Carbon Reporting and Science-based Targets: Precursors to Effective Corporate Climate Action?
by Danielle Yeow and Brian Chang
The Intergovernmental Panel on Climate Change (IPCC) has reported that, to meet the Paris Agreement’s ambition of limiting global warming to 1.5°C, the world, including businesses, has to collectively act to reduce absolute carbon emissions by 45% by 2030 (from 2010 levels), and reach net-zero by 2050. Businesses can take commensurate action by committing to and implementing science-based targets, which are aligned with the goals of the Paris Agreement. This is underpinned by the need to quantify and disclose the carbon emissions associated with each business, including indirect emissions within their value chain (Scope 3 emissions).
This blog post will discuss developments relating to the corporate reporting of Scope 3 emissions and implementation of science-based targets, compare and connect them with developments relating to human rights due diligence, and conclude with some observations and questions. This is the first post in a two-part series; the second post will examine the issues discussed below with specific reference to the fashion industry and its associated supply chain.
Carbon Reporting, Science-Based Targets and Their Limits: Scope 3 Emissions
While an increasing number of companies around the world are reporting on carbon emissions from their own operations (Scope 1) and from their energy providers (Scope 2), few companies report on indirect carbon emissions throughout their value chain (Scope 3), and specifically on carbon emissions produced by their suppliers of goods and services. Quantifying and understanding carbon emissions from suppliers is critical for companies to develop strategies for reducing their Scope 3 emissions, which for many businesses account for more than 70 percent of their carbon footprints.1 However, most carbon reporting requirements imposed by stock exchanges and regulators to date only relate to Scope 1 and Scope 2 emissions but not Scope 3 emissions. They also do not require companies to commit to or implement ambitious science-based targets that would reduce global emissions by 45% by 2030 and reach net-zero by 2050.
Standards2 such those of the Greenhouse Gas (GHG) Protocol, Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), Taskforce on Climate-related Financial Disclosures (TCFD), Climate Disclosure Standards Board (CDSB) and CDP (formerly the Carbon Disclosure Project) all generally provide guidance on how companies may calculate Scope 3 emissions, but do not require companies to do so. As a result, most of the sustainability and climate reports and corporate pledges to date have focused on reducing Scope 1 and Scope 2 emissions, rather than Scope 3 emissions within global value chains.
The Science-Based Targets initiative (SBTi)3 is the exceptional standard that requires disclosure and target-setting for Scope 3 emissions, by companies whose Scope 3 emissions cover more than 40% of their combined Scope 1, 2 and 3 emissions (i.e. most large companies). The Scope 3 emissions target has to cover at least two-thirds (67%) of total Scope 3 emissions within the company’s value chain. However, the level of ambition of Scope 3 emissions targets may be aligned with a “well-below 2°C scenario” rather than the “1.5°C scenario”, which is required for Scopes 1 and 2. Companies are also given the option to set targets to either reduce their absolute emissions, or to decrease their carbon intensity (or both). Intensity targets have been criticised because they allow companies to grow their absolute emissions if their production increases (even if they meet their intensity targets). The SBTi restricts companies from using carbon credits or offsets towards meeting their near-term science-based targets, effectively requiring companies to take stronger actions to reduce their emissions. The SBTi has produced an increasing number of sector-specific guidance for different industries to provide more detailed target-setting guidance, including guidance for the Apparel and Footwear Sector. SBTi has also published a more ambitious net-zero standard in October 2021, although adoption remains nascent.
