Securities and Exchange Commission (SEC) Chair Gary Gensler made waves last week when he stated that the SEC’s proposed climate disclosure rule would consider walking back its intention for “scope 3” emission disclosure. This isn’t unexpected, as it’s typical for regulators to make big promises that get watered down before finalization. But it’s worth diving a bit deeper into what scope 3 emissions tracking means for businesses, given that the topic is poorly understood and likely to re-emerge.

Scope tiers are used in breaking down emissions from a product: scope 1 emissions are the direct emissions involved in the production of an item, scope 2 are the indirect emissions, and scope 3 can be thought of as the indirect emissions of the indirect emissions. For example, if someone makes a ton of steel, scope 1 is the emissions of burning the coke and fuel to make the steel, scope 2 is the emissions involved in producing the coke and ore for the steel, and scope 3 is all of the emissions involved in supporting the business. The SEC’s proposed rule used the emissions of employees commuting to work as an example of scope 3 emissions.

Scope 3 may be useful as a philosophical concept, but it’s wholly impractical for policymaking for two key reasons. First, it’s easy to see that for most companies measuring scope 3 emissions is probably not feasible. One can measure direct emissions, and one can likely estimate the scope 2 emissions, as suppliers may be measuring their scope 1 emissions. But how practical is it to track the mileage of employees’ commutes, what types of vehicles they’re driving or the emissions from the paper they’re using in the office?

Second, it isn’t clear that scope 3 emissions offer any useful information to investors. The point of the SEC climate rule is to prevent companies from potentially mischaracterizing the risk they expose investors to from either physical climate impacts or “transition” risks like the implementation of a carbon tax. Whether the employees of a company commute via combustion-engine vehicles or electric vehicles doesn’t show if the company is more or less likely than other investments to go sour. For example, if a carbon tax were implemented, it would hit employees of Disney just as hard as employees of Chevron, but Chevron is clearly much more risk exposed under a carbon tax even though the scope 3 emissions would probably indicate otherwise due to Disney having four times as many employees.

The bigger problem, as R Street points out in its comment to the SEC, is that equating emissions with overall climate risk is an oversimplification that isn’t particularly helpful. There might be some emission-intensive products that increase in demand for climate reasons, like natural gas or electric vehicles, and distilling every company down to their emissions takes a lot of work without giving much actionable information. What’s worse, the SEC’s proposal to impose scope 3 emissions accounting requirements on companies that make climate commitments would just deter private sector climate action.

All in all, policymakers need to appreciate that the establishment of new regulations creates real compliance costs that will get passed on to customers, acting as a de facto tax on the public. For the SEC to best do its job, it needs to focus on the information that is truly useful for investors.  

Image credit: maykal

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