What are scope 3 emissions and why are they a business risk?

In simple terms, scope 3 are all the emissions associated, not directly with a company, but indirectly with a company. 

This means emissions that are produced throughout a business’ supply chain. 

As an example, emissions from the products that are bought from a business’ suppliers, and then the emissions from those products that are used by its customers. 

Emissions-wise, Scope 3 are nearly always the biggest, and typically they account for 70% of a business’ indirect emissions. 

All indirect emissions that occur in the supply chain of a business, including both upstream and downstream, are scope 3 emissions. 

Scope 2 are all the indirect emissions through the use and purchase of energy, while scope 1 refers to the direct emissions from operations or sources owned by the business itself.

Scope 3 make up most of a business’s carbon output – around 70% according to the United Nations. They are also the most difficult to tackle, and the easiest to forget, as they are not produced by the direct actions of one company.

This is why most businesses are simply failing to keep track, let alone reduce scope 3 in line with sustainability objectives. 

A report by Net Zero Tracker shows that only 37% of businesses with net zero targets include scope 3 emissions, while 20% only have partial coverage, and the rest either don’t count it or don’t include it in published plans.

After a summer of record heat and obvious planetary stress, the environmental risks of failing to decarbonise are clear. 

What may not be so obvious for business leaders, however, is the growing risk they face of possible stern punishment by an array of regulators.

A raft of new laws, that aim to enforce the tracking, publication and/or reduction of emissions, including scope 3, are imminent – from a myriad of regional, national and international authorities.

The most important regulations to note for any business or subsidiary operating in the EU is the Corporate Sustainability Due Diligence Directive (CSDDD) and the Corporate Social Responsibility Doctrine (CSRD). These laws were both passed by the EU in early 2023.

The former will require qualifying large businesses to embed due diligence into their policies – which includes the prevention or mitigation of climate impacts. 

Most importantly, it mandates that businesses align their long-term strategy with the goal of keeping global warming to 1.5 degrees. 

Small to medium sized enterprises and micro companies are not affected.

The key elements of the CSDDD are as follows:

• Scope: It will extend to all risks under the ESG bracket – including climate change, child labour, environmental damage such as deforestation, and human rights abuses.
• Risk management: Companies will have to identify, assess, prevent, and mitigate adverse impacts – both from their own actions and those of their suppliers and manufacturers in their supply chain.
• Reporting obligations: Businesses will have to disclose information regarding their due diligence policies, the actions taken, and any results achieved.
• Remedying harm: The CSDDD aims to give access to effective remedies for the victims of the climate crisis – by allowing judicial recourse, for example.

The CSRD will cover the reporting stage. It will make businesses publish their emissions, including scope 3, alongside their yearly financial disclosures. 

This aims to make greenwashing harder for both the business in question, as well as the investment funds which play fast and loose with the ‘green’, ‘sustainable’, or ‘ESG’ (environmental social governance) labels they use for funds which may not be as green as a conscientious investor may want.

The punishments for failing here are severe; a fine of up to 5% of global turnover, exclusion from public tenders, reduction in bonuses, and the potential for those impacted by climate change to sue for damage.

In the UK, the Financial Conduct Authority (FCA) has been discussing how sustainability can be standardised. 

The consultation period ended in January 2023, and final rules are expected to be set in a Policy Statement released in Q3 2023. 

It is expected that this will create consistent ‘sustainable labels’, whether that’s for consumers or investors, to ensure a reliable disclosure of environmental impact.

The US is proposing to standardise climate related disclosures through the Securities and Exchange Commission (SEC). 

This will mean all businesses have to “assess, measure, and manage climate-related risks” in a uniform and consistent manner – which includes greenhouse gas emissions.

Globally, the International Sustainability Standards Board is developing standards to ensure a comprehensive baseline of sustainability disclosures. 

This has backing from the G7, the G20, the International Organisation of Securities Commissions (IOSCO), the Financial Stability Board, African Finance Ministers and Finance Ministers and Central Bank Governors from more than 40 jurisdictions.

The ISSB proposal has four key objectives:

•   Develop standards for a global baseline of sustainability disclosures.
•   Meet the information needs of investors.
•   Ensure companies provide comprehensive information to global capital markets.
•   Facilitate interoperability for disclosures between different regional and national requirements and differences.

The world is fast coming to the realisation that regulations are needed to ensure all consumers, investors, and businesses read from the same rule book. 

Although different political authorities are progressing at different speeds, the rate of progress is obvious – and it seems change is due to come.

The lesson here for businesses is to jump before you’re pushed.

Collaborate with your suppliers, and innovate accordingly. Only through cooperation and communication can you start to find out the dirtiest elements of your supply chain, understand the needs, challenges, and risks of all involved, and improve accordingly.

This is of course no job for manual arithmetic. Digital tools, and therefore the automation of scope 3 emissions monitoring, are key to tracking and reducing your carbon output.

This will not be simple or easy, but unless you want to be at the mercy of the many new regulations that will come to pass this decade, or the growing expectations of consumers and investors for businesses to go green, you best get started now.