Enabling Transition Finance through Emissions Intensity Evaluation

The white paper presents a novel approach for the financial sector to incorporate carbon emissions considerations into investment and lending evaluations. As global efforts to meet the Paris Agreement targets intensify, there is a critical need to mobilize substantial financial resources, particularly in emerging economies like India, which requires an estimated USD 2.5 trillion by 2030 for its climate goals.

Currently, the financial sector’s evaluation processes, which rely heavily on conventional credit ratings, do not adequately account for carbon emissions or the environmental impact of companies. This gap poses a significant challenge to transition finance, especially in hard-to-abate sectors such as steel and cement, where investment is essential but often hindered by the perceived high risk of climate-positive projects.

To address this issue, the paper introduces the concept of a Carbon Rating Framework—a methodology designed to rate companies based on their carbon emission intensity, both current and projected, over the next three to five years. This framework is intended to complement existing credit ratings, offering a new paradigm for evaluating the environmental impact of business entities. By integrating carbon intensity into the decision-making process, the framework aims to direct capital towards low-carbon technologies and practices, thus supporting the broader transition to a green economy.

Key components of the proposed framework include:

1. Quantitative and Qualitative Assessment: The framework assesses companies’ carbon emission intensity through a combination of historical data and future projections, considering both quantitative metrics and qualitative factors.
2. Weighted Evaluation: The framework proposes a weighted approach, emphasizing past emissions and accounting for future reductions, incentivizing companies to adopt low-carbon strategies.
3. Rating Scale: A 10-point rating scale is suggested, where a lower ratio of emissions per unit of revenue results in a better carbon rating. This scale is designed to be sector-agnostic but can be adapted to include sector-specific considerations.

The Carbon Rating Framework is envisioned as a tool to facilitate transition finance by providing a standardized method to evaluate and compare the carbon intensity of companies. It could serve as a valuable input for financial institutions, helping them to channel capital more effectively towards projects that contribute to the global climate goals.

The paper highlights areas for future research, including the potential expansion of the framework to include Scope 3 emissions and other environmental factors, as well as how credit rating agencies and banks might adopt and adapt the framework.

This white paper represents a starting point for dialogue and development in the financial sector’s role in driving the transition to a low-carbon economy.

Download the paper here