Emissions reporting gaps threaten ESG markets

IFR 2433 - 14 May 2022 - 20 May 2022
3 min read

Index provider FTSE Russell is calling for mandatory disclosure of companies' Scope 1 and 2 carbon emissions data after it identified huge gaps in such information and major inaccuracies in estimation models.

Scope 1 and 2 emissions data cover direct and indirect emissions that companies make in their own operations. It is the most mature and influential metric in sustainable investment.

The data are a cornerstone of corporate and regulatory reporting, and are used by investors to allocate capital and underpins billions of dollars of ESG-labelled debt. But the research shows that there are still significant problems.

“I think there is a perception that this is a battle that has been won. What we're showing here is that is not the case," said Jaakko Kooroshy, FTSE Russell's head of sustainable investment research.

Progress on disclosure has been incremental and is uneven in different geographies. While nearly all (98%) of FTSE 100 companies disclose Scope 1 and 2 emissions, only 10% of companies in the Russell 2000 small-cap index do and 11% of those in the FTSE China A Share index.

Mandatory disclosure standards that have been implemented in the UK and proposed by the Securities and Exchange Commission in the US, are urgently required across the world, Kooroshy argues.

"It is very important to get the basics right and making Scope 1 and Scope 2 emissions disclosures mandatory should be a no-brainer," Kooroshy said.

The market’s attention is now turning to more complex metrics, such as indirect Scope 3 emissions that cover emissions from companies’ value chains, and implied temperature rise models, but the gaps in Scope 1 and 2 data are jeopardising ESG financial products and targets.

"We are moving into a world where these metrics are being hardwired into everything that investors do in financial markets and for that we need to make a step-up in the process and transparency of this data," Kooroshy said.

Investors are turning to estimates to fill the gaps, but with no scientific or industry consensus on the best method, nearly half of the estimated values diverge from reported data by 100% or more, and more than a quarter of estimates are off by 200% or more, the FTSE Russell research shows.

FTSE Russell, which like IFR is owned by London Stock Exchange Group, has created a formula to address the “estimation gap” that it says gives more consistent estimates that are less likely to underestimate emissions for polluting companies.

"We need to make this metric mandatory so that we can rely less and less on estimates and get more and more accurate data into the system. There is a transparency and credibility issue, and we think the industry is not doing itself a favour by not being upfront about that," Kooroshy said.

The methodologies for disclosing Scope 1 and 2 emissions were fixed in 2004 with the Greenhouse Gas Protocol, but lingering data gaps show that it is still very hard to estimate carbon emissions precisely.

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