What’s Scope 3 Good For?

Authors

Madison Condon, Boston University School of LawFollow

Document Type

Article

Publication Date

6-2023

ISSN

0197-4564

Publisher

University of California - Davis

Language

en-US

Abstract

Opposition to the Securities and Exchange Commission’s (“SEC”) new rule on updated climate risk reporting has focused on one category of disclosures as particularly objectionable: Scope 3 emissions.⁷ Otherwise known as “supply chain emissions,” Scope 3 emissions have been voluntarily reported by a growing number of companies since the term was invented as part of the Greenhouse Gas Protocol in 2001.⁸ They include all the emissions both up and downstream of a corporations’ own activities: the emissions of the privately-owned factory that produced the shoes Target sells, as well as the emissions you burn while driving to the store to buy them, all count as Target’s “Scope 3” emissions.⁹ The other two GHG Protocol scopes are less sprawling: Scope 1 emissions include sources the company directly owns and controls — the natural gas to heat buildings and gas-powered delivery vehicles, for example.¹⁰ All emissions that come from purchased electricity fall in Scope 2 — this is the bill Target pays for the power from the grid that keeps store lights on.¹¹ While the SEC proposes that all companies be required to report their Scope 1 and 2 emissions, Scope 3 emissions are only mandatory if they are financially material to the company, or the company has publicly set emissions targets.¹²

Objections to Scope 3 reporting requirements often highlight difficulties in collecting emissions information from third-parties, particularly smaller or private entities.¹³ Corporations bristle at the idea of being held “responsible” for emissions over which they have no control.¹⁴ And market participants that do not object to the concept of supply-chain emissions reporting have enumerated complications that come from applying Scope accounting in practice, anecdotal puzzles abound: “How do you divide up the emissions between” the milk and the meat that a single cow produces over its lifetime?¹⁵ Nevertheless, investors largely support the SEC’s Scope 3 proposal, and have used their own shareholder power to press for increasingly stringent supply-chain emissions disclosures from corporate management directly.¹⁶

Investors justify their pursuit of corporate emissions disclosure for two broad reasons. The first is that emissions are useful as a proxy for measuring transition risk, or their exposure to regulatory and market changes affecting fossil-dependent investments.¹⁷ This reason is consistent with a “single materiality” framework that compels disclosure of risks to a company. ¹⁸ This contrasts with a “double materiality” framework that additionally aims to capture risks that a company imposes on others, including other corporations in the market.¹⁹ While discourse in the United States has tended to accept the traditional single materiality of Scope 1 and 2 emissions, Scope 3 is often described as a metric limited to “double materiality.”²⁰ This Article argues that because the division between Scopes 1, 2, and 3 follow the arbitrariness of firm boundaries, certain channels of transition risk — and reputational risk — are not eliminated by simply outsourcing a high-risk process to a third-party. A blinkered focus on Scopes 1 and 2 misses these exposures. The second reason U.S. investors demand emissions disclosure is that it is needed for monitoring corporate progress over time. Metrics on emissions reduction progress are used throughout corporate governance: informing decisions on board member support, setting executive pay incentives, and monitoring portfolio-level alignment with climate indexes.²¹ Institutional investors are increasingly adopting their own reduction-commitments simultaneously as retail inventors seek out “carbon aligned” funds. Firm-level Scope data is needed before an asset manager can market any low-emissions fund.²² Investors are increasingly adopting their own reduction-commitments, and retail investors are seeking “carbon aligned” funds of various kinds — the firm-level Scope data is needed in order construct footprints of assets and funds.

While the number of ESG reports about emissions “data gaps” grows, just where the data comes from and how it is (mis)used by market actors has been underexplored in the legal literature, particularly beyond the realm of ESG metrics for portfolio-screening. In Part I, this Article discusses how Scope data is collected and shared in practice, as well as its widespread adoption as a metric for financial risk and corporate governance. Part II argues that these uses of emissions data demonstrate that this information is broadly material to investors, requiring standardization and assurance. For these reasons, the SEC should not back down on requiring the disclosure of relevant Scope 3 emissions.²³ Corporate claims of lack of control and access to data should be met with skepticism for large companies, especially in light of recent technological advances related to emissions monitoring and trends in supply chain contracting.²⁴ However, the usefulness of Scope 3 data depends upon its use-case — a fact that has been relatively underappreciated — as well its granularity and the availability of other contextual data. This Part goes on to offer a brief critique and qualification of the uses of Scope 3 data, highlighting how U.S. financial regulators can improve upon the early approaches of other jurisdictions. Part III concludes.

Recommended Citation

Madison Condon, What’s Scope 3 Good For? , in 56 U.C. Davis Law Review 1921 (2023).
Available at: https://scholarship.law.bu.edu/faculty_scholarship/3657