Regional Developments
The Singapore Exchange (SGX) has required ESG reporting since 2016, and upgraded this requirement in 2021 to introduce a mandatory requirement for climate-related disclosures, which must be based on the TCFD recommendations. This made SGX the first exchange in Asia to make such disclosures mandatory (for certain industries). Because the TCFD has historically focused on providing information on climate-related risks and opportunities to investors, lenders and insurers, the TCFD recommendations do not require reporting on Scope 3 emissions (though TCFD now encourages this). Both the SGX rules and the TCFD recommendations require companies to set out climate-related targets and measure performance based on these targets, but there is no requirement on the level of ambition of these targets. Having said that, the TCFD’s 2021 implementation guidance does recommend that companies set targets that are “in line with anticipated regulatory requirements or market constraints or other goals”, which in Singapore may well be read with reference to Singapore’s Nationally Determined Contribution, Singapore’s Long-Term Low Emissions Development Strategy and the Singapore Green Plan 2030. It also remains open for companies to voluntarily adopt more ambitious science-based targets.
Turning to what has historically been the largest global source of suppliers, China has also embraced ESG reporting, with a focus on listed companies and major polluters. The Hong Kong stock exchange has required listed companies to issue ESG reports since 2016, and upgraded these disclosures in 2020 (to include TCFD-aligned disclosures by 2025 for certain sectors), while the China Securities Regulatory Commission has required all listed companies and bond issuers to disclose ESG related risks since 2018. Major polluters or firms that have violated environmental laws are now subject to mandatory requirements to disclose carbon emissions, under the 2021 rules on disclosure implementing the “Plan for the Reform of the Legal Disclosure System of Environmental Information” issued by China’s Ministry of Ecology and Environment. In addition, China requires mandatory carbon emissions disclosures from companies subject to China’s emissions trading system (which presently includes power generation and heating companies), and plans to expand this obligation to cover more companies. Similar to the position in Europe, smaller companies in China are generally not yet subject to mandatory requirements to disclose information relating to ESG or carbon emissions. While China has yet to embrace mandatory requirements to report on Scope 3 emissions, the disclosure of Scope 1 and Scope 2 emissions by major Chinese companies, together with voluntary Scope 3 emissions disclosures by these companies, in conjunction with ambitious science-based targets, could facilitate impactful and effective climate action.
Developments in the Global North
Starting with California’s 2010 Transparency in Supply Chains Act, many countries in the Global North have legislated to require companies to conduct due diligence and disclose their efforts to eradicate human trafficking and modern slavery in their supply chain, such as the UK and Australian enactments of Modern Slavery Acts. More recently, mandatory human rights due diligence and reporting requirements have been enacted in France (2017) Germany (2021), Norway (2021) and Switzerland (2022). These domestic laws have crystallised soft law norms such as the UN Guiding Principles on Business and Human Rights, the OECD Guidelines for Multinational Enterprises and the OECD Due Diligence Guidance for Responsible Business Conduct. A similar trend appears to be building on the issue of reporting and action on Scope 3 emissions, with legislative initiatives emerging from California, the EU and New York.4
Building on California’s early-mover status on human rights due diligence, auto emissions standards, and cap-and-trade, California’s Senate recently passed the Climate Corporate Accountability Act, which will require all large U.S. companies that do business in California, to disclose their Scope 1, Scope 2 and Scope 3 emissions, and to obtain independent third-party audits of these disclosures.5 However, the proposed legislation does not require companies to set or implement emissions reduction targets. The scope of this proposed legislation potentially covers virtually all large U.S. companies – as most U.S. companies do business in California – and to indirectly cover the foreign suppliers of these companies. The proposed legislation is sensitive to the fact that foreign suppliers may not have the capacity to calculate their exact carbon footprint, allowing for modelling and estimates in such situations. The draft also excludes foreign (non-U.S.) companies doing business in California from the reporting requirement, with the stated purpose of placing the bill on a firmer footing under the U.S. Constitution.6 Nevertheless, the fact that foreign suppliers may be asked by covered companies to quantify their carbon footprint demonstrates the potential extra-territorial implication of such legislative proposals.
