Capital markets today face increasing risks due to the physical impacts of climate change and legal and regulatory measures aimed at shifting the economy away from fossil fuels. Investors and other market players concerned about climate-related risks have focused on greenhouse gas emissions, the emissions that cause climate change. Indeed, knowing if and how a company is responsible for greenhouse gas emissions can have significant effects on its profitability, its risk profile and its long-term resilience. As such, the United States Securities and Exchange Commission (SEC) should require state-owned companies to disclose the issue information that investors need, including Scope 3 issues.
Without disclosure, Scope 3 issues are a hidden risk for investors
Public information on companies’ Scope 3 emissions is difficult to find. Without consistent, reliable and comparable information from companies, investors cannot determine whether companies are meeting their declared climate commitments or to what extent they are exposed to changing policies to reduce emissions.
In particular, because Scope 3 includes emissions up and down the value chain, it is often the most important category of emissions. This is especially true for certain industries. An obvious example is that of oil and gas companies, whose products are responsible for a wide range of emissions down the value chain, including the combustion of fuel in airplanes, trucks, heavy equipment and cars. . In fact, Scope 3 emissions represent about 88% of total emissions from the oil and gas sector. A low-carbon economy cannot be achieved without tackling these emissions, which is why shareholders have pressured companies to disclose their Scope 3 emissions and demonstrate how they manage them.
Financial institutions are a unique example of an industry where Scope 3 shows dominate and why it is imperative that they be disclosed. These companies have comparatively few issues in Scopes 1 and 2. Instead, the issues embedded in their loan, equity and insurance portfolios are Scope 3 issues, often referred to as “funded issues”. In other words, the Scope 1, 2 and 3 issues of the companies to which they lend, invest or insure constitute the Scope 3 issues of the financial company. The financial company bears a share of responsibility and risk for these issues depending on its investment in a company. A bank that owns 30 percent of Company A, for example, should include 30 percent of the total issues of Company A in the bank’s Scope 3 issues.
Financial institutions are uniquely positioned to pressure a wide range of companies to disclose and manage their issuance, as they too are likely to be interested in the potential risk to their portfolios and have the leverage to encourage clients to assess their Scope 3 emissions. Indeed, this is why federal regulators are starting to focus on the systemic risks posed to the financial system by climate change. Transparency regarding Scope 3 issuance is also essential to ensure that capital formation is aligned with the objectives of investors, other market participants and the public.
Scope 3 issuance reporting protects investors
Unless climate disclosure regulations require reporting of Scope 3 emissions, investors and other market participants may have no way of knowing the extent of a company’s Scope 3 emissions or steps the company is taking to reduce them.
Many of these companies, including oil and gas companies, have pledged to reduce their climate emissions to zero by a certain date; or they may be located in a jurisdiction that has made such a commitment. For example, federal, state and local restrictions or charges on the burning of fossil fuels could affect a company’s inputs up the supply chain or its ability to sell products for use down the supply chain. ‘supply. In July 2020, a study by Ceres found that 92% of S&P 100 companies planned to set emission reduction targets, a fact that was noted by SEC Chairman Gary Gensler. However, investors concerned about climate risk cannot assess these commitments without information on companies’ Scope 3 emissions.
Although Scope 3 emissions reporting is currently voluntary under the Greenhouse Gas Protocol, there are signs that this could change, which could expose companies that ignore their Scope 3 emissions, as well as their investors. In the UK, reporting of a Scope 3 emission type is already mandatory for some companies, and the UK government has made it clear that more Scope 3 emission reporting categories will be required in the future. If the US does not require reporting of Scope 3 emissions while the UK and other countries move forward, investors in US companies will be at a disadvantage.
The disclosure of Scope 3 emissions must be standardized
The data and methodologies needed to calculate Scope 3 emissions are important to ensure that information on Scope 3 emissions is reliable, consistent and comparable for investors. But to date, they have not been fully developed for all industries. At the same time, Scope 3 emissions represent a substantial part of the greenhouse gas emissions of many companies. Experience from countless disclosures in the past suggests that getting started is the fair and most effective way to approach the disclosure of Scope 3 broadcasts, whether starting with the largest companies or those with the greatest impact on emissions or starting with certain industries.
However, without a specific regulatory requirement to disclose Scope 3 emissions, it is unlikely that most companies will incorporate Scope 3 calculations into their climate risk analysis in a serious and reasonably accurate manner. Worse yet, companies can make claims about Scope 3 emissions that cannot be verified as they are not part of the annual report which is provided by external auditors, but rather exist in unverified accounts which could be misleading. for investors.
Progress on data and methodologies for calculating Scope 3 emissions is advancing rapidly, so it may become easier for financial and non-financial companies to calculate their Scope 3 emissions. Obviously, in the case of fuel sales fossil fuels, very precise estimates are available to estimate the emissions expected when the fuels are ultimately burned. It would therefore be very straightforward to require fossil fuel companies to disclose these clearly predictable emissions to their investors. At the same time, for banks and other financial companies, the Partnership for Carbon Accounting Financials has developed an American platform with data and methodologies to make it easier for financial institutions to calculate their Scope 3 emissions. non-financial corporations, the U.S. Environmental Protection Agency’s greenhouse gas reporting program includes a GHG Emissions Factors Center, which provides standardized data and methodologies that travel, transport of products and commuting of employees, and waste, as well as purchased electricity (Scope 2). While these initiatives do not cover all Scope 3 broadcasts, they will eventually cover much more.
These efforts alone could provide a solid basis for the SEC to take the lead in requiring and standardizing the disclosure of Scope 3 broadcasts. They demonstrate that the SEC, as an agency, does not need to. have in-depth expertise in the science of greenhouse gas emissions, but can instead provide the leadership given to it by Congress in the 1930s to ensure that companies make reliable and consistent disclosures that investors can use to compare companies. In addition, the processes for accompanying public comments, letters from staff and advice, and input from industry and investor advisory groups would accelerate progress in standardizing and improving this important area of science. risk disclosure.
Inevitably, some companies will claim that reporting Scope 3 emissions will result in double counting, but this is not a serious issue. The purpose of disclosing Scope 3 emissions, as with Scopes 1 and 2, is not to create a national inventory, but rather to help investors understand which companies are related to emissions and therefore exposed to a risk. increased risk. With comprehensive issuance information, investors can make informed investment and voting decisions. As mentioned above, this information is currently not easily found for investors through public sources. The lack of reporting on Scope 3 emissions also leaves gaps in reporting that companies may be able to exploit to avoid risk disclosure.
The pressure is there. Investors are increasingly aware of the risks associated with a company’s greenhouse gas emissions. They want full program disclosures. The SEC should therefore require financial and non-financial companies to begin tracking and reporting Scope 3 issues. An SEC Scope 3 issue disclosure requirement could facilitate standardized formats for reporting Scope issues. 3 in 10-K files, as well as standardized data and methodologies as well as a progressive compliance plan. It is only with the direction of the SEC that investors can get the reliable, consistent and comparable information they need about Scope 3 issues to make informed investment and voting decisions.
The author would like to thank Alex Martin, Trevor Higgins and Todd Phillips for their contributions to this column, and Chester Hawkins for helping to create the graphic.