Companies are expanding their reporting on greenhouse gas emissions and adjusting production and work processes. However, the innovations are not enough to achieve the Paris climate goals. The experts of Swisscanto Invest see in the emissions metric "Scope 3" One major reason for this.
The "Scope 3" metric is designed to measure the greenhouse gas emissions of companies' supply chains and customers. Thus, Scope 3 can serve as one key lever among many to set new benchmarks in terms of the Paris climate goal. "A consistent implementation of Scope 3 with a detailed recording of greenhouse gases in supply chains is certainly associated with considerable effort. However, we strongly believe that as part of a move towards sustainable business models, resource conservation and circular economy, a process of 'Creative Destruction' as defined by the great economist Schumpeter can be or has already been set in motion", say Silke Humbert, Head Product Specialists and Gerhard Wagner, Head Sustainable Impact of Swisscanto Invest, the asset manager of Zurcher Kantonalbank.
Investigation of greenhouse gas emissions
- A company's greenhouse gas emissions are divided into "Scope 1" and "Scope 3" emissions, "Scope 2" and "Scope 3":
- Scope 1: Greenhouse gases generated directly in a company's production process.
- Scope 2: Greenhouse gases generated in the context of purchased energy.
- Scope 3: Greenhouse gases generated in a company's supply chain or at the customer's site through the use of the manufactured product.
Scope 1 and 2 are easy(er) to report on
According to the experts, the greenhouse gas emissions generated in the production process – i.e., Scope 1 and Scope 2 – can be relatively well controlled and reported by each company through the form of energy it purchases. Scope 3 emissions, on the other hand, are hardly ever reported. The reason for this is that the companies report that the upstream and downstream emissions are outside of their control, they have no data on this," emphasize the Swisscanto Invest experts. Furthermore, it is unclear how complex supply chains and the use by customers are to be treated. "There are therefore many obstacles to measuring Scope 3, although constructive proposals already exist, for example through the Greenhouse Gas Protocol, according to the Swisscanto Invest experts.
Scope 3 is relevant for the climate
In their opinion, a more consistent recording of Scope 3 emissions would be important simply because most greenhouse gas emissions occur in the Scope 3 category, as the following chart shows using the MSCI ACWI IMI index as an example. The MSCI All Country World Investable Market Index (ACWI IMI) provides access to equities from 23 industrialized and 27 emerging countries worldwide. The index comprises securities from the large caps, mid caps and small caps segments. It is clear that scope 3 emissions are almost three times higher than scope 1 and 2 combined. It can also be seen that Scope 3 is mainly used in the "downstream" area arises – i.e., the use of products by buyers/end users.
Intensity of greenhouse gas emissions (Scope 1 and 2 versus Scope 3)
Companies with more than 75% Scope 3 emissions
At Apple, for example, more than three quarters of the emissions occur in the Scope 3 category, namely in the manufacture of preliminary products in the supply chain. And in the case of energy companies such as Shell or BP, more than three quarters of the emissions also occur in the Scope 3 category – this time, however, not in the supply chain, but in the use of the raw material by the end consumer. "If companies design their in-house production processes with emissions from Scope 1 and 2 categories in such a way that they cause fewer emissions, that is all well and good. However, this is not enough to achieve the Paris climate target. The really relevant impact on the climate is caused by Scope 3 emissions", emphasize the Swisscanto Invest experts.
Efforts are already being made to record and reduce Scope 3 emissions, for example through the Greenhouse Gas Protocol. Companies such as Apple and Microsoft are also now focusing on issuance in supply chains. That there is much to be done in this regard is shown by the example of Apple, where only 1% of the CO2 footprint is accounted for by emissions in categories 1 and 2, and the rest by Scope 3 (supply chain 76%, end use 14%, transport 5%, other 5%), as shown in the Apple Environmental Responsibility Report 2019. If Apple seriously wants to do something for the climate, it must control its supply chain – and that is exactly what it intends to do.
Humbert and Wagner raise the question of whether corporate self-regulation is more likely or further legal regulation, and expect this to be one of the big topics at upcoming international climate conferences and WEF meetings.
Scope 3 is important for returns
Not only for the climate, but also for the return, Scope 3 plays an important role for companies, but also investors, the experts continue. That's because with current efforts by governments and businesses to meet the Paris climate goal and reduce greenhouse gas emissions, green technologies are becoming increasingly important and in demand.
For example, the stock prices of solar equipment manufacturers have recently soared. Solar power systems enable their users to generate energy without polluting emissions. This is why they have very low Scope 3 emissions. However, CO2 emissions are also generated during the production of solar plants; solar manufacturers therefore have higher Scope 1 and 2 emission values than financial companies, for example. "Thus, it is clear that investors who only consider those with currently low Scope 1 and Scope 2 data when selecting climate-friendly companies do not necessarily benefit from the pioneers of decarbonization", Humbert and Wagner note, adding, "We expect that the stocks of companies that are leading the way in decarbonization will be among the winners on the stock market.
However, because reliable scope 3 data are hardly available today, fundamental research and expertise are needed to assess the scope of new technologies and new policy frameworks. However, this knowledge will only be effective if as many companies as possible take up the challenge of providing transparent data on their scope 3 emissions.
Reduce scope 3 emissions
"Like other institutions, we believe that measuring Scope 3 emissions opens up a wide range of climate benefits, as well as economic benefits in the form of cost-cutting opportunities", Humbert and Wagner emphasize. Companies are finding entry points to do this within their own businesses, such as business travel and commuters, but especially by identifying opportunities for energy efficiency and cost reduction in their supply chain and in the use of their products.
"As part of Engagement, the direct dialog with companies, we place great emphasis on companies joining the Science Based Target Initiative to pursue a transparent climate strategy. Companies that follow a traceable decarbonization path and can document this path with forward-looking Scope 3 reporting not only contribute to climate improvements – they will also be among the winners on the stock market.", the Swisscanto Invest experts are convinced.