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Carbon Accounting Gets a Banking Boost

Three banks commit to greater transparency on climate-risk exposure

August 2020

Hardly a day goes by without major news about climate risk and how companies are responding to it. Amid this onslaught it can be hard to spot what’s truly significant.

In recent weeks, a group of investors sounded the alarm about the financial risks of climate change, Microsoft’s billion-dollar climate innovation fund joined a coalition to support investment in climate solutions, and Apple made a pledge to be carbon neutral within ten years.

While these announcements grabbed the headlines, what caught our eye was one that drew less fanfare. Investment firm Morgan Stanley said it joined the Partnership for Carbon Accounting Financials, becoming the first major US financial institution to join the 66-member group. Bank of America and Citi joined just days later.

Sure, accounting might seem boring to the average person. But it is the grease in the machine, the stuff that turns the wheels of commerce. Financial accounting makes the modern economy possible, by setting out principles and standards. In much the same way, an agreed methodology for carbon accounting can improve transparency about climate risk, attract investment, and speed the transition to a low-carbon economy.

Benefits for banks and investors

Formed in 2019, the PCAF aims to standardize carbon accounting for the financial sector, which would enable firms to assess and disclose the greenhouse gas emissions financed by loans and investments.

It’s an ambitious undertaking, but it could bring greater transparency about climate risk to bank balance sheets. Indeed, the TCFD emphasized the important role of the financial sector in assessing climate risks and making sound capital allocation decisions, and the task force developed specific guidance for banks, insurers, asset managers, and asset owners, such as pension funds.

Better carbon accounting can also help financial firms improve their scenario modeling as they assess climate risk, a practice that has been slow to take off. A 2019 update from the TCFD said few companies were using scenario modeling, and underscored the need for companies to use it to “assess the resilience of their strategies under a range of plausible future climate states.”

We’ve found that some US companies have made a start on scenario modeling, despite its complexity. Our September 2019 report (“The State of Climate Risk Disclosure: A Survey of US Companies”) noted that 44% of the companies we surveyed use scenario modeling or stress testing to assess climate risks. With stronger carbon accounting tools, more companies will adopt the practice and their reports will be more detailed and useful to investors.

A boost for carbon accounting

The steps by the US banks are a vote of confidence in the PCAF, which has been under the radar and led by smaller asset managers and commercial banks, mainly in Europe. But the involvement of top US banks could be significant in other ways, too.

For one thing, these firms can supply considerable analytic horsepower and research expertise, which would help the PCAF refine its methodology and extend it to more asset classes than it covers today. The banks also bring a wealth of knowledge and relationships from across the US financial ecosystem, including trade groups, regulatory organizations, and advisory bodies. For example, Morgan Stanley has a presence on the Investor Advisory Council of the Financial Accounting Standards Board (FASB), which sets the accounting rules for public and private companies.

Looking down the road, it’s intriguing to think about how these banks’ knowledge of distributed ledger (blockchain) technology might come into play, too. A robust carbon accounting system paired with a distributed ledger could create an efficient, inexpensive way to manage portfolios of carbon assets comprising offsets, permits, and credits. Carbon pricing or taxation (a possibility after the November elections) could give it momentum.

But we’re getting ahead of ourselves. For the moment, we’ll be watching as the banks prepare to say more about their climate risks and bring carbon accounting into their investing and lending processes.

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