Deciphering ESG: why scope 3 disclosures are the real deal
The notion of corporate personhood
Corporate personhood was bestowed on corporate America based on a false premise started by Roscoe Conkling, the head lawyer representing Southern Pacific in a series of lawsuits in the late 1800s. Whether or not you believe in corporate personhood, the idea that corporations should be treated as legal persons1, corporations should have accountability for a host of issues such as human rights, the environment, and their impact on communities and society at large.
A different, yet thoughtful, perspective on corporate personhood, was offered by former Daily Show host Jon Stewart: "If only there were some way to prove that corporations were not people... maybe, we could show “their inability to love?"
That makes you think because, until recently, corporations—in particular, large corporations—operated based on Friedman’s doctrine. In his own words, Friedman, in a peculiar article riddled with questionable concepts and published in The New York Times2 in September 1970 said:
“There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”
One could ask how Friedman, an accomplished economist and statistician, could not foresee the systemic risk posed by some large organisations running their business to the detriment of human rights abuses or with no environmental or social moral compass. Perhaps one explanation for that failure is that in the 1970’s Friedman could not foresee that individual economies had the potential to become more integrated globally, until one day there would be no corporate borders or well-defined industry sectors, but rather globally interconnected stochastic ecosystems. A random failure in one area of the system could propagate potentially within the entire system until the significant risk is triggered.
How should we regard corporations?
So, the question is: do we want to regard corporations as non-persons or do we want in the virtue of that, to co-opt them in a global accountability effort to solve the wicked problems that we are facing as an Earth collective? I would prefer the latter.
Larry Fink’s letters to CEOs in 2018, 2019, and 20223 gave new meaning to corporate social responsibility. He said that “stakeholder (stakeholder, our note) capitalism is not about politics. It is not a social or ideological agenda. It is not “woke.” It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper. This is the power of capitalism.”
The recent efforts made on the ESG and UN SDG fronts spring from this philosophy.
Before adhering to the ESG-driven movement of corporate responsibility, several large corporates engaged in discrediting the foundations upon which the social responsibility movement was built. For instance, between 1998 and 2003, ExxonMobil granted $16 million to advocacy organisations to continue disputing the impacts of global warming. It took ExxonMobil almost 10 years to ramp down funding to climate-denier organisations.
ESG started to make its way initially into the financial markets and then into the corporate DNA, not long after. But macro beliefs have never been the forte of the US Congress. The socially conservative fiscal right in the US has sought to undermine ESG principles ever since the publication of a landmark document titled “Who Cares Wins5” in 2004. “Who Cares Wins” was published by the UN and the Swiss Federal Department of Foreign Affairs and endorsed by a number of financial institutions such as ABN Amro, Goldman Sachs, Morgan Stanley, BNP Paribas to name just a few. It contained recommendations to financial institutions, regulators and NGOs on how to tackle ESG and offered a set of goals that led to “better investment markets” and “more sustainable societies”.
Today, only a few corporations remain sceptical of the merits of ESG; most have incorporated the principles of reporting progress in their corporate strategy and some are well advanced in quantifying the full impact and materiality of their emissions across the entire value chain, i.e., direct and indirect emissions (scope 2 and scope 3). Others use ESG as a marketing or PR tool in an effort to remain relevant. This is obviously misguided.
Global discrepancies in ESG reporting
However, regional differences remain in the way that the ESG battle is fought.
In Europe, governments are enacting new regulations at a higher pace than in the US, where the very concept of ESG is heavily politicised. Having said that, the SEC and the EU are working toward clearing the hurdles for a globally accepted set of standards based on which, regional policies can be devised and disclosures enacted.
While the European Union’s Corporate Sustainability Reporting Directive (CSRD) was primarily oriented toward EU-based companies, non-EU companies and US-based transnationals with a significant European presence will feel the pressure. In part, this is due to the incorporation of stringent double materiality and scope 3 reporting as stipulated in the forthcoming ISSB S2 standard. Scope 3 emissions are indirect emissions across the value chain and are split between “upstream emissions”, or emissions that come from the production of a company’s products and services, and “downstream emissions”, which are those that come from the use and disposal of a company’s products or services.
Based on the CSRD guidelines, international companies with subsidiaries in Europe that exceed €40 million in turnover and €20 million in assets are deemed “significant operations” and will need to abide by CSRD rulings. That includes sustainability information across their value chain in order to quantify and disclose indirect scope 3 emissions, information that many corporates find difficult to estimate. The ISSB announced that it will set a grace period for the scope 3 reporting and that it will also introduce exemption clauses to provide “practical disclosure standards” for businesses. This will provide organisations with the time that they need to sense, adapt and re-configure operations to meet societal demands. Hence, the concept of “dynamic capabilities” coined by David Teece in the late 1990s should be brought to the surface in re-thinking corporate strategy and the ability to adapt.
How can companies adapt?
After years of operating in a profit-driven echo chamber, many organisations will find it difficult to find their true ESG guiding principles. But the idea is not to try to be all and everything in the E or S or G fronts, but rather to try and find where, based on the company’s core business, it can make an impact at scale, be that on the environmental or social front. Companies should be deliberate, intentional, and bold.
The introduction of scope 3 emissions reporting has the objective of integrating our individual purposes into a larger global purpose. By thinking in “systems”, businesses are forced to assess interconnectedness, interdependencies, and the secondary indirect impacts that they have as global citizens. As an organisation, buying electricity from a power plant that uses child labour is your business. Intuitively we knew that, but new regulations based on scope 3 upstream disclosures will make organisations think twice.
For most businesses, scope 3 emissions are material and can amount to 60%-90% of their total emissions and so, defining a roadmap to deal with these regulatory requirements without promoting greenwashing, an offence that in some countries is now enforced via heavy fines, is challenging.
Global data are asymmetric and the access of emerging market and developing economies (EMDE) to pertinent data is challenging at best. This should not detract us from pursuing the right course of action just because it is hard but in spite of it.
The ESG data will most likely need to be captured through the same ERP systems that the organisation makes use of during its normal modus operandi. This could mean that the cost of business transformation and collaboration will be material to many organisations’ bottom line.
A question that many CEOs ask is: how much will it cost us to adapt our business to respond to these new regulatory requirements regarding sustainability disclosures. Can we afford that?
The better question would be: can we afford not to align ourselves with society’s expectations on environmental and social responsibility fronts?
The philosophy based on which scope 3 emissions reporting was introduced is right: we can only tackle the wicked environmental and social problems we face if we move forward as a collective. It supports the notion that cogent outcomes at a global scale can only be achieved when individuals, organisations and governments come together in policy and deed (action).
1 corporations are “persons” within the meaning of the Equal Protection Clause of the Fourteenth Amendment, but not “citizens” for the purpose of the Privileges and Immunities Clause.
4 Robert Brulle: Inside the Climate Change "Countermovement”. Frontline. PBS. October 23, 2012. Retrieved February 21, 2015.