By: R Mukund, Founder & CEO of Benchmark Digital Partners LLC
Despite fair warning, business leaders have found plenty of reason to object to the U.S. Securities and Exchange Commission’s (SEC) recent proposal to require public companies make standardized climate risk disclosures. Chief among these is the rule mandating that companies disclose information regarding their value chain emissions if those emissions are either material (i.e., financially relevant) or have been included in the companies’ public climate commitments.
For the vast majority of companies that have yet to disclose their upstream (and downstream) emissions, these provisions present a conundrum. Scope 3 emissions, as these indirect emissions are known, not only comprise the majority of many companies’ total emissions but, thanks in part to relatively underdeveloped accounting methodologies, are indeed difficult to quantify. And that’s to say nothing of either the challenge of managing companies’ value chain emissions inventories or, eventually, having them audited.
Considering this, a company may be forgiven for keeping mum about its Scope 3 climate issues management. The SEC’s rules, after all, stipulate that companies only need disclose such information if it is material or if Scope 3 is included in the companies’ public climate commitments.
But the omission of Scope 3, while an attractive route to some, could be short-sighted. Regardless of their relative size or severity, Scope 3 climate issues affect both financial performance and stakeholder outcomes. More to the point, considering their typically outsized contributions to companies’ aggregate climate issues, effectively managing Scope 3 stands to deliver similarly outsized cost savings, regulatory risk mitigation and reputational advantages.
Eliminating this opportunity cost will require companies to overcome the greatest barrier to managing their Scope 3 climate issues: the lack of ownership or unilateral control over them. To do this, without compromising their companies’ financial performance, business leaders will need to take a systematic approach to value chain sustainability management, engage strategically with their stakeholders and, finally, commit to strengthening their Scope 3 climate issues management with continuous, granular, investment-grade data.
On the systematic approach, it’s worth first noting that no two businesses and, in turn, no two Scope 3 climate issues inventories are the same. In practice, this means companies will need to largely eschew the peer-to-peer comparisons that are commonplace in Scopes 1 and 2 emissions measurement and management. Instead, businesses will need to perform their own value chain emissions and climate risk accounting and use the financial relevance of any identified upstream and downstream sustainability vulnerabilities to help them prioritize.
For upstream climate issues management, business leaders should first employ widely accepted estimation techniques, such as the GHG Protocol methodologies enshrined in the SEC’s proposed rules, to evaluate the emissions inventory and, by extension, the climate risk profile of their supplier networks. Once complete, business leaders will need to perform a key supplier spend analysis, including degree of buying power, to shortlist the climate delinquents identified in their Scope 3 emissions inventory.
Suppliers that double as major sources of climate risks and impacts as well as major financial commitments will, clearly, be the company’s priority, especially if the buying power analysis suggests these suppliers will be more receptive to the company’s engagements. This comprehensive materiality assessment, though, is only the first step in upstream climate issues management.
Strategic engagement is the only way business leaders will be able to measurably align their suppliers’ Scopes 1 and 2 climate risks and impacts management with their own companies’ Scope 3 performance targets. And this will only be achieved through engagement that’s undergirded by mutual commitment to transparency and informed by reliable, contemporaneous data.
In practice, this will require business leaders to set and communicate their expectations. Executives need to define the Scope 3 emissions abatement and climate risk mitigation targets around which suppliers will be expected to orient themselves. And they will need to clearly establish the methods through which they aim to effectuate changes in their suppliers’ Scopes 1 and 2 climate issues management.
But, regardless of whether a company employs contractual supplier codes of conduct, relies on third-party standards or simply promotes action by the supplier, the chosen “reduction lever” needs a fulcrum.
This fulcrum is investment-grade ESG data – accurate, contemporary, complete, financially relevant and verifiable climate-related performance data from suppliers and, in turn, their buyers. The former will be used by companies to determine whether their suppliers’ Scopes 1 and 2 climate issues management are supporting their own Scope 3 performance targets. And the latter will be used by companies to communicate to suppliers whether they’re at risk of running afoul of the procurer’s predetermined expectations.
Ensuring this fulcrum leverages any impact, though, is a separate matter. Companies will need to collect, analyze and store the data from their various suppliers, and they will need to use that data to inform future supplier engagements, shape their own sustainability and corporate strategies and, of course, execute satisfactory climate-risk disclosures to the likes of the SEC.
Even still, a majority of companies facing compliance with the SEC’s proposed rules are performing these tasks through manual, spreadsheet-driven processes. And a growing body of evidence suggests that this apparently ubiquitous approach is failing to meet companies’ ESG performance measurement, management and reporting needs.
To combat this, and ensure that their supplier engagement efforts pay off, business leaders will need to adopt cloud-based ESG performance data management and reporting systems.
These enterprise software solutions minimize the person-hours needed to collect and make use of suppliers’ climate issues management data. And they equip their end-users with the forward-looking insights needed to anticipate any misalignment of suppliers’ sustainability performance with their Scope 3 climate risk and impact management targets. Additionally, these systems are capable of automatically translating ESG KPI inputs into financial outputs. And, with their data storage and retrieval functions, enable their users to prepare auditable disclosures of ESG and financial performance across the full value chain-wide.
The challenges of Scope 3 emissions and climate risk measurement and management are, and have been for some time, well-documented. As a result, there’s no shortage of third-party guidance and dedicated software solutions at companies’ disposal; resources that enable companies to turn what would otherwise be just another compliance obligation into a unique opportunity.
About the author:
R Mukund is Founder & CEO of Benchmark Digital Partners LLC (renamed from Gensuite LLC on 1-Jan-2021) and a proven organizational leader with nearly 30 years of experience in progressive roles as a technical professional, team leader, Six Sigma Master Black Belt, executive program manager, and most recently, chief executive officer since 2010. He has a track record of distinction in diverse organizations from research & technology, consulting, corporate diversified & global, and cloud-based, tech-enabled services.