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This is the final article in a five-part series on Scope 3 by Responsible Investor. Other articles have looked at how asset owners are grappling with the topic, corporate efforts, data challenges and assurance

Scope 3 reporting has risen rapidly up the regulatory agenda amid the proliferation of new rules and frameworks for climate and sustainability-related reporting.

In some ways, corporates appear increasingly prepared for this. According to the CDP, companies have made progress on assessing their Scope 3 emissions, with the number of reported categories increasing for all sectors between 2019 and 2022.

On average, companies disclosed between five and six (out of 15) Scope 3 categories in 2022, a 28 percent increase from 2019.

The number of US-listed firms making some sort of Scope 3 disclosures jumped significantly in the months after the Securities and Exchange Commission (SEC) released its proposed climate disclosure regime in March 2022, according to MSCI.

But when it comes to regulatory requirements on the issue – something investors generally support and have called for – there has been pushback from reporting organisations.

Corporates are worried that the data is simply not good enough, that collecting it is too complex an undertaking, and that they could face legal challenges if disclosures are wrong.

To allay these concerns, regulators and standard setters are making it clear that they are not expecting swathes of detailed and ‘perfect’ data overnight. Most of the regulatory provisions come with phase-ins, safe harbours and other reliefs.

No longer voluntary

But regulatory action still marks a significant shift and elevation in climate reporting: Scope 3 is no longer a voluntary extra.

Perhaps most notably, Scope 3 reporting made it into the draft US SEC climate rule – and this has proved controversial. It is still unclear whether the final version, which has been delayed several times and is now due by April this year, will see these requirements changed or watered down.

But regardless of the closely watched SEC decision, many thousands of companies will need to face the regulatory reality of Scope 3 reporting in some way in the coming years.

State-level climate disclosure rules in California were approved in October, and reporting will start in 2026 (Scope 3 reporting from 2027). A similar bill is currently working its way through the New York legislative system.

In the EU, the European Sustainability Reporting Standards (ESRS) mandate companies to report Scope 3 emissions if they are material (although there is a one-year phase-in period). And the bloc’s securities watchdog ESMA has made Scope 3 one of its 2024 supervisory priorities for non-financial reporting.

“If you see the same business model in the same sector giving rise to extremely diverging Scope 3 emissions – that’s not necessarily a lack of compliance, but it’s a red flag where you can ask more questions”

Alessandro d’Eri, ESMA

On a global level, the International Sustainability Standards Board (ISSB) standard on climate includes Scope 3 requirements. This was not an obvious decision and there had been questions around whether Scope 3 is financially material or decision-useful.

But in October 2022, ISSB confirmed the inclusion of Scope 3 “given feedback from investors that they cannot fully understand a company’s transition risk without information about its absolute gross Scope 1, 2 and 3 emissions”.

Best guesses

Notably, the ESRS and ISSB with their Scope 3 asks “are a step up from the TCFD recommendations”, says Sacha Sadan, ESG director at the UK Financial Conduct Authority (FCA), referring to the Taskforce for Climate-related Financial Disclosures, which most existing climate reporting rules are based on.

“There is a lot of work to be done around capacity-building and this is acknowledged by standard-setting bodies,” he tells Responsible Investor.

Sadan adds that companies preparing to publish transition plans in line with the UK-led Transition Plan Taskforce framework often flag Scope 3 disclosures as one of their main challenges.

“Companies are still building capacity to fully understand and measure their level of Scope 3 emissions,” he says. “What they have is estimates and best guesses, and we’ve heard from them about their concerns about improving the reliability of these measurements.”

He says the FCA knows there is no one-size-fits-all approach to Scope 3 reporting. “But what is important is that firms get started, use incomplete data, make mistakes and then learn from them – accept that learning is part of the process here.

“Small iterative steps that are started tomorrow are better than achieving a perfect solution in 10 years’ time. We don’t expect perfection, but we do expect credibility – and so do investors.”

‘Pain points’

Unsurprisingly, some are uncomfortable with this approach.

Disclosing estimates and ‘imperfect’ Scope 3 data could have repercussion for companies. Enforcement action is not the only concern. Firms are also worried about private litigants and reactions from stakeholders, says Michael Littenberg, a New York-based partner at Ropes & Gray and global head of the firm’s ESG practice.

“This is one of the main pain points companies are focused on. They need to think about how users are going to read and use the disclosure, and what exposure that may create for the companies,” he adds.

“They need to think about how users are going to read and use the disclosure, and what exposure that may create for the companies”

Michael Littenberg, Ropes & Gray

The SEC has suggested a safe harbour for Scope 3. Statements on these disclosures in SEC filings would not be deemed to be fraudulent unless it is shown they were made without a reasonable basis or not disclosed in good faith.

