Abstract

As human activities increase pressure on ecosystems, approaching more planetary boundaries, societal demand for businesses to play a role for a transition towards sustainable development increases. Financial industry efforts on understanding dependencies between natural capital and business are gaining attention. UniCredit, among the first signatories of the Natural Capital Declaration, is engaging in measuring externalities generated by its investments and trying to understand potential consequences for its business.

The Experience

The financial resources that we allocate to the economic system drive production processes. And despite national and international regulations, these processes may negatively impact human health, biodiversity, ecosystems, climatechange, and reserves of natural resources. In the current economic environment, the success of financial institutions depends on their capacity to manage risks. Sound risk management requires a deep understanding of aspects of risk, including environment-related risks and their potential effects on financial results and the balance sheet. That is why lenders must take responsibility for their loan portfolios and enter into a dialogue with public organizations and affected populations. This dialogue should result in a minimization of negative externalities.

At UniCredit, we prioritize the measurement of pollutants generated in connection with our loan portfolio, in order to understand dependencies between business and environmental impacts.

In June 2012, UniCredit was among the first 37financialinstitutions to endorse the Natural Capital Declaration (NCD), which was officially launched at the United Nations Conference on Sustainable Development, also known as Rio+20. Indeed, the NCD is in line with the focus of our Group’s approach consisting in understanding the full social and economic impacts of pollution. Conservation of biodiversity and ecosystem services is crucial for businesses, asstated in the Declaration itself: Ecosystem goods and services from natural capital underpin productivity and the global economy.

In particular, the NCD takes the form of a commitment made bychief executive officers from the financial sector and emerged from the belief that financial institutions could benefit from guidance on ways to embed environmental factors into their risk management, due diligence, loan, investment and insurance activities. The financial institutions that are signatories to the NCD have made a commitment to: 1. understand the relationship between natural capital and their operations, 2. integrate natural capital considerationsintotheirdecision-makingregardingfinancialproducts and services, 3. build a consensusto integrate natural capital into their reporting, 4. work towards integrating natural capital into private-sector accounting and decision-making. At the NCD launch, Unicredit CEO Federico Ghizzoni stated, “UniCredit acknowledges that only by preserving ecosystem services is it possible to maintain economic development in a sustainable way. Climate change, loss of biodiversity, soil degradation and water scarcity are undermining human activities.”

UniCredit is committed at promoting sustainable solutions in its financing and investmen tdecisions and has adopted an integrated, multifaceted approach to understand and manage environmental and social impacts and risks associated with its commercial activities. Moreover, over the years, UniCredit had issued a series of special credit policies to regulate its financing of the nuclear energy, mining, coal and water infrastructure sectors.

Although these policies help reduce the overall impact of its portfolio, they represent a voluntary initiative that does not fully integrate environment driven risks into a wider commercial strategy. In order to more broadly understand environmental and social impacts, UniCredit measures and monitors other indirect environmental impacts and related risks by periodically analyzing portfolio exposures of specific industries. In the meanwhile, models that assess environmental impacts and externalities related to the lending portfolio are being developed and tested.

The process was accomplished through a coordinated effort at Group level of staff from Sustainability, Business and CRO, and implied the definition of scope as first step. In 2013, as first step, a pilot project was launched to quantify, in monetary terms, the impacts of the pollutants generated by the construction and operation of all the coal-fired power plants financed by UniCredit. In the analysis, onlyonetype of environmental flow was taken into account: air emissions. After identifying all the coal-fired power plants and power generation companies that received project financing or other loans from us, an emission inventory wa screated and the financed emissions estimated. These have then been assessed for their impacts on human health, ecosystems, climate change and reserves of natural resources. Finally, a monetary value was assigned to each impact indicator, using a peer reviewed budget constrained valuation model.

In 2014, the externality analysis were further extended to emissions intensive industries, such as those monitored under the EU Emissions Trading System. After identifying its client lending exposure portfolios for the Italian perimeter, UniCredit created a specific emission inventory to estimate, once more, the so-calledf inanced emissions.

This project aims to develop a methodology to analyze external costs of investments not captured in traditional profitability assessments. Quantitative factors that can be incorporated into corporate investment allocation calculations will deliver better results than adherence to less rigorous voluntary guidelines for mitigating indirect impacts. The methodology applied was a combination of life cycle assessment (LCA) data, Scope 3 GHG reporting data, and company financials. In the use phase analysis, in order to avoid multiple counting use phase emissions were applied at the point of potential regulation. As per the loan portfolio definition, whereas in the first project, related to externalities from coalfiredpowerplantsfinancing, wechose to assess the total impact during construction phase and lifetime of the projects, a different approach was needed for the larger portfolio assessment. In the latter case, a snapshot analysis was chosen as the most appropriate approach, not taking into account duration of financing. The limit of this approach is that the analys is misses a real life impact based on the duration of the loans due to the high number of assumptions required by running such analysis on a wide portfolio. The work is still in progress but for all the industries within scope a significant monetary value of externalities was detected. In particular, some industries showed a larger impact in the operation phase, others were rather marked by a strong use phase of products impact.

Considering the approach is still in a pilot phase, it is not possible today to use the externality analysis sic et simpliciter for business purposes, given the caveat and assumptions to be made. Nevertheless it can be immediately used as a signal to choose which sectors are most at risk and then opt for a specific sector analysis based on different instrument and tools. In otherwords, externality analysis gives a proxy of materiality of environmental risks, at least a first idea of wherethey are likely to materialize, for instanceas a consequence of a regulatory shift imposing internalization to the involved corporates or for extreme events.

Besides all methodologicalr estriction and proxy to be found, currently not yet addressed at industry level, the analysis made clear that there is the need of improving the understanding of links between impact and business. The project was well received and currently UniCredit is partnering with NCD to test other similar methodologies.

Looking externally, a strong push will certainly come from regulators in line with new trends in non-financial reporting both by requiring additional information and steering industry efforts toward the best environmental indicators, under the condition to define standards which make it easier to compare financial and non-financial values in terms of time frame and asset class.