Scope 3 emissions: biggest reporting challenge yet?
ESG standards measure a business’s impact on society, the environment, and how transparent and accountable it is. ESG is fast becoming a mainstream consideration for all investors, and was one of the key topics discussed at the first summer AFC face-to-face event since Covid.
Investors are increasingly scrutinising ESG performance – and looking for companies to rise to the challenge. Environmental ESG reporting is now more prominent with increased regulatory pressure to report on emissions with Scope 3 reporting.
A panel of industry experts comprising John Rees, Community Head, Equipment Finance at Asset Finance Connect, alongside Karima Haji, Director of Transformation at Scania UK, Michiel Kranenborg, Manager Group Finance & Reporting at DLL, and René Kim, Founding Partner of Steward Redqueen debated the issues surrounding Scope 3 emissions measurement, management and reporting at the AFC Summer conference.
Scope 1 emissions: direct Green House Gas (GHG) emissions from company-owned and controlled resources, e.g., emissions released into the atmosphere as a direct result of a set of activities, at a firm level.
Scope 2 emissions: indirect emissions from a company from the generation of purchased energy, from a utility provider, e.g., all GHG emissions released in the atmosphere, from the consumption of purchased electricity, steam, heat and cooling.
Scope 3 emissions: all indirect emissions – not included in Scope 2 – that occur in the value chain of the reporting company, including both upstream and downstream emissions, i.e., emissions linked to the company’s operations.
Scope 3 emissions are all indirect emissions that occur in the value chain of the reporting company, including both upstream and downstream emissions. They are by far the largest source of emissions for most auto and equipment finance businesses.
Unfortunately, Scope 3 emissions are the hardest emissions to measure and manage and there are significant problems around reporting on them as there is a myriad of Scope 3 emissions along the value chain.
René Kim, Founding Partner of Steward Redqueen explains what Scope 3 emissions means for an asset finance company:
In order to effectively manage scope three reporting, companies must stay on top of the usage data. So essentially, practitioners in the industry must know how often their asset is being operated, and what emissions it is making during the life of the finance agreement to be able to report the data.
Kim highlights that there are three levels to managing Scope 3 emissions: improved efficiency, cleaner fuels and new technologies:
- Improved efficiency. Efficiency of the asset and its components e.g., machine performance, better engines, transmissions, tyres; operational efficiency – is it the right asset for the right task; pricing – what can be done on the pricing side to entice a customer to make more efficient use of the asset, e.g., usage-based business models.
- Cleaner fuels. Liaise with vendors to see whether the assets can run on cleaner fuels; incentivise a client to use cleaner fuels.
- New technologies. Can newer technologies affect residual values and render an asset obsolete?
For bank-owned finance companies, banks are already falling in line with their net zero reports, while asset finance and leasing companies need to start looking at the processes and setting targets.
The first step in the process is to measure and disclose – as Kim points out, companies must “measure what you can, estimate what you must and make sure that, over time, you have systems in place to get better data, especially for new assets.” Companies must also set targets which can be difficult when you need to set a target on something that is beyond your control, but over time things will become clearer and easier. Kim warns that “not setting targets is not an alternative anymore.”
While many companies are announcing their target to be net zero by 2050, Kim advises companies to set a shorter term, for example, 2030, which means focusing less on new technologies and more on improving the Scope 3 emissions within current regulations and within current technologies.
When discussing current actions in the ecosystem, Kim highlights three areas of focus for asset financiers:
- The need to finance the growing demand for infrastructure, housing, and food; the whole system, not just the asset, but also the supporting infrastructure.
- Get involved with regulation.
- Engage in continuous conversations between vendors and clients: What are the technology roadmaps? What is possible on the OEM side? What are the real needs of clients? Scope 3 emissions reporting has made companies look at the planet and their carbon footprint – business is not only about profit, it is also about the reputational risk of being seen as a polluting company which can be extremely damaging for the business.
Case study: Scania
Scania has a very strong roadmap up to 2030 to reduce their carbon footprint, by 50%, by 2025, for Scope 1 and 2, and then by 20% for scope three emissions. In 2017-18, Scania launched a plug-in hybrid vehicle and currently in Sweden, Norway and Denmark their battery electric vehicles are thriving.
Karima Haji, Director of Transformation at Scania UK hopes that “by 2030-2035, Scania should be able to offer a product that you can transition for all of your use cases across the transportation industry. We’re driving our agenda around new products, battery electric vehicles.”
Obviously, HGVs are very expensive assets and battery electric vehicles are more costly than diesel or petrol-powered vehicles, so Scania are looking at new business models, such as pay per use, to engage customers and allow them to transition towards battery electric vehicles and to reduce their carbon emissions through different business models. Haji points out that Scania want to work with their customers to make sure that the proposition is financially palatable.
