The Net Zero Investment Framework 2.0 approach to financed emissions

Financed emissions are widely accepted as a useful approach for measuring and attributing emissions associated with investments. However, focusing on them as a sole metric to understand portfolio emissions and target-setting can lead to unintended consequences. We outline and explore its nuances. 

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Most investors have exposure to heavy-emitting assets, typically in high-impact/transition sectors. Because of this, ‘the emissions of their investments’ are generally the most material scope 3 category.  

Much of the focus in investor net zero efforts to date have centered around how investors can address these emissions, whilst understanding that as per all scope 3 emissions, their reduction can only be achieved indirectly through various levers of influence.  

These emissions are now generally known as ‘financed emissions’, which are calculated using quantitative metrics developed during early efforts to address climate change in financial portfolios. 

Through the development of the Net Zero Investment Framework (NZIF) 2.0, we found that many investors now question the efficacy of setting targets to reduce financed emissions, with some even questioning whether they meaningfully contribute to global decarbonisation efforts. When used in isolation, such targets might inadvertently reduce investments in climate solutions, transition assets, and emerging markets — actions which could slow down climate action.  

Financing reduced emissions 

We provided further clarification on using financed emissions within targets and transition plans in NZIF 2.0, published in June 2024, in collaboration with our members, network partners and the broader investment community. The updated framework builds on the principles of the first, emphasising a practical and balanced approach to portfolio decarbonisation. 

NZIF 2.0 is a useful guide for investors to consider when managing their own individual portfolios and, in doing so, can help maximise their practical contribution towards global decarbonisation goals.  

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Systemic financial risks posed by climate change can only be mitigated by genuine reductions in real economy greenhouse gas emissions. NZIF recommends the two overarching elements of net zero objectives: to support real economy decarbonisation and to increase investment in climate solutions. 

The emphasis is on “financing reduced emissions” and not “reducing financed emissions”. 

NZIF 2.0 does not state that financed emissions are good or bad, nor should they be disregarded; rather, they must be considered in context. The limitation of this accounting metric stems from two factors — what it signifies and how it is used. 

What it signifies  

Financed emissions attribute real-economy emissions generated by assets based on the amount of capital provided by investors, and can help to evaluate an asset’s (and, in the aggregate, a portfolio’s) climate performance. However, they are not forward-looking and do not consider the purpose of the finance, such as whether the investment is driving real economy emissions reductions over time. 

Financed emissions can be reduced ‘on paper’ by divesting from certain sectors or assets and when certain financial input metrics fluctuate, i.e., enterprise valuation or currency value changes. However, this may not reduce real economy emissions and mitigate physical climate risks.  

Many assets and sectors with high or rising emissions require increased finance to assist with global real economy emissions reductions. Examples include renewable energy, electric vehicles, and transition assets like cement and steel producers. Additionally, many emerging and frontier markets need investment to drive economic growth that outpaces developed markets. This development will likely lead to increased emissions, even when using the lowest carbon technology options currently available.  

NZIF promotes a more comprehensive perspective on portfolio decarbonisation by prioritising multi-criteria maturity scale alignment metrics, known as Asset Alignment Targets. These targets provide a forward-looking approach to target setting and evaluating portfolio decarbonisation, helping investors track the transition of assets towards net zero. 

How it is used 

In conversations with The Partnership for Carbon Accounting Financials (PCAF), the group that developed the concept of finance emissions, they were clear that these metrics were not necessarily designed to create year-on-year linear emissions reduction targets.  

Their original intended use was as an accounting metric to allow attribution of emissions for assets with multiple investors and lenders, providing a clearer view of a financial institution’s scope 3 emissions.   

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After a number of years of investors reporting against their financed emissions targets, it is increasingly clear that strict financed emissions targets may not be as effective in achieving net zero goals as the industry had once hoped.  

Whilst many investors have been able to achieve substantial reductions in financed emissions, global emissions are nonetheless increasing, and with them, the risks of climate impacts affecting asset performance and overall financial stability.  

In updating the Portfolio Decarbonisation Reference ‘Target’ to an ‘Objective’, NZIF 2.0 recommends investors use financed emissions as a metric to evaluate progress over a long- term horizon. Ten years with a five-year stocktake, for example, can help them to understand the effectiveness of net zero strategies and drivers of portfolio decarbonisation, but not as the primary means of influencing real economy emissions reductions.  

Increasingly, the investment industry is evolving to use asset-level alignment assessments, such as NZIF’s multi-criteria maturity scale methodology, to set net zero targets. This assessment of assets’ efforts to improve their alignment with a net zero future can help inform overall investment strategies and stewardship practices. 

Conclusion 

While a valuable metric for measuring portfolio impact and understanding how to prioritise engagement, financed emissions are not recommended in NZIF for target setting at the portfolio level. A narrow emphasis on reducing financed emissions alone can lead to unintended outcomes.  

NZIF highlights that investors can gain a more nuanced understanding of their portfolio emissions by identifying — not ignoring — financed emissions associated with climate solutions, transition assets, and emerging markets. Support for these assets is crucial for achieving global net zero goals.  

NZIF 2.0 encourages investors to transition portfolios to align with the Paris Agreement’s goals, focusing on real economy decarbonisation and increasing investment in climate solutions.  

By adopting this holistic approach, investors can better align their portfolios with net zero goals and identify high-impact opportunities to contribute while mitigating the financial risks posed by climate change. The isolated and over-extended use of financed emissions may hinder this approach. 

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