The push for emission disclosures
The regulatory ecosystem on sustainability disclosures has been in flux around the world as work towards the transition to a low-carbon economy accelerates. In this scenario, emissions disclosure requirements are rapidly gaining traction. Globally, several standards have been advanced that would require organisations to undertake robust reporting of their greenhouse gas (GHG) emissions. These include:
- The International Sustainability Standards Board’s (ISSB)
- The European Sustainability Reporting Standards (ESRS) under the Corporate Sustainable Reporting Directive (CSRD)
- The U.S. Securities and Exchange Commission’s (SEC) climate-related disclosure rules
IFRS S1 and S2 are efforts to streamline reporting standards to ease the reporting process and increase adoption. On the other hand, CSRD and US SEC’s disclosure rules are state mandates that impose climate-related reporting requirements on certain entities. Emissions disclosures allows investors to understand pertinent transition risks and thus informs strategic decision making and effective resource allocation. These disclosures can guide organisations in setting accurate emission reduction targets and monitor progress while prioritizing actions contributing towards a low-carbon transition.
Roadblocks to measuring emissions
While there is a regulatory and investor push for emissions reduction, multiple challenges for entities are emerging when it comes to emissions measurement and disclosures. Organisational capacity is a major roadblock to emissions measurement and reporting. Additionally, a lack of certainty regarding how to start the process and construct a business case, a deficit in the availability of data and reporting practices, and insufficient assistance from relevant stakeholders are some of the central challenges. Moreover, companies may also have budget-related concerns when it comes to assigning funds for this task.
The quality of data generated is another source of concern. Low-quality data can lead to significant error margins when it comes to the evaluation of transition risk that a given organisation faces owing to its emissions. Inaccurate transition risk assessment can, in turn, lead to skewed transition planning that can hurt the company in the long run.
Sustainable investments have shown rapid growth having exceeded US $30 trillion globally as of 2022, and are projected to increase to more than US $40 trillion by 2030. This asset class is a substantial 25% of the estimated USD 140 trillion of the global assets under management (AUM). AUM for climate funds specifically saw a surge with a 16% increase to reach US $540 billion in 2023. In addition, both institutional and private investors have become more conscious of their practices, increasingly prioritizing non-financial disclosures and ESG factors when assessing company performance. Consequently, weak sustainability reporting can lead to a loss of funding opportunities.
Furthermore, as financial institutions (FIs) face regulatory and investor pressure to report their financed emissions (FEs)- defined under the Greenhouse Gas Protocol as Scope 3, Category 15 emissions- borrowing entities might face a financing challenge. FIs, in the face of increased scrutiny, might opt out of financing organisations with a higher transition risk like the hard-to-abate sectors since it would increase their FE. As the scrutiny on emissions and reporting increases, FIs also need to reflect low financing to emission-intensive sectors. Even while financing transition efforts, the shorter-term FEs for FIs will be high, which can likely make them weary of such investments. However, this is also where emissions reporting can prove to be an opportunity for businesses.
From challenges to opportunities
Mr. Ravi Menon, the chair of the Network for Greening the Financial System (NGFS) recently remarked on a supervisory directive towards transition planning and blended finance, highlighting emissions reporting and transition planning as an opportunity for hard-to-abate sectors. This is due to the fact that firms in such sectors can reduce risk perceptions among investors with reliable transition strategies. The NGFS is working towards promoting FI-enabled transitions through innovative financial instruments like blended finance. Blended finance and other such mechanisms like green, social, sustainable and sustainability-linked (GSS+) bonds and results-based financing are designed to pool funds for socio-environmental causes that look beyond merely achieving financial benefits. While these can be great sources for transition funding, they also require the borrowing entities to show credibility on their ability to achieve the set cause-related goals. In this context, investing in emissions measurement and disclosure becomes vital as it can not only help firms design credible transition plans but also capitalise on the current market opportunities by mobilising transition financing. Thus, firms can reduce their transition risk while simultaneously building credibility and lowering their reputational risk.
Firms can utilise several mechanisms like internal carbon pricing (ICP) and science-based targets- aligned with the Science Based Targets initiative (SBTi)- to build their decarbonization plans. ICP helps firms place a monetary value on carbon emissions which can incentivise emission reductions and efficient resource allocation, thus playing a role in transition planning by encouraging businesses to account for environmental costs and adopt sustainable practices. SBTi, on the other hand, provides guidelines for companies to set emission reduction targets aligned with climate science, crucial in transition planning as they enable businesses to mitigate climate risks and contribute to a low-carbon economy. Tata Steel presents an example of firms using ICP in its quest to become carbon neutral by 2045. It trusts that decarbonizing can generate higher market access for it and reduce the burden of carbon taxes. On the other hand, Hindustan Zinc Limited sets forth an example of an SBTi-aligned Indian firm. The organisation believes that incorporating sustainable practices in its business model can lead to growth and increase its operational efficiency.
Furthermore, as the complexity of adherence to reporting standards rises, various organisations are working together to provide guidance. For example, the International Federation of Accountants (IFAC), in collaboration with different organisations, has released a two-part guidance to enable professionals working in finance and accounting to build vigorous GHG emissions reports. Such guidance instruments can assist companies in their transition journey.
With escalating regulatory demands and investor scrutiny, emissions reporting and transition planning not only mitigates transition risks but also unlocks crucial funding opportunities for companies. It can position companies at the forefront of sustainability and resilience in a rapidly evolving global economy.
Bibliography:
https://carbonaccountingfinancials.com/files/downloads/PCAF-Global-GHG-Standard.pdf
https://sciencebasedtargets.org/companies-taking-action/case-studies/hindustan-zinc-limited