Environmental Sustainability

Expect More Scrutiny
of Scope 3 Emissions

The momentum from COP26 and pressure from consumers will force public companies to act, explains Rick Lacaille, global head of environmental, social and governance (ESG).

January 2022

In the aftermath of COP26, there will be greater focus on the measurement of greenhouse gas (GHG) emissions at every level. For public companies, that’s going to mean paying far more attention to something they’d rather not – scope 3 emissions.

Companies typically focus on reporting and setting targets to reduce their direct operational GHG emissions (scope 1) as well as their electricity use (scope 2). But scope 3 includes everything else – indirect GHG emissions from throughout a company’s value chain, including suppliers. And more often than not, the majority of a firm’s emissions fall into scope 3.

To date, a minority of companies report scope 3 emissions, and those that do tend to disclose one or two categories such as business travel. While business travel is a legitimate source of scope 3 emissions, there are many others. In fact, the GHG Protocol outlines 15 emission categories in scope 3 including purchased goods and services, capital goods, upstream and downstream transportation and distribution, employee commuting and the life cycle of sold products.

As the largest source of emissions for a typical company, scope 3 reporting and targets offer the single biggest opportunity for corporate GHG emissions reduction. While companies have been able to avoid full disclosure of scope 3 emissions without consequences, that is changing.

Consumers and investors are increasingly looking for scope 3 emissions data from companies. It’s not hard to imagine a world where every product sold will be required to have a GHG emissions metric to enable consumers to factor carbon intensity into their buying decisions. Investors want companies to disclose GHG emissions, set targets in line with science and implement action plans.

Recent research from State Street Associates looked at scope 3 data and how it could benefit portfolio construction. The researchers concluded that including various types of climate data – reported scope 1 and scope 2 carbon data, modeled scope 3 and climate risk ratings – can help investors design strategies to manage climate risk while increasing risk-adjusted returns. That means scope 3 emissions data can make a difference to investment decisions.

To be fair to public companies, measuring scope 3 emissions is not straightforward. In the aggregate, reporting on scope 3 emissions could lead to double counting if two or more companies account for the same emissions. Then there are basic firm level issues, for example, as everything is connected to everything else, where does a company draw the boundaries? You may include the emissions your workforce emits in commuting to work but what about a supplier’s workforce?

And then there’s the data challenge. How do you measure your workforce’s commute? Or the activities of secondary parties? Finally, how do you affect the behavior and decision-making of many different individuals and organizations outside of your direct control?

While these challenges have prevented widespread disclosure of scope 3 emissions to date, the momentum from COP26 and a sense of urgency will force companies to act. Luckily, it’s a solvable problem. If every company did its part to report scope 1 and scope 2 emissions, measuring and reporting scope 3 emissions would be a lot easier.

Individual companies have a lot of leverage. They can look for low-carbon alternatives in their supply chain, buy from suppliers with low carbon footprints and engage suppliers in conversations about reducing emissions. They can also engage with customers on the carbon intensity of products, increase the life cycle of products and increase the efficiency of products and services. Companies can put a price on carbon, increase efficiencies in logistics and invest in low-carbon products and services.

Thinking through the entire value chain could lead to unintended benefits like cost reduction, innovation and new products and services. By tackling scope 3 emissions head on, public companies can lead the way in reporting and reducing GHG emissions.

So stepping back, sometimes the things we want to do the least, end up being the best for us. That might turn out to be the case when it comes to scope 3 emissions, not just for individual companies but the world.

 

This article originally appeared in the Winter 2022 edition of the Official Monetary and Financial Institutions Forum Journal.