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What’s your organisation’s strategy on financed emissions?

Updated: May 16, 2023

Identifying the pathways to abating emissions and mitigating carbon costs

In our deep dives in March 2023, “Mastering Financed Emissions,” and October 2022, “An Energy Crisis Today, a Carbon Crisis Tomorrow” we exposed some of the complexities that portfolio and risk managers encounter in attempting to measure financed emissions – and discuss the drivers that will ultimately enable them to take action.

A brief recap: all portfolio emissions entail a cost of carbon – even if market-based carbon pricing has not yet been applied. Emissions trading systems like the EU ETS and RGGI provide a robust, market-based price signal, and for companies they offer a means of hedging carbon exposures. The regulation governing these systems is evolving.

We have identified three types of costs:

  • Increasing financing costs – resulting from the additional capital banks will be required to hold due to results from climate risk stress-test exercises [1]

  • Costs incurred through additional purchases of carbon credits (in excess of regulated allowances allocated under the scheme) at increasing prices

  • Costs associated with new carbon border taxes [2]

The following two charts show how the price of CO2e has been increasing and what the resulting costs mean in terms of company earnings.

Figure 1: Costs of verified emissions as % of EBITDA

Source: S&P, EEX, EU-ETS and Arcturus calculations [3]

In Figure 1, we calculated the total verified emissions at the parent company level for six well-known European firms. We then expressed these costs as a percentage of EBITDA for 2020 and 2022. The proportion of reported EBITDA that would be required for HeidelbergCement to fund future carbon allowances stands out, based on two-year increase.

To put this in context, figure 2 indicates the trend in carbon pricing under the EU-ETS across the same period.

Figure 2: Evolution of EU-ETS prices achieved at auctions in 2020 and 2022

Source: EEX and Arcturus calculations

Figure 2 highlights the complete paradigm shift in EU ETS auction pricing within two years. The median auction price for 2022 was EUR 84 per m/t CO2 equivalent.

What does the near future hold?

The regulatory deadlines facing your firm

The clock is ticking on several regulatory initiatives driving banks – and asset owners, in particular – to measure their financed emissions.

More regulation is kicking in this year. The EU is implementing its Carbon Border Adjustment Mechanism (“CBAM”), with the transition period commencing on October 1st. A similar regime is expected in the UK during the next 12 months.

This will mean additional carbon cost pressure for companies by 2026-27. This timing aligns with the substantial aggregate drawdowns in freely allocated credits to companies in the EU and UK ETS.

If your firm is a signatory to the Task Force on Climate Financial Disclosure (TCFD) or operating a regulated financial institution in the UK or EU, you are likely to be required to file a TCFD climate report with financed emissions a recommended disclosure.

In addition to best practice TCFD reporting, there are the EU’s Corporate Sustainability Reporting Directive [4] reporting requirements, which came into effect in January 2023 for fiscal year 2024 implementation for listed companies with 500 or more employees.

It’s anticipated that the SEC will implement new climate reporting regulation in 2023. And for members of the Net Zero Banking Alliance initiative, the review date of April 2024 is envisaged to be the hard stop for members to report their financed emissions.

What are your challenges and opportunities?

Understanding your financed emissions is not just about regulation and reporting. It’s about proactively managing risk – and being positioned as effectively as possible to take advantage of a more rapid energy transition. And depending on where you sit, it may also be an opportunity for ahead-of-the curve advice to your corporate clients.

You first need to know where you stand. Then, have access to the tools to efficiently drill down into your portfolio’s emissions concentrations by sector or by position, and look at performance relative to peers and on different time horizons.

Can you answer the following questions?

“Have we identified the laggards in our portfolio(s)? Do we have a strategy in place to manage these positions?”
“What is the emissions abatement potential of my portfolio? How likely is it that my portfolio can get to a climate pathway consistent with 1.5˙C or Well Below 2˙C?”
“How do I address the gaps in emissions coverage?
“I need to recalculate financed emissions in multiple portfolios given recent data updates and restatements, and for different portfolio cut-off dates. How do I do this and yet meet our reporting deadline?”

