Institutional investors seeking to reduce their portfolios’ carbon footprint should pay more attention to scope 3 emissions, says Priti Shokeen, head of environmental, social and governance research and engagement at TD Asset Management Inc.
“Typically, when investors engage issuers on climate change, the focus tends to be on industries traditionally understood as high emitting, for example, oil and gas and utilities,” she wrote in an email to Canadian Investment Review. “However, when it comes to scope 3 emissions, investors should also be aware of the risks posed by some under the radar emitting industries, such as technology.”
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The term scope 3 emissions comes from the Greenhouse Gas Protocol, a widely used standardized approach developed by the World Resources Institute and the World Business Council for Sustainable Development that measures a business’s climate impact. Under the protocol, greenhouse gas emissions fall into one-of-three categories.
Scope 1 emission are gasses released by resources directly controlled by a company. Scope 2 emissions are those released as a result of a company’s use of an electrical grid. Scope 3 emissions, sometimes referred to as indirect emissions, are released at some point in the value chain, such as the emissions released through supply chains or from products and services provided by a business.
Companies with low operational emissions and high indirect emissions face high transition risks as the world moves away from its reliance on fossil fuels, said Shokeen. “[Companies] with the bulk of their scope 3 emissions in [purchased goods and services] may also face cash flow constraints from policy risks and carbon pricing if they do not proactively address these emissions and green their value chains.”
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By tracking scope 3 emissions, corporations and investors can push for changes throughout supply lines, she added. “[When] a tech company stipulates zero emissions products, it will have a ripple effect into their manufacturing and supply chain, including part makers, mineral sourcing and development.”
The value of scope 3 emissions reporting has recently come under fire within academic circles. In the latest edition of the Harvard Business Review, an article by Robert S. Kaplan and Karthik Ramanna, suggested the GHG protocols’ approach to measuring scope 3 emissions be replaced with a more accurate one based on blockchain technology.
“Estimating all those upstream and downstream emissions — especially for companies with long, complex and multi-jurisdictional value chains — introduces high measurement error, opening the door to bias and manipulation,” wrote the authors. “Not surprisingly, many ESG-reporting companies ignore scope 3 measurements entirely. But that limits any meaningful contribution to mitigating total emissions across their supply and distribution chains.”
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Shokeen acknowledged the challenges to working effectively with scope 3 disclosures, noting just 40 per cent of companies on the MSCI all-country world index report them, while 65 per cent report on scope 1 and 2 emissions.
“We use estimated data for the rest, but that’s only an estimation and shows that companies themselves have not accounted for their scope 3 emissions. Given these gaps, there is significant opportunity for investors to step up climate engagement efforts and tackle this area with more rigour.”