A green ledger turns carbon compliance into business opportunity for financial firms

By Christian Kupper & Denise Iwersen

The Paris Agreement’s goal of keeping global average temperatures from rising more than 1.5 degrees Celsius above preindustrial levels is well known. Less familiar is another top priority of the treaty: “Making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.”

So, the most important environmental treaty in history (no offense to the Montreal Protocol) put the financial industry at the center of humanity’s efforts to maintain the planet’s habitability as we know it.

No pressure.

National laws and rafts of regulations the Paris Agreement spawned help financial institutions steer those financial flows in more planet-friendly ways, and there’s no shortage of associated regulatory reporting involved. What’s been less clear is that the heavy environmental responsibility financial institutions now shoulder also comes with great opportunity.

That opportunity comes in two broad areas. One emerges through greater precision – and, with that, less risk and more profitability – in the pricing of the bank’s own loans and financial products. A second involves financial institutions emerging as trusted advisors that help their customers make choices that quantify and incorporate sustainability into their own capital-spending and operational decisions. Both depend on precise carbon tracking and an ability to make use of that data through green ledgers.

A green ledger lifts carbon accounting to the level of financial accounting

A green ledger is to carbon emissions what a financial ledger is to money, recording every transaction not only in dollars, euros, and so on, but also in CO2 equivalent associated with the underlying asset.

Consider the simple example of two different consumer auto loans, one for an electric vehicle, the other for a gasoline-fueled SUV. Each vehicle has different embodied emissions as well as lifetime emissions. Each may also have different terms and conditions. Those differences influence the carbon intensity of the bank’s portfolio. A green ledger can capture and quantify all that, recalibrating the carbon footprint of the bank’s investment portfolio upward with each new loan and downward with each monthly payment.

What can mastering that sort of detail do for a financial institution? In the near term, it makes regulatory reporting a lot easier. A multinational financial firm may be subject to IFRS S2 climate-related disclosures, the EU Taxonomy and its Green Asset Ratios,  CSRD (Corporate Sustainability Reporting Directive), SDFR (Sustainable Finance Disclosure Regulation), PCAF (Partnership for Carbon Accounting Financials) for measuring financed emissions and SEC rules adopted this year in the United States, among others.

With reliable, detailed carbon data, a bank or insurer can automate and tailor ESG reporting to particular jurisdictions based on actual carbon emissions. Knowing precisely how much carbon you’re financing also crystallizes how much risk you’re taking – and what a given loan or insurance policy’s terms should really be. That same sort of precision can also pay off on the securitization side, letting you tune pricing to the actual ESG-related risk of the bundle.

Emissions-related risk remains a moving target with serious potential consequences for financial institutions. Scenarios and analytics will become increasingly vital tools in managing that risk. A green ledger enables that based on your own real-world data. That lets you run analytics on the CO2 exposure in your balance sheet and scenarios on how that might change with, say, a new plastics tax, carbon tax, or oil-price shock.

A green ledger enables new business models

That brings us to the second opportunity, and that’s for financial institutions to become trusted partners in green ledger-based carbon-related and environmental compliance. Banks and insurers can exploit two basic advantages in developing consulting services around carbon accounting and ESG compliance. They’re dealing with regulatory complexity themselves, and their investment portfolios – and thus expertise – span markets and market segments, so they can cross-fertilize carbon-accounting best practices across their customer base.

United Arab Bank, which is laying the foundations for its green ledger, recognized that its clients can’t mitigate carbon if they can’t measure it. The bank saw clients that wanted to do the right thing environmentally but didn’t know where to start. United Arab Bank aims to harness its own carbon-accounting expertise to help their customers consider product portfolios, suppliers, materials, logistics, and other ways to reduce their carbon footprints.

Artificial intelligence will play a role here. As green-ledger data accumulates over time, nontechnical financial-services staff will be able to quickly run analytics and simulations based on generative AI-powered natural-language queries. Combinations of machine learning and GenAI will then deliver answers at the right level of detail and complexity.

AI goes beyond the green ledger 

GenAI’s role in carbon reduction will extend beyond the green ledger. Its ability to gather and distill information from diverse sources make it well suited to what would otherwise be manually intensive gathering, summarizing, and analyzing of ESG-related information on potential and actual customers and markets. That capability depends, of course, on accessible sustainability and carbon-related data along the value chain – still a major hurdle. Similarly, GenAI can support in handling much of the tedious work of tracking and analyzing regulatory requirements related to a given market, client, or even current or potential product line. Those requirements affect risk and, ultimately, pricing and profitability.

The Paris Agreement placed a lot of responsibility on the financial industry. The data captured in a green ledger and the insights AI can surface based on granular carbon tracking will help institutions stay complaint. But perhaps more importantly, a green ledger will let financial firms serve their customers better and more profitably. That’s good for business and the environment.

Christian Kupper is global value advisor for finance, risk, and investment sustainability at SAP. Denise Iwersen is a customer advisor for financial services and sustainability at SAP.