This article is the second in a five-part series on Scope 3 by Responsible Investor. The first article looked at how asset owners are grappling with the topic. Look out for upcoming deep dives on how data providers, regulators and assurance providers are tackling the push to address indirect emissions across value chains.
Firms are facing pressure from their investors to report on and reduce their Scope 3 emissions, not to mention increasing regulatory requirements and customer expectations.
Heather Palmer, partner and co-head of the ESG and climate change practice at Sidley Austin, says disclosure across all three scopes of emissions “has been an expectation for a while now” from investors. Pressure is also coming from customers looking to understand the climate impact of their business relationships.
Investors are also setting out their expectations for how to disclose. One sustainability figure at a large European company notes that disclosures to the CDP are so in demand by investors that they are “almost statutory”.
Emily Pierce, chief global policy officer and associate general counsel at carbon accounting software provider Persefoni, echoes this reasoning. She says Scope 3 reporting will be something that’s expected of companies over the next few years. “It’s simply not going away.”
Even those most well-versed in climate reporting have faced challenges. A spokesperson for Enel, the Italian utility and first company to fully align its climate disclosures with the CA100+ benchmark, tells Responsible Investor that it faces a long list of issues with its Scope 3 disclosure and targets.
Its 2023 disclosure includes figures for a range of emission sources, including the use of its sold products and its own purchased goods and services.
While measuring and managing Scope 3 can reduce value chain risk, “unlock new innovations” and help the firm’s reporting, quantifying emissions is challenging because of the lack of reliable primary data, the spokesperson explains. There are also inconsistencies in the availability of data from different providers and national authorities.
The spokesperson adds that the GHG protocol – the most widely used accounting standard for greenhouse gas emissions – itself only offers high-level guidance. This “prevents companies from using a standardised and detailed methodology to calculate and model different GHG sources”.
“It’s not about a holistic number or percentage, it’s about transition risk and where it’s reflected in the value chain.”
Emily Pierce, Persefoni
Despite the challenges it faces, the Enel spokesperson says the firm sees value in having an SBTi-validated 1.5C target, as this is one of the main expectations for investors integrating climate considerations in their investment portfolios and is “greatly appreciated” by financial markets.
Enel was the first European issuer to come to the market with a sustainability-linked bond, and recently added Scope 3 targets to its issuances. The spokesperson says this is in line with its medium- and long-term business strategy and was a “logical evolution” of its SLBs.
A company like Enel, the spokesperson continues, is highly exposed to external factors. One of its main Scope 3 sources is indirect emissions from energy which is purchased from third parties and sold on to customers.
Where some firms in other sectors might be able to more directly influence suppliers and customers, Enel is slightly more at the mercy of national decarbonisation trajectories.
While complaints about data and estimations are widespread, this does not need to get in the way of companies reporting, says Pierce.
“For a company that’s looking at its emissions profile and determining whether or not it’s material, it’s not about a holistic number or percentage,” she adds.
Scope 3, she continues, “is designed to be a category that can be built on estimates and assumptions” and is useful as a tool to reflect exposure to transition risk in the value chain.
“A lot of companies are trying to start with mapping their risk, using estimates and methodologies built into the GHG protocol and then trying to improve their data sources where they can.”
Regulatory ramp up
Companies reporting under the EU’s Corporate Sustainability Reporting Directive (CSRD) will be mandated to disclose Scope 3 emissions if they are material, and both EU and many US companies will be caught in this net.
US companies are also facing homegrown regulation. They must deal with new Californian laws, potential SEC requirements and Taskforce on Climate-related Financial Disclosures (TCFD) reporting requirements for federal contractors.
The SEC’s proposals to mandate Scope 3 disclosures at firms with such targets or where Scope 3 emissions are material has been one of the most controversial parts of its climate rule.
The size of California’s economy means that its state-level Scope 3 disclosure requirements are likely to cover many of the same companies as the SEC rule. A similar bill is currently working its way through the New York legislative system.
Pierce, who spent close to 13 years at the SEC before joining Persefoni last year, says that while the California rules are welcome and the requirements for limited Scope 3 assurance from 2030 are also a good step, those disclosure rules are more designed for policymaking and consumer decisions than investors.
The SEC’s form 10-K disclosures, however – which require detailed annual reporting from companies and are also one of the proposed destinations for mandatory emissions reporting – “are an extremely important part of financial markets”, she says.
Given that this information is being disclosed in annual reporting and SEC filings, “there’s a real concern around liability”, says Palmer, and companies are worried about litigation risk.
In order to mitigate this risk, Palmer says many firms are “reviewing and taking a hard look at the contracts that are already in place and considering revision of those contracts such that responsibility for the accuracy of the information is placed on the supplier”.
Regardless of regulatory requirements, Pierce says there will be increasing market pressure to disclose.
“It absolutely matters in terms of US public markets and getting comprehensive, consistent, comparable, reliable disclosure to investors to better inform their decision making,” she adds. “But in terms of what a company really should be doing to manage its business and be prepared for the new expectations of the market… the answer is pretty clear that they need to get ready anyway.”
