How the Emissions Disclosure Gap Poses Risks for Corporates and Investors

Carbon disclosures are lacking in scale, accuracy and completeness, making it difficult for investors to drive impact as a result
Posted by
Yannick Pape
on
December 1, 2022

Accounting for company and portfolio emissions is widely seen as the first step needed to decarbonise, and more companies than ever have been disclosing their emissions. The Carbon Disclosure Platform (CDP), the leading initiative for company carbon disclosures, has steadily seen increases in responses. Last year more than 13,000 companies disclosed emissions on the platform, equal to 64% of global market cap. So why are some sustainability professionals still referring to a ‘disclosure gap’?

In this guide we will cover:

  1. What is the disclosure gap?
  2. What are the impacts of the disclosure gap on corporates and investors?
  3. How can corporates and investors alleviate the issue?

1) What is the carbon disclosure gap?

The carbon disclosure gap refers to two issues:

Emissions are still insufficiently disclosed in many sectors and jurisdictions.

Looking at the leading global market indexes, many companies still do not disclose emissions.

  • 60% of companies in the MSCI ACWI index (an index covering 85% of the global investable equity opportunity set) do not disclose Scope 1 & 2 emissions. 42% of large and mid-cap companies in the FTSE All World Index (covering 95% of the global investable market capitalisation) do not disclose Scope 1 & 2 emissions.
  • 25% of companies in the MSCI ACWI report Scope 3 emissions
  • 20% of companies on the Bloomberg ESG database had Scope 3 emissions in 2020

Percentage of companies in MSCI index and Bloomberg ESG database that disclose Scope 3 emissions

It is important to highlight that big regional and sectoral differences exist. For example, FTSE Russel points out that as 89% of companies in developed Europe reported emissions on Scope 1 & 2 in the FTSE All World index, compared to 23% of Chinese firms.

Especially the Scope 3 results should warrant some concern, as it is meanwhile very well established that these emissions make up the majority of a company’s value chain footprint. Some statistics place supply chain Scope 3 emissions as high as 93% of total emissions, or roughly 11.3 times higher than combined Scope 1 & 2 emissions.

Emissions disclosures from companies are often incomplete.

Even when supply chain emissions are disclosed, companies often fail to account for the full scope of their supply chain emissions. An analysis of the leading German blue-chip companies represented in the DAX index found that only half reported emissions on all Scope 3 categories. Researchers looking at the tech sector found that corporate reports omit half of all emissions. To add to this, of the 13,000 companies that disclosed emissions on CDP in 2021, only 1% disclosed data on all 24-key emissions indicators identified by the organisation.

The magnitude of these incomplete Scope 3 measures could be significant, as it is often downstream Scope 3 emissions that are not adequately covered. These are the emissions associated with the use of sold products, which tend to be very high for certain carbon intensive industries such as automobile manufacturers.

2) What is the impact of the carbon disclosure gap?

The above highlighted disclosure gap brings about significant risks for corporates as well as investors.

Incomplete risk assessments for both corporates and investors.

Carbon exposure is increasingly used as a measure of transitional risk. These are risks associated with changes in policy and markets due to climate change, such as costs incurred by firms due to carbon pricing policies implemented.

If a company exhibits a blind spot in its carbon footprint, it could underestimate how increased carbon pricing by governments will impact its supply chain and balance sheet. This, in turn, could lead to a decrease in the returns seen by investors. Carbon footprints can be used by corporates and investors as a tool to prepare and plan for unforeseen market changes. Incomplete Scope 3 measurements hamper this ability.

It jeopardizes investor decarbonisation commitments.

In the absence of emission data, investors often resort to estimating carbon emissions of portfolio companies. This brings about complications when it comes to driving action.

According to FTSE, half of estimates diverge from reported emissions by more than 100%. Research by Kalesnik et al. also suggests that emissions estimates are 2.4 times less effective than reported emissions. These statistics only refer to Scope 1 & 2 emissions methods, which implies that the issues are even greater for Scope 3 emissions due to their spread and impracticability.

Source: FTSE Russell

Investors with decarbonisation targets, such as those made by leading financial institutions in the Glasgow Financial Alliance for Net Zero (GFANZ), may hence find it hard to drive action due to incomplete data. It is worth noting here that investor targets are also primarily based on Scope 1 & 2 data, thereby ignoring the largest source of emissions. Capital allocation decisions that may follow from these targets therefore could also lead to greater economy-wide risks.

3) What can corporates and investors do to tackle the issue

The risks posed by the disclosure gap imply several key actions:

Detailed and complete carbon accounting has to be scaled across industries and geographies.

Recent legislation, such as the International Sustainability Standard Boards decision to require Scope 1, 2 and 3 emissions disclosures and the EU adoption of the Corporate Sustainability Reporting Directive will help further this. However, many companies still struggle attaining the right data from their suppliers to accurately measure Scope 3 footprints. These are often measured based on spend data, which are not able to accurately capture supplier or product specific details. Corporates should look to increase the share of their supply chain carbon footprints that is based on supplier specific data.

Investors need to gradually move away from emissions estimations and engage portfolio companies to measure and disclose carbon emissions.

This will especially be key in the private markets, as companies here face less regulatory pressure to disclose emissions.

To sum up, carbon accounting still needs to scale and increase in accuracy. The current market landscape of emissions disclosures means that certain corporate climate risk assessments may have significant blind spots. Investors may also find it harder to drive action. Corporates need to find better carbon accounting tools to cover organisational complexity and investors should use their influence to incentivise bottom-up carbon accounting.

Sources:

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