The ‘E’ in ESG: How to tackle emission disclosures

Law student Indrakshi Chaku offers a comparative analysis of the UK and India’s disclosure regimes

In recent years the growth of the ESG sector has witnessed a profound change in the business landscape. The vision of many businesses has shifted from mere profit maximisation and towards sustainability. Countries have also started recognising the importance of ESG-related disclosures from businesses and as such have implemented guidelines in order to aid the same. However, such disclosures being voluntary requirements, still remain at the mercy of business as usual. Among the growing concerns about meeting the objectives of the Paris Agreement and tackling climate change, it becomes pertinent to look at the reporting of these emissions, especially the Scope 3 emissions which often go uncharted by businesses.

As per the Green House Gas Protocol of 2001, Green House Gas (GHG) emissions produced by corporations can be divided into three categories: Scope 1, Scope 2 and Scope 3.

• Scope 1 emissions: these are direct emissions produced by a company’s owned or controlled assets.
• Scope 2 emissions: these are indirect emissions produced by a company’s use of energy.
• Scope 3 emissions: these are all the indirect emissions found in the corporate value chain. It includes all the emissions produced by the suppliers and the customers of the business.

Accounting for 70% of a business’s emissions, Scope 3 emissions are hard to monitor. Since an organisation has little to no control over its suppliers and customers, calculating and reducing Scope 3 emissions can become an insurmountable task. Organisations therefore avoid reporting these emissions at all. On top of that, several legislative, judicial and corporate governance loopholes make it easier for corporations to avoid reporting these emissions. This article aims to explore such loopholes and provide solutions that businesses can implement to reduce their Scope 3 emissions.

Loopholes in the Scope 3 reporting requirements

1) Legislative loopholes:

In the UK,  disclosure requirements regarding emissions are governed by the Streamlined Energy and Carbon Reporting Policy in the UK. However, the regulations come with the following set of loopholes which can jeopardise the country’s net zero target by 2030.

• The policy is focused on the reporting of Scope 1 and 2 emissions, significantly omitting the relevant disclosures regarding Scope 3. Furthermore, the policy only extends to large, unquoted companies, meaning that quoted companies can escape the policy.
• Section 7 of the guidelines further eliminates the necessity of hiring specialists to calculate emissions within the value chain, thus diminishing the probability of accurate findings.

In the case of India, there is no uniform legislation governing the disclosure of Scope 3 emissions. However, the Securities and Exchange Board of India (SEBI) mandates Environmental, Social and Governance (ESG)-related disclosure for the top 1000 listed companies by market cap in relation to Business Responsibility and Sustainability requirements.

The SEBI issued a consultation paper in Feb 2023 containing guidelines for ESG disclosures. The paper provides for the supply chain disclosure for the top 250 companies by market cap, on a non-mandatory basis for the year 2024-25, and a mandatory basis for 2025-26. However, the regulations only apply to large multinational corporations (MNCs) while 90% of Scope 3 emissions are caused by micro, small and medium enterprises (MSMEs). Further, the disclosures are voluntary in nature and can thus be avoided by MNCs if not in their strategic interests.

2) Judicial loopholes

In the case of non-compliance with  ESG standards, a corporation or someone in its value chain can face lawsuits related to GHG emissions. However, the judicial position in cases of non-compliance with ESG standards remain unclear in both India and the UK. In  R (Finch on behalf of the Weald Action Group & Others) v. Surrey County Council (& others), the UK Supreme Court upheld The High Court’s decision which emphasised that the scope of Scope 3 emissions remains “a question of law” and is not automatically governed by the EIA directive. Since the decision emphasises that inclusion of Scope 3 emissions is not an inherent part of project planning, but rather a matter to be left up to the discretion of law, it minimizes voluntary consideration and disclosure of such emissions by big corporations.

In another case of R (Friends of the Earth Ltd) v SSIT and others, the High Court was divided on whether Scope 3 emissions were to be considered by the UK Export Finance (UKEF) department while investing in offshore projects or whether not reporting these emissions would be equivalent to going against Article 2(1)(c) of the Paris Agreement and thus an improper discharge of its duty.

The Indian Judiciary provided a new approach to these questions. In Sukhdev Vihar Welfare Residents Association v. Union of India, public health and public interest were prioritized over environmental concerns, and ‘reasonable care’ was set as a standard to get carbon credit. The National Green Tribunal Of India gave primacy to developmental projects over the environmental degradation that such projects may create. This precedent is particularly relevant in the context of Scope 3 emission disclosures by government bodies. In developing nations like India, States may find it hard to develop a binding framework regarding such disclosures due to the development being the prime focus. As such, the lack of prioritisation of environmental degradation in the Courts creates a significant loophole in incentivising Scope 3 emissions disclosure.

