Financial institutions face growing pressure to disclose and manage climate-related risks across their portfolios—including emissions resulting from activities they fund (known as financed emissions). Portfolios with highly financed emissions tend to carry greater exposure to financial energy transition risks, such as stranded assets, carbon taxes, and regulatory penalties. Leading firms are turning those compliance obligations into an opportunity: They’re using insights about climate-related risks and clients’ financed emissions to reprice risk, generate new business, and strengthen client relationships.
A number of governments recently introduced (or plan to introduce) regulations around financed emissions (see sidebar “New regulations covering financed emissions”). For example, the European Banking Authority guidelines that came into effect in January require institutions operating in the European Union1 to identify, measure, and manage climate-related risks—including those associated with financed emissions—and develop transition plans aligned with the European Union’s climate targets.2
However, many financial institutions are struggling to fulfill these obligations. Achieving financed emissions targets requires not only robust reporting capabilities but also capital investments and operational changes by clients in hard-to-abate sectors that are largely beyond any single financial institution’s control. A 2024 survey conducted by the European Central Bank (ECB) of 95 banks operating in Europe3 found that most credit portfolios are not in line with Paris Agreement goals. The ECB concluded that, because of this misalignment, 90 percent of surveyed institutions face “elevated credit risk” that makes them vulnerable to potential transition-related losses, such as loan defaults by borrowers whose operations become uneconomic as carbon prices rise.
In this article, we examine the challenges financial institutions face in complying with financed-emissions regulations. We also explore how leading firms are building the capabilities and processes necessary to capture opportunities arising from financed emissions. While financial institutions operating in Europe are most likely to benefit from this approach, those in North America and elsewhere may also find it useful.
Challenges in managing financed emissions
Financial firms need to manage their financed emissions both because of disclosure obligations and to understand the energy transition risks in their portfolios. Yet several obstacles hamper their ability to track and measure those emissions, as well as the associated financial, regulatory, and reputational risks.
First, the lack of reliable and consistent emissions data, especially for small and midsize companies, complicates the development of emissions baselines for clients. Without accurate baselines, institutions cannot set credible targets for clients’ emissions reductions, accurately estimate the investments needed to achieve those targets, guide prioritization of decarbonization initiatives, or effectively track clients’ decarbonization progress. They also cannot fully assess their own exposure to the risks posed by their clients’ emissions.
Second, many institutions don’t incorporate sustainability analytics into their business decisions. For example, while some have started to offer financing tailored to specific decarbonization efforts, in most cases that financing isn’t based on data indicating the investments clients would need to make to reach their desired emissions reductions.
Third, organizational silos limit many firms’ ability to foster collaboration between sustainability leaders and other decision-makers, which is critical to ensuring that sustainability objectives align with institutions’ business strategy. Sustainability-related functions are often disconnected from strategic decision-making, and insights from risk assessments and transition-planning analyses aren’t incorporated into day-to-day lending, capital planning and investment, and risk management.
However, some institutions are finding ways to overcome these challenges and help clients navigate their climate transition journeys while mitigating risks. What differentiates the leading players is not access to emissions data but the ability to translate that data into detailed, economics-backed actions at client and portfolio levels.
How leading institutions support clients’ decarbonization journeys
Growing regulatory scrutiny of financed emissions is giving rise to new commercial models that integrate insights about “in the money” decarbonization business cases (based on current energy and materials price outlooks) as the foundation for advisory services, financing innovations, and deeper client engagement. The following five approaches illustrate some of the ways leading firms are seizing these opportunities.
Applying industry-level models to fill data gaps
To bridge gaps in client data, some financial institutions leverage industry emissions profiles that aggregate publicly reported emissions into industry-level views (Exhibit 1). These models help institutions estimate their clients’ emissions and compare their decarbonization progress with that of their industry peers. Firms can also compare financed emissions across their portfolios (see sidebar “Our capabilities: Empowering decarbonization and growth”). Sharing these insights across functions such as risk, financial planning, and strategy can help institutions ensure alignment and consistency in managing both sustainability-related risks and opportunities.
Prioritizing decarbonization options
Financial institutions can use industry-level models to build marginal abatement cost curves (MACCs) that help them identify and recommend the most cost-effective decarbonization actions for clients (Exhibit 2). Institutions serving investment funds can provide these clients with detailed views of both baseline emissions and decarbonization opportunities across their portfolio companies. Investment managers can then aggregate company-level decarbonization business cases and select the most effective actions across their portfolios (as business cases vary across regions based on local economic conditions). For example, one bank used MACCs to identify approximately 35 percent of emissions in a client portfolio that could be reduced through cost-neutral or value-creating actions.
Building transition plans stress-tested across scenarios
Some firms are developing bespoke ten-year transition plans, with intermediate milestones, for their clients. These plans outline the capital investments the clients would need to make to meet their emissions reduction targets and forecast the effects on operating costs. The firms then test the plans against a variety of macroeconomic and climate-related scenarios (such as 1.5°C- and 3°C-aligned pathways4) and model the impact of different energy price projections, new carbon taxes, regulatory shifts, or technological advances. By simulating a range of scenarios, financial institutions can assess the plans’ resilience and adapt them as clients’ assumptions or priorities change. Aside from guiding clients’ decarbonization journeys, such plans provide banks’ relationship managers with a view of the emissions reduction trajectory across their client portfolios (Exhibit 3).
Embedding sustainability considerations into decision-making
Incorporating sustainability targets into business decisions helps financial institutions align their decarbonization objectives with strategic goals. By integrating emissions reduction targets into the criteria for credit underwriting, capital allocation, and risk management, business leaders can track risk exposure, prioritize mitigation actions for their portfolios and individual clients, and identify the best governance structures to oversee progress. For example, they can aggregate clients’ emissions reduction initiatives and compare them across the portfolio to identify the most cost-effective options and potential economies of scale as part of their capital-planning process (Exhibit 4).
Establishing decarbonization advisory services
Some financial institutions are becoming strategic partners in their clients’ climate transition journeys. Armed with data-backed insights, relationship managers can move beyond transactional interactions to help clients identify the most effective decarbonization opportunities, estimate the required investments and potential returns, and design loans and other financial instruments that align financial incentives with decarbonization outcomes—for instance, by tying a loan’s interest rate to the client’s achievement of emissions reduction milestones.
To turn regulatory requirements into catalysts for innovation, growth, and competitive differentiation, financial institutions can partner with providers to access the data needed to assist clients with their decarbonization plans. By incorporating sustainability considerations into their strategic objectives, leaders can position their institutions to finance clients’ energy transition needs. By understanding each client’s unique challenges and offering tailored solutions, firms can become trusted partners in their customers’ sustainability journeys.
