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Scope 3 Data Remains Weak Spot for ESG Disclosure

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International Earth Day, which will be marked on Saturday, comes around as the ESG disclosure space becomes increasingly preoccupied with solving one of its thorniest problems: gathering quality Scope 3 emissions data.

The subject has gathered pace as regulators around the world, and in particular the US’ Securities and Exchange Commission (SEC), grapple with ways to ensure greater reporting of Scope 3 data without placing additional burdens on the companies that fall under their remit. To make the job of data gathering easier, a string of carbon accounting software start-ups have launched products and services in the past couple of years.

But even with those providing the plumbing for data transfer, investors will be no more appraised this weekend than they were during Earth Day 2022. The findings of an investigation by reporting framework setter CDP show that just two-fifths of companies that make disclose to it were reporting supply-chain emissions, “despite their impact significantly outsizing their direct emissions” by a ratio of more than 11-1.

A separate report released days earlier by ISS ESG shows that as well as a shortage of data there is a deep problem with reported Scope 3 data quality. In the year to February, it discarded about 4,000 – or 70 per cent – of all such corporate disclosures because of quality issues, mostly relating to incomplete reporting. In contrast, it said, the company binned just 1 per cent of Scope 1 and 2 emissions data.

“This limited disclosure poses a challenge for investors who view these corporations through the lens of various reporting standards and initiatives that are becoming more important as the world moves towards a low-emissions economy,” noted ISS ESG in a report of its own.

Low Engagement

The CDP report released last week paints a grim picture of corporates’ approach to establishing their full carbon footprints. It found that that 70 per cent of companies had no process in place to assess the impact of their value chains on the environment and nature.

This, in part, is because gathering data on Scope 3 emissions is a huge task. The Greenhouse Gas Protocol established the emissions framework in 2001. Scope 1 refers to carbon emitted directly by an organization and Scope 2 to those produced by their energy suppliers. Scope 3 emissions, by far the largest contributor to a company’s carbon footprint, are those emitted by businesses and organisations that provide supplies and services along its value chain.

Obtaining that data involves companies engaging with their suppliers and service providers, who themselves, are unlikely to have a great understanding of how to collect their own data.

“Companies are not treating their impact on the environment as a whole, with most not engaging suppliers on climate and vital parts of nature, including water security, deforestation and biodiversity,” the CDP report stated.

The failure to address Scope 3 data gathering and reporting by companies will have a substantial impact on companies’ own ESG scores because they cover between 70 per cent and 80 per cent of a firms’ total emissions. It will also be a hindrance to many companies’ hopes of reaching their net-zero targets, a key metric watched by investors, Grace Brennan, senior product specialist at ESG analytics firm Clarity AI said in recent webinar.

For this reason, regulators and standard setters have included the disclosure of value chain emissions in their reporting frameworks. The SEC and regulators in the UK, Hong Kong and Japan will require such information by 2025. In the EU, it is anticipated that at least 80 per cent of all Scope 3 emissions will be disclosed by 2030 under the Corporate Sustainability Reporting Directive (CSRD).

Scope 3 emissions disclosures are also expected by the International Sustainable Standards Board – an umbrella organisation for a number of ESG reporting frameworks – and within net-zero targets set by companies and countries.

Don’t Panic

Help is at hand. Companies including Tata Consultancy Services (TCS) and ICE-owned Urgentem have released tools in the past year to help investors assess Scope 3 emissions within their portfolios. Others, such as Novata’s platform, are geared towards private equity firms, who tend to have better engagement and, therefore, better data on the SME sector, which accounts for the vast majority of supply and services companies.

At the corporate level, providers like enterprise software maker o9 and EcoVadis have built platforms that enable and encourage corporates to track their value chain emissions data – information that can then potentially be accessed by investors.

Nevertheless, full disclosure of Scope 3 emissions is unlikely, owing to the breadth of the task of gathering the data. And when they are reported, they will also need to be scrutinised to ensure they haven’t been double counted and artificially boosting the reporting firm’s ESG scores.

That means companies will continue to rely on estimates and other approximations. Vendors such as Clarity AI are applying machine learning (ML) techniques to the task and ISS ESG also has a suite of tools that can help fill the data gaps.

While estimates aren’t a perfect replacement for real data, a report published this week by the University of Oxford’s Sustainable Finance Group said that studies into the use of ML showed AI analytics greatly improved emissions predictions. It said such models were shown to boost the accuracy of forecasts by 78 per cent.

“These machine learning models have been used to provide greater information on emissions when not otherwise available, while also addressing the issue of confidence and trustworthiness in the data for financial institutions,” it wrote in a report this week.

“These methods illustrate how there are other quantitative methods that can be used to increase accuracy in emissions estimation that draw from a wider variety of data sources, often from perceived lower quality data sources, rather than adherence to a universal data quality.”

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