In July 2021 the Task Force on Climate-related Financial Disclosures (TCFD) proposed new guidance on climate-related metrics, targets, and transition plans, as well as a portfolio alignment technical supplement. The TCFD was created in 2015 by the Financial Stability Board (FSB) to develop consistent climate-related financial risk disclosures for use by companies, banks, and investors in providing information to stakeholders.

It remains to be seen how the final version of the new guidance will look like, but three things seem clear, at least when it comes to financial institutions (FIs).

First, there will be a requirement to disclose indirect (Scope 3) greenhouse gas (GHG) emissions. This is crucial especially for FIs, because most of their relevant emissions are in fact indirect. Direct emissions (Scope 1 and 2), i.e. emissions from owned/controlled sources plus emissions from the generation of purchased electricity (and heating/cooling), will typically account for less than 5% of all the emissions of a FI.

Indirect emissions include straightforward categories like business travel and employee commuting, which all things considered are also important to account for, but the relevant categories where major impact can be achieved are investments and the use of sold products.

Investments include all the equity and debt investments FIs make in companies and businesses, which in turn produce GHG emissions. Occasionally this category is appropriately called financed emissions. So when a bank underwrites a loan with the purpose of financing the construction of a new power plant, we’re talking about financed emissions.

Use of sold products comes into play in insurance companies, because there will often be GHG emissions when an insurance policy is being used. A simple example is motor insurance, because when you repair a vehicle, you’ll need to use materials and energy. There’s a sizable carbon footprint in several claims settlement processes of Property & Casualty (P&C) insurance companies.

Second, there will be a requirement for banks, insurance companies, asset owners, and asset managers to measure and disclose the alignment of their portfolios to below 2°C or lower temperature pathway. This is also very important, because it means that it won’t be enough to just disclose GHG emissions. Instead, FIs will also have to adjust, i.e. decarbonize, their investment portfolios. It means updated investment policies for asset managers and new underwriting guidelines for banks.

Third, there’s still room for improvement in the TCFD guidance. For example, while it’s great with a Paris Agreement aligned approach, it would’ve been nice to see an alignment to 1.5°C, which would be in line with the latest IPCC findings. Additionally, WWF has pointed out that alignment assessments should be based on multiple scenarios (i.e. warming function), because while single scenario analyses are easier and quicker to do, they are also fundamentally less robust and more sensitive to bias.

WWF also criticizes the TCFD recommendation for the use of emission intensity rather than absolute emission reduction. Their main concern is that a reduction of emission intensity does not necessarily result in absolute or real-world emission reductions in line with the science and agreed carbon budgets.

To summarize, the financial services sector is absolutely critical for enabling us to reach the targets set by the Paris Agreement. The simple truth is that money talks, and when FIs cease to fund or insure polluting businesses, major changes will be achieved.

There’s widespread adoption and acceptance of TCFD recommendations among FIs and therefore it’s critical that the recommendations are regularly updated to reflect the dire climate situation we’re facing and the latest science. The upcoming guidance is a great leap forward, both in terms of clarity and ambition level, but fact of the matter is that they could’ve been even more ambitious.