The EU’s proposed Corporate Sustainability Reporting Directive (CSR Directive)7 looks set to introduce a requirement for all large companies operating in the EU to make annual public reports (which will be subject to assurance or auditing) based on a mandatory set of European Sustainability Reporting Standards (ESRS). The ESRS will be prepared by the European Financial Reporting Advisory Group (EFRAG), a body of European stakeholders comprising of national accounting standard-setters, industry groups and civil society groups. EFRAG has published the draft ESRS for consultation which include mandatory disclosure of Scope 3 emissions, and transition plans, policies and measurable targets for climate change mitigation. The draft ESRS also include broad-ranging environmental, social and governance (ESG) reporting requirements, representing a next step towards an EU-wide corporate due diligence reporting framework that covers climate, environment and human rights concerns. In contrast with the TCFD framework, the proposed CSR Directive embraces the concept of “double materiality”. This means that companies are required to report on sustainability from the perspective of what is financially material to the companies’ business value, as well as from the perspective of the companies’ material impact on people and the environment. Notably, the proposed CSR Directive will cover all large companies that do business in the EU, including the EU subsidiaries of non-EU companies that have a turnover of more than €150 million in the EU, as well as all companies listed on regulated markets in the EU. The proposed Directive will also indirectly affect foreign suppliers to covered companies, as it will likely result in covered companies asking foreign suppliers for information on their carbon emissions and other ESG concerns contained within the ESRS.
The EU has also proposed a Corporate Sustainability Due Diligence Directive (in February 2022, which is at a much earlier stage of legislative progress) that would go further than the proposed CSR Directive, and impose a duty on certain companies active in the EU to conduct due diligence over their entire supply chains to address environmental and human rights issues. Notably, the set of companies included within the scope of the CSDD Directive is not limited to EU companies, but extends to non-EU companies that have significant EU turnover. Larger companies will also be required to have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5 °C in line with the Paris Agreement. In addition, the proposed legislation would require emissions reduction objectives8 for all companies for which climate change is identified as a principal risk for, or a principal impact on, the company’s operations. Companies would also be required to take these obligations into account when setting remuneration policy.9
Integrating climate change, environmental and human rights reporting?
The current trend of ESG reporting standards and requirements, particularly in the Global North, appears to be blurring the distinction between human rights due diligence (HRDD) and climate and environmental sustainability reporting, as exemplified by the EU’s CSR Directive which will require reporting on human rights, climate and the environment, the German Due Diligence in the Supply Chain Act which requires HRDD as well as reporting on environmental risks that can lead to human rights violations, such as pollution, excessive water consumption and unlawful eviction, and the Global Reporting Initiative’s integration of the UN Guiding Principles on Business and Human Rights (UNGPs) into its 2021 Universal Standards. This is also reflected in ongoing advocacy by some quarters to evolve the UNGPs into a legally binding treaty form. For example, the proposed Article 6.4 of the Third Revised Draft treaty requires regular human rights, environmental and climate change impact assessments to form part of companies’ human rights due diligence measures.
Although there are standalone climate reporting standards such as the Greenhouse Gas Protocol, TCFD, and CDP, these are integrated with wider environmental and human and labour rights reporting requirements by ESG reporting standards such as the GRI, SASB Standards, Integrated Reporting Framework and the International Sustainability Standards Board (ISSB)’s forthcoming global baseline of sustainability disclosure standards, and by forthcoming legislation such as the EU’s CSR Directive. The common thread between action to combat climate change, protect the environment and human and labour rights is the stated objective of sustainable development, as referenced in the UN’s Sustainable Development Goals and the preamble of the Paris Agreement.
Conclusion
To conclude with some observations and questions: While the trend of proposed legislation and regulations requiring the implementation of science-based targets and reporting of Scope 3 emissions and other ESG information from suppliers has laudable goals, it raises questions about who is setting the rules and how and to what extent they take into account the concerns of diverse suppliers and suppliers’ countries. The issue of representation of suppliers is critical to legitimacy, effectiveness and questions of fairness and equity. This is particularly in relation to sharing the burden of climate action consistent with the principles of common but differentiated responsibilities and respective capabilities, in light of different national circumstances, and in conjunction with the provision of needed climate financing and support.
