January 12, 2023

Why the Asset Finance Sector Must Plan for Emissions Reporting

As the world progresses towards a more sustainable future, businesses in the asset finance sector must be thinking about emissions reporting. As part of the broader sustainability agenda, emissions reporting is a form of non-financial reporting that is gaining relevance for businesses of all sizes, and particularly those in the financial sector because of the impact of the 'financed emissions', i.e. those resulting from the finance company's portfolio.

There are both regulatory and commercial reasons for this heightened focus - companies need to be prepared for new regulations, and they also need to be able to demonstrate their commitment to sustainability. By planning and putting processes in place now, businesses can stay ahead of the curve and be prepared for the upcoming requirements.

Relevant Emissions

In order to accurately report on greenhouse gas (GHG) emissions, businesses need to identify the specific sources of their emissions and categorise them into three distinct scopes as set out by the GHG Protocol Corporate Standard - the most widely used standard in emissions reporting.

Scope 1 - refers to direct emissions that are released from activities owned or controlled by the business, such as combustion in boilers or furnaces.

Scope 2 - refers to indirect emissions that are a consequence of the business's activities but which occur at sources owned or controlled by third parties, such as purchased electricity.

Scope 3 - refers to other indirect emissions, often referred to as 'value chain emissions', which are a consequence of the business's activities, but which occur at sources not owned or controlled by the business, such as business travel, use of sold products, and leased assets.

Importantly for finance companies, Scope 3 includes financed emissions, which are the greenhouse gas emissions resulting from the assets funded and massively outweigh the direct emissions in Scope 1.

These Scope 3 emissions are often the largest source of an organisation's greenhouse gas emissions. They are also the most complex to measure since organisations typically need to gather information from their supply chain and other stakeholders to report on their Scope 3 emissions, using methods such as surveys, data collection, and modelling.

There are a number of drivers for tracking and reporting on emissions and, of course, proactive efforts to reduce these. A regulatory requirement is a clear driver, but there are other factors to consider, in particular, due to the trickle-down effect being created due to the way the emissions reporting is structured.

So, even if you don't meet the regulated requirement to report (yet), it's important to address this topic and have a plan in place.

Trickle-down demand

It is worth noting that a growing number of organisations are starting to report on Scope 3 emissions and this is having a trickle-down effect in requiring information from other organisations in their supply chains.

These value chain emissions are indirect greenhouse gas (GHG) emissions within the value chain of an organisation's operations. For large companies trying to meet mandated Task Force on Climate-Related Financial Disclosures (TCFD) reporting requirements, their suppliers must provide data to allow them to evidence Scope 3 emissions. So, a growing number of businesses will find that, as part of a customer or supplier's value chain, they are asked to provide emissions data. A smaller organisation working with those that need (or choose) to report emissions will find that they are impacted even though they may not have been covered by the regulatory requirements directly.

This could become a 'requirement to do business' for those looking to work with large organisations or those focused on their sustainability strategy. As a result, even if not legally required to do so directly, more and more organisations will find themselves needing to report on emissions - hence this trickle-down effect.

Regulatory Requirements

Relevance of Scope 3

Currently, for those organisations that are required to report on emissions, only Scope 1 and Scope 2 are required, with most of Scope 3 being voluntary. For now, only large, quoted companies and LLPs are required to report on some of Scope 3: energy use and related emissions from business travel in rental cars or employee-owned vehicles where they are responsible for purchasing the fuel.

Government guidelines for other companies are currently voluntary but strongly encourage reporting, especially where this is a material source of emissions. For finance companies, Scope 3 emissions in the form of financed emissions account for by far the largest source of emissions and, therefore, the most significant potential impact under a sustainability strategy.

A report by CDP (formerly Carbon Disclosure Project) states:

"The finance sector is critical to achieving a net zero future. Our flagship report finds that portfolio emissions are over 700x larger than direct emissions - and the risks of inaction are huge. Financial institutions must urgently decarbonise their portfolios by disclosing the impact of their financing activities, setting science-based targets and aligning all financing activity with the Paris Agreement."

The significance of financed emissions highlights that, whilst not a current requirement, reporting on Scope 3 is likely to be mandatory in the future. Organisations are encouraged to make the transition smoother by starting now.

Companies Act

The legal framework for reporting is based on the Companies Act 2006 Regulations 2018, which is used to implement the government's Streamlined Energy and Carbon Reporting (SECR) policy. This expanded upon the 2013 Regulations that required quoted companies to report annual emissions and widened the scope from 1 April 2019 to include large unquoted companies and LLPs who must disclose energy use and greenhouse gas emissions.

The legislation affects:

  • quoted companies
  • large unquoted companies (including charitable companies)
  • large Limited Liability Partnerships (LLPs)

The definition of 'large' is the same as applies in the existing framework for annual accounts and reports, based on sections 465 and 466 of the Companies Act 2006.

