Overview
The value of reporting on scope 3 greenhouse gas emissions as decision-useful information in capital allocation is one of the hottest ESG issues in 2022. Unlike scope 1 emissions (under the direct control of the reporting entity, such as gas combustion for heat) and scope 2 emissions (which are indirect emissions, but attributable to the direct consumption of the reporting entity, such as electricity consumption), scope 3 emissions are a rather more nebulous category of indirect emissions elsewhere in the reporting entity’s value chain. The concern about whether such information is useful, comparable, and indeed accurate, is a big factor in the current debates.
The role of scope 3 emissions and its value in decision-making has already seen a number of controversies in 2022.
In March, Steptoe commented on the US Securities and Exchange Commission's proposed rule for climate disclosures (see here). One of the most controversial elements of the proposed rule is the requirement for reporting scope 3 emissions. Under the proposed rule, scope 3 emissions must be disclosed if 'material', or if the registrant has set a scope 3 emissions target or related goal. The rule includes a safe harbor for liability for scope 3 emissions disclosures and exempts smaller reporting companies from scope 3 reporting requirements.
This year has also seen two separate UK legal cases which considered the role of scope 3 emissions in decision-making. In the first[1], the English Court of Appeal held that scope 3 emissions could not be ignored in environmental impact assessments, and those emissions with a 'sufficient degree of connection' to a project may need consideration. The judges were split on whether the authority had acted lawfully in not doing so. In the second[2], two judges in the English High Court came to opposing views on whether UK Export Finance, part of the UK Government, needed to undertake a quantitative assessment of scope 3 emissions when concluding that financial support for an overseas project is compatible with the UN Paris Agreement. This case is heading for the Court of Appeal.
Now it appears that the UK Government is considering the role scope 3 emissions should play in corporate reporting. Having already brought in a law to make climate-related financial disclosures mandatory for larger companies (the first G20 country to do so, and in force from April 2022), the UK is looking at further reform, and has launched a call for evidence[3] to inform an update to its Green Finance Strategy, due to be published later this year. The consultation asks for views on the importance of scope 3 emissions in investment decisions and the management of assets, and whether there is a role for the UK Government to support ''good quality'' scope 3 emission disclosures.
The consultation paper acknowledges that reporting on scope 3 emissions is not solely a task for large businesses, but also places a burden on the small and medium enterprises in the value chain who will be required to provide the data for the larger reporting entities. The consultation asks how such businesses may be supported to make such disclosures.
The questions are phrased in an open manner, but it is clear that some degree of mandatory scope 3 reporting is at least under consideration.
The consultation paper also addresses a number of other challenging issues within the world of sustainable finance and ESG investment. It asks for comments on the role of the UK Government to ensure high integrity in the voluntary carbon markets, and the regulatory levers needed to drive investment into ecosystem services and natural capital. Ensuring the flow of capital into less developed countries to improve the natural environment and reduce greenhouse gas emissions, and ensuring that this capital flows through London as a ''world-class'' leading global centre for green finance, is also a central aim of the strategy refresh. The outcome is likely to have wide-ranging impacts on the UK's green economy and international sustainable investments financed through London.
The consultation is open until 22 June 2022, and Steptoe's ESG team is on hand to help clients engage in this important debate.
[1] https://www.steptoe.com/en/news-publications/why-a-ruling-upholding-approval-for-an-oil-well-extension-fails-to-rule-out-future-scope-for-carbon-emissions-in-eias.html
[2] R (Friends of the Earth Ltd) v SSIT and ohers ([2022] EWHC 568 (Admin)
[3] https://www.gov.uk/government/consultations/update-to-green-finance-strategy-call-for-evidence