Connect with us

Hi, what are you looking for?

Investing

Scope Creep: Mandating Disclosure of Scope 3 Emissions is Costly (and Creepy)

Travis Fisher and Jennifer J. Schulp

Proposals to mandate transparency and accountability in corporate environmental practices are becoming law. So far, the most aggressive actions have come from the European Union (EU) and the state of California—both have ordered large companies (public and private) to begin disclosing all greenhouse gas (GHG) emissions. The EU’s program is already in effect, with reports due in 2025. The California law requires companies to report Scope 1 and 2 emissions in 2026 and Scope 3 emissions in 2027.

The US federal government is poised to take similar steps.

The Securities and Exchange Commission (SEC) proposed a rule on the “Enhancement and Standardization of Climate‐​Related Disclosures for Investors” in March 2022, requiring disclosure of Scope 1 and 2 emissions by all public companies and Scope 3 emissions by many of those companies. (The final rule remains pending.) A related measure under federal acquisition regulations would require comprehensive GHG reporting for major federal contractors.

Disclosure of Scope 3 emissions encompasses all indirect emissions in a company’s value chain. “All” is the operative word. Emissions come in three categories—Scope 1, 2, and 3. Mandating a comprehensive accounting scheme for Scope 3 emissions (the catch‐​all category for all emissions a company doesn’t directly control) would balloon compliance costs, pry into Americans’ privacy, and grant expansive authority to the federal government.

What Are Scope 1, 2, and 3 GHG Emissions?

Scope 1 emissions come from anything directly owned or controlled by the company in question. For example, the GHG emissions from a boiler at a factory would be included in the factory owner’s Scope 1 emissions. Scope 1 emissions tend to be easy to count.

The Environmental Protection Agency (EPA) describes Scope 2 emissions as the “indirect GHG emissions associated with the purchase of electricity, steam, heat, or cooling.” Like Scope 1, Scope 2 emissions are not difficult to estimate. If a company knows its overall electricity consumption and the average GHG intensity of the electricity on the grid, it can estimate Scope 2 emissions. (Note: marginal or time‐​of‐​day GHG intensity can add a wrinkle for some companies.)

Scope 3 is everything else. EPA guidance says Scope 3 emissions “are the result of activities from assets not owned or controlled by the reporting organization, but that the organization indirectly affects in its value chain.” These emissions can be upstream and downstream. Scope 3 emissions for an automobile manufacturer, for example, would include the GHG emissions associated with all raw materials purchased to manufacture a vehicle (upstream) as well as all emissions associated with the use of the vehicle over its lifetime (downstream).

According to the new reporting law in California, titled the “Climate Corporate Data Accountability Act,” Scope 3 emissions “may include, but are not limited to, purchased goods and services, business travel, employee commutes, and processing and use of sold products.” EPA states that Scope 3 emissions “often represent the majority of an organization’s total” emissions. Hence, while Scope 3 emissions are probably large, they are very difficult to quantify (and, especially in the case of future downstream emissions, impossible to know with certainty).

The Cost of Mandatory Scope 3 Disclosure Would Make a Bureaucrat Blush

Counting and reporting all Scope 3 emissions would be an onerous and costly process. As Jennifer wrote regarding the SEC’s proposal last year:

The SEC estimates that its new rules would raise the annual cost of compliance from $3.8 billion to $10.2 billion. And the SEC’s estimates of $420,000 to $530,000 in annual expenses, including the services of climate modelers and emissions accountants, places a substantial burden on companies, particularly smaller ones.

And that’s likely an underestimation, with some estimating the SEC’s proposal to quadruple the cost of a company’s primary securities filings.

The EU- and California‐​type Scope 3 mandates apply directly to large companies, but there are countless small companies upstream and downstream of reporting companies that would be indirectly impacted. Specifically, mandating Scope 3 reporting would, of course, increase compliance costs at large companies, but it would also raise accounting and reporting costs for all the mom‐​and‐​pop businesses in the company’s “value chain.” The type of impact is the same regardless of whether the regulation’s target is a publicly traded company or a company of a certain size.

By their very nature, Scope 3 emissions disclosures are incredibly burdensome. Wearing a utilitarian hat for a moment, the marginal benefit of a regulation should exceed its marginal cost. And each regulator has responsibility for a different type of benefit—securities regulators are focused on investors’ needs, whereas environmental regulators have a different mandate. At some level of GHG emissions disclosure, though, the cost of obtaining an additional unit of transparency surely exceeds the benefit.

In the securities context, are climate‐​risk disclosures really worth making securities disclosures four times more costly? On the environmental side, how much more useful is additional GHG disclosure when the EPA estimates that 85–90% of GHG emissions are already covered by existing reporting? In other words, even if the juice is worth the squeeze when it comes to Scope 1 and 2 emissions for many companies, Scope 3 could be a different type of fruit altogether.

