The PCAF standard defines how a company's emissions should be allocated to derive the financed emissions of the company’s debt or equity. If an investor holds stock in a public company, the financed emissions are calculated using the formula (1) :
Financed Emissions = Company emissions x $ value of stock held / EVIC of company
where EVIC is the enterprise value of the company including cash.
Both the value of the stock held and the EVIC of the company will go up and down with the stock price. But they may not go up and down by the same amount. Generally, the EVIC will move proportionally less that the stock price, because the EVIC also includes the value of the company's debt, which will not move much. Therefor, significant changes in financed emissions may occur, not as a result of either the listed company emitting more or less, nor as a results of changes in the investor holdings, but simply as a result of fluctuations in the stock market. Given recent volatility, this may account for significant differences between portfolio financed emissions between 2021 and 2022.
We can illustrate this with an example.
Let's say an investment manager owned a million dollars of Air Canada stock at the end of 2021. At that time the stock was trading at $21.13 and the EVIC was $24,084 million. Last year Air Canada reported scope 1 and 2 GHG emissions of 5,044,252 tCO2e. So, the financed emissions for that holding at the end of last year would have been:
5,044,252 x $1 / $24,084 = 209 tCO2e
As of last week, Air Canada stock closed at $17.31, a decline of 18%, so the value of the stock would have decreased to $819,214 and the EVIC had declined to $22,865 million (2). If Air Canada's emissions did not change, the financed emissions would be:
5,044,252 x $0.819 / $22,865 = 181 tCO2e
This is a 14% decrease, almost entirely due to decline in the stock price. That is because the EVIC declined only 5% when the stock lost 18%. Since the value of the stock went down by more than the EVIC, the financed emissions decreased. Air Canada's enterprise value comes mostly from the $16.5 billion of debt it carries, and that did not change in value as the stock price declined.
For organizations holding debt of a company the effect is in the opposite direction to equity owners. Air Canada debt holders (including banks that have provided loans) will have an increase in their financed emissions. A one million dollar bond or loan at the end of 2021 would have financed emissions of 209 tCO2e, the same as the million dollars of equity. However, by mid-October 2022 that would become:
5,044,252 x $1 / 22,865 = 221 tCO2e
The debt financed emissions have increased by 5%, the opposite of the change in the enterprise value.
When we do the same calculations for a million dollars of equity and a million of debt of Suncor Energy the direction of the change in financed emissions is reversed, and the magnitude of the changes is larger, because Suncor's stock price has increased by 40% since the start of the year. The results are summarised in this table:
| Change in Stock Price | Change in EVIC | Change in Equity Fin. Emissions | Change in Debt Fin. Emissions |
Air Canada | -18.1% | -5.1% | -13.7% | 5.3% |
Suncor Energy | 40.3% | 19.4% | 17.4% | -16.3% |
In essence, the effect of the change in stock price and corresponding change in EVIC results in a reallocation of the company's emissions between the equity holders and the debt holders. This is because the equity holdings change in value and the debt does not. The magnitude of the reallocation is dependent on the capital structure of the company, i.e. the proportion of the EVIC that is equity and the proportion that is debt.
What is the significance of all this?
Financed emissions are driven by several factors beyond both the value of the financing and the underlying corporate emissions of the investee. If we understand the mechanics of financed emission calculations we know what to expect as these factors change, and we can plan for it accordingly.
Likewise, if we can quantify the reasons for the changes in financed emission year over year, we can explain it better to our stakeholders, and that can help reconcile our emissions trajectory with our reduction targets. Zfolio is the only platform with built-in tools specifically designed to help with these tasks.
Footnotes:
From PCAF (2020). The Global GHG Accounting and Reporting Standard for the Financial Industry. First edition. Section 5.1, Listed equity and corporate bonds
All values in Canadian dollars. Dates used are Dec 30th, 2021 and October 13th 2022.
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