3) Corporate governance loopholes

Shareholder activism refers to a situation where shareholders can put pressure on a corporation to function in an environmentally friendly manner, through rights endowed on share ownership. Shareholder activism related to Scope 3 emissions disclosure has gained significant momentum in recent years in the UK. However, it has not been able to bring significant changes in the internal strategies of corporations. Total Energies, in its May 2023 resolution asked the majority of its shareholders to reject a resolution proposed by a small group of shareholders advising the company to cut down on its oil and gas emissions to align with the goals of the Paris Agreement.

A very similar pattern can be noticed in India. In April 2023, the shareholders of BP were encouraged by a few institutional investors to pass the resolution on cutting its carbon emissions to net zero by 2030 as per the Paris Agreement. The same was discouraged by the company.

What can businesses do?

1) Focus on small suppliers

Most small businesses act as suppliers for large corporations. Consequently, it becomes pertinent to monitor the activities of such businesses. The Scope 1 and Scope 2 emissions of such businesses are the Scope 3 emissions of large corporations. The challenge arises when they do not conform to the reporting standards. Such businesses lack the necessary incentives, resources, knowledge, and public scrutiny to report their Scope 3 emissions. It’s only through the intervention of large corporations, that the standards can be implemented. The corporations can intervene in the following ways:

• Mandating small suppliers to set their own long-term sustainability goals.
• Appointing specific staff to extend the corporation’s sustainability strategy to the suppliers.
• Incentivizing the suppliers such as by providing preference to those who align with the corporation’s long-term sustainability goals.
• Providing funding to such suppliers to conduct Scope 3 screenings.
• Taking steps to verify, monitor, and regulate the tier 2 and tier 3 suppliers that a corporation is engaged with.

2) Leveraging the potential of AI

Businesses can use AI algorithms to analyse the public data of their key suppliers and estimate whether suppliers are, for example, calculating Scope 3 emissions; setting climate targets; putting a climate transition plan in place; and adopting decarbonisation measures. Issues arise when suppliers are not transparent and such data is not made public, especially small suppliers who are not legally bound to disclose such information. The prediction of Scope 3 emissions in the case of these suppliers is limited to assessing their present sustainability practices. This in itself poses another issue of funding.

While MNCs can afford to invest resources in Scope 3 screening procedures, such suppliers lack resources. AI can contribute to solving these issues. Machine learning models designed to collect and analyse data regarding Scope 3 emissions can be designed in such a way that the data of existing MNCs who have invested resources into identifying their Scope 3 emissions be used to train AI systems to improve their predictive abilities.

3) Taking the merger route

A firm’s economic resources play a part in shaping its ESG policies. In the contemporary era, mergers and acquisitions (M&A) are the fastest routes to raise revenues. And thus, M&A can indirectly help in the faster implementation of ESG guidelines. Contrary to the popular notion that mergers can increase the GHG emissions of a corporation by increasing its critical mass, mergers can reduce the overall emissions of a company and promote the chances of voluntary disclosure.

This is very evident through the acquisition of XTO Energy and its subsidiaries by ExxonMobil leading to a significant improvement in the overall environmental score of the combined entity. Although the GHG emissions associated with the process of hydrocarbon extraction, production, and distribution are considered to be negative, the combined merger of the oil and gas-producing entities still led to a significant reduction in Scope 3 emissions. Another similar example can be noted in the case of the acquisition of Wyeth by its friendly rival Pfizer. Along with the improvement in its financial performance, the acquisition led to a significant rise in its ESG scores of Pfizer.

Conclusion

Scope 3 emission disclosure, previously uncharted territory for many businesses, is gaining momentum. From piquing the interest of investors to being at the centre of public concern, it plays a growing part in establishing a company’s reputation. Even though countries like India and the UK have enacted legislative frameworks to regulate GHG emission disclosures by companies, the explicit focus on Scope 3 emission disclosures is still missing. In its absence, compliance with ESG standards is entirely left to company discretion. While some companies choose to comply, others do not.

However, companies can take several routes when it comes to reporting Scope 3 emissions such as the regulation of small suppliers within their value chain, leveraging the potential of AI, and using strategic mergers to navigate the financial aspect of navigating implementation of ESG policies.

Indrakshi Chaku is a first-year law student keen to explore various facets of international commercial law, including insolvency and restructuring, dispute resolution, and ESG. She is also a passionate advocate for mental health and social mobility within the legal industry and runs a page called PsychoLAWgy.