For many investment managers, superannuation funds, banks and insurers, financed emissions make up the bulk of their scope 3 emissions. This category of ‘indirect emissions’ can be challenging to measure due to lack of access to quality data as well as complex fund structures.
But progress is being made – universal methodologies for scope 3 carbon accounting are available, powered by technology. As a result the share of financial institutions, and companies, reporting these indirect emissions is growing.
In this guide we explore the implications of being accountable for the emissions of companies along your value chain, how financed emissions are categorised under scope 3 by the Greenhouse Gas Protocol, as well as the challenges of measuring scope 3 emissions.
Scope 3 is a broad group of greenhouse gas (GHG) emissions that includes the ‘indirect’ emissions that arise from a company’s upstream and downstream operating activities.
Core guidance on the emissions categories comes from the Greenhouse Gas Protocol, which is the global accounting standard for corporate emissions. Specific details about scope 3 are laid out in the Corporate Value Chain (Scope 3) Accounting and Reporting Standard.
The table below lays out the three components of a company’s GHG emissions.
|
Scope 1 |
Direct emissions from owned or controlled sources e.g., operating buildings and other facilities, or a vehicle fleet. |
|
Scope 2 |
Indirect emissions from the generation of purchased energy. Scope 2 emissions from one company are part of the scope 1 emissions from another company. |
|
Scope 3 |
All indirect emissions (not included in scope 2) that occur in the value chain of the reporting company. This includes both upstream and downstream emissions e.g., financed emissions, business travel or employee commuting. |
These groups are differentiated by the level of control that an organisation has to manage them.
Scope 1 emissions are direct emissions, meaning a corporation has direct control of the operations that are producing them. Whether that be a power-plant burning fossil fuels, or greenhouse gas emissions from a vehicle fleet.
Both scope 2 and scope 3 are indirect emissions. Scope 2 is more specific, it’s essentially emissions from electricity production, which means it’s relatively easy to measure and manage.
Scope 3 includes a broader mix of emissions, with some categories being harder to influence than others. While indirect emissions like corporate travel are relatively simple to keep track of, other categories like financed emissions and upstream fuel usage require engagement with separate organisations.
The Greenhouse Gas Protocol has evolved to include 15 categories of scope 3 activities. This structure enables consistent analysis and reporting across the various sources of emissions.
The Greenhouse Gas Protocol defines the indirect emissions from the many upstream and downstream activities of a company. The 15 categories are as follows:
Upstream
Downstream
Such specific categorisations of scope 3 emissions helps to reduce the chance of double-counting. The categories offer detailed treatment for each emissions type, as well as exceptions for activities that may have already been captured in scope 1 or scope 2.
The requirements to calculate and report scope 3 emissions can be found in the Corporate Value Chain (Scope 3) Accounting and Reporting Standard. It defines the specific requirements for corporate reporting of GHG emissions in the value chain.
The supplementary document, Technical Guidance for Calculating Scope 3 Emissions, offers further guidance on use of the 15 categories and which are material for a particular industry and sector.
And, the Land Sector and Removals Guidance explores the measurement and reporting of emissions from land management, land use change and carbon dioxide removal technologies.
It’s important to understand that one company’s scope 3 emissions is another company’s scope 1 emissions. This is a feature, not a bug.
On the surface this may look like double-counting, but when you dig a little deeper you begin to appreciate the elegance of the structure that puts your product at the centre of the carbon account.
It’s your value-chain, and you’re responsible for the emissions produced along the way, because you can influence them, for example through product design, selection of materials or suppliers of services.
The same business practices that built our globalised system of supply-chains and capital allocation can be used to drive the reduction of GHG emissions.
It’s all about collaboration and gentle pressure on value-chain partners, and it’s essential to create a positive ripple effect of decarbonisation across such value chains.
For financial institutions the most relevant category of scope 3 emissions is financed emissions. This is category number 15 on the Greenhouse Gas Protocol’s list of scope 3 emissions, and they’re the emissions linked to the investment and lending activities of financial institutions.
While investment managers, superannuation funds, venture capitalists, private equity investors and bankers may not have large direct greenhouse gas emissions (scope 1 & 2), they tend to have large indirect greenhouse gas emissions in terms of their investing and lending activities (scope 3).
An investment firm’s scope 3 emissions include the scope 1, 2 and 3 emissions of its portfolio companies or investments.
An investment firm’s scope 3 emissions can be many multiples greater than their direct emissions, which highlights the central role they have in the decarbonisation of the economy.
They can exert influence and pressure through their financing activities. This may come in the form of shifting funding allocation due to carbon exposure risks, or favouring companies that have made progress towards or enable decarbonisation.
The chart below shows estimates of the value chain emissions for various industries. Most striking is the ‘financials’ sector which has 92% of its value chain emissions in financed emissions (scope 3, category 15).
Source: MSCI, data as of March 22, 2022.
The core challenge for financial institutions is accessing reliable data on the emissions of the companies they finance.
This can be complicated by complex fund structures, data being in inconsistent formats, and companies simply not having done the measurement.
These challenges have led to many companies putting scope 3 emissions in the too-hard basket, and simply focussing on the more manageable scope 1 and scope 2 streams. This approach will slow progress towards net zero, and will leave firms exposed if and when new emissions disclosure rules are imposed.
In lieu of access to specific company data, firms often use proxy data that comes from industry averages driven by the partner company’s revenue numbers. This is a useful first step to understand the extent of emissions exposure, and to target problem areas.
The short answer is, not yet, or at least not yet in Australia. Some jurisdictions and industries in Europe do already face mandatory reporting rules, and many others around the world are getting close.
The Securities and Exchange Commission (SEC), a US government oversight agency responsible for regulating the securities markets and protecting investors, has released a proposal that includes a requirement for scope 3 emissions, where relevant, to be disclosed by companies under its jurisdiction.
The SEC stated that its rules would be aligned with the International Sustainability Standards Board (ISSB). ISSB has released a first draft of new global accounting standards for sustainability disclosures, and it has confirmed that scope 3 will be included.
The direction of travel is clear, and it’s likely that in years to come, measuring and reporting scope 3 emissions will be commonplace (and hopefully as streamlined) as reporting key financial indicators like revenue and EBITDA.
Early movers are already using frameworks like Task Force on Climate-Related Financial Disclosures (TCFD), which is the leading model for reporting on climate risk. It requires disclosure of scope 1 and scope 2 emissions, with reporting for scope 3 only required if it’s appropriate.
The Science-Based Targets initiative (SBTi) further complements the process by offering a model for setting targets.
The challenges of measuring and reporting scope 3 emissions are being overcome, and those leading the charge have a competitive advantage in an increasingly carbon-constrained world.
Broader adoption of the reporting treatments of scope 3 is vital to drive consistent global disclosures. This will allow financial institutions and companies to better measure and benchmark their decarbonisation progress, while also helping investors and consumers to make more informed decisions.
Pathzero unites private market participants including asset owners, asset managers and portfolio companies on a common platform enabling the disclosure of carbon emissions and the actions being taken to address them.