They’re the elephant in the room when it comes to climate change. Value chain emissions, known as Scope 3 emissions, include all indirect emissions that are not owned or controlled by a company. This covers everything from the products and services a company buys, to the investments it makes, and the way the products it sells are used. Given this potential wide range of sources, Scope 3 emissions often contribute the largest part of corporate-related emissions.
Few companies provide detailed information on their Scope 3 emissions. Some businesses say the accounting methodologies are complex. Others choose not to report on factors over which they claim they have limited direct influence or control. Current regulations are also relatively loose. This means there is a lower disclosure rate for Scope 3 than there is for Scope 1 and 2 corporate emissions – potentially leaving investors in the dark about a company’s true exposure to climate risks.
But scrutiny is increasing. Regulators are taking an increasing interest in monitoring Scope 3 emissions through mandatory disclosures and target setting. Regulators in the US, the EU and New Zealand have already proposed requiring mandatory disclosure from listed companies. Some central banks now include Scope 3 emissions in climate stress tests. We expect to see more regulations and policies in the coming years.
The approach to climate accounting is also likely to evolve. The Greenhouse Gas Protocol is an international set of accounting and reporting standards used by many businesses and regulators. It divides Scope 3 emissions into 15 sub-categories, and gives companies leeway to set their own reporting boundary – including the flexibility to decide which of these 15 they will report on – provided they apply the principles of relevance, completeness, accuracy, and consistency. This makes comparison across companies difficult, as the emissions profiles can vary wildly, even within sectors. There is also a widespread perception that some companies omit Scope 3 categories that are likely to be significant to their business without properly explaining why. But we expect a more nuanced and consistent approach to disclosure to evolve over time, especially as scrutiny intensifies.
In our view, Scope 3 emissions are a useful indicator for examining climate risk and the true climate ambition of companies. They enable investors to assess the exposure companies may have to carbon-intensive activities within value chains and products. Higher Scope 3 emissions might come with higher transition risks in the future that could impact asset values and operating costs if not acknowledged and addressed. We think investors should ask for more Scope 3 disclosures, as well as scrutinise these disclosures to a higher degree.