Jane: [00:00:00] Hello! Welcome to the LSEG Sustainable Growth podcast, where we talk to leading experts on topics that intersect sustainability and finance. I'm Jane Goodland, and this week I'm talking to Jaakko Kooroshy, who is the Global Head of Sustainable Investment Research here at LSEG. Jaakko’s team conducts some great research, and we thought that the most recent piece deserved a conversation as it reveals some fascinating facts about Scope 3 emissions and comes up with a solution to enhance our reporting of this very important part of our collective carbon footprint. But before we listen to the conversation, a quick reminder to follow us so you don't miss any future episodes. And also, don't forget to rate us on Spotify, Apple Podcasts, or any other platform you use. Right, let's find out more about this new research.
Well. Hello, Jaakko, thank you so much for joining us here on the LSEG Sustainable Growth Podcast. It's really nice to see an LSEG face here.
Jaakko: [00:00:56] Great to be here, Jane.
Jane: [00:00:57] And now we are here to talk about a piece of new research that you and your team have just published, which is called Scope for Improvement Solving the Scope 3 conundrum. But before we get into the detail of that paper and that research, can you just tell us a little bit more about your role and the work that your team does here?
Jaakko: [00:01:17] I'm the Global Head of Sustainable Investment Research here at LSEG. And I head up a team of sustainability experts and data scientists dotted around the globe. And we basically do 3 different things. So one is that we write research like the Scope 3 report that we're discussing today, which helps us to guide our product development here at LSEG in the sustainable finance space. We also develop prototypes of new models or data sets or analytics. So, the prototype for the LSEG Scope 3 data, which underlies this report, was originally developed by the same experts and data scientists that wrote the wrote the piece. And finally, we also spend a lot of time discussing these issues with clients and other stakeholders. So, the idea for this report actually came from some questions on Scope 3 that we got from Blackrock at the time. And that inspired us to then put this report together for other clients too.
Jane: [00:02:13] Interesting. Okay, so before we get into the detail of the report, let's make sure that we've got a very clear understanding about what we mean by Scope 3 emissions. And I'm sure it's a phrase that many of us hear and see written. But, let's get super clear about what do we mean by Scope 3 emissions. What are they? Where do they come from? Give us the insights.
Jaakko: [00:02:32] So Scope 3 emissions are the emissions that occur outside of the operational control of the company, which we would typically refer to as Scope 1 emissions. And they also exclude the energy related emissions which are typically captured under the Scope 2 emissions. So, everything else is really Scope 3. So, what does that mean if you're a smartphone manufacturer, you may have the emissions that occur during the manufacturing process and the distribution and the sales. But then you also have the emissions that happen before the smartphone was produced, which are embedded in the materials. So, when plastics and steel and glass were extracted and put together. But then you also have downstream emissions that occur during the use phase. So, when you are charging your mobile phone that contributes to the Scope 3 emissions of the manufacturer or also if you if you engage in energy intensive data usage, for example.
Jane: [00:03:32] Are there are other examples of that you can bring it to life as well. What about a car company, for example.
Jaakko: [00:03:37] Yeah. Car companies is another great example. Right. So, they produce obviously emissions while they produce the vehicle. They also have those upstream emissions from the materials that they use in the vehicle. But there's also these really important downstream emissions that occur when the car is driving around. And actually, for a car, most of the emissions come from that use phase, and that might be linked to the tailpipe emissions if you're driving a combustion engine car or it might be linked to the power generation that you use to charge your electric vehicle, for example. And they can be hugely different depending on your driving behavior, what kind of weight your car has or what type of car it is. So, that makes them important. The greenhouse gas protocol actually cuts the Scope 3 emissions into 15 different categories across upstream and downstream. So, yeah, that's where a lot of complexity comes in.
Jane: [00:04:31] And that greenhouse gas protocol is really sort of almost like the Bible, isn't it, for categorisation of emissions, both 1, 2 and 3. But that varies hugely across different sectors, doesn't it, as you've just kind of illustrated with the examples of the phone or the car, um, that you do in the paper as well. So, really, it's becoming clear that the vast majority of our carbon footprint typically comes from Scope 3 emissions. So is that why it's so important to measure it?
