Carbon Market Watch has formulated a response to the consultation on the draft paper by the Glasgow Financial Alliance for Net Zero (GFANZ), titled “Defining Transition Finance and Considerations for Decarbonization Contribution Methodologies.” This paper addresses the introduction of an Expected Emission Reductions (EER) methodology, which aims to reward financial institutions (FIs) for their role in achieving emissions avoidances through the transition plans of their investees and clients.
The response we formulated highlights concerns regarding the potential risks associated with the EER approach, emphasizing the need for alternative strategies that focus on strengthening engagement policies and exclusion criteria in the finance sector to effectively combat climate change.
Carbon Market Watch criticises the EER approach for potentially exacerbating investments in high-emission industries without adequate engagement measures, as it relies on complex, subjective assumptions and may be easily manipulated. The EER approach is based on baselines to determine the amount of avoided emissions through financial investments. It relies on calculating the disparity between a theoretical “business-as-usual” baseline for emissions in companies or sectors that don’t transition, and the projected emissions trajectory in a future with a successful transition plan. Both the baseline and the pathway involve intricate, inevitably opaque, and easily manipulable subjective assumptions regarding factors like energy demand, economic growth, corporate performance, and legal, regulatory, political, and social changes, spanning many years, possibly decades.
Due to this complexity and the inherent uncertainty of a counterfactual, companies and their financiers may exploit overly optimistic assumptions to inflate the difference between the baseline and the desired trajectory. It’s worth noting that current and historical experiences from carbon markets have demonstrated the problematic nature of establishing such baselines.
In the case of certain heavily carbon-intensive industries like cement, steel, and aluminum, their products have limited substitutes and will maintain high demand. While Carbon Market Watch acknowledges that transition finance is essential in such scenarios, the paper lacks any case studies demonstrating the efficacy of the EER concept in expediting these industry transitions. The paper fails to address the need for stronger engagement strategies to reduce emissions effectively.