BankingScope 3: Holy grail of emissions control set to test corporates to the limit

Scope 3: Holy grail of emissions control set to test corporates to the limit

Corporates and their treasurers will face extensive pressure to cut emissions in support of net zero 

Firms are coming under increasing pressure from investors and consumers to cut their carbon footprint and as challenging as it is for them now, the years and decades ahead will only get tougher as the demands for emissions control intensify.

Much of the focus currently within organisations is on Scope 1 and Scope 2 emissions, as defined by the Greenhouse Gas (GHG) Protocol, the most widely used corporate accounting standards for assessing emissions.

What are Scope 1, 2 and 3 emissions?

Scope 1 covers direct emissions from company owned sources, such as boilers and vehicles, while Scope 2 addresses indirect emissions from the generation of purchased electricity, steam, heating and cooling consumed by the reporting company. These two groups of emissions are largely under organisations’ control and lend themselves to accurate tracking, with most firms are likely to have ready access to all the data they need, such as gas and electricity purchases.

The last group of emissions under the GHG Protocol, Scope 3, however, presents a far bigger challenge for corporates and their treasurers. This group aims to address all other indirect impacts from company activity, ranging from the goods it purchases, the suppliers it deals with, to the disposal of the products it sells.

Under Scope 3, a company that manufactures products, for example, is indirectly answerable for carbon emissions from the extraction, manufacture and processing of the raw materials used. For oil and gas companies, Scope 3 means they are answerable for both upstream and downstream emissions beginning with the sourcing of the raw materials, and continuing through to manufacturing, transporting, and use of the final products, for example by car owners and industrials.

Because Scope 3 emissions fall outside a company’s direct management or ownership, and collecting high-quality data on them is difficult, they are fiendishly challenging to accurately assess, which in turn makes their control all the more challenging. But given their outsize contribution to greenhouse gas volumes – the UN estimates that for many businesses across most industries they account for more than 70% of global greenhouse emissions – getting to grips with them will be essential for achieving net zero by 2050.

Treasury levers key for Scope 3

Garima Thakur, head of treasury at US-based Creative Artists Agency (CAA), says that the collection, management and analysis of a wide range of operational data will be critical for tackling Scope 3.  Treasuries, with their access to data across sales, procurement, supply chain and liquidity and investments, will be expected to play an increasingly important role in helping their firms cut emission in the years and decades ahead.

“Treasuries are uniquely positioned to action net zero targets and ESG initiatives generally. ESG is already top of mind for treasurers and CFOs but clearly Scope 3 represents a considerable additional challenge,” she says.

“The impact of scope 3 on companies and treasurers will vary by industry, type of company – whether it’s private or public – and its size. Right now, I think more awareness of it is needed across all functions, including corporate treasury, particularly as it relates to communications with lenders, banks, rating agencies, key vendors and potential public company reporting requirements.”

As treasurer at CAA, a global talent representation agency focused on film, television, music, publishing, and sports, she has been exploring ways in which companies can begin to tackle Scope 3.

“Companies are looking at business travel, for instance, which is a scope 3 emission that can be tracked and reported through travel portals that offer carbon footprint tracking for bookings made through them. Depending on industry, business travel may be significant so it could be a meaningful way forward for companies.”

Green bonds are already proving popular with treasurers, with Climate Bonds Initiative, predicting global issuance of the instrument will top $1trn this year for the first time. Thakur believes such instruments will play an important role in managing Scope 3 too.

“ESG demands on treasurers will only increase,” she says. “We are already addressing ESG questionnaires from existing and new lenders. Investors are much more focused on ESG metrics now and becoming more demanding with their information requirements.”

The drag of limited data

As investors become savvier, ask more searching questions about a company’s ESG credentials before deciding on whether or not to buy its securities, they are also demanding more accurate intelligence on the company from ratings agencies.

But, as Bernhard Bartels, executive director at Berlin-based ratings agency Scope ESG Analysis explains, ratings agencies have their work cut out when it comes to providing accurate assessments of Scope 3. “Although Scope 3, specifically emissions related to purchased inputs or from use of sold products, often dominate a corporate’s carbon footprint, we rarely observe corporates reporting on those because of their difficulty in accounting for emissions they don’t have direct control over,” he says.

As a result, ESG rating providers are often left with assessing the governance of supply chain management. Typically, this means analysis of contracts with suppliers, including policies for minimum standards and bidder exclusion criteria. However, according to Bartels, these qualitative assessments “lack precision in terms of comparability and scope if compared to the available quantifiable information on Scope 1 and 2”.

A study by Scope ESG last year illustrates the scale of the problem. The agency analysed the reporting of Scope 3 emissions by the 2,000 of the largest companies by market capitalisation across their entire value chain, from purchased goods and services in the supply chain to business travel and end-of-life treatment of sold products and investments. It found that more than three quarters of the companies studied disclose no information at all, while more than two thirds report incomplete or no information for even the less onerous Scopes 1 and 2.

More generally, the latest analysis by Scope ESG shows that industries with heavy carbon footprints in own production, such as the energy sector and materials (cement, chemicals), are providing increasingly precise emissions data, as are their main direct clients, manufacturers and construction companies. Nonetheless, companies with both high upstream and downstream impacts, such as manufacturers and fashion industries, generally continue to face more difficulties in accounting for their indirect emissions than sectors with limited or easily identifiable supply chains.