However, any discussion of Scope 3 mandates should go beyond the most visible costs and include the “unseen” costs of heavy‐​handed disclosure rules. Economists call these opportunity costs, and they are just as important as the costs that are easy to see. First, obsessing over GHGs would create a distracted federal government and a less effective private sector. Under a mandatory Scope 3 emissions regime, it is very likely that too many resources would go to the GHG accounting effort while too few would go to things people care about more than GHGs.

Second, even within a typical “ESG” framework, GHGs are not the only environmental issue investors and consumers may care about. Other concerns in a company’s value chain, such as toxic pollutants, water usage, and effects on biodiversity, are also important. In fact, polling data on consumers’ willingness to pay to address climate change tends to reveal modest amounts. The Associated Press reported, “To combat climate change, 57 percent of Americans are willing to pay a $1 monthly fee; 23 percent are willing to pay a monthly fee of $40.” These low figures could help explain why voluntary reporting schemes are not satisfactory to regulators—left to their own devices, people aren’t willing to spend much to address climate change.

Privacy and Other Rights Issues Abound

The government, at its best, is a force for preserving individual liberty and economic freedom. Voluntary initiatives, consumer choices, and market forces can drive positive change without the need for government mandates that may infringe upon personal and economic freedoms.

The collection of data related to a company’s supply chain and business relationships may necessitate the sharing of sensitive and proprietary information. Not only may some of that be required to be turned over to the government as a part of the reporting process, or for the government to audit the company’s reports, but the company itself may have to undertake intrusive inquiries to make the report in the first place. This is where Scope 3 accounting gets creepy.

For example:

To calculate the emissions from their employees’ commutes, companies may need to collect personal information from employees about the methods by which they commute, how often, and maybe even the time of day.
To calculate emissions produced from their supply chain, companies will be required to gather information from their suppliers about their emissions. Calculating or verifying those figures may require suppliers to provide confidential or proprietary information about their business practices.
To calculate emissions from the usage of a company’s products, companies will have to collect data on what their customers do with the product, including how they dispose of it. Some of this data collection may be intrusive (and the need to collect more comprehensive data than data collected for market research may increase the intrusion).

All of this is at odds with the rights of individuals and businesses to protect their privacy and trade secrets without unwarranted government interference. But privacy isn’t the only right in play.

Where the government compels a company to make disclosures, the First Amendment extends to protect from “not only expressions of value, opinion, or endorsement, but equally to statements of fact the speaker would rather avoid.” Disclosures about emissions are politically charged (and, at least in the case of the SEC, extend far beyond the type of investor‐​relevant information that the agency is empowered to require). By forcing companies to condemn themselves, mandated emissions disclosures promote one side in a policy debate and violate the First Amendment’s requirement of viewpoint neutrality.

Allow Scope 3 Disclosure to Proceed Voluntarily

Forcing companies to account for Scope 3 emissions would inflate compliance costs, invade people’s privacy, and expand the bounds of an overzealous government. And if the SEC requires the disclosure of GHG emissions, there’s little to stop it from mandating the disclosure of any other information.

Scope 3 emissions disclosures, in particular, place the burden and responsibility for emissions on those who are not clearly responsible. Holding a company to account for the use of its products seems to make little sense. Should a blue jean manufacturer really be held responsible for the carbon emissions based on its customers’ entirely voluntary decisions about how often to wash those jeans, at what temperature and time of day, etc.?

Rather than relying on government mandates, businesses should have the freedom to respond to market demand for sustainability and transparency, which can drive innovation and responsible practices. If there is a strong demand for accurate climate disclosures, nothing is stopping private companies or third parties from supplying them. Indeed, 96 percent of the companies in the S&P 500 provided some form of sustainability reporting in 2022.

Policymakers should let markets work. The American people—investors and consumers alike—should be free to drive the disclosure of all types of environmental information by the companies they invest in or support with their purchases. Government mandates distort this process and open the door to further intrusion into our lives by busybody officials.

Advertisement

    You May Also Like

    Investing

    RevisingTheBankSecrecyAct_NorbertMichelAndJenniferSchulp_CMFAWP007   The post Revising the Bank Secrecy Act to Protect Privacy and Deter Criminals (CMFA Working Paper No.007) appeared first on Alt-M.

    Investing

    Recently, an investment advisor and Bitcoin proponent tweeted the claim that “[f]or most of human history” the “[s]eparation of money and state was the...

    Business

    Rollee enables worker’s to share their professional data, spread over one or more financial platforms. Ali Hamriti, CEO and Co-Founder of Rollee, is on...

    Business

    The energy crisis means that as the price of wholesale commercial energy hits an unprecedented high, businesses must pay notably more for their energy...

    Disclaimer: successfuldealnow.com, its managers, its employees, and assigns (collectively “The Company”) do not make any guarantee or warranty about what is advertised above. Information provided by this website is for research purposes only and should not be considered as personalized financial advice. The Company is not affiliated with, nor does it receive compensation from, any specific security. The Company is not registered or licensed by any governing body in any jurisdiction to give investing advice or provide investment recommendation. Any investments recommended here should be taken into consideration only after consulting with your investment advisor and after reviewing the prospectus or financial statements of the company.

    Copyright © 2024 successfuldealnow.com | All Rights Reserved