Reducing the carbon footprint: How carbon portfolio control and risk management are shaping the financial sector

Meaning

CO2 portfolio management is a concept that aims to reduce the CO2 emissions of investment portfolios and thus make a contribution to climate protection. The CO2 emissions of the individual investments or companies contained in the portfolio are measured and evaluated. Based on specific targets and criteria, investment decisions are then made with the aim of reducing or offsetting the portfolio’s carbon footprint. Banks, insurance companies and investment houses in particular are crucial in the transition to a green economy. A study by Bloomberg has shown that loans cause 700 times more CO2 emissions than locations and offices.

Urgent need for action

In addition to the urgency of reducing CO2 emissions to mitigate climate change, regulatory requirements also play a major role: the Sustainable Finance Disclosure Regulation (SFDR) obliges financial market participants to disclose GHG emissions as part of the so-called adverse sustainability impacts. In the Pillar 3 disclosure, credit institutions are required to provide information on the emissions financed by mid-2024 at the latest. In addition, from 2025, companies in Europe, including those based abroad that operate in Europe, must report on Scope 3 emissions (indirect emissions from their value chain) in accordance with the EU Sustainability Reporting Standards (ESRS). Scope 3 emissions are particularly relevant for financial institutions, as they also include the impact of owned or controlled assets. However, the measurement and reporting of financed emissions in portfolios is about more than just an onerous regulatory obligation.

Thread of losses

Analyses show a correlation between ESG risks derived from controversies and poor market performance. Controversies can significantly affect the market value of a company and lead to a decline in the company’s total value of between 2% and 5% within six months. This negative effect is directly proportional to the severity of the controversy.

The good arguments in favour of investing in sustainability or ESG clearly outweigh the bad ones. By looking at ESG (Environmental, Social and Governance) criteria, investors can manage portfolio risks that they might otherwise have neglected. According to the World Economic Forum, six of the ten biggest risks to the global economy over the next ten years are nature-related and two are social. An example from the environmental sector illustrates the need for a more holistic risk perspective when making investment decisions.

Nature and the environment set the limits for life on earth and for all economic activities. Looking only at the direct physical risks of climate change, such as droughts, wildfires and extreme weather events, central banks could expect global GDP to fall by at least 20% by the end of the century under current climate policies, compared to just 3% if the world were to reach net zero emissions by 2050. These figures make it clear that the faster we phase out fossil fuels, the less costly it will be.

Recognising opportunities and risks

Implementing carbon portfolio controls and risk management strategies is critical to reducing the carbon footprint of the financial sector, avoiding losses and recognising opportunities for growth and innovation. Carbon portfolio controls involve evaluating investments based on their carbon emissions and focusing on low-carbon companies and projects. This can be achieved through the use of carbon benchmarks and reduction targets. Risk management strategies related to climate change include the assessment of climate risks and the development of risk reduction measures. This includes, for example, the consideration of climate scenarios in risk assessment, the development of insurance products to cover climate-related losses and the promotion of investments in climate-resilient infrastructure.

Consieleon’s expertise in ESG

We support the sustainability transformation of financial sector players in the areas of regulation, asset & portfolio management, credit processes, supply chains and ESG data management. As a technology specialist, we have made reporting more consistent and faster through automation by developing a structured ESG data repository. Building on this, we have succeeded in unlocking the potential of our clients’ ESG data for better decision-making and risk management.

Please contact us if you would like to find out more about our ESG consulting services. We would be happy to advise you!