Another major problem for investors when it comes to assessing a corporate’s green credentials is the huge variation in ESG (including Scope 3) ratings across agencies. Bartels says it is difficult to identify the exact sources of disagreement across agencies given the lack of transparency in ESG rating methodologies. Split ratings can be driven by a host of factors including the choice of data sources, data definitions, weightings or simply the rated universe. Potential differences in Scope 3 assessments are also likely driven by different methodologies being used to calculate Scope 3 emissions although, he points out, even the GHG Protocol allows for different approaches with calculations.

Horses for courses

With such a difficult, messy and confusing state of affairs, how can corporates, their treasurers and finance teams best address the Scope 3 demands of ratings agencies and potential investors?

Bartels says a good and popular strategy for smaller corporates is to adopt disclosure practices of larger capital market oriented peers. Industry front-runners, meanwhile, will have the resources at hand to invest in hiring consultants to support them in assessing their supply chains and the monitoring of direct as well as indirect suppliers. Some industries may use a shortcut by explicitly excluding specific materials or resource inputs – a strategy that requires strict contractual clauses for direct suppliers and their supply chains, .

Despite the variation in ratings across agencies, Bartels says that within them there is generally an emphasis on consistent metrics, which allows at least for comparable assessments within sectors and across regions.

Looking ahead, he has high hopes that the recently created International Sustainability Standards Board (ISSB) will help deliver clarity, credibility and coherence to sustainability reporting for the benefit of companies, their shareholders, investors, and consumers. The ISSB’s bold mission, announced at COP26 in Glasgow last year, is to establish a global consensus for sustainability disclosures and standardise the practice of non-financial reporting.

Combined with increased investor scrutiny, one potential, major benefit of a universal accounting standard could be a significant reduction in corporate greenwashing. Bartels points out that today’s ambitious carbon reduction strategies from companies often refer only to their own emissions or electricity use – Scope 1 and 2. These, however, may also be achieved by outsourcing heavy footprint operations, or simply by ignoring the reliance on energy-intensive inputs. A universal accounting standard for Scope 3 could significantly reduce such observed practices, he believes.

Despite the plethora of problems associated with Scope 3 assessment and monitoring and control,  pressure from capital markets, investors and regulators is helping to accelerate the adjustment of corporate disclosure practices towards accounting of these complex group of emissions. “For many sectors, the lack of common methodologies and disclosure practices remain the biggest obstacle. Major developments on Scope 3 accounting have been triggered by some front-runners, which have invested significant resources in supply chain management and set up in-house expertise for impact accounting” says Bartels, adding: “These private sector efforts, combined with a dedicated focus of regulators and standard setters on harmonised disclosure practices, are major ingredients for a global reporting regime on Scope 3.”

All eyes on the heavy hitters

With their outsized direct and indirect carbon footprints, much is expected of multinationals in particular in mapping out pathways to a low carbon future. In so doing, they can, it is hoped, help encourage smaller firms, including the vast number that are part of their own supply chain to lower their own. Banks have crucial role in this respect, controlling as they do the flow of money into industries ranging from coal mining to development of solar power farms.

As the UN points out: “The role of the banking industry in tackling the net zero challenge is key. Banks will need to support the transition to a net-zero economy through their lending and financing decisions and through facilitating their clients’ transition.”

Banks and other financial institutions generally produce low Scope 1 and Scope 2 emissions, but their Scope 3 exposure is very high due to “financed emissions” – a greenhouse gas emission by clients that banks finance through loans and securities. A study by CDP, a non-profit that helps companies and investors manage and track their environmental impact,  estimates that on average, banks’ financed emissions are over 700 times higher than their operational emissions (Scope 1 and 2) .

Banking on the future

Barclays is one bank that has committed to aligning all its financing to the goals and timelines of the Paris Agreement and set a target of being net zero by 2050. With reference to the GHG Protocol, the bank says its own operational emissions – Scopes 1 and 2 – represent “an incredibly small proportion of its overall emissions, with the vast majority coming from its [Scope 3] financed emissions”.

In order to meet its net zero ambitions Barclays has set targets for reducing client emissions it finances via lending and capital markets activities. Last month it revealed its new 2030 emissions targets for four of the highest-emitting sectors in its portfolio, energy, power, cement and steel.

Barclays plans to introduce targets for additional sectors in 2023 and 2024, with it has already looking to set targets for the automotive manufacturing and residential property sectors later this year.

Barclays’ approach to reducing its Scope 3 financed emissions is underpinned by BlueTrack, a methodology developed in-house that measures the bank’s financed emissions and tracks them at a portfolio level against the goals of the Paris Agreement.

Barclays says BlueTrack is already playing a vital role in helping it make “solid progress” against key targets. Having aimed for a 30% reduction in the greenhouse gas intensity (emissions relative to revenue) of its power portfolio by 2025, it had achieved an 8% reduction by the end of 2021. Similarly, it had set a 15% reduction target in absolute financed emissions (actual physical amount of emissions) for its energy portfolio by 2025 and by year end 2021 had achieved a 22% reduction.

The bank’s strategy for cutting its financed emission footprint is being complimented with climate change related financing measures. In 2018 it announced a target of making available £100bn of financing for green activities by 2030. So far it has facilitated a cumulative £62bn, reflecting increasing demand for more innovative products including Sustainability Linked Loans and Bonds. In 2021, it facilitated £29.8bn of green financing, up 69% from £17.6bn in 2020.

“Having made significant progress against our target with green financing measures, ahead of our initial expectations, we are reviewing our sustainable financing strategy and all green financing frameworks and targets. We expect to provide a further update later this year, including new and more granular green financing targets,” says the bank.

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