For companies and other organisations to be able to address and lower their greenhouse gas emissions – and for investors to be able to evaluate those efforts – it is important to have a clear picture of where these emissions come from and to what extent sources can be held accountable. In this explanatory article, Thibaud Clisson focuses on Scope 3 emissions.
The standard-setting Greenhouse Gas Protocol (GHG Protocol), based on a partnership of the World Resources Institute and the World Business Council for Sustainable Development, classifies emissions of climate-warming gases into three “scopes”:
- Scope 1 covers direct emissions that occur from sources that are owned or controlled by the company, e.g., those coming from combustion in boilers and plants
- Scope 2 covers indirect emissions associated with the generation of purchased electricity consumed by the company
- Scope 3 is more complex: it covers all other indirect emissions created throughout a company’s value chain including those linked to the use of the product sold or the extraction and production of purchased materials.
As mentioned in the GHG Protocol, scope 3 emissions result from the activities of the company, but occur from sources the company does not own or control.
On average, scope 3 emissions account for over 80% of a company’s total carbon footprint, although the actual percentage varies from sector to sector. According to CDP data, emissions from investments accounted for over 700 times the direct emissions of financial firms in 2020. By contrast, for cement, scope 3 accounts for just 16%.
It should be noted that for different companies, emissions can fall into different categories: scope 1 emissions of power producers are scope 2 emissions of their customers.
Why does measuring scope 3 emissions matter?
In addition to meeting changing regulatory requirements and investor expectations, measuring these emissions can provide companies with a range of benefits. They include:
- Setting and monitoring reduction targets for hotspots in their value chain
- Identifying sustainability leaders and laggards in their supply chain
- Engaging with suppliers to help them implement sustainability initiatives
- Informing emissions reduction decisions across procurement, product development and logistics
- Driving innovation to create products that are more energy-efficient and sustainable
- Identifying opportunities to transition away from fossil fuel-related activities
- Engaging with employees on low-emissions business travel and commuting
- Updating climate strategies to include progress on scope 3 emission reduction targets
- Improving their reputation through information sharing and public reporting.
What are the key challenges?
First, we note that reporting scope 3 emissions is largely optional under the GHG Protocol.
Second, given the broad range of activities covered by scope 3, companies may find calculating them more burdensome compared to scope 1 and 2. The GHG Protocol points out that companies should identify and prioritise the scope 3 activities that have the largest GHG emissions, offer the greatest potential for cuts, and are most aligned with their business goals.
One major hurdle is sourcing specific, reliable and accurate data. Data from value chain partners could be insufficient, so companies may need to use imperfect or estimated data.
The protocol offer a wide range of methodological choices. This adds to the difficulties of making scope 3 emissions comparable from one company to the next: do you include suppliers that you control operationally or only financially, what is the period covered, can you measure the emissions directly or do you rely on estimates?
Moreover, many companies are unable to report – or choose not to report – on all scope 3 categories. This means that companies in similar industries can report wildly different results.
All in all, few companies disclose scope 3 emissions and even fewer disclose comparable and meaningful scope 3 emissions.
Do accounting standards and regulations help?
Scope 3 emissions have been integrated into the standards set out by the Task Force on Climate-Related Financial Disclosures (TCFD), the International Sustainability Standards Board, the Global Reporting Initiative, and the Science Based Targets initiative.
Regulators — in the EU, UK, Japan, the state of California, and most recently China, among others — intend to make disclosing scope 3 emission mandatory. US federal regulations had been proposed, but after thousands of comments from companies and business groups, the Securities and Exchange Commission voted against requiring scope 3 emissions disclosures.
The EU’s Corporate Sustainable Reporting Directive (CSRD) is expected to significantly expand the need to report scope 3 emissions. Large companies operating in the EU will have to report these emissions from 2025; for non-EU companies and certain sectors, this is 2026.
While the CSRD regulation will not necessarily address the issue of comparability between companies, the TCFD and the Principle Adverse Impact indicators under the Sustainable Finance Regulation may provide some common ground.
What can investors do to address the challenges?
A paper by the Institutional Investors Group on Climate Change, of which we are an investor member, argues that, despite the challenges, investors must examine a company’s scope 3 emissions to understand and assess its contribution to climate change.
The group suggests that asset-level engagement will help investors identify where action on decarbonisation is most needed.
A report by the London Stock Exchange Group has proposed using empirical data to identify the most material scope 3 categories in each sector. This would simplify company disclosures and improve the quality and comparability of reported and estimated data. Ultimately, this should help investors make better informed investment decisions.
What is BNPP AM doing on scope 3?
Given the reporting and data limitations, BNP Paribas Asset Management believes we cannot yet make a commitment to scope 3 financed emissions. Estimation methodologies by data providers do not help in improving the comparability of scope 3 emissions at the issuer level and the quality of companies’ reporting on scope 3 emissions needs to be improved.
In our Principle Adverse Impact (PAI) reporting, we take a conservative approach using only data from companies disclosing all subcategories of scope 3 emissions considered material by CDP. These companies represent a small fraction of our scope 3 financed emissions.
In this year’s PAI report, scope 3 financed emissions rose substantially after one company reported eligible data. This illustrates how as of today, financed scope 3 emissions are concentrated in a few issuers in sectors where companies have large scope 3 emissions such as oil and gas, automotive, and construction.
We might see a further rise in scope 3 emissions as large emitters disclose emissions more fully. When low emitters start to better disclose their emissions, this should dilute the share of large emitters.
