Climate Blog #2: You can't manage what you don't measure. Quantifying Carbon
You can’t manage what you don’t measure.?
In my last role, I spent four plus years working at a firm that rebuilt financial operations for scaling businesses. Typically, early stage companies are trying to do it all, build a team, product, sales, identify customers, and make payroll, so early on financial systems, operations, controls and reporting are generally an afterthought. Survival is the priority. Then suddenly an outside third party forces you to professionalize. Banks, boards, investors, or audits often act as catalysts, prompting founders to realize their accounting and financial processes are flawed or unscalable.
Through this experience, I witnessed how crucial accurate financial data, streamlined reporting, and financial controls are to a business's growth and success. If you don’t know, or worse, choose to ignore what the data is telling you, the company is effectively flying blind and making strategic decisions on bad information. Understanding and reporting accurate financials are not only critical to business performance, but also to ensure you stay out of jail! Go provide inaccurate financial information to the bank, auditors, or the IRS and see what happens. There are consequences for ignoring the problem or fudging the truth.?
There is a parallel problem in climate. I’d argue in a largely capitalist society our collective failure to quantify and assign a tangible cost to carbon emissions is the root cause of climate change. Corporate entities, driven by the primary goal of maximizing shareholder value, have been particularly resistant to the idea of quantifying their carbon footprint. This reluctance stems from a fear of being held accountable for environmental degradation—a liability many are not prepared or simply choose not to face. The prevailing 'head in the sand' mentality, characterized by a deliberate avoidance of confronting the issue (and actively fighting against), is proving increasingly untenable in the face of mounting evidence, public scrutiny