Littenberg welcomes this but says the SEC “perhaps did not go far enough”. For example, he and many others recommended that the safe harbour be expanded to cover any climate-related disclosures that rely on third-party data and the use of estimates.

Looking at the California rule, Littenberg says any potential safe harbours will be laid out in the implementing regulations, which the California Air Resources Board (CARB) has been tasked with developing.

Asked what regulators could do more broadly to ease company concerns around Scope 3 requirements, he says the simplest step would be to introduce bifurcated reporting timelines “to acknowledge that it takes longer to pull together Scope 3 than Scope 1 and 2”.

Regulators should also avoid asking for “highly prescriptive” information and continue to give companies flexibility in the level of disclosure, he adds.

Red flags

Some regulators have been looking at existing Scope 3 reporting as part of companies’ non-financial or climate disclosures – or called for more of it – in recent years.

EU securities watchdog ESMA has flagged the issue numerous times. Most recently, in October, it said that because companies covered by the EU Non-financial Reporting Directive (NFRD) – which is being replaced by the CSRD – need to report on material sustainability matters, they “should assess whether the reporting on GHG emissions can be considered complete in all material respects in the absence of disclosures on Scope 3 emissions”.

“When disclosures of Scope 3 emissions are considered not to be material, ESMA encourages issuers to state that fact and to provide adequate explanations as to the most significant judgements leading to this conclusion.”

In 2024, Scope 3 disclosures will be a supervisory priority for ESMA. Senior policy officer Alessandro d’Eri tells RI that this means national regulators have to “devote more time” to the issue.

“We’ve seen that Scope 3 is still underreported,” he says. “This is despite the fact that, for certain sectors, Scope 3 constitutes most of the emissions contribution.”

He adds that ESMA’s priorities for this year “have a bit of a transitional meaning”. “It can serve as a bridge between NFRD and CSRD. The NFRD was not very explicit in terms of data point [for Scope 3]. We will hopefully move to something better with the ESRS.”

In terms of what national authorities should be doing on Scope 3, d’Eri says: “We’re not asking the supervisors to redo the calculations – that’s not their job. What we expect is that peer comparison will take place, to help shine a light on any divergence.

“If you see the same business model in the same sector giving rise to extremely diverging Scope 3 emissions – that’s not necessarily a lack of compliance, but it’s a red flag where you can ask more questions.”

International alignment 

Looking ahead, a key question for investors will be whether different jurisdictions will ask for the same or similar levels of Scope 3 disclosures to ensure information is easily comparable. India’s corporate sustainability rules, for example, list Scope 3 as a voluntary indicator.

National adoption of ISSB rules will also shed further light on Scope 3 interoperability.

Australia is consulting on how to implement the standards, and has suggested going slightly further in terms of Scope 3 reporting relief than the IFRS S2.

The UK government last year launched a separate consultation on Scope 3 reporting, which closed in mid-December. It asked for input, for example, on “the costs, benefits and practicalities of Scope 3 greenhouse gas emissions reporting to help inform the government’s decision on whether to endorse the ISSB standards in the UK”.

While the UK has said its planned endorsement of the ISSB standards, expected in July this year, will only diverge from the global standard “if absolutely necessary”, it raises the question of whether Scope 3 will prove a sticking point in the adoption process. A spokesperson from the department running the consultation declined to comment.

In response to the consultation, the UK Investment Association (IA) called on the government to adopt the standards in full, including Scope 3 provisions, to “set an example for other jurisdictions”.

Overall purpose

A consultation response by the Institute for Chartered Accountants in England and Wales (ICAEW) partly captured a broader question that will arise as jurisdictions implement their Scope 3 requirements: what is their overall purpose?

The institute calls for the UK to endorse the IFRS S2 as a “good starting point” for Scope 3. But it notes there are three separate but interrelated purposes to such reporting: to inform investment decisions; to encourage behavioural changes to reduce emissions; and to provide stakeholders with information they need for compliance or data collection purposes.

“The characteristics of information produced to meet each of these purposes are likely to differ,” ICAEW says.

Of course, investors have different views, expectations and use cases for the data – but early reporting under the CSRD is likely to provide some insights into the extent to which Scope 3 reporting resulting from regulatory requirements will be useful for investors.

At the same time, there appears to be a wider understanding and acceptance that the first years of Scope 3 disclosures will not necessarily lead to a transformation, but gradual improvements in reporting availability and quality.

In addition, third-party and sector data will likely remain crucial for companies to be able to make their disclosures.

“I think where the market is ultimately going to land for Scope 3 is that much of the work is not going to be as specific to companies as for Scope 1 and 2 – it will largely be based on industry information and third-party data sets,” says Littenberg. “A lot of the Scope 3 data is probably going to be more directional than specific to individual companies.”