Are institutions truly comparing financed emissions reductions fairly?

Virtually every financial institution has set targets to reduce its financed emissions and thereby help limit climate change. In setting these targets, the GHG Protocol and European Sustainability Reporting Standards (ESRS)¹ require companies to report their GHG emission reduction targets in absolute value (either in tCO2e, or as a share of base year emissions) and, where relevant, in intensity value (e.g., tCO2e per unit). Most companies set their reduction targets as a percentage against a base year and determine a baseline value at the moment of target setting. As organizations grow through acquisitions or obtain more accurate data on their GHG emissions², they need to adjust this baseline to ensure that they are still comparing ‘apples to apples’ when measuring their current year performance against the baseline. Therefore, the GHG Protocol prescribes that companies need to implement a base year emissions recalculation policy to reflect a change in the structure of the company or to reflect a change in the accounting methodology used. This policy is to clearly specify the basis and context for any recalculations needed to keep the base year emissions value relevant and up to date.

In contrast to the requirements of the GHG Protocol, PCAF Standards, and other standards, we find that, in practice, many financial institutions have either not set such a policy (clearly) or don’t live up to it yet. This is especially noteworthy when considering that financed emissions (Scope 3, Category 15) reporting over time is often affected by improvements in data quality and availability, as increasingly (investee) companies have started to report on – or have significantly improved – their reporting on GHG emissions. By not adjusting base lines, the reporting may unfairly present the entity’s actual performance and/or the ambition level of current targets.

As per the GHG Protocol³ Chapter 5, companies are to implement a base year emissions recalculation policy. Such a policy should “clearly articulate the basis and context for any recalculations” and state the “significance threshold” applied for deciding on historic emissions recalculation. The following situations should be causes for considering the need to trigger a recalculation of the baseline (and related targets, if relevant):

1. “structural changes in the reporting organization” (e.g., mergers, acquisitions and divestments);
2. “changes in the calculation methodology or improvements in the accuracy of emission factors or activity data” (e.g., restatements in the reported GHG emissions by investee companies, moving from estimated to reported data); and
3. the “discovery of significant errors, or a number of cumulative errors, that are collectively significant”.

The availability of more reported GHG emissions data and improvements in the accuracy of reported GHG emissions from (investee) companies, should be cause for many financial institutions to consult their base year emissions recalculation policy and assess whether the changes are significant and thereby trigger an update. Please note, changes in emission factors or activity data that reflect real changes in emissions are, as such, not a trigger for recalculation (e.g., decline in the emission factor for electricity due to increase in renewable energy on the grid).

Incorporating control activities related to the base year recalculation policy into an entity’s internal control system ensures timely and appropriate updates to the base year when significant structural changes occur or when there is a shift in accounting methodology. The control activities will require sufficient reliable data on the data quality of reported emissions of (investee) companies over time to facilitate a proper understanding of the triggers for changes in the financed emissions over time.

Most financial institutions apply the PCAF standard for their financed emissions reporting.  PCAF requires establishing a baseline recalculation policy in line with the GHG Protocol Corporate Value Chain (Scope 3) Accounting and Reporting Standard. In accordance with PCAF requirements, financial institutions are required to design, implement, and disclose the significant triggers they apply for recalculation, such as structural changes, methodological updates, and significant thresholds.

In practice, we find that many financial institutions have not set such a (clear) policy or don’t fully live up to it. This potentially results in reporting that does not meet the qualitative characteristics related to comparability of the entity’s performance and/or affects the ambition level of previously set targets, which exposes them to scrutiny from stakeholders. Please note, unsuitable targets can undermine the effectiveness of the related policies and actions required to steer toward Net Zero. In recent years, various stakeholders have become more critical of whether targets set by companies are (indeed) ‘Paris aligned’ and being met, which due to significant changes in the baseline can easily be questioned. We therefore call upon institutions to set a baseline recalculation policy and regularly consider whether there have been noteworthy changes in, e.g., data availability or quality, that might trigger the need to reset the baseline.

1. ESRS E1-4, 34(a)
2. This may also include data on the GHG emissions that occur in the value chain as part of scope 3
3. GHG Protocol Corporate Accounting and Reporting Standard – Revised edition

Tristan Helsloot
Partner
Sustainability Reporting and Assurance
KPMG in the Netherlands

Vais Kargar
Senior Manager
Sustainability Reporting and Assurance
KPMG in the Netherlands

Gerard de Weerdt
Senior Manager
Sustainability Reporting and Assurance
KPMG in the Netherlands