“Regulation is coming into place because investors were demanding it, and investors were demanding it because they recognised that it was an important piece of information to reflect transition risk and how companies managing that,” she says. “That’s why companies are looking at it, because many of them understand that as well.”
While investors and regulators are increasingly pressuring companies to report and set Scope 3 targets, firms which want to move beyond estimated emissions are reliant on their suppliers to be able to collect data.
Jennifer Motles, chief sustainability officer at Philip Morris International, says the firm regularly engages with its suppliers on their emissions.
In 2022, around 10 percent of the firm’s supply chain spend was on tobacco leaf, with pulp and paper for product packaging and electronic devices for its smoke-free products also large sources of expenditure.
“We receive numerous questionnaires but we’re a large company and we can manage. It’s not in our interest to overwhelm SMEs with data requests.”
Debbie Allen, BAE Systems
The firm has set a target to cut the emissions from one kilogram of flue-cured tobacco by 75 percent by 2025, and also has a goal for 15 percent of its suppliers by spend to have science-based targets in place by the same year.
“To achieve this, we engage directly with suppliers for direct and indirect materials to help them understand the importance of decarbonisation for PMI, and to support their development and maturity on sustainability issues,” she says.
In 2023, the firm engaged in a capability-building programme with five of its top suppliers to help them better understand, measure and report on their sustainability and climate performance.
Similarly, the Enel spokesperson says the firm receives emissions data directly on more than 60 percent of its supplies purchased, and that this would trend upwards as suppliers will be required to provide this data during the supplier qualification process.
France’s Schneider Electric has set a target to slash its supply chain emissions by 25 percent by 2030, which an aiming of net-zero CO2 emissions by 2050.
According to its 2022 integrated report, the firm has an opt-in programme to collaborate with its suppliers on disclosing and reducing their emissions. Participating suppliers are required to quantify their GHG emissions, and put in place targets and transition plans, and the firm is aiming to help them reduce their emissions by 50 percent by 2025.
Schneider said there had been good progress, with disclosures from 946 of 1,013 suppliers, and participating firms having cut their emissions by 10 percent at the end of the year against the baseline, up from 1 percent in 2021.
The firm has also conducted intensive capacity-building efforts with its suppliers. In 2022, it conducted more than 130 decarbonisation sessions with its suppliers.
Where some suppliers in emerging market regions may find this more difficult, it has also run workshops on decarbonisation levers. These have taken place across Asia, the Middle East and Africa.
The idea behind these workshops, Schneider said, “is that suppliers lack the practical knowledge to decarbonise and if this information gap were filled, they would readily adopt emission reduction practices”.
Small suppliers and reporting burdens
A popular talking point used against requiring firms to disclose on Scope 3 is the burden that data collection can place on small suppliers, with the spectre of family farms and mom-and-pop businesses being handed detailed technical questionnaires often brought up. The US Chamber of Commerce, for instance, warned that Scope 3 disclosure requirements for federal contractors would place “an enormous burden” on small businesses.
Debbie Allen, group director for governance, conduct and sustainability at BAE Systems, the UK’s largest defence firm by market cap, says the firm receives many questions about its own emissions “but we’re a large company and we can manage”, she says. “It’s not in our interest to overwhelm SMEs with data requests.”
“There’s a real concern around liability. Companies are certainly concerned about the litigation risk around that.”
Heather Palmer, Sidley Austin
However, smaller suppliers contribute relatively less to emissions and so an additional focus on them is relatively less warranted. For instance, of BAE’s approximately 21,000 suppliers, fewer than 600 contribute more than 70 percent of its supply chain emissions.
PMI’s Motles says the firm is taking steps to reduce the burden on its suppliers. Where possible, it uses public data, for instance pulling data that has already been disclosed to an initiative like CDP or to EcoVadis.
It prioritises primary data collection from suppliers in terms of spend, volume of materials and the largest emitters. Information from the smallest farmers is generally collected by larger suppliers. These suppliers will sample a selection of smaller farmers, carrying out surveys and interviews, and then making inferences from the data selection about similar farms in the region.
As well as making demands of their smaller suppliers, larger firms are also in a position to help drive decarbonisation in their supply chains.
For example, Schneider Electric has launched a programme to help drive decarbonisation in the semiconductor and IT services supply chain. Intel and Applied Materials signed up to the programme, named “Catalyze”, in the summer, and Schneider announced at COP28 that Google, HP and ASM had also joined.
Suppliers to these firms are able to join the programme, which aims to educate them on decarbonisation and provide them access to renewable energy by allowing suppliers to pool their purchasing power.
Speaking about the programme at COP, Schneider chair Jean-Pascal Tricoire emphasised the importance of firms working together.
“Sustainability is teamwork,” he said. “At Schneider 99 percent [of our footprint] is with our suppliers and customers. When we make the commitment to be carbon neutral by 2030, it’s teamwork and we need to help each other.”
In the semiconductor and IT sector, he said, “everyone is the Scope 3 of someone else. If we want to progress together either we do it company by company, which will be extremely inefficient, or we put our energies together around one platform, one methodology, and we progress faster.”
“If you want to progress fast, you do it alone. If you want to progress far, you do it together.”