Optimising ESG rankings with Scope 3 reporting

Environmental, social and governance (ESG) factors have become central to evaluating a company’s sustainability and societal impact. The E in ESG – environmental – is particularly prominent, as carbon emissions often dominate discussions around sustainability.

Scope 1 and Scope 2 emissions are directly controlled by a company and are thus relatively simple, albeit often painful, to manage. However, Scope 3 emissions, the indirect emissions that occur across a company’s supply chain, are increasingly influencing ESG rankings, which in turn can influence a company’s valuation. Because of this, managing Scope 3 emissions is a critical part of corporate planning and risk management.

Scope 3 emissions encompass a wide range of activities, such as the production and transportation of purchased goods and services, business travel, waste disposal and even the use of sold products. Because they are not under a company’s direct control, they are challenging to monitor and reduce. But they often account for more than 70 per cent of a company’s total carbon footprint.

Problems with Scope 3 emissions

It is hard to manage Scope 3 emissions because of their indirect nature: their origins can span a broad network of suppliers, customers and other third parties. This presents several challenges

Data collection is difficult. Accuracy cannot be guaranteed, especially when it is collected from suppliers across different geographies. In many cases, suppliers may not have the capability or regulatory incentive to report their emissions accurately.

Even when data is available, the absence of standardised methods for calculating Scope 3 emissions creates inconsistencies that make benchmarking difficult. For example, different industries may have different reporting practices and collect different data.

Another problem is that companies often have difficulty influencing external parties including suppliers: where a company has limited control over its suppliers, it is challenging to work towards reduced Scope 3 emissions. Time-consuming negotiation, expensive incentives or even a potentially risky search for new suppliers may be required.

Managing Scope 3 emissions

Despite these challenges, there are ways for companies to manage their Scope 3 emissions successfully, something that can significantly improve their ESG rating.

Supply chain mapping

As with any risk management process, prioritisation is critical. For Scope 3 management, understanding where the most significant emissions occur in the supply chain is the first step. By mapping emissions across the supply chain, companies can prioritise areas that have the most impact or that are the easiest to influence.

Managing suppliers

This can involve setting clear expectations for sustainability performance and the meeting of ESG criteria in supplier contracts. Additionally, some companies, such as H&M and Unilever, provide support to their suppliers for carbon reduction initiatives. Collaborative approaches, such as forming industry alliances or working groups, can also help drive improvements in the ways that emissions are managed.

Designing for the circular economy

Companies that invest in innovation can significantly reduce their Scope 3 emissions by shifting design outcomes to address the circular economy. This can involve redesigning products to be more energy-efficient or durable. It can also involve developing new business models that promote reuse and recycling. Manufacturing processes can also be improved by using recycled or low-carbon materials.

Leveraging data analytics: Advanced data analytics using emerging technologies such as blockchain and artificial intelligence can be applied to improve supply chain transparency and thus track and manage emissions across the supply chain more effectively. These technologies can help companies predict trends and optimise decision-making for emission reductions.

Reporting on success

Because of the wide variation in the data that is reported, companies can enhance their credibility in sustainability by adopting internationally accepted reporting standards. Recognised frameworks include the IFRS Climate-related Disclosures framework in the financial services sector, and the more generally applicable Global Reporting Initiative. Adopting established frameworks can help companies provide clear, comparable and credible information.

Scope 3 emissions represent a significant challenge for companies aiming to enhance their ESG performance. But because credible and comparable reporting is difficult, they also represent an opportunity to be more favourably reviewed by the increasingly important ESG rating agencies such as MSCI and S&P Global.

The key for business leaders lies in adopting a strategic approach that aligns environmental responsibility with core business objectives. This involves setting ambitious targets that will win favour with investors, maintaining reporting transparency and achieving real change by fostering collaboration across the value chain, investing in design and manufacturing innovation and taking a proactive but supportive approach to managing suppliers.

As ESG considerations continue to shape the business landscape, companies that manage their Scope 3 emissions effectively will be better positioned to attract investment and drive long-term value. The time to act is now, and the stakes have never been higher.