Jaakko: [00:05:00] So one, as you say in most sectors actually, Scope 3 emissions are the bulk of the emissions. So about 80 on average. In some sectors, like for example, the auto industry, but also the oil and gas sector, it doesn't really make sense to look at the carbon footprint of the company without looking at the Scope 3 emissions. So, if you're an oil and gas producer, and you have some emissions that occur in the production of the oil and gas, but actually the bulk of it will occur when you combust the oil and gas at the end of the process. So, for that, it's really important that we understand not only the Scope 1 and 2 emissions, but also those Scope 3 emissions. The problem is that we don't often have good data on that. And that's really at the heart of this report and what we call the Scope 3 conundrum that on the one side, Scope 3 emissions are really important. On the other side, we don't really have great data available. So, there's lots of missing data. And the data that we do have is often very volatile and hard to compare.
Jane: [00:06:11] And that's important because effectively that climate risk ultimately could affect a company's overall profitability in the long term or their prospects, their value creation long term, right?
Jaakko: [00:06:15] Absolutely. I mean, companies that produce a lot of Scope 3 emissions may face, face, certain transition risks, right, if they’re relying on very carbon intensive inputs in their products, or if their products will generate a lot of emissions once they go into the use phase, then there will be pressure to find alternatives for that. Right. And the car company is a great example here. If you're producing combustion engines and you have a huge Scope 3 footprint because of that, that creates risks as people then may want to switch to lower carbon alternatives.
Jane: [00:06:48] Okay. So now, as you describe in the paper, you and your team conducted this research about the different categories of Scope 3 emissions. And really you looked at the materiality of those different categories to different sectors. Tell me a bit more about that research. How did you go about it and what did you find.
Jaakko: [00:07:07] So one of the key points that we're making is that while you have these 15 different categories, actually for most companies, just 2 or 3 main categories cover the bulk of the emissions. And the way that we did this was to look at over 4000 companies in the FTSE all world. So, these are large and medium sized companies in developed and emerging economies. And we looked at the Scope 3 disclosures that they made. Now many companies don't disclose anything, but those companies that do disclose data may do that on one or two or three categories, but they rarely cover all of the 15. And so, what we did in each sector, we calculated what we call a carbon intensity. So, we looked at okay per dollar of product in that sector, how much Scope 3. How many tons of Scope 3 emissions are being generated. And so, we can see even though we don't have data from everyone on everything we can see in each sector, what are those most material categories and how much they make up of that overall carbon footprint of the company. And so, what we find is that actually, on average, the top two categories in each sector make up more than 80% of the Scope 2 emissions in that sector on average. And so that's what we describe as the most material Scope 3 emissions.
Jane: [00:08:32] And your research also found that some companies aren't reporting those categories which are most material to their sector, which is quite relevant really. If you're an investor looking to understand the full picture of a company's carbon footprint and those categories are emitted, that can be quite a big deal, right? So why is it so important then when we're thinking through these categories, how does this come into play in terms of these new reporting standards and regulations? Because and I'm curious to know who decides which categories to report or not. Do the companies decide themselves which categories they report or is there some sort of guidance out there. What do we see coming through?
Jaakko: [00:09:14] So, Jane, I think you sounded a little bit confused there. And actually, that's exactly what our data shows. Companies are confused. So, we see a lot of adjustments in reporting. So, they may report on some categories in some years. And then the next year you pick up the annual report and it's different Scope 3 categories that's being reported on. But often we find that companies are, like you said, not necessarily reporting on the most material stuff. Actually, less than half of the companies that disclose any Scope 3 data, disclose the most material categories. And that's a huge problem. So, the most common category that companies disclose is actually probably the least material Scope 3 category business travel. And they do that often because it's easiest to measure. You have that data in the company. Whereas there might be other stuff like purchased goods and services which might be much, much more material, but you may have less data available, and you may not be so sure how you're going to go about the measurement. So, what we see is that you see a lot of the switching of categories and that causes a huge amount of volatility in the actually disclosed data. And that also means, you know, it's that data that feeds also the estimation models that the people in the industry use. And so that causes also volatility in those estimates. So, what we're saying is that it's incredibly important that there is clearer guidance about what companies should report on. And that helps the companies and makes it easier for the companies to report. But it also means that we will get much, much better data.
Jane: [00:10:51] So, Jaco, why do you think that companies aren't reporting consistently? Is this intentional or is this something else?
Jaakko: [00:10:58] Well, I think there's a few things at play. One is that the reporting practices are developing incredibly rapidly in this space. Companies are hiring people to help with the reporting, bringing in external experts around this. And so as the reporting improves, you know, you may then decide that actually here's a category that we didn't cover, but that's actually quite important and bring that in. But there may also be an element of greenwashing. And we've seen that in some, some industries where we know that Scope 3 is important, and companies may have been quite reluctant to put that data out because it may not it may not look great. And so, that's really a reason why we need these clearer standards, to show companies what's most material and then also get that more consistent, higher quality data out.