In addition to introducing new sustainable products and new business models to their clients, Scania is also keen to be part of the circular economy by working across the full value chain, looking at all the components sourced, how long those components will last, and what the lifecycle of those components will be.
Haji points to the work at Scania to initially manufacture products using green steel which helps in a circular economy when it comes to regulation and reporting:
Case study: DLL
The reporting process is different for a bank-owned leasing company such as DLL, who have distinguished the various portions of their portfolio due to their portfolio being made up of various different types of assets for which there is “no single one-size-fits-all roadmap”.
DLL have therefore disaggregated their portfolio and are now working on what Michiel Kranenborg, Manager Group Finance & Reporting at DLL calls “a theory of change”, looking at every part of the portfolio where they can engage with vendors and end users to see what is possible for the end user and come up with a journey for that part of the portfolio, moving it from the current high intensity emission asset to the lower or zero emission type of asset.
DLL as a leasing company will work with the vendor to see how they can come up with a package for the end user that is attractive rather than pushing something that they cannot use.
In addition to proposing increasingly sustainable packages for the end user, DLL is equally happy to promote a circular economy, helping the planet through the transition and reusing assets or asset components to create a second and third life for assets. DLL will buy secondhand assets, refurbish them and lease them out, because they believe that the value chain has not ended yet.
However, sometimes in its second or third life, the equipment may have higher carbon emissions because it is slightly less efficient than it was. However, it stops the original manufacturing process and, on a net basis, even though the emissions of the used asset are higher, they are still less than the original manufacturing costs of new equipment. This refurbishment concept can therefore cause problems when it comes to Scope 3 reporting.
While Scope 3 reporting provides the opportunity for companies in key industries to multiply their carbon reduction impact by decarbonising their supply chains, there are several challenges when measuring and reporting Scope 3 emissions:
Data. When reporting Scope 3 emissions, there can be problems with the consistency of data, the risk of double-counting, and availability of accurate data. This is the case for bank-owned leasing companies who are not as close to the asset and data as an OEM, for example. There is also the issue of who owns the data from the asset.
At Scania the data is owned by the customer, not the OEM. Scania may generate the data from their sensors, particularly in the Scania trucks, but they offer customers service packages, such as a data monitoring package or a reporting package, which allows the customer to monitor fuel usage, driver efficiency and the CO2 emissions from the amount of diesel.
Methodology. There can be methodological challenges involved in capturing scope 3 emissions. These include estimating emissions for suppliers that do not calculate their own emissions, defining an appropriate calculation approach for each Scope 3 category whilst recognising that double counting may occur when emissions are aggregated across multiple organisations.
Refurbishment issues. Michiel Kranenborg, Manager Group Finance & Reporting at DLL highlights a further inconsistency with Scope 3 Reporting: “DLL do a lot of asset refurbishments as part of our sustainability drive…. but in the calculation of financed emissions, probably refurbished slightly older assets will score less than a brand-new asset. So, in the financed emissions calculations and disclosure, there is an incentive to not refurbish because that will increase your emissions.”
The European Commission’s Corporate Sustainability Reporting Directive (CSRD) which envisages the adoption of EU sustainability reporting standards, sees refurbishment or the circular use of assets as one of its cornerstones. However, this is in contrast to Scope 3 reporting as Kranenborg highlights in the video below.
Risk of reporting. There is a risk that emissions reporting and reporting requirements will become so onerous that it will stifle innovation. As Kim notes, “companies could be very environmentally sensitive, and have good internal policies that follow a good ESG strategy. But if they can’t send the necessary reporting to their shareholders, to their regulators, it defeats the purpose of being that environmentally friendly company.”
Looking to the future
Scope 3 emissions can no longer be ignored. While it can be easy to forget the impact that extends beyond direct activities, “out of sight, out of mind” can no longer be an excuse. With such a high percentage of carbon emitted from assets along the value chain, and with so many potential benefits from reducing this carbon, it is fast becoming imperative for businesses to measure and reduce Scope 3 emissions.
Companies who are currently working to reduce their Scope 3 emissions have the opportunity to differentiate themselves from their peers and competitors. Effective Scope 3 reporting positions these companies as innovative, conscientious and forward-looking organisations who are working to reduce the environmental impact along the value chain.
DLL’s Kranenborg agrees that the world is changing and customers will see the reporting rules differently; this can already be seen when engaging with customers and seeing that vendors are changing: “it might hurt to make that transition but not making them essential in the end will hurt a lot more, because the world is changing.”