over time as evidence of success or failure in those targets becomes the driving force behind the credibility of financial institutions’ Net Zero targets.

The mechanism by which ambitions translate into performance are three-fold. First, the share of the institution’s portfolio invested in companies that should be financed – like those providing climate solutions such as renewable energy – should rise over time. Second, the share of companies that should not be financed such as new fossil fuel assets should be avoided. And finally, everything in the middle between those that are incompatible with Net Zero and those that are instrumental for its achievement will need over time to align with a Net Zero pathway excluding any carbon credits used for ‘neutralization’ of residual emissions.

The guidance includes strong points such as broad coverage for any financial activity over which a financial institution has ‘influence’ and the cap on emissions that can be excluded from the Net Zero target to 5% of total emissions. Despite the statement that SBTi seeks to “harmonize its boundary approaches to be consistent with the evolution of best-practice GHG accounting standards such as [GHG Protocol] and [the Partnership for Carbon Accounting Financials (PCAF)]”, the guidance seems to add another definition of financed & facilitated emissions – what it calls Scope 3, Category 15+.

The ’plus’ expands the definition beyond the GHG Protocol’s definition, which covers only equity financing and debt financing with known use of proceeds. SBTi says it “intends to expand on the definition of facilitated emissions proposed by the [PCAF] to cover a broader range of emissions that are facilitated through the services provided by a financial institution (e.g., capital markets and insurance underwriting activities)”.

The definition of Category 15+ broadens the coverage to include more emissions under the influence of the financial institution, which will lead to a more complete coverage. However, in the interim, it is possible it will create more confusion in reporting about financed emissions as it adds another set of screening that in some cases overlaps with PCAF while diverging elsewhere.

The sectoral coverage of customer Scope 3 emissions includes key sectors of agriculture; oil and gas; and forest, land and agriculture (FLAG), although ambiguously stating that financial institutions “shall follow the latest criteria and guidance of GHGP and PCAF” since those standards differ on whether to cover customer Scope 3 emissions and the timeline for phasing them all in.

The proposed Net Zero guidance from SBTi also has an ambiguous relationship with International Sustainability Standards Board (ISSB) S2 Climate Disclosure Standards released last week. That standard requires disclosure of Scope 3 emissions following the narrower GHG Protocol guidance – for example including only customer Scope 1 and 2 emissions – and will not automatically update if that standard is updated.

Efforts to translate global Net Zero pathways into credible Net Zero plans at financial institutions are difficult. As the SBTi writes in the consultation document: “Portfolio alignment can be considered a leading indicator, driving the action needed in the real economy, with portfolio emissions being a lagging indicator, representing the emissions reduction being achieved from having more aligned portfolios.”

At the company level, emissions reduction is often an easier thing to measure than ‘alignment’, which makes it challenging to assess the credibility of Net Zero plans. This challenge is magnified substantially when zooming out from one company’s progress to the Net Zero plan for a financial institution with an investment or loan portfolio, or with a more complex array of financed and facilitated emissions.