A company qualifies as 'large' in a year where it meets two or more of the following:

  • Turnover of £36 million or more
  • Balance sheet total £18 million or more
  • 250 or more employees

The following diagram helps determine if you need to report under the SECR framework

Task Force on Climate-related Financial Disclosures (TCFD)

The Financial Stability Board (FSB) created the TCFD to develop recommendations on the types of information that companies should disclose to support investors, lenders, and insurance underwriters in appropriately assessing and pricing risks related to climate change.

TCFD has developed a globally recognised framework for climate-related disclosures, which has been formally endorsed by the UK government. Implementation is being guided by the Transition Plan Taskforce, which includes policymakers, Financial Conduct Authority (FCA) members, and finance industry representatives.

As of the end of December 2021, the following regulated firms have climate-related disclosure requirements aligned with the TCFD's recommendations:

  • premium listed companies
  • issuers of standard listed shares and global depositary receipts (GDRs)
  • asset managers
  • life insurers
  • FCA-regulated pension providers

The FCA is approaching the finalisation of the TCFD requirements, and implementation is being phased in, with requirements for smaller firms expected in 2023.

Cross market impacts

Those trading in EU markets will have a requirement to comply with EU legislation.

Another potential pressure on UK firms is via investors, especially those which are part of a global group with EU-based entities. It's likely that we will see many of these firms implement the EU Sustainable Finance Disclosure Regulation (SFDR) as a global standard.

Investors and Shareholders

Pressure from investors and shareholders increasingly influences companies' disclosure of greenhouse gas emissions. With growing awareness of the financial risks associated with climate change, shareholders demand greater transparency on how companies manage their carbon footprint and reduce their emissions.

As a result, many companies voluntarily report their emissions to be more transparent and responsive to investors and shareholders.

investors focused on esg

Competitive Advantage

Disclosure of greenhouse gas emissions can help businesses create a commercial advantage in various ways.

Reputation and brand: By disclosing their emissions, companies can demonstrate their commitment to sustainability and environmental responsibility, enhancing their reputation and appealing to environmentally conscious consumers and stakeholders.

Innovation: Companies that are transparent about their emissions may be more likely to invest in new technologies and business models that reduce their emissions and improve their competitiveness.

Investor appeal: Companies that disclose their emissions may be more attractive to socially responsible investors and funds.

Stronger supply-chain relationships: Disclosure can help companies to build trust with suppliers and identify opportunities for collaboration, leading to improved supplier engagement and collaboration.

Efficiency and cost-savings: By measuring and reporting on their greenhouse gas emissions, organisations can identify and track opportunities for improving efficiency and cutting costs.

Risk Management

Disclosing greenhouse gas emissions can help businesses manage risk by providing a clear understanding of their emissions profile and exposure to climate-related risks. This allows companies to identify areas where they may be exposed to risks such as regulatory changes, supply chain disruptions, or physical impacts of climate change. By understanding and managing their emissions, managers can reduce their exposure to these risks and improve their overall risk management.

Corporate responsibility/environmental impact

Business leaders are increasingly aware of the need to reduce their environmental impact and be more responsible in their operations. However, without a clear understanding of their emissions profile, companies may struggle to develop an effective ESG strategy to help them meet sustainability goals.

Greenhouse gas emissions reporting is key for companies who want to make a genuine effort towards reducing their environmental impact. By measuring and reporting on greenhouse gas emissions, businesses can gain insights into where they stand regarding their carbon footprint and identify areas where improvements can be made.

This data-driven approach allows businesses to track progress over time and ensure that any implemented changes or initiatives have the desired effect on reducing emissions.

Additionally, by disclosing this information publicly, companies demonstrate transparency about their efforts towards sustainability which helps build trust with stakeholders such as investors and customers.

green trees in a wood with a sunrise shining through the branches

Avoiding Greenwashing claims

The move towards the UK Government's Net Zero carbon emissions presents opportunities for asset finance companies to help customers transition to a lower-carbon future as they seek to acquire new, 'green' assets.

However, in doing so, finance companies must take care to ensure accuracy and transparency when introducing sustainable solutions to avoid greenwashing accusations.

Emissions reporting can provide companies with an understanding of how their overall emissions are changing due to their green products or services. This data can be used to back up their claims that they are genuinely engaged in sustainability efforts.

Taking the next step

The asset finance sector needs to understand emissions reporting and create plans. As well as being able to respond to the impending regulatory requirements and demands from various stakeholders, a focus on sustainably has the potential to bring about real business benefits by helping to improve efficiency, reduce costs, manage risk, and demonstrate corporate responsibility, while also avoiding greenwashing claims.

Those who get ahead of the game now will be better prepared for future regulations and open up opportunities in the market.

If you are thinking about how to tackle your emissions reporting or exploring ESG-related finance products, please contact Phil Gerrard for an initial discussion.

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