A plastics manufacturing plant in Deer Park, Texas, on Feb. 15, 2023. Proposed new guidance from the Canadian Sustainability Standards Board, would require companies to report not only the greenhouse gas emissions they produce, either through their own operations or from the energy they consume – known as Scope 1 and Scope 2 emissions, respectively – but also Scope 3 emissions, which come from their upstream supply chains or the end use of their products.MERIDITH KOHUT/The New York Times News Service
Kevin Thomas is the chief executive officer of SHARE, the Shareholder Association for Research and Education.
Canadian regulators have come to a fork in the road on corporate climate disclosures and are asking the public for directions. They will be consulting widely this year on which route to choose.
One route, set out in proposed new guidance from the Canadian Sustainability Standards Board (CSSB), would require companies to report not only the greenhouse gas emissions they produce, either through their own operations or from the energy they consume – known as Scope 1 and Scope 2 emissions, respectively – but also Scope 3 emissions, which come from their upstream supply chains or the end use of their products.
European and Chinese regulators have already gone down the Scope 3 path, but last week the U.S. Securities and Exchange Commission (SEC) announced it would only require companies to report Scope 1 and 2 emissions.
Canadian markets and regulators will have to make a choice between those two routes. As shareholders we can’t afford to let them take a wrong turn. For investors, Scope 3 is where the real action is.
There is little resistance to reporting Scope 1 and 2 emissions, because these are the ones a company can most easily control and because they result in short-term hits to the balance sheet.
There are, of course, challenges to reporting Scope 3 emissions, which have been suggested as reasons not to regulate disclosure.
The first is that, unlike directly controlled emissions, Scope 3 is not “material” to a company. But this is based on a narrow interpretation of materiality that is focused solely on the current balance sheet or income statement.
That narrow vision is what leads markets to severely misprice real risks that are not recognized in the short term or reflected in current prices. Just ask major pharmaceutical firms whether the downstream impacts of the opioids they manufactured and distributed, which have led to more than US$26-billion in legal settlements, were “immaterial.”
For many companies, Scope 3 emissions are just such a risk. They can account for as much as 70 per cent of a company’s actual emissions – 88 per cent in the case of oil and gas companies – and come largely from the downstream use of their products. In the case of banks, the primary Scope 3 risk comes from the emissions they finance.
As our trading partners around the world adopt more stringent regulations and policies to address climate change, ignoring Scope 3 emissions may leave companies vulnerable to regulatory changes, new tariffs (such as those emerging in Europe), fines or other penalties. As investors, we need to be able to model the potential impact of regulation, litigation, taxation and tariffs on a company’s future financial performance and competitiveness. Scope 3 data is essential to that task.
The second argument is that it remains difficult to accurately measure Scope 3 emissions. There’s some truth to this; we do need to improve the availability and reliability of data down the supply chain or into consumer markets. But in fact, the argument gets the process backward: We shouldn’t be waiting for universal, perfect data to adopt regulations; we need to regulate in order to close the existing data gaps. We’ve seen that when other jurisdictions regulate emissions reporting, companies and markets react with solutions to data availability and quality.
Lastly, regulators worry that Scope 3 reporting adds undue burden on companies. It’s actually the reverse: Individual corporations should welcome the inclusion of Scope 3 data in regulatory mandates because it will help them identify the major sources of emissions in their own value chains, especially as suppliers and others are increasingly required to report emissions data. Scope 3 data will allow companies to focus resources closely on the areas where they can most effectively reduce both costs and potential liabilities.
In their consultations this year, Canadian securities regulators will be told that requiring Scope 3 reporting is too hard, that it’s immaterial, that the data is imperfect and that we should take the easy road.
But when it comes to addressing the climate crisis, there is no easy road. There’s just the one that leads us where we need to go and the one that takes us down the garden path.