As global greenhouse gas emissions continue to rise, so do the climate and energy transition risks. A growing number of investors and asset owners are seeking data on the carbon footprint of their investments, and they’re not the only ones. Increasingly, we’re seeing new financial regulations and global standards designed to encourage greater transparency and consistency in carbon accounting.
To date, reporting has largely focused on asset classes where data is publicly available and estimates are more easily accessible. Large corporations and sovereign governments that issue in the public securities markets often disclose their greenhouse gas emissions, and if they don’t, there are several data providers that estimate their emissions based on public information and proprietary models.
But what about private assets?
Calculating the financed emissions of private investments is not easy or straightforward. It takes time, effort and a deep understanding of the use of proceeds, in addition to other key challenges that need to be considered.
Recent years have seen a surge of interest in private credit as investors seek higher yields in a low-interest-rate environment. For investors to properly manage their climate transition risks, make credible climate commitments, or respond to the new regulatory requirements, they need to be able to accurately measure the greenhouse gas emissions for all their investments, not just their public assets.
As such, there are a number of ways to assess the greenhouse gas emissions across private credit investments in response to growing demand from investors. The majority of deals we see in private markets do not provide reported emissions data. However, there are voluntary reporting standards, such as the Partnership for Carbon Accounting Financials (or PCAF), that can provide frameworks for how investors can calculate the carbon emissions associated with their business loans, project financing or commercial real estate investments, among others collectively known as "financed emissions."
Calculating financed emissions for private investments involves gathering data about an “ownership” share or attribution of the underlying financing of a project or company, as well as the emissions of the specific business activity being undertaken. The nature of the underwriting process allows managers access to deal-level data that is necessary to both make an emissions estimate and to better inform risk management and investment decision-making processes. Additionally, there are proxy sources such as the PCAF emissions database that help estimate what the typical emissions would be for a project or building.
In working through the process of calculating financed emissions from private investments, we’ve gained many useful insights. Here are several key things investors should be aware of when attempting to calculate or assess their financed emissions:
Data quality is one of the biggest challenges: The highest quality emissions data under the PCAF standard is directly reported. If this is not available, several assumptions need to be made, which can result in a lower-quality score. To improve data quality over time, investors should be specific about emissions reporting expectations with borrowers during deal underwriting. Borrowers operating in certain industries, including utilities and other more carbon-intensive sectors, may be more likely to provide reporting on Scope 1 and 2 emissions as well as energy generated. Where the data is not directly available from a borrower, managers could use alternative sources, including regulatory and other government filings to source reported data.
Be clear on the use of proceeds: How loans are classified within a sector, industry or activity may vary from the underlying credit’s sector. This is critical for determining what emissions factor to use. For example, we categorize credit tenant leases and ground leases at government buildings as real estate, which is the asset being financed, as opposed to government, which is the sector of the underlying credit.
Financing structure matters: We found that how private debt investments are structured, especially in project finance, often leads to higher financed emissions than similar sized public bond investments in companies engaged in similar business activities. For example, certain projects could receive a higher relative attribution factor due to low book equity value in the capital stack. Further, many vendors and asset owners use public market equivalents when estimating private asset emissions, and this practice can lead to significantly different emissions estimates vs. applying the PCAF methodology.
Don’t compare or aggregate asset classes: The scale and scope of financed emissions for different asset types can vary greatly. Allocations to different asset types, from sovereigns to real estate, could have material impact on the financed emissions intensity of a portfolio, and not fully understanding the asset level attribution could lead to misleading conclusions about a portfolio’s positioning vs. peers or a benchmark. It’s important to try to look at each asset type on a stand-alone basis vs. an appropriate benchmark.
Additionally, it’s important to monitor trends and movements of emissions intensity over time. The speed and scale of the energy transition will not be straightforward. For investors who seek to invest in carbon-intensive companies with credible plans to decarbonize or have climate goals in their investment mandates, it’s critical to use various capabilities and methods to understand exactly how companies are meeting these goals.
With the growing demand for private assets among institutional investors bolstered by an ever-expanding regulatory regime designed to address climate-related risks, it is essential for managers to possess capabilities to calculate financed emissions for their private credit portfolios to meet both near- and long-term market demands.
Andrew Harris is managing director, sustainable investing, at SLC Management. He is based in Wellesley, Mass. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.
