Company disclosures on carbon emissions have been a crucial source of data for investors focused on environmental, social, and governance strategies. But asset manager GMO argues that relying on self-reported data isn’t enough.
According to a whitepaper published by GMO on Wednesday, most ESG investors determine the sustainability of their holdings by analyzing what’s called scope 1 and scope 2 emissions data, which are that produced by companies themselves and from their energy providers, respectively. Scope 1 and 2 are both reported by companies. However, investors also need to consider scope 3 carbon emissions, which reflect the activities of other organizations in a company’s value chain, according to the paper. Companies are not required to disclose scope 3 emissions, but GMO believes they need to be included to determine a sustainability profile. And even companies that do report scope 3 emissions, the data are “inadequate,” according to the paper.
In the paper, GMO detailed a new approach to capturing all of a company’s carbon emissions. The model includes self-reported scope 1 data; but GMO needed to then map out supply chains — from raw material producers all the way to household consumers.
“It’s a top-down approach that maps out the supply chain, and then we supplement that with bottom-up information on each company,” said Deborah Ng, head of ESG and sustainability at GMO. “What that gives you is a very consistent framework for allocating emissions across all of these companies.”
According to the paper, the utilities sector is the least carbon-efficient sector, with an average of 3,426 tons of carbon emissions produced for every $1 million in revenue generated. The financial and real estate sectors are the most efficient, with 366 tons and 370 tons of carbon emissions produced for every $1 million in revenue generated, respectively.
According to Ng, the key advantage of this approach is that it solves the double counting issue that many ESG data vendors face when they try to capture all scopes of emission data. For example, a company’s scope 1 emissions may become its client’s scope 2 emissions, and even the end-consumer’s scope 3 emissions. GMO’s new approach ensures that companies receive accurate allocations of carbon emissions based on their activities within the supply chain, Ng said.
In some cases, GMO’s approach can produce results that are meaningfully different from those of data vendors. Take China State Construction Engineering Corporation, for example. According to GMO’s estimates, the company produced 260 metric tons of indirect carbon emissions in the third quarter of 2022, while another large data vendor reported that it only produced 101 metric tons during the same period.
But overall, Ng found that the results produced by GMO’s approach have “decent” correlations with those produced by other ESG data providers. The main difference is that other data vendors tend to “consistently underreport scope 3 emissions,” she said.
According to Ng, the new approach allows investors to construct a better ESG portfolio and engage with companies that are less carbon-efficient. “We are using it as a broader measure of emissions and then building portfolios that are optimized,” Ng said. “The other way we would look at it is on the engagement case…It allows you to have a full insight into where the companies’ emissions are coming from.”
