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Sustainable Finance Initiative is a cross-campus effort of the Precourt Institute for Energy.

Publication

The Road to Climate Stability Runs through Emissions Liability Management

Working within the context of the Greenhouse Gas (GHG) Protocol, this paper proposes limited changes to carbon emissions accounting standards that will improve reporting efficiency and accelerate progress toward effective climate solutions. These proposed changes build the foundation necessary to traverse from voluntary and sub-scale climate action to mandatory disclosure regimes and robust carbon markets. An improved carbon accounting structure also enables visibility and management across corporate, national, and global carbon ledgers.

The first section summarizes a method to account for emissions as liabilities tied to product or service outputs that pass down a supply chain. By carefully constructing emissions liabilities from the ground up, and passing those liabilities downstream, reporting firms in a supply chain accurately resolve their upstream supply chain emissions. This method also addresses two particular concerns with Scope 3 emissions: arbitrary overcounting and reporting on activities out of one’s control. In this framework, any buyer knows with confidence the emissions produced to deliver a product or service by combining upstream passed liabilities with their own Scope 1 emissions. As a result of this accounting method, firms are able to construct the liability side of a carbon balance sheet.

The second section builds on the liability side of the balance sheet and presents a pathway for what we call Emissions Liability Management (ELM), akin to traditional balance sheet management. Emissions result in essentially permanent liabilities. Few carbon offset strategies match the certainty and duration of emissions liabilities. As a result, offsets have been shunned by leading standards bodies like the Science Based Targets Initiative (SBTI), thereby stifling needed investment in protecting natural capital and technology-driven sequestration. ELM enables buyers to shift from having to distinguish between “high” and “low” quality offsets to managing a portfolio of permanent (i.e., extinguishes liabilities) and non-permanent (i.e., requiring continued liability management over time) assets. This section proposes two key steps necessary to manage carbon balance sheets with assets of varied risk. First, the use of reference assets that meet stringent permanence and additionality standards would serve as accepted means to extinguish liabilities, or “risk-free assets.” Second, relative valuation approaches would systematically describe uncertain natural or technological sequestration strategies as important intermediate solutions.

The second section also raises a number of technical issues around carbon ownership, trading, and custody concerns that must be overcome in an implementation process. Resolving these issues will provide a viable mechanism for action as financial markets translate carbon liabilities into financial risk — a mechanism unfortunately lacking on the current path.

Author(s)
Marc Roston
Alicia Seiger
Thomas Heller
Publisher
Sustainable Finance Initiative
Publication Date
November, 2022