Next era in ESG Investing - Green House Gas (GHG) Emissions: It’s a matter of Scope
The SEC ESG disclosure proposal would require environmentally focused funds to disclose their carbon footprint and the Weighted Average Carbon Intensity (WACI) in the fund’s annual report, along with disclosing Scope 3 emissions. To note, however, if a fund states that it does not consider issuers' emissions as a component of its investment strategy, it can be omitted.
The SEC notes that requiring two metrics on carbon within a portfolio helps fit the needs of different investors, as the measuring of carbon footprint and WACI are both helpful tools to determine investment considerations for different purposes.
The requirement to disclose a fund's Carbon Footprint is helpful to provide investors the information about the number of tons of CO2e per million dollars invested in a fund. This metric is helpful as it is used to calculate the absolute total carbon emissions of the fund as well. Investors are looking to analyze a fund's carbon footprint as a tool to access both if a fund is creating the change it states in its prospectus, as well as assess how a fund's carbon footprint could impact financial performance.
On the other hand, the requirement to disclose the WACI metric is helpful for investors who are looking to examine a portfolio’s exposure to carbon-intensive companies. This metric is helpful to identify funds that invest in more carbon-efficient companies or find laggers within investment portfolios that they wish not to be invested with.
Both metrics can be beneficial in shaping the landscape of carbon-focused investments to align the desired impact with the actual impact and to help break through greenwashing efforts by funds that label themselves as “clean” or “renewable” energy. If we can apply a well-calculated standard across these metrics, it’s much easier to compare.
Understanding Scope 1, 2, and 3 Emissions
When considering Scope 1, 2, and 3 emissions it’s best to orient ourselves with what they are and how they are calculated.
- Scope 1 covers direct emissions from owned or controlled sources. These could be emissions coming from fuel combustion, the use of company vehicles, or even unintentional leakage emissions from building leaks or owned emissions storage.
- Scope 2 are indirect emissions from the generation of electricity, steam, heating, or cooling purchased for a business, or consumed by the reporting company.
- Scope 3 includes indirect emissions coming from a business's supply chain. Consider this as the emissions coming from purchased goods or services, travel, employee commuting, waste disposal, and transportation to name a few sources. Scope 3 emissions are often the highest emitter areas and are hard to directly quantify, though many developing technologies are helping in tracking and calculating these emissions.
The SEC believes that the addition of Scope 3 metrics could have the potential to provide investors with a more complete picture of emissions tied to a portfolio, especially when disclosed with Scope 1 and 2 emissions.
We also believe that the addition of disclosing and calculating these metrics is essential not only for advisors to have a full picture of carbon within possible investments but by calculating these emissions it also aids in creating the ability to get down to net-zero emissions faster/
Why Scope 3 can create opportunities for businesses
Scope 3 emissions are often the most complex to calculate and track, but are where most of our emissions come from. By creating a more regulated process to track and assess these emissions, there also comes the ability to find cost-saving measures along supply chains.
Though the SEC is mainly focused on protecting end investors, organizations that make this a priority prior to the proposed enactment to gain additional opportunities to assess where possible resource and energy risks are in their supply chain, understand energy efficiency and cost reduction opportunities, improve energy efficiency, and even create positive change at a company and employee level to reduce emissions from travel. Equally, with any of this analysis, new investment ideas could be considered to search out companies that help address any of these issues.
When examining global supply chains, especially at a business operations level, issues such as higher gas prices, strains on global supply, and geopolitical sparks across the world, adapting and saving money on transportation, storage, building efficiency, and even cargo shipping costs or manufacturing styles can help the bottom line, create better impacts on our earth, and can, in turn, create higher investment opportunities.
Overall, the SEC's requirement to add GHG emissions disclosures is a great step that falls in line with EU standards and helps create more accountability for all of us to see what impact our investments can make on the planet in calculatable ways. One missed opportunity is the lack of disclosure on the S (social), and G (Governance) issues for funds that are also an important piece to the entirety of ESG investing.
If you want to learn more about how important global supply chains are to the economy and how climate change affects all aspects of our life and investing, I recommend watching my recent interview with Suchi Gopal, where we talked about her work in tracking global supply chains and also understanding the ripple effects a green energy project can bring in unintended ways.