Scope 3 emissions data capture is limited but can be overcome to prepare for more stringent CSRD, TCFD, and SFDR compliance requirements
Intrinsic complexity has hindered integration so far
Scope 3 emissions have proven much more difficult for companies to account for than Scopes 1 or 2 [1], both of which are under their direct control. The lack of standardized methodology and the need to rely on modeling have until now led to a limited and cautious integration of Scope 3 data into investment processes.
European regulation acknowledges these difficulties: the climate benchmark regulation allows for a four-year transition period for the inclusion of Scope 3 data and companies have until January 2023 to include them in their SFDR reporting.
However, there are strong limitations to Scope 3 data reliability, such as breadth and accuracy of company reporting, comparability, and double counting issues for “portfolio footprinting”. Even if the number of public companies reporting Scope 3 emissions in 2021 grew 30% from 2020, more than 40% of companies reporting Scopes 1 and 2 are still not reporting Scope 3 – a trend that has remained unchanged for the last three years [2].
Assessing Scope 3 emissions for reporting requires internal modeling capacities or additional reliance on third party expertise. When companies do report, they often omit part of their Scope 3 emissions and, according to our analysis, only 30% of companies rely on external verification processes to increase accuracy and completeness.
We found that there is a 44% difference between the medians of Scope 3 emissions for verified and unverified reports. As shown in the chart below, the effect persists when doing the analysis at industry level [3]. Additionally, a study recently published by the Technical University of Munich [4] which looked at 56 software and hardware manufacturers that were included in the 2019 Forbes Global 2000 list found their self-reported emissions were underestimated by 391 MT CO2eq – an amount roughly equivalent to Australia’s total annual emissions.
Even with the existing GHG protocol framework [5], reported Scope 3 emissions strongly vary with regards to the modeling assumptions and the inventory boundary, which makes it difficult to compare. Third party models have work to overcome this issue but divergences among data providers remain very high [6]. Lastly, integrating Scope 3 at the portfolio level will lead to double accounting which is complex to adjust for beyond an approximated discount rate.
There is no pathway to net zero without incorporating Scope 3 emissions
As the shift towards low carbon development pathways becomes an even stronger imperative, Scope 3 emissions can no longer be ignored. The recently published SBTi Corporate Net Zero Standard requires companies with Scope 3 emissions that are at least 40% of total emissions to set near-term science-based Scope 3 targets. According to our research, that could apply to over 87% of companies [7]. SBTi will update this year its Scope 3 target setting methods and criteria to ensure full alignment with its Net Zero Standard [8].
The largest pension fund in the world, Japan’s Government Pension Investment Fund (GPIF), has identified a “shockingly large gap” between its reported carbon emissions over the past two years, after including its Scope 3 emissions in its latest analysis [9]. The Carbon Disclosure Project (CDP) found that value chain emissions are, on average, 11.4 times higher than operational emissions [10]. This change in magnitude implies a shift in sector hierarchy and priorities to reduce GHG emissions at portfolio level as illustrated in the graph below.
From a macroeconomic point of view, the integration of Scope 3 also allows for better monitoring of pathways to decarbonization. The net carbon content of national trade balances represents a country’s Scope 3 emissions. Imported goods will be consumed locally but have generated GHG emissions in other countries for their production. Exported goods have generated emissions locally but will be consumed in other countries. For example, while emissions per capita in France for Scopes 1 and 2 (i.e., produced emissions) are 50% lower than in Germany, the two countries are comparable when accounting for Scope 3 (i.e., consumed emissions) [12]. This is closely related with financial materiality of climate impact [13], as implementation of a carbon border tax is high on the political agenda in Europe [14] and will impact the competitiveness of exporters when matched to the carbon intensity of their value chain.
Investors, corporations and countries must turn to technology to enhance coverage and reliability of Scope 3 emissions data
To overcome these limitations, corporations and countries need a way to deliver consistent Scope 3 data and to integrate upstream and downstream emissions into their reporting. Investors too must rely on data to ensure their sustainable analysis of portfolio holdings is robust. Recently, the US Securities and Exchange Commission (SEC) has proposed a new change in the rules to enforce registrants to disclose information on Scope 3 emissions, if some criteria like materiality or having specific climate targets are met [15].
As the race to net zero gains momentum, more and more investors are taking active measures to integrate Scope 3 emissions in their analyses and assessments [16]. Technology solutions which offer a robust and consistent methodology to deliver Scope 3 emissions at scale with deep granularity and full transparency will allow investors to better manage their paths to decarbonization, while also expanding their engagement strategy to supply chain emissions.
Quantity and quality of reported Scope 3 emissions by corporates will likely increase driven by different factors, for example more stringent regulatory requirements like CSRD and TCFD, and deployment of cloud-based climate performance reporting and management tools.
However, the need will remain for coverage expansion – for example to private markets – and reliability, including consistency assurance and clear comparability.
This need can only be solved at scale, speed and without bias by advanced sustainability technology.
And time is running out.
[1] A company’s greenhouse gas (GHG) emissions break down into direct onsite emissions (Scope 1) and indirect emissions from the generation of purchased energy (Scope 2) and Indirect emissions from the company’s value chain (Scope 3). Scope 3 breaks down into upstream emissions (suppliers’ emissions) and downstream emissions (use and disposal of the company’s products).
[2] Clarity AI research based on CDP data
[3] Clarity AI research based on CDP data
[4] Lena Klaaßen, Christian Stoll. Harmonizing corporate carbon footprints. Nature Communications, 2021; 12 (1) DOI: 10.1038/s41467-021-26349-x
[5] Corporate Value Chain (Scope 3) Standard
[6] A comparison of Scope 3 data from two providers that we conducted for 600 European companies showed that they diverged on average by 112%!
[7] Clarity AI research based on CDP data
[8] SBTi Climate Action in 2022
[9] GPIF Climate Report, 2020
[10] CDP Global Supply Chain report, 2021
[11] Clarity AI data, based on a sample of 28,000 public companies
[12] Between 11 and 12 to of CO2eq per capita, France has a structural trade deficit linked to energy import whereas Germany has a structural trade surplus leading to a neutral carbon content of its trade balance.
[13] Which now needs to be assessed under a growing number of regulations including SFDR, Climate stress-testing for banks and insurances and TCFD.
[14] Broader, tighter EU carbon border tax sought by leading EU lawmaker, 2022
[15] SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors, 2022
[16] Debunking 7 misconceptions on Scope 3 emissions, Lombard Odier August 2021
