The Scope 3 challenge amid wave of regulation and public scrutiny

The Greenhouse Gas Protocol – which provides the most widely recognised accounting standards for greenhouse gas emissions – categorises GHG emissions into three ‘scopes.’
Scope 1 covers direct emissions from owned or controlled sources. Scope 2 covers indirect emissions from the purchase and use of electricity, steam, heating and cooling.
Scope 3 emissions are those produced by a company’s customers and supply chain. They typically account for more than 80% of a company’s carbon footprint.
When asset managers first made commitments to align their portfolios with net-zero emissions, they mostly skirted the thorny issue of Scope 3.
That’s no longer possible. A wave of regulation and public scrutiny is pushing investors to face what a unit of London Stock Exchange Group calls “one of the most vexing problems in climate finance.”
The urgency comes as regulators from the European Union, Japan, the UK and elsewhere signal mandatory Scope 3 disclosures are on the horizon for corporates.
The US Securities and Exchange Commission also has discussed whether big emitters should be required to disclose their Scope 3 emissions.
The Institutional Investors Group on Climate Change says: “Without recognising the Scope 3 emissions of a company, it isn’t possible to fully understand and assess its contribution to climate change.”
FTSE Russell, the indexes and benchmark unit of LSEG, calls this the “Scope 3 Conundrum.”
Incorporating value-chain emissions is “indispensable to a clear-eyed assessment of climate risks for companies,” but integrating Scope 3 data with portfolio analysis and investment decisions is “often hobbled” by the complexity of Scope 3 accounting.
That complexity is caused by low disclosure rates, variable data quality and poor comparability, says the report.
FTSE Russell has found that just 45% of the 4,000 medium to large-sized publicly traded companies in the FTSE All-World Index disclose Scope 3 data, and less than half of those do so for the most material-emissions categories in their sector.
When investors in the Net Zero Asset Managers initiative set targets to align their portfolios with net-zero emissions by 2050, they are only required to take into account Scope 3 emissions to “the extent possible.”
Many of the asset managers in the $57tn initiative say they intend to add Scope 3 as the availability and quality of emissions data improves.
The share of the global economy covered by independently verified pledges to cut emissions surged in 2022 as companies faced with climate change and greenwashing concerns sought a stamp of approval from the UN-backed Science Based Targets initiative.
Companies with targets or commitments represented 34% of the global economy, by market capitalization, SBTi said in a new report that looks at 2022. That was up from 28% from a year earlier and was driven by a record 87% increase in validations to 1,097, more than the previous seven years combined.
Investors are pressuring companies to validate their targets and to show progress amid evidence of inflated and misleading claims. Measuring Scope 3 emissions has several benefits. For most businesses and public bodies, the majority of their GHG emissions and cost reduction opportunities are outside their own operations.
For sure, addressing Scope 3 emissions can help advance an organisation’s decarbonisation and sustainability journey.
But one problem is that the most widely used voluntary emissions reporting standard, the GHG Protocol, was not originally designed with investors in mind.
The protocol was devised in the early 2000s and divides Scope 3 into 15 categories, ranging from the emissions resulting from purchased goods and services, to business travel and the processing of sold products.
And unlike Scope 1 and 2 emissions, which are derived from a company’s own activity and from purchased energy, accurately assessing Scope 3 is much more difficult.