What are Scope 3 emissions? In simple terms, they are the greenhouse gas emissions generated across a company’s value chain – both before and after its own operations. They include the emissions produced by suppliers as well as those generated by customers when using the company’s products or services. Though complex, measuring and managing Scope 3 emissions is – in our view – essential if net zero by 2050 is to be achieved. The good news? Solutions exist.
Tackling Scope 3 emissions is necessary for all stakeholders to move the economy further towards net zero.
Mounting pressure from regulators and other stakeholders should help corporates to better understand and address their Scope 3 emissions.
The complex cascading system of emissions throughout the layers of the economy brings challenges as well as solutions.
Financed emissions are those linked to investment activities, and asset managers should look at efficient ways to manage these as part of their net-zero commitments.
US President Theodore Roosevelt famously said that “nothing worth having was ever achieved without effort” – an axiom that could be applied to the measurement and management of Scope 3 emissions. This will undeniably involve hard work on the part of stakeholders but will pay dividends on the way.
How are the different types of emissions categorised? The Greenhouse Gas Protocol Standard classifies a company’s greenhouse gas (GHG) emissions into three scopes (see Exhibit 1). Scope 1 emissions are the direct emissions from a company’s owned or controlled activities, while Scope 2 emissions are indirectly generated from purchased energy consumed by a company.
Scope 3 goes a step further to address indirect emissions – both “upstream” and “downstream” of the company’s own activities. Upstream emissions might include those generated in producing the raw materials (eg, metals and rubber) required to manufacture a car. Downstream emissions are those generated after the car is produced, such as waste management or the emissions generated by the car when driven. In summary, the value chain may
consist of multiple stages of a product or service’s lifecycle which contribute to Scope 3 emissions, including material sourcing, distribution, and end-of-life-treatment.
The GHG Protocol Corporate Standard1 has developed a detailed accounting system that includes 15 categories of Scope 3 emissions covering business activities along the entire value chain (see Exhibit 1).
Exhibit 1: Overview of GHG corporate value chain accounting
Scope 3 emissions account for over 70% of the average company’s total emissions.2 This highlights why, in our view, addressing Scope 3 is key to reaching net zero by 2050,3 thus limiting global warming to 1.5°C. Furthermore, we believe that addressing Scope 3 emissions will help individual companies better mitigate the risks and seize the opportunities of the climate transition. Take the example of a car manufacturer. The emissions generated by the cars it sells are its largest source of Scope 3 emissions. By considering the market opportunity to produce lower-emissions vehicles the manufacturer may appeal to increasingly eco-conscious drivers while meeting more stringent regulatory requirements.
Regulators across the globe are steadily pushing for mandatory climate disclosures, which would include material Scope 3 emissions. Leading this charge are the EU Commission,4 the US Securities and Exchange Commission,5 and the Hong Kong Stock Exchange.6 Each is looking to leverage existing standards like the Taskforce for Climate-related Financial Disclosures7 and emerging standards like the International Sustainability Standards Board (ISSB).8
Furthermore, widely recognised initiatives such as the Science Based Targets initiative (SBTi) have very specific requirements for validation of Scope 3 emissions reduction targets. These requirements include a full GHG inventory of emissions, including Scope 3 emissions coverage of at least 67% for any near-term targets9 and 90% for long-term targets.10 With more than 5,600 companies looking to take action in line with SBTi,11 there is clear momentum to tackle this topic.
Challenges for corporates
One key challenge for corporates is how to consider Scope 3 emissions in the wider economic value chain (see Exhibit 3). The energy to power the economy causes an estimated 73% of global emissions,12 and the starting point for any value chain is the energy already produced. Steadily, relevant emissions are passed down layer by layer through the value chain via products and services. These emissions combine with those caused by a company’s own operations.
Exhibit 3: Cascading model of energy related emissions in the economic value chain
Companies in each layer of the economy pass down the total carbon footprint of their products through emissions inherited from their suppliers in the layer above, combined with those caused by their own value-adding operational activities.
Source: Allianz Global Investors
The complexity of this flow of emissions through the economic value chain explains why the most significant of the 15 categories are, “purchased goods and services” and “use of products sold”. Together these represent over 70% of all reported Scope 3 emissions.13 Both categories are highly complex as they are difficult to measure and manage, and challenging to decarbonise.
What are the solutions for corporates?
We believe there is a solution to these obstacles. As companies increasingly set targets for reducing their Scope 3 emissions (or set general SBTi targets) they will engage collectively through the entire value chain, including with suppliers and customers. Over time, this may solve Scope 3 data and complexity issues, and drive decarbonisation in the real economy. Achievement of a company’s Scope 3 targets depends on its suppliers’ and customers’ attitudes towards decarbonisation and their own progress towards it. Therefore, creating direct interdependencies for emissions reduction targets and collective engagement through the layers of a sector’s value chain is critical to ensuring long-term alignment.
Help is at hand through initiatives like the Carbon Disclosure Project (CDP) Supply Chain Program14 and supplier engagement guidance from SBTi15 to help companies collaborate with suppliers in a structured way. Industrial associations – like the Cargo Owners for Zero Emission Vessels16 – can help companies in hard-to-abate sectors know where and how to start managing emissions.