If not, there is work to be done.

At Arcturus, our solutions for financial institutions recognise that accessing this data via multiple channels – and being able to integrate this data with our clients’ existing platforms and workflows – is very important.

That’s why we offer flexibility to fit the needs of different users.

  • Our APIs, cloud data sharing sandbox environment and the Arcturus platform all enable collaboration across teams.

  • Arcturus functions as a source of record on carbon and energy transition positioning.

We identify common pain points – whether you’re a bank, capital allocator, or investment manager – not least, time & resource pressure.

As we’ve broadened our engagement with our clients, we continuously learn about their compounding data challenges. Current reporting practices often rely on manual data collection, intensive use of spreadsheets, and lack of clarity on versioning. In many instances, recalculating portfolio data can take weeks.

Arcturus – and our Financed Emissions API – cuts that timeframe to minutes.

Users can deploy their own preferred data and use Arcturus infrastructure to manage it, or leverage Arcturus’ data as well as tools. Arcturus will enable more complex analysis to be run, such as scenarios with specific holdings included or excluded.

To accompany our financed emissions engines, Arcturus delivers solutions to matching portfolio holdings and corporate entities that can otherwise present substantial barriers to calculating financed emissions.

Imagine a roadmap that illuminates the abatement potential of an investment position – or an entire portfolio.

At Arcturus, we deliver a suite of metrics and insights that enable the portfolio or risk manager to better understand how their portfolio’s GHG emissions compare to an industry benchmark.

We call these metrics Potential Abated Emission KPIs.

A company's potential abated GHG emissions are the result of a comparison to the carbon efficiency of a peer group. [5]

Understanding a company’s near- to medium-term abatement potential can better inform managers on emissions that could (or indeed should) be offset. This holds true whether you’re a bank risk manager, an investment steward at an asset owner, or a VP of finance or sustainability at a corporate.

Certainly, there is a passive component to decarbonising your portfolios: many business activities will be electrified, and grids will transition to renewables. But we believe that a “passive only” approach to your emissions will leave risks unmitigated. This is particularly true of sectors known for high energy use: chemicals, cement, steel – and, of course, oil and gas.

Decisions about actions to be taken cannot be made in isolation of valuations, the need for portfolio diversification, and the fiduciary requirement to deliver risk adjusted return.

  • Arcturus believes that financed emissions assessment is an essential component of delivering on investor return objectives over time.

Banks are taking the first steps to assessing how to effectively integrate carbon costs into their risk and capital allocation models. Companies need to ensure they have continued access to bank credit and capital markets to finance growth.

  • Positioning on a decarbonising trajectory enables CFOs and Treasurers to take this potential risk off the table.

  • The inaction here may result in increased cost of capital, refinancing risk, and even debt service pressure with increasing costs of offsetting emissions and financing costs compounding.

Where emissions cannot be abated near term, then use of regulated carbon allowances or voluntary carbon offsets is one option available to risk managers – not just to companies themselves.

[1] Leading central banks including the ECB, the Fed, Bank of England and Bank of Japan are requiring banks to undertake climate stress tests in an energy transition context assuming carbon prices escalate to circa $150-200 per m/t of CO2 equivalent.

[3] Total emissions are multiplied by the median EU-ETS auction prices for 2020 and 2022 and then normalised by comparing these values against the company reported EBITDA to illustrate the impact on profitability. In cases where 2022 EBITDA data was not available, we used 2021.

[5] The peer group can be defined from an industry index or a selected comparable group of companies. Our implementation is based on Arcturus Carbon Intensity Index, which is based on the yearly historical distributions of carbon intensities by Arcturus Sector.

The abatement potential is measured for each holding in a portfolio by comparing the company's reported or estimated carbon intensity against the sector reference carbon intensity threshold and then converting this difference into an absolute emissions number.


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