What if banks had to disclose the climate impact of their investments?

The United States Securities and Exchange Commission recently proposed a new federal rule requiring all publicly traded companies to disclose climate risks and carbon emissions. This rule has the potential to make huge strides in forcing banks to disclose the carbon-intensive projects they finance. If passed, the rule will give bank investors greater transparency on the global climate emissions generated by their investment; once disclosed, banks will strive to reduce their carbon exposure, which means new products and terms to fund low-carbon projects – globally. People should understand the transformative effects of disclosing the carbon impacts of bank financing, if only the SEC rule can pass.

The United States Securities and Exchange Commission recently proposed a new federal rule requiring all publicly traded companies to disclose climate risks and carbon emissions. It is intended to provide greater transparency to guide investor decisions. The proposed settlement comes as no surprise — it has been widely publicized and eagerly awaited. But whether regulation is finalized into regulation or not, there is a transformative impact that few realize. By covering publicly traded U.S. banks, this rule would cover, by leaps and bounds, climate emissions across much of the global economy.

How it works?

The proposed regulations would require public companies to report their climate emissions, which come in three standardized reporting forms. Scope 1 emissions are those generated on site. Scope 2 emissions are those from purchased energy. Scope 3 emissions are generated by a company’s supply chain and products in service. Some companies already disclose scopes 1 and 2. These are the easiest to report using energy supply and utility bills. Scope 3 is difficult. This requires an analysis of all the greenhouse gas impacts of a company’s sourcing inputs as well as the carbon implications for the company’s products used throughout their lifetime. Many companies point to the burden that regulation could create. At the same time, new data mining and modeling methods are being developed to help calculate Scope 3 emissions.

follow the money

Consider the proposed rule through the lens of a bank. Scope 1 for a bank could be the boiler in the basement burning natural gas to provide heat to the building. Scope 2 could be electricity purchased from the local utility. In addition to the supply chain, Scope 3 would be the carbon emissions resulting from the bank’s loans and investments, which are products from a bank. These range from real estate to fossil fuels and other carbon-intensive products. Let it sink in.

While US public banks are required to disclose the carbon emissions of loans, they essentially cover the global economy as they lend to public and private companies, institutions and entities around the world. This regulation would tie funding directly to programming in a way that has never been done before. The implications are vast:

  • Banking investors will have greater transparency on the global climate emissions generated by their investment.
  • Likewise, the public (and regulators by extension) will have a better understanding of the money that fuels carbon emissions.
  • And presumably, once disclosed, banks will strive to reduce their carbon exposure, which means new products and terms to fund low-carbon projects – globally. Presumably, an asset’s carbon profile will become as relevant as its credit risk in guiding banking terms.

losers and winners

Exploration and extraction of fossil fuels is capital intensive and requires bank financing. The carbon impact of this funding would now have to be reported by the proposed rule, even if the fossil fuel company does not self-report. The money may not flow as easily to the fossil fuel sector, or at least not at today’s rates and terms.

On the other hand, more money could be spent on the development of renewable energies. Another beneficiary would be buildings – the world’s largest investment asset class and one of the largest users of bank funding, particularly for mortgages. In big cities like New York, buildings account for 70% of carbon emissions. The SEC regulations would bring banks’ interests closer to carbon emissions from buildings, in hopes of funding more building energy retrofits to lower the carbon profile of cities. This would not only save carbon, but also prevent the release of air pollutants when burning fossil fuels, thereby improving public health – particularly respiratory health most relevant in the Covid-19 crisis.

Financing “dirty” projects

Where will carbon-intensive projects get funding? Private sources of capital can step in to fill the void, such as private equity firms. However, this may not completely escape the intent of the SEC rule since each company’s scope 3 issue is another company’s scope 1 issue. In this scenario, a carbon-intensive project can secure private capital, but may still have to report its carbon impact to clients as part of their Scope 3 reporting. Banks are more likely to still be able to lend to these projects, but under different conditions. “Dirty” projects may have to pay higher costs – a sort of “brown” premium while “green” rebates are given to low-carbon entities. It would also start pricing carbon in a new way.

Just a suggestion?

The SEC’s proposal is just that – a proposal on which the public can comment and the government will decide whether or not to adopt a final rule. Many industries oppose the measure, and members of Congress are calling for hearings on the SEC’s approach. Despite this opposition, members of government who want to advance the climate agenda will quickly see the widespread benefits of the SEC’s proposal. It is important to note that the SEC has the ball and the power to act without Congress. Washington’s give-and-take process will work itself out. But the more people understand the transformative effects of disclosing the carbon impacts of bank finance, the more interest will grow. Progressive banks can voluntarily decide to disclose these emissions whether or not there is regulation, and due to the highly competitive nature of the industry, this could encourage more banks to follow suit.

Ironically, where governments have failed to slow global carbon emissions, a proposal to require disclosure from the US private sector could have the biggest impact in the fight against climate change – and few realize it yet.

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