The international community is currently working together to develop high-quality global ESG reporting standards through the newly created International Sustainability Standards Board (ISSB), but jurisdiction-specific legislative proposals such as the EU CSR Directive, the California Climate Corporate Accountability Bill and the New York Fashion Bill risk creating varying, potentially more onerous standards with extra-territorial implications. While ESG reporting standards and requirements don’t appear to affect the market access of suppliers de jure, could they result in de facto restriction of market access that is inconsistent with international trade law?
These developments also point towards a fragmentation of governance, with corporates and sub-national authorities playing increasingly important roles in norm-making (e.g. through the ISSB and EFRAG, the New York Fashion Bill, and the California Climate Corporate Accountability Bill). The multiplicity of reporting approaches and growing regulatory divergence – with some being specific to certain sectors, while others being general and sector-neutral; some focusing on risk-based assessments, while others focusing on compliance – also raises questions of viability and compliance burden for supply chains, especially in relation to suppliers that serve multiple sectors.
Finally, perhaps the most important empirical question of all is: Will ESG, carbon reporting, and science-based targets prove to be an effective way for non-state actors to push suppliers to take action beyond what may be required under the respective applicable national carbon reduction targets, and thereby achieve the ambitions of the Paris Agreement of limiting global warming to well below 2°C, and perhaps even below 1.5°C?
1 The proportion of carbon emissions varies by industry and individual businesses; CDP’s Global Supply Chain Report 2020, based on reports by 8,033 suppliers, found that “supply chain emissions are on average 11.4 times higher than operational emissions.” Put differently, CDP found that, on average, 92% of emissions are attributable to the supply chain (Scope 3) while 8% are attributable to operations.
2 The ESG (environmental, social and governance) and climate reporting standards described in this blog post are developed by varied and diverse sources, that are generally based on multi-stakeholder partnerships between accounting standard-setting bodies/experts, civil society and industry. CDP is a non-profit organisation that develops disclosure questionnaires in consultation with other stakeholders. The SASB Standards, Integrated Reporting Framework and CDSB Framework have been consolidated into a new International Sustainability Standards Board (ISSB) as part of an effort to reduce the number of global standards. We do not include the ISSB’s proposed standard on climate-related disclosures within the standards described in this paragraph, as the ISSB’s proposed standards are still under consultation and have yet to be finalised.
3 https://sciencebasedtargets.org/
4 The New York Fashion Bill will be discussed in the second blog post in this series.
5 Note that this proposed legislation still needs to be passed by the lower house and signed into law by the Governor (by 30 September 2022 for the 2022 legislative session). It also remains to be seen whether the proposed legislation will survive a constitutional challenge before the U.S. Supreme Court under the Dormant Commerce Clause theory that states may not usurp the federal Congress’ power to regulate interstate commerce, or a First Amendment challenge that the proposed legislation would require “compelled speech” from companies.
6 The U.S. Securities and Exchange Commission has also proposed rules that would require U.S. and foreign companies that are publicly listed on U.S. stock exchanges to make climate-related disclosures, including disclosures on Scope 3 emissions, but this rule is opposed by large industry groups such as the US Chamber of Commerce as well as Republicans, and will likely be subject to legal challenges. Cf. The U.S. Supreme Court’s decision in West Virginia v. Environmental Protection Agency (EPA) finding that the US EPA may not make a rule on a “major question” of “vast economic and political significance” without “clear congressional authorization”.
7 The CSR Directive is likely to pass this year.
8 The proposed legislation does not specify a level of ambition for the emissions reduction objectives.
9 The UN Special Rapporteur on Human Rights and the Environment David Boyd has noted that non-compliance with the climate obligations specified within the draft CSDD Directive may not result in any penalty because they are not included within the core due diligence duties that may result in civil liability.