IIGCC guidance: why materiality matters for Scope 3 emissions
IIGCC guidance recommends materiality assessments and a priority list to guide engagement efforts on indirect emissions
Ahead of Shell’s annual general meeting in May this year, investors rallied behind a shareholder resolution that took aim at the company’s Scope 3 emissions. 27 institutional investors filed the resolution which ultimately received just 18.6% of the vote. Scope 3 emissions - attributable to a company’s value chain - have long been a subject of division and deliberation.
At its core, the challenge for investors is one of data availability and reliability. Estimating a company’s Scope 3 footprint is prone to both complexity and error. A range of techniques, standards and tools have emerged in recent years, each with its own strengths and caveats.
This fragmentation of methodology has fueled a fierce debate between companies who grapple with reporting Scope 3 emissions and the stewards of capital who demand they do.
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New guidance issued by the Institutional Investors Group on Climate Change (IIGCC) highlights the state of play and recommends a way forward, rooted in the notion of materiality.
Prioritise addressing Scope 3 at asset level and be cautious in aggregating it at portfolio level
Scope 3 and climate risk
That Scope 3 emissions are an empirical challenge is hardly disputed. Yet, it is their scale and significance that seems to warrant attention. For oil and gas behemoths such as Shell, Scope 3 emissions are their largest source of emissions.
In 2023, emissions from Shell’s use of sold products stood at 878 million tonnes of CO2- equivalent. For reference, Scope 1 and 2 emissions combined were 57 million tonnes.
In addition to scale, the IIGCC guidance suggests that a company’s value chain emissions are indicators of potential transition risk and have a reputational, regulatory and financial relevance.
“Ultimately, given the magnitude of Scope 3 and its value as an indicator of transition risk, investors risk omitting the key sources of greenhouse gas emissions that they are exposed to through asset value chains from their analysis of portfolio emissions”, the guidance says.
Some investors have linked Scope 3 emissions with potential physical risks. Responding the UK government’s call for evidence on Scope 3 disclosures in 2023, Border to Coast Pension Partnership’s former head of responsible investment Jane Firth wrote:
“As well as being able to assess the transition risk of investee companies and alignment with progress towards Net Zero targets, we think it is additionally important to recognise their value in the near-term to assess physical risks as a result of increasing frequency of extreme weather events”.
Asset-level materiality
The way forward, according to IIGCC’s guide, is to consider material Scope 3 emissions. “Focusing on material sectors and relevant categories is likely to reduce data issues and help to make Scope 3 information decision-useful”, advises the IIGCC.
One way for investors to do so, the coalition says, is to conduct an analysis aimed at identifying investments most likely to have high Scope 3 emissions materiality.
The level at which this analysis is conducted is a critical consideration. Some asset owners have analysed their Scope 3 footprints at the portfolio level.
Take for instance, Canada’s Healthcare of Ontario Pension Plan which estimated that for each one million dollars invested, 36 tonnes of CO2- equivalent Scope 1 and 2 emissions were produced. The fund says it has initiated a similar Scope 3 carbon footprint analysis for a portion of its portfolio.
The IIGCC guidance suggests that materiality assessments should be conducted at the asset level as opposed to the portfolio level.
“Prioritise addressing Scope 3 at asset level and be cautious in aggregating it at portfolio level”, the coalition advises its members.
“While calculating and tracking this exposure at the portfolio level can be useful for some specific purposes, such as inputting to engagement resource prioritisation, it cannot be used to meaningfully benchmark performance as it does not reflect the physical reality”, the guidance says.
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Priority list
Materiality, however, varies across sectors and sub-category of emissions. So does the robustness of any future methodologies. This, combined with the fact that engagement is a resource-intensive endeavour suggests that investors must narrow their efforts.
To further narrow the focus of Scope 3 engagement, the guidance recommends that investors prioritise Scope 3 engagement in some sectors over others.
If there is a priority list for Scope 3 materiality, which the IIGCC suggests there is, energy is at the top of it. Coal mining, electric utilities and the oil and gas sector rank high on the recommended priority list. Other entrants on the Scope 3 priority list include the automobile and chemicals sector.
If the IIGCC’s advice finds an audience amongst its membership, future engagement over Scope 3 emissions could be focused in these priority sectors and driven by materiality assessments at the asset-level. All else equal, investors seem unlikely to forego a discussion about value chain emissions solely based on methodological constraints.
