What are Scope 3 emissions and why do they matter?
Learn more about the difference between Scope 1, Scope 2, and Scope 3 emissions, and why they’re so important for understanding climate risk of investments.
By Asiyah Choudry
April 20, 2022
Last month, the Securities and Exchange Commission (SEC) moved forward with its proposal to mandate disclosures of Scope 1, Scope 2, and in some cases Scope 3 emissions for public companies. Let’s take a look at the differences between these emission types and explore why Scope 3 emissions, in particular, are so important.
What’s the difference between Scope 1, Scope 2, and Scope 3 emissions?
Scope 1 emissions are direct emissions produced by sources that a company owns or controls. These include emissions from a company’s vehicle fleet or office facilities, for example.
Scope 2 emissions are indirect emissions that come from purchased electricity and steam.
Scope 3 emissions are indirect emissions that come from sources that are not controlled or owned by a company, but which occur across its value chain. Scope 3 emissions include employee commuting, investments, and transportation and distribution of products. For some industries, Scope 3 represents the largest source of emissions. According to MSCI, Scope 3 emissions in the oil and gas sector are six times higher than Scope 1 and Scope 2 emissions combined.
Scope 3 emissions: upstream vs. downstream
Scope 3 emissions can be upstream or downstream, depending on where they originate along the value chain. Upstream emissions come from the goods and services that a company acquires, whereas downstream emissions come from the goods and services that a company sells. GHG Protocol has developed 15 categories of Scope 3 emissions which are listed below:
- Upstream: Purchased goods and services, capital goods, fuel- and energy-related activities (not accounted for in Scope 1 or Scope 2), upstream transportation and distribution, waste generated in operations, business travel, employee commuting, and upstream leased assets.
- Downstream: Transportation and distribution of sold goods and services, processing of sold products, use of sold products, end-of-life treatment of sold products, downstream leased assets, franchises, investments.
What do Scope 3 emissions look like in finance?
For financial institutions, emissions resulting from lending and investment activities count as Scope 3. In a study of 332 financial institutions, the Carbon Disclosure Project found that GHG emissions associated with investing and lending activities were 700 times greater than Scope 1 emissions. Fewer than half of these financial institutions were undertaking efforts to align their holdings with the Paris Agreement target of limiting global warming below 2 degrees Celsius.
The practice of disclosing Scope 3 emissions is not well-established among financial institutions. Let’s take a look at JPMorgan Chase & Co. In its latest ESG Report, the bank only discloses Scope 3 emissions for business travel, which accounted for 5% of the bank’s total GHG footprint. Clearly, this statistic does not tell the full story. The company has not published any disclosures related to Scope 3 emissions from lending and investment activities. This is a critical omission given that JPMorgan Chase invested $382 billion into fossil fuels from 2016 to 2021 – more than any other bank globally.
Why is it important for organizations to measure and disclose their Scope 3 emissions?
Scope 3 disclosures are valuable for investors because they give insight into an organization’s climate risk. If a bank has high Scope 3 emissions from its lending portfolio, this may be an indication of high climate risk. But what exactly is climate risk? The Task Force on Climate-related Financial Disclosures divides climate risks into two categories: transition risks related to the global shift to net-zero and physical risks related to the physical impacts of climate change such as floods or other extreme weather events.
When a bank invests heavily into industries that are highly susceptible to transition and physical risks, they increase their credit risk – that is, the risk that borrowers will not repay them. For example, businesses in the fossil fuel sector face the transition risk of being displaced by renewable energy. If the fossil fuel sector fails to remain profitable in the long term because it loses market share to renewable energy sources, then banks that invest heavily in fossil fuels are susceptible to large financial losses.
According to the Center for American Progress “if climate-related transition shocks or physical shocks cause severe losses at a systemically important financial institution…stress could be propagated throughout the financial system.”
Challenges of Scope 3 accounting
Scope 3 emissions are generated by a range of suppliers and customers across an organization's value chain, therefore they can be extremely challenging to quantify. Furthermore, companies do not have direct control over their Scope 3 emissions, so it can be difficult to target efforts to reduce them. The Partnership for Accounting Financials has released a Global GHG Accounting and Reporting Standard for the Financial Industry to address the challenges associated with measuring Scope 3 emissions and to support the standardization of disclosures.
The future of GHG accounting
While we applaud the SEC’s efforts to boost climate-related disclosures through mandatory Scope 1 and Scope 2 reporting, we believe that mandatory Scope 3 reporting would be a great next step. As of now, organizations would only be required to report Scope 3 emissions to the SEC if that information is considered material or if a company has set targets for reducing them.
Given that Scope 3 emissions are related to an organization’s climate risk, we believe this information is material for investors. Scope 1 and Scope 2 data can fail to capture the full extent of an organization’s climate impact, particularly when it comes to financial institutions.
If you are looking to assess an organization’s climate impact, consider looking at their ESG or sustainability report to determine whether they disclose their Scope 3 emissions and whether they have targets for reducing them.
If you’d like to divest your funds from fossil-fuel-funding financial institutions, check out our list of climate-friendly banks and learn more about how your checking or savings account can support positive climate impact!
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