Jane: [00:11:44] So we've got the greenhouse gas protocol. We've got our 15 categories of scope 3 emissions. And we're starting to realise that there's certain categories which are more important than others for certain sectors. Why is it so important that we get this right and we get consistency across the board?
Jaakko: [00:12:02] There's a number of reasons for that. For companies, it's really important that they get better guidance and a clearer message on which categories to report on in their sectors. And that will also help to improve the data quality. So, when companies actually consistently report on the most material categories, we see actually in the data the quality of the data becomes much better, it's much less volatile, and much more reliable. But it's also important because Scope 3 reporting is now becoming mandatory in the EU, in the UK, in Japan, in California, regulators have all announced that Scope 3 reporting will become mandatory for companies. And so we will see this dilution of Scope 3 data coming our way. But it's very important that we have this materiality question sorted out. And it really can be a win-win for companies and investors. On the one hand, the reporting burden goes down because companies understand better what categories to report on. And on the other hand, investors get more material and more reliable data on this.
Jane: [00:13:06] And so we know that not all companies are reporting the material categories, so that's obviously a data gap. And you've talked about data quality as well. And when it comes to the reporting guidelines, we see that there isn't consistency across those either, is there. So, you know, TCDF are talking about disclosing the appropriate emissions. And whereas ISSB is talking about materiality. So, this need to get consistency in the rules seems really, really important. Right.
Jaakko: [00:13:33] Well. I guess there is consistency in the rules in the sense that all of the standards out there as well as the regulations that we're seeing, they're saying, well, disclose what is most significant or material. What is lacking is the guidance to work out well what really should be considered as material. There is some high level principles around that in the greenhouse gas protocol, but there's not really a kind of a practical how to guide. If you're a company in sector X, what categories should you make your starting point in your reporting. So that's why we think it's quite important that standard setters become a little bit more prescriptive around that and that should help the companies and that should also help the market by producing this more reliable, more comparable data.
Jane: [00:14:17] So how should investors be thinking about the contents of your paper? Should they be asking for different information than they currently get from companies, or what should they be asking?
Jaakko: [00:14:27] So there's a couple of points here. So one is that this approach that we're suggesting in the paper actually gives investors a very useful rule of thumb on trying to decide, well, this Scope 3 data that I'm looking at is that actually covering the most material categories. And it allows them also then to monitor that data quality in a different way. It's also, for example, in the corporate engagement, you can go to the companies and say, well, in your sector category 3 or 5 or whatever it is, it seems to be very material, but you're not reporting on that. Why is that ? So, there's really a few angles for investors here.
Jane: [00:15:07] Yeah, I think that would be really helpful for investors. That rule of thumb, I think, is a very practical way in which they can use the information. So, thinking forward, the paper has been published. What now? What do you do with the research.
Jaakko: [00:15:20] So we have had actually a great reception. It's been picked up in the press. We've had lots of questions from clients and investors around this, trying to understand that research better and wanting to know more about the data behind it. We've been speaking with the greenhouse gas protocol about this. So, the guys that actually make the rules on these disclosures. And we also have a great webinar coming up, where we are discussing the research together with CDP and the ISSB and investors to, to really get a shared understanding of what next steps are around Scope 3 look like. And this type of research can end up being very useful for the market. We actually did a couple of years ago a report on Scope 1 and 2, and there was an interview with Gary Gensler last week in the Financial Times. And he's quoting data out of that report. So, it is really something that hopefully supports the market in developing the standards around this, helps issuers to figure out what they should be reporting on and helps investors as well to make sense of the Scope 3 data that they're using.
Jane: [00:16:22] Well, that's really fascinating. I'm afraid it's all we've got time for at the moment, but it really is quite fascinating, the research that's coming out of your team and really looking at kind of the impact that it can have. So, thank you again for sharing the insights and telling us about your research. Thanks again.
Jaakko: [00:16:37] Thanks so much, Jane. It was great to chat.
Jane: [00:16:41] So that's it for this episode of the LSEG Sustainable Growth podcast and what a fascinating chat it was. Big thanks to Jaakko for sharing his research with us, which, if you're interested, you can find the paper free of charge on lseg.com and the link is also in the show notes. If you've got questions, comments, or someone you'd like us to talk to, then do get in touch by email at fmt@lseg com. That's all from me but watch out for the next episode very soon.
