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Will Scope 3 Emissions See More Scrutiny?

Oct. 13, 2023
A new California law could be the beginning of the end of greenwashing.

IndustryWeek's elite panel of regular contributors.

Measuring, reporting, and reducing carbon emissions along the entire supply chain could become a new normal for large companies in the United States, courtesy of a new law in California that the federal government is also looking at.

The law makes deeper reporting on emissions common practice but also accounts for companies not yet having full visibility into their suppliers’ practices.

On October 7, California Gov. Gavin Newsom signed Senate Bill (SB) 253 into law. Under this new law, more than 5,300 companies that operate in California and make more than $1 billion in annual revenues will be required to report both their direct and indirect emissions. 

Meanwhile, the U.S. Securities and Exchange Commission (SEC) is finalizing new rules that would mandate public companies to make climate-related disclosures in their annual reports and registration statements. SEC Chairman Gary Gensler commented recently that California’s law could influence federal regulators’ decision.

California’s law requires companies to measure and report Scope 1, 2 and 3 emissions.

Scope 1: direct greenhouse gas (GHG) emissions a company generates

Scope 2: indirect GHG emissions a company generates, such as buying energy/electricity for heating and cooling buildings.

Scope 3: emissions generated up and down the company’s value chain by its suppliers

The new law allows public disclosures of emissions in stages. Beginning in 2026, qualifying companies in California must disclose annually about their Scope 1 and Scope 2 GHGs for the prior fiscal year.  From 2027 onwards, they must also annually disclose their Scope 3 emissions no later than 180 days after disclosing Scope 1 and 2 emissions.

To ensure reported emissions are accurate and truthful, an independent third-party auditor must verify all of a company’s Scope 1, 2, and 3 emissions.

Major companies such as Apple and Patagonia support this new law. However, the California Chamber of Commerce, agricultural groups and oil giants oppose the law because most companies do not have the experience or expertise to track Scope 3 emissions committed by their external supply chain partners accurately.

Indeed, since only 2% of companies have visibility beyond their second-tier suppliers—suppliers that provide materials and parts to their direct suppliers—most companies are not equipped to measure emissions further downstream in their supply chains.

Fewer than 30% of companies report meaningful Scope 3 emissions, according to the corporate governance consultancy ISS Corporate Solutions. However, as estimated by the nonprofit CDP, companies’ Scope 3 emissions are on average 11.4 times greater than their Scope 1 emissions. 

Recognizing the inherent difficulties for reporting entities in California to measure Scope 3 emissions accurately, SB 253 offers a sensible compromise. 

Specifically, the new law stipulates that a company’s penalties may not exceed $500,000 in a reporting year. Also, reporting entities will not be subject to an administrative penalty for any misstatements regarding Scope 3 emissions disclosures made on a reasonable basis and disclosed in good faith. Further, any penalties assessed on Scope 3 reporting between 2027 and 2030 will only be for non-filing.

The EU Model

California is taking the lead in the United States by requiring firms to disclose emissions in their supply chains beginning in 2026.  But European Union regulation is leading the way.

In June 2023, the EU adopted the first set of European Sustainability Reporting Standards. This new regulation requires publicly traded companies in the EU to disclose their scope 3 emissions in their annual reports, beginning from the fiscal year 2024.

As more regulations require public disclosures of Scope 3 emissions, it will put more pressure on companies to improve supply chain visibility so that they can track Scope 3 emissions. 

And this is a good thing because Scope 3 emissions are significant, yet often not measured or reported.

Without proper and accurate reporting of Scope 3 emissions, consumers are rightly concerned that companies that claim to have low emissions may be greenwashing without taking action to reduce emissions in their supply chains to combat climate change. 

For example, Amazon’s revenue in 2022 is comparable to Walmart’s, yet Amazon reported its emissions from shipping are only one-seventh of Walmart’s. But when researchers reviewed public data on imports, they found only about 15% of Amazon’s ocean shipments could be tracked.

If the SEC requires public companies to report Scope 3 emissions properly, consumers and investors gain more transparency into companies’ actual GHG emissions use—and empowers them to pressure companies to take actionable steps to reduce Scope 3 emissions, the most significant part of their carbon footprint.

Ultimately, these regulations can be the beginning of the end of greenwashing.

Christopher Tang is a distinguished professor at the UCLA Anderson School of Management. 

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