Better emissions data won't compensate for insufficient understanding of physical climate risks in companies' value chains
There is a tug-of-war underway in sustainability that strongly impacts responsible finance. What is the appropriate balance between data availability and standardization and action on topics like climate change? Often, the relationship is viewed as complementary: mandating stronger data disclosure requirements is seen as strengthening the ability of companies and their stakeholders to advance action on issues that are material to their businesses.
Transparency is valuable for supporting more informed decision-making relating to climate change, as it is in many other fields. The advance in better data availability comes with a cost, however, in how to responsibly gather, validate and report the data. This has led to efforts to weaken or streamline reporting requirements, depending on your perspective, as has been proposed in the EU Omnibus, for example.
‘Reporting fatigue’ has been widely shared among smaller companies, those based in emerging markets, and startups, and it impacts large companies as well.
Most of those expressing concern about reporting burdens are not pushing back on the financial importance of climate, nature and other ESG issues. The concern is often about whether particular reporting requirements strike the right balance between comprehensiveness and data quality (often pressed by users of the data) and efficiency in producing and disclosing the data (often heard from those reporting the data). But this is not a two-dimensional game of push and pull, and the right level of disclosure is not categorized as ‘more’ or ‘less’ of existing disclosures.
The context in which this is occurring overlaps with a global coordination problem centered on climate change and nature loss in a way that has huge economic implications. These issues care not about the volume of data produced; the only thing that matters is whether the right decisions for the future are made today, even if they are made using imperfect or incomplete data. Having more high-quality data is not enough if it doesn’t measure the right things, or lead to the right decisions.
To take an example, the issue of carbon emissions has (rightly) absorbed most of the oxygen in the sustainability data discussion. The data question focuses on finding the right measures for the emissions related to corporate activity, and for the investors, banks and insurers who enable it. This results in Scope 1, Scope 2 and 15 different categories of Scope 3 with crisscrossing links between reporting companies, especially on Scope 3.
Emissions reporting is premised on the idea that by reducing the measured emissions, companies, investors and financial institutions are contributing to mitigating climate change and the impacts that will be financially material to them. The opportunity cost of condensing companies’ climate exposure (or opportunities) only to emissions, however, is that physical climate risk, nature risk, and adaptation finance get short shrift given the technical challenge of producing validated emissions data.
A recent study by S&P highlighted the relatively lower priority placed on supply chain management, where transmission of physical climate risks is likely to have the greatest impact. As evidence, they pointed to their Corporate Sustainability Assessment that only 6.5% of companies said it was a leading material issue.
One explanation for this may be that companies, investors and financial institutions currently place higher focus on measurement of their value chain emissions as a result of stronger disclosure requirements for these data, even where currently unmeasured physical risk is the highest. This is particularly likely for sectors whose contributions to emissions are relatively modest, where their value chain emissions and value chain physical risks are more complex.
For these companies — which account for a broad range of the economy — their emissions measurement and mitigation efforts can be important, and may still need to be balanced against mitigation of physical risks in their value chain. For investors and financial institutions, the issue is one of prioritization in their engagement with companies about the degree of precision and completeness that is necessary on emissions versus their understanding of different risk channels through which physical risk could be transmitted, or where investments could be made to mitigate the risk.
Beyond the financial impacts, there is also an important climate justice dimension to the question about what level and types of disclosures are most effective. The distribution of emissions in the global economy is heavily weighted towards developed markets (often at the end of supply chains), while the physical impacts of climate change are disproportionately felt in emerging & developing countries (generally further down the supply chains).
S&P highlighted that “lower- and lower-middle income countries are up to 4.4x more exposed to climate hazards than more developed economies [and] have the least capacity to adapt.” Although mitigation is critical to contain the damage that climate change is creating, it is also important that countries most exposed to the physical impacts receive investment to mitigate or adapt to them.
Better climate disclosure is a tool towards better informed decisions, but more disclosure on its own will not substitute for effective actions to mitigate climate change or deal with those physical impacts that are already locked in. Investors and financial institutions engaging with investees and customers should ensure they do so in a way that contributes to prioritizing the most effective actions, rather than merely ticking a box on a data collection checklist.