By the end of 2022, more than 16,400 suppliers were participating in the CDP Supply Chain Program17 following customer requests, resulting in collective reported emissions savings of 70 million tonnes of CO2e.18 While this is a good start, momentum needs to accelerate as reducing Scope 3 emissions will take time because it often requires changes in business models and product design, and investment in the transition.
Exhibit 4: Limited disclosures of Scope 3 emissions across sectors
*Low coverage of reported Scope 3 emissions means less than half of the MSCI estimation.
Source: Emissions data from MSCI as of 7 June 2023 applied to MSCI ACWI Index by GICS® sectors
How can investors contribute to solving Scope 3 challenges?
This topic becomes more complicated when considering Scope 3 “financed emissions” – those that are linked to the investment and lending activities of financial institutions (such as investment managers). Significant resources are required to aggregate and report financed emissions, as evidenced by the fact that less than 20% of companies in the MSCI ACWI Financials sector report Scope 3 downstream emission categories and even fewer report financed emissions (see Exhibit 4).
Given these challenges, we have identified the following potential ways forward for investors seeking to capture and reduce Scope 3 emissions:
Seek guidance from initiatives and standard setters
We welcome last year’s finalisation of the Partnership for Carbon Accounting Financials Global GHG Accounting and Reporting Standard19 which provides accounting standards for financed emissions. Additionally, in December 2022, the ISSB decided on a core requirement for financial firms20 to report financed emissions.21 Lastly, the European Union Sustainable Finance Disclosure Regulation22 requires financial institutions to report quantitative metrics on the carbon footprint of their investments in their Principal Adverse Impact (PAI) statements.23 Within firms’ PAI statements, even with little data coverage, it is good practice to be transparent by disclosing the level of data coverage and quality. Allianz Global Investors’ (AllianzGI) PAI Statement 2022 is available on our website.
The discussion on financed emissions invariably ends up with the question of whether Scope 3 emissions metrics include double counting, which occurs when GHG emissions are counted more than once in the financed emissions calculation.24 It is true that different companies within a value chain can claim the same emissions in their respective Scope 3 accounting. However, the GHG accounting system was designed to represent each entity’s emissions responsibility, and aggregated numbers are not meant to estimate emissions of the global economy but can help investors to steer their climate strategies.
Engage with investees collectively and individually At a time when understanding the data can be challenging, collective engagement with companies covering every part (or most) of the value chain is a critical and powerful tool for investors. Collaborative bodies like the Ceres Food Emissions 50 Initiative, of which AllianzGI is an active member,25 produces comprehensive scorecards on Scope 3 disclosures and target setting.
Vote at Annual General Meetings Beyond engagement, there are increasing options to escalate climate strategy and disclosure shortcomings through proxy votes. Last year, AllianzGI voted against the approval of a climate report by an Australian energy company because it lacked a Scope 3 emissions reduction target.26 Such stewardship requires a full understanding of value chain emission transmission mechanisms and hotspots. We have a tool to support this: our proprietary sector materiality matrix covers 24 industry sectors – illustrated in Exhibit 5.
Exhibit 5: Excerpt of AllianzGI emissions sources materiality matrix for six sectors
Source: MSCI ACWI as at 7 June 2023
In summary, we believe that investors and corporates should view measurement and management of Scope 3 emissions as an opportunity rather than a problem. The evolving standards and regulations can be met with a pragmatic approach of identifying and prioritising emissions categories to help promote a specific decarbonisation pathway. Detailed frameworks are evolving for the value chain of each sector. Over time, we believe this could allow for a genuinely connected alignment of emissions reductions targets from the top of the value chain to the bottom, which is critical to achieving net-zero goals.
Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.This material has not been reviewed by any regulatory authorities. In mainland China, it is for Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations and is for information purpose only. This document does not constitute a public offer by virtue of Act Number 26.831 of the Argentine Republic and General Resolution No. 622/2013 of the NSC. This communication’s sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of his document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced, except for the case of explicit permission by Allianz Global Investors. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Brazil, Panama, Peru, and Uruguay. In Australia, this material is presented by Allianz Global Investors Asia Pacific Limited (“AllianzGI AP”) and is intended for the use of investment consultants and other institutional /professional investors only, and is not directed to the public or individual retail investors. AllianzGI AP is not licensed to provide financial services to retail clients in Australia. AllianzGI AP is exempt from the requirement to hold an Australian Foreign Financial Service License under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order (CO 03/1103) with respect to the provision of financial services to wholesale clients only. AllianzGI AP is licensed and regulated by Hong Kong Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG; Allianz Global Investors UK Limited, authorized and regulated by the Financial Conduct Authority; in HK, by Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; in Singapore, by Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; in Japan, by Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424], Member of Japan Investment Advisers Association, the Investment Trust Association, Japan and Type II Financial Instruments Firms Association; in Taiwan, by Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan; and in Indonesia, by PT. Allianz Global Investors Asset Management Indonesia licensed by Indonesia Financial Services Authority (OJK).
Interesting rates: What can bonds tell multi asset investors about the future?
Bond markets don’t just guide fixed income decision-making. They can help with investors’ broader allocation decisions by offering insight into a range of different asset classes. With yields down sharply in recent months, which assets could be poised to benefit?
How could climate change impact my expected portfolio returns?
More extreme weather is making many investors ask how the potential impact on portfolios can be measured and mitigated. In this new series focused on the big questions for investors, risklab has three ideas for future-proofing your portfolio against climate change – without making radical changes.