(Bloomberg) -- By many accounts, the primary yardstick used to measure the finance industry’s progress on climate change is deeply flawed.

Pretty much every major western bank and asset manager, including BlackRock Inc., HSBC Holdings Plc and JPMorgan Chase & Co., discloses their financed emissions, or the greenhouse gas-pollution that they enable via the loans and investments they make.

The metric has grown in prominence over the past few years, with more and more financial firms committing to making annual disclosures about the most carbon-intensive areas of their balance sheets. Even the International Sustainability Standards Board, which sets global reporting standards, has made its own request for financed-emissions disclosures. 

But according to Jonas Rooze, head of sustainability and climate research at BloombergNEF, the ubiquity of the metric in financial circles shouldn’t be mistaken as a measure of its utility. In fact, financed emissions might be a distraction rather than a solution.

“The way it has become this all-encompassing one-metric-to-rule-them-all for financial institutions to manage their transition can be a bit like focusing on the problem (emissions) at the expense of the solution (transition),” Rooze said. “You manage what you measure, and so financial institutions are trying to manage their financed-emissions number—not real-world emissions.”

Rooze isn’t the only one taking aim at the metric. A paper published this month by Ilmi Granoff and Tonya Lee for the Sabin Center for Climate Change Law and the Columbia Center on Sustainable Investment found that “despite widespread adoption,” financed-emissions metrics “face two key methodological challenges: lack of comparability of outputs within and between portfolios, and vulnerability of calculations to portfolio volatility.”

In a blog post to accompany the report, Granoff said the financed-emissions calculation has become popular because “it provides a single measure of portfolio progress” and offers third parties “a practical means to attribute emissions to financial institutions.” 

But the problem is there is a “misguided intuition that financed emissions capture all the ways that you might connect financial activity to GHG-emitting activities of borrowers and investees,” Granoff said in an email. “It doesn’t.”

The most commonly-used method for calculating such emissions, developed by the Partnership for Carbon Accounting Financials, uses the outstanding amount of corporate borrowing as the numerator and the value of the company being financed as the denominator. The issue is this approach is prone to volatility and can lead to counterintuitive readings.

For example, when higher energy prices pushed up the valuations of fossil-fuel companies following Vladimir Putin’s invasion of Ukraine, lenders such as Deutsche Bank AG and Citigroup Inc. saw their financed-emissions numbers fall. That was at least partly due to a methodology that evaluates a company’s enterprise value, which includes the cash of the respective clients. 

Additionally, focusing only on current financed emissions can arguably disrupt funding that would otherwise go to facilitating future real-economy decarbonization programs. 

Angélica Afanador, executive director of PCAF, said financed emissions disclosures are useful in providing a baseline against which progress can be monitored, but assessing the transition risks of a portfolio ultimately “requires analysis across multiple metrics.”

In a response to a consultation from the Basel Committee on Banking Supervision, the American Bankers Association said in March that measurements of financed emissions and facilitated emissions—those generated from capital markets activities such as debt underwriting—are “substantially irrelevant to a bank’s transition risk” and that a disclosure of financed emissions “will normally obfuscate a bank’s credit risk.” 

The European Banking Federation has said financed-emissions disclosures should be paired with “more dynamic disclosures about transition trajectories being financed by banks over time.” Without that, banks “could be disincentivized from providing transition finance to the high-emitting sectors that need it the most.” And the Rocky Mountain Institute has said that many banks have expressed the view that “more granular metrics are needed for risk-management purposes. “

Some work is underway to develop other metrics to measure banks’ progress. BloombergNEF calculates the role banks play in the energy transition by comparing the industry’s debt and equity underwriting for clean-energy projects relative to fossil fuels. BNEF researchers concluded that spending on low-carbon infrastructure needs to exceed fossil-fuel spending by a ratio of 4 to 1 by 2030 for the goals of the Paris climate agreement to be met.

BNEF’s Rooze said looking at financing for clean energy is vital because it aligns with solutions for the climate problem, which ultimately means displacing fossil fuels. It also allows banks to develop a more positive narrative about their climate actions.

Among others, New York City’s massive retirement plans have been pressing the biggest North American banks to publish how much financing they provide for clean-energy projects relative to fossil fuels.  

“If we’re going to achieve the goals of the Paris agreement, we have to rapidly phase out fossil fuels and rapidly ramp up low carbon energy,” said Michael Garland, assistant comptroller for corporate governance and responsible investment at the Office of the New York City Comptroller. “And the elegance of the ratio is that it capture both of those things.”

Sustainable finance in brief

A long-held belief about ESG is being challenged—namely the idea that the strategy is best-suited to active fund management. For 11 of the past 12 quarters, clients have redeemed cash from actively managed funds registered as “promoting” environmental, social and governance goals. The data, provided by Morningstar, appears to show a recalibration is underway. As active ESG funds “bleed money,” Morningstar’s global director of sustainability research, Hortense Bioy, says the managers overseeing such portfolios are now “licking their wounds.” Meanwhile, she said, “passive ESG investments continue to appeal to more investors.”

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