Navigating the murky waters of Scope 3 emissions is crucial

Do you think we’ll get there, that one day we’ll say, Scope 3 data is as reliable as 1 and 2? Or do you think it's always going to be a bit problematic?

"We're particularly optimistic about Scope 3 upstream emissions. But Scope 3 downstream is more challenging due to factors like product end-of-life and usage duration. It will take longer to achieve an acceptable data quality comparable to the other scopes, but I believe we'll get there eventually.

We've compared multiple data providers to assess the quality of Scope 3 information. Interestingly, there's a good degree of consensus among providers for Scopes 1 and 2, and increasingly for Scope 3 upstream. That consensus is a strong indicator of data quality.

The main issue with carbon data is our lack of intuition for what the 'correct' values should be. In the financial world, an interest rate of 200 would immediately flag as incorrect. But when it comes to emissions data, especially Scope 3, we simply don't have that level of understanding yet."

How do you see the role of a regulator? Is it absolutely necessary to push people to look at and improve data, and curb emissions? Or do you find it sometimes adds more frustration than support?

"Now for us, it's sometimes the latter. Scope 3 data requirements are often unclear and impractical, and the associated reduction targets can be so one-dimensional that the regulation doesn’t leave a lot of room to look at other measures. For example, in my own house, Scope 1 would mean heating it with natural gas. But my Scope 3 is so big, I could just leave my windows open while the heat's on, and it would barely make a dent in my total emissions. Scope 3 downstream is so dominant; it includes end-of-life products, product usage, things companies have less control over compared to any other scope.
We all want things. Phones, computers, three TVs in our homes. Should we only blame the companies? Sure, it’s on them to make things as clean and resource-efficient as possible. But we have to take responsibility as well. Adding the full Scope 3 to the equation really muddies the waters, as our consumption emissions are included as well. It becomes a stats game — just lowering Scope 3 without really picking the clean companies. You end up with some that just have high Scope 3 outliers, and that's it."

Is the regulatory environment driving improvements in data quality?

"Yes, exactly. For instance, we've recently started using Bloomberg data in some areas. They're leveraging AI, but that alone doesn't necessarily make it better. It's clear, though, that the industry is waking up. For example, Bloomberg's adoption of AI might push competitors to innovate, particularly those that might not have made significant progress on Scope 3 downstream data in recent years.

Regarding other factors that could help, one major thing is regulatory requirements. But the ultimate factor, I believe, is the quality of research from data providers.

Another party that could facilitate progress is the companies that report their own data. The problem is that the quality of reported data, especially concerning Scope 3, is often low. Entities like MSCI and Bloomberg override company-reported data with their estimates, which could be more accurate but will never surpass well-reported data from the companies themselves.

Good third-party auditing could be a game-changer. If carbon reports are not only audited critically, but also by auditors who possess the specialized knowledge to offer constructive feedback, then the exercise really moves beyond one of just ticking boxes.

New climate metrics such as CVAR (Climate Value at Risk) and ITR (Implied Temperature Rise)—do they offer genuinely new and relevant information for investors, or are they just ‘old wine in new bottles’? Do you feel these new metrics are innovative?

“The short answer is, I don't know for sure. But let's delve a bit deeper. For the most part, yes, it's 'old wine.' A company with high emissions has a high ITR and high CVAR—no surprise there. However, there could be added value in these metrics, especially when you consider a company's plans. Current metrics like ESG and SDG scores might not capture these plans adequately. So if a company says, "We’re investing in technology that will significantly reduce our emissions from 2025," that's important information which might not be fully reflected in our current metrics. The question then becomes whether you want this data included in ITR and CVAR or as a separate metric.

CVAR is also influenced by the regulatory environment. Take two similar companies in different countries: one with strict carbon rules and another with lax rules. The company in the stricter country will have a higher CVAR because it has to account for those regulations. This isn't captured in current metrics either. How significant are these effects? That's still up for debate. In summary, these new metrics can add value, but more research is needed to quantify it.

From a portfolio management perspective, if a portfolio manager has to optimize for both carbon emissions and ITR, it complicates things because they overlap significantly. It’s cleaner and more focused if the metrics used for restriction are uncorrelated. So, what we really want is a small set of variables that capture all the essential information about climate impact.”