Scope 3 Supply Chain & Financed Emissions

Scope 3 Supply Chain & Financed EmissionsBy Alexis Normand, co-founder and CEO at carbon accounting platform, Greenly

Increasing environmental-focused regulations around the globe mean it’s no longer enough to rely on internal sustainability and ESG programmes. Instead, it’s critical to look at the environmental impact of your entire value chain and operations.

Carbon emissions are in the spotlight, with various regulations enforcing the reporting of a company’s Scope 1, Scope 2 and Scope 3 emissions. Scope 3 emissions being all indirect emissions that occur in a business’ upstream or downstream activities (namely, its supply chain). And with supply chains often accounting for more than 90% of an organisation’s emission, it’s vital that businesses not only know the carbon footprint of their entire value chain, and where these emissions are coming from, but also that they take steps to reduce them.

Getting a handle on supply chain emissions

Scope 3 emissions are notoriously the most difficult to measure because they include all other emissions generated outside the company’s own premises and operations – for example, emissions generated by business travel, what happens to products after they are sold, or activities carried out throughout the various supply chains the company has chosen to work with – and therefore rely on external parties to provide the information required.

If a business can decarbonise – or, at the very least, reduce emissions from – its supply chain then it’ll stand a good chance of significantly reducing its own corporate footprint. Which is what regulators and governments are increasingly wanting to see. But how does a business go about this?

Supply chain decarbonisation

From a business’ cloud and IT providers, to physical office space and associated facilities, to customers and suppliers, the size of a supply chain may be vast. To have any chance of making meaningful reduction in Scope 3 emissions, the starting point for any business is to identify which of its suppliers are better than average in terms of carbon intensity. Simply selecting the right partners can help businesses to: reduce the impact of their servers’ electricity consumption, reduce the impact of business travels, optimise their facilities’ energy consumption, implement climate-related terms into their purchasing policies, and much more.

But the real deal for banks and investment firms, when it comes to Scope 3 decarbonisation, are financed emissions.

Understanding financed emissions

Financed emissions have gained considerable traction in recent years. These emissions do not stem from a bank’s direct or indirect operations. Instead, financed emissions are generated from the projects, industries, and enterprises a bank chooses to finance; be it through loans, investments, or other financial services.

While banks and finance firms might not physically emit greenhouse gases in the way that an oil company or a steel manufacturer does, the capital that they provide enables these sectors. Hence, the carbon footprint of a finance firm’s financed ventures is attributed to it. And, given the massive scale of financing that global banks and finance firms provide, the collective impact of these emissions is monumental. For example, a coal mine’s operations or an infrastructure project’s construction, though indirectly funded, are tangible extensions of a bank’s ecological influence. By focusing on these financed emissions, regulators, governments and environmental bodies are able to discern the often hidden but substantial influence financial institutions exert on the environment. And, in turn, the urgent necessity for them to steward their resources towards a more sustainable future.

Progress towards quantifying financed emissions

Prominent banks like Barclays and Morgan Stanley, part of a standard-setting consortium, have been debating the best methods to quantify the carbon footprint of such deals. The core challenge, however, and the root cause of disagreement as to the best approach, is that more than a third of the $669bn directed towards fossil fuel sectors in 2022 by the world’s top 60 banks came not from direct loans, but from underwriting bonds and equities later sold to investors. Yet, the ephemeral nature of underwriting deals, which aren’t typically long-term fixtures on balance sheets like loans, has caused reluctance among bankers to recognise and account for the climate ramifications of this function.

Stepping into this tumultuous debate is the Partnership for Carbon Accounting Financials (PCAF) with its facilitated emissions working group. This group has been deeply engrossed in determining the extent to which banks should be held accountable for emissions linked to underwriting. Some factions within the banking community advocate for banks to take responsibility for just a fraction (as little as 17% or 33%) of these emissions. Others, like NatWest, champion a comprehensive 100% disclosure; mirroring the rigorous standards applied to their loan portfolios. Yet, as negotiations have intensified, reaching a consensus has proven elusive.

Whilst this continues to play out, and adding another layer of complexity, some European banks have proposed amalgamating decarbonisation targets for underwriting with existing net-zero goals for lending. Critics warn that such bundling, if executed using disparate methodologies, risks greenwashing and undermining the genuine intent behind sustainable finance. The stakes remain high as banks traverse this intricate path, striving to balance economic ambitions with environmental stewardship.

Tracking financed emissions

Whilst the various bodies and banks thrash out how to quantify financed emissions, all finance firms should be embedding financed emissions into their carbon accounting programmes. Calculating financed emissions is a meticulous process which requires multiplying an attribution factor (otherwise known as the investee’s estimated share of emissions in relation to the loan or investment, or their outstanding amount divided by their total equity and debt combined) by the emissions created by the investee. However, this requires emissions data from the investee or investor which is often hard to come by. Therefore, increasing the quality of this data through various investor engagement and education programmes should be part of a finance firm’s supply chain decarbonisation efforts.

Setting milestones for decarbonisation

Companies can take baby steps to comply with the demands currently associated with disclosing financed emissions, and to prepare to future expectations. For example, a company can implement ESG values into its future investment choices to help to mitigate future financed emissions and encourage more environmentally friendly investments.

In addition to this, having a structured engagement programme with both internal and external stakeholders can help to raise awareness of the emissions created by financial activities and, in turn, facilitate change. Programmes like this can also encourage stakeholders and financial institutions to drive new ideas to avoid future financed emissions and illustrate their commitment to bringing sustainable change to the industry.