How do ESG funds measure Scope 3 emissions exposure?

Scope 3 emissions refer to indirect greenhouse gas emissions that occur in a company’s value chain, both upstream and downstream. These emissions are often difficult to measure due to their indirect nature. However, ESG (Environmental, Social, and Governance) funds are increasingly focusing on assessing and managing Scope 3 emissions as part of their commitment to sustainability. Here's how they measure and incorporate Scope 3 emissions exposure into their investment strategies.

What Are Scope 3 Emissions?

Scope 3 emissions are the most challenging to measure as they come from sources not directly owned or controlled by the reporting company. These emissions include the entire supply chain, such as the extraction of raw materials, transportation, product use, and disposal. For instance, when a company manufactures a product, the emissions from the entire production and distribution process — not just from the company’s facilities — are counted as Scope 3 emissions.

Scope 3 emissions are significant because they often make up the largest portion of a company's total carbon footprint. This makes them a critical factor for ESG funds that are serious about reducing their investments’ environmental impact.

How ESG Funds Measure Scope 3 Emissions Exposure

ESG funds measure Scope 3 emissions exposure by using a combination of data collection, reporting standards, and estimation techniques. Below are the key ways they approach this:

• Data Collection and Reporting Standards: ESG funds rely on publicly available data provided by companies through annual sustainability reports and other disclosure frameworks like the Global Reporting Initiative (GRI) or CDP (formerly the Carbon Disclosure Project). Companies often report their Scope 1 (direct emissions) and Scope 2 (indirect emissions from energy use) more accurately than Scope 3 emissions, making it a challenge to track full exposure.
• Supply Chain Data and Engagement: ESG funds often engage with companies to understand the indirect emissions from their supply chain. Through surveys, interviews, and partnerships, they gather data from suppliers regarding their emissions. Companies with transparent and proactive reporting practices on Scope 3 emissions are more likely to be favored in ESG investment strategies.
• Estimation Models: Since exact data is often unavailable, ESG funds may use industry-specific estimation models to calculate the potential Scope 3 emissions for companies based on their industry, production methods, and supply chain activities. These models are continuously refined to improve accuracy.
• Third-Party Ratings and Assessments: To assess Scope 3 emissions exposure, ESG funds rely on third-party ESG rating agencies like MSCI, Sustainalytics, or Trucost. These agencies often provide in-depth analysis of companies’ environmental impact, including their Scope 3 emissions exposure. ESG funds use these ratings to evaluate a company’s overall sustainability risk.

Why is Measuring Scope 3 Emissions Important for ESG Funds?

The accurate measurement of Scope 3 emissions is crucial for ESG funds for several reasons:

• Comprehensive Sustainability Strategy: By measuring Scope 3 emissions, ESG funds ensure that their investment strategies account for all emissions, not just those that are directly under a company’s control. This creates a more accurate representation of a company’s overall environmental impact.
• Better Risk Management: Scope 3 emissions are often linked to supply chain risks, regulatory changes, and consumer preferences. By tracking these emissions, ESG funds can identify companies at higher risk due to unsustainable practices or non-compliance with evolving environmental standards.
• Aligning with Global Standards: Many countries and regions are introducing regulations around emissions reporting and reduction. By evaluating Scope 3 emissions exposure, ESG funds position their portfolios to align with these global standards, which can help avoid potential penalties or risks associated with non-compliance.
• Investor Demand: Increasingly, investors demand transparency regarding Scope 3 emissions. Investors want to know that their money is not indirectly supporting high-carbon companies. ESG funds that measure and report Scope 3 emissions are better equipped to meet these demands.

As ESG investing becomes more mainstream, understanding and measuring Scope 3 emissions exposure has become an essential part of building sustainable investment strategies. ESG funds that effectively track and manage these emissions are not only better positioned for long-term growth but also help mitigate environmental impact and comply with global standards.