What Businesses of Every Size Must Know About Climate Accounting
The path your business needs to walk has never been clearer.
November 18, 2022
Things are moving quickly for businesses around the issue of climate change. No longer merely considered a social issue used to identify with certain in-groups, the climate is now a growing regulatory, financial, and operational risk that smart businesses are addressing, the unwise are ignoring, and all will have to deal with shortly. Effectively, it is time to get on the bus or be in danger of getting run over. Here are the basics of what you need to know:
International Scientific, Political, and Financial Consensus is Largely Achieved
The Paris Accord was signed in 2015 at the 21st annual climate summit of the United Nations known as the Conference of the Parties – aka COP21. The agreement continues to be enacted and in force in every country on Earth.
Though the Paris agreement is not binding, it sets specific targets for emissions reductions to achieve climate goals – roughly 50% of all greenhouse gas emissions need to be cut by 2030, with the remaining 50% effectively eliminated by 2050.
There remains a small opportunity for carbon offsetting in 2050 for the most difficult to decarbonize sectors. This balance of offsetting the most essential emissions is known as Net Zero.
The following several meetings were largely technical affairs discussing means of giving teeth to the Paris Accord, but at COP26 in Glasgow in 2021, there were many breakthroughs. Most notably, asset managers representing 40% of the world's wealth – an astonishing $130 trillion of assets under management – committed to a Net Zero future.
Regulation is Happening
European regulators put into force the Non-Financial Reporting Directive (NFRD) in 2018, which requires European companies with greater than 500 employees to analyze and report their exposure to climate risk. This regulation will be largely superseded by the Corporate Sustainability Reporting Directive (CSRD), which goes into effect in 2023 and requires nearly every public company and private company with greater than 250 employees, $44 million in revenue, or a $22 million balance sheet to report and forecast greenhouse gas emissions, including Scope 3. Similar regulations exist in the United Kingdom post-Brexit.
At the same time, the United States Securities and Exchange Commission (SEC) has proposed climate disclosure rules that are currently out for public comment and will go into effect in mid-2023. These rules will require all public corporations to disclose their Scope 1 & 2 emissions to investors, and for large corporations, those that have public climate goals, or those with a materially significant emissions profile, the requirement will also include Scope 3 emissions.
Scope 3 reporting requirements are creating pressure outside of the public markets, as the suppliers of public corporations must now provide accurate climate accounting, forecasting, and emissions reductions to maintain the business relationship. Two examples: - - General Motors: “Suppliers will track Scope 1, 2, and 3 greenhouse emissions… and establish time-bound emission reduction goals” - - Microsoft: Suppliers are required to track Scope 1, 2, and 3 emissions and to reduce them by 55% by 2030.
Simultaneously, those seeking capital are increasingly required to provide their financiers with emissions accounting, with pressure coming both from regulators in Europe (SFDR) and the United States (ESG Rule), but also from upstream asset managers with voluntary climate commitments such as the COP26 commitment.
Basics of Greenhouse Gas Emissions Climate Accounting Standards
Climate emissions are also known as “Greenhouse Gas” emissions – GHG emissions for short – and lead to a process known interchangeably as GHG, carbon, or climate accounting.
There are six different categories of GHGs, including methane, a variety of industrial gases, refrigerants, and of course carbon dioxide (CO2). Each of these gases has a different climate effect, so they are all baselined to carbon dioxide. This leads to the common and technically inaccurate shorthand of all climate emissions being called “carbon” emissions.
The international standard of emissions calculations is to account in metric tons of carbon dioxide or its equivalent – abbreviated to tCO2e – and colloquially referred to as tons of carbon.
For a company’s accounting, GHG emissions are accounted for as either Scope 1, Scope 2, or Scope 3. - - Scope 1: The emissions a company is directly responsible for, such as the fuel they burn in their vehicles or the leaking refrigerants from their air conditioning systems. - - Scope 2: The emissions associated with energy used by a company in its operations, but which were produced elsewhere. A typical example would be the electricity used in lighting or manufacturing that was purchased from an electric utility. - - Scope 3: Corporate value chain emissions that are broken down into 15 categories, including business travel, employee commuting, downstream use of products, shipping of goods to/from a company, and investments.
Scope 3 emissions are about the relationships between companies. For Microsoft or General Motors to disclose and manage their Scope 3 emissions, their suppliers need to report their Scope 1 & 2 emissions, and as a result, all business climate accounting standards require a minimum of Scope 1 & Scope 2 emissions. However, as the examples illustrated, these companies are also requiring Scope 3 calculations, so prudent businesses would measure the material emissions associated with Scope 3.
Material emissions are those emissions that a sophisticated investor would be misled about if the emissions were omitted from a climate-related disclosure. As a subjective term, caution would recommend including those emissions about which doubt around materiality exists. An example of emissions from downstream utilization of products, depending upon company and product: - - A law firm’s legal briefs would be clearly immaterial. - - An oil producer’s sale of petroleum would be clearly material. - - A device manufacturer’s sale of a specific product would require a deeper climate accounting project to determine materiality. Alternatively, conservative emissions estimates could be included to avoid detailed calculations.
Emissions reporting is not about being against business growth, but it is about the decoupling of business activity from GHG emissions. Spoken plainly:
Those companies that do not find a way to make money without emitting greenhouse gasses will be struggling to exist in 2030 and completely out of business by 2050.
Carbon Offsets are Part of the Solution
Net Zero explicitly indicates that there will be specific, difficult-to-decarbonize sectors, allowing for some offsetting of emissions from third-party providers. In the meantime, the most responsible companies are already offsetting their existing emissions. Microsoft, as an example, is offsetting all its historical and ongoing emissions. While this exceeds current and proposed regulatory requirements, it also allows Microsoft special marketing and branding opportunities, improved employment marketability, and access to specific capital opportunities.
Offsetting is broken broadly into two categories: Avoided Emissions and Carbon Removals - - Avoided Emissions: When a company pays another company to reduce its emissions. These are projects that have met some minimum standards that without additional finance would not have been feasible for development. This includes projects that capture methane from livestock, prevent deforestation, and renewable energy projects. - - Carbon Removals: When a company pays another else to capture carbon from the atmosphere. As this is a more intellectually pure argument — you make a mess and pay someone else to clean it up — removals are increasingly in demand, which of course affects the price. Carbon removals come in two flavors: nature-based and tech-enabled. Nature-based removals are projects that increase the capacity of natural and working lands to increase their capture and storage through photosynthesis. Tech-enabled removals try to capture carbon dioxide with machines or other manufacturing processes.
Offset markets are massively fragmented, so sourcing offsets has historically been done through brokers with the knowledge and connections to enact transactions for the offsets with the right blend of location, type, mechanism, impact, and registry. Small buyers are generally unable to access these services and turn to a variety of websites selling specific projects.
Take Credit for the Work
For all the reasons stated above, now is the time to incorporate a climate accounting project into your company’s activities, but it is also an opportunity to establish your company as a leader in its sector. This has additional benefits: - - Business Efficiency: The average rate of return on emissions reduction projects is 57%. - - Access to Talent: 76% of Millennials prefer to work for socially responsible companies and two-thirds will take a pay cut to do so. Competition for talent is tight. - - Product Differentiation: 73% of consumer purchasing decisions are affected by a company’s environmental and social positions.
Identification of primary and secondary outcomes is part of how any company should build its climate action plan and should include plans on reporting and publicity. This takes several forms, including press releases, blog posts, social media, certifications, and corporate branding.
Aclymate is Here to Help
Aclymate provides the leading end-to-end solution for small and medium-sized businesses. Our climate accounting software application filters the data you already have to identify and calculate emissions, displays the information you need to reduce emissions, provides an industry-leading selection of offsets for purchase, and provides a Climate Leader certification to help you win the business and employees you need to succeed. Sign up for a 33-day free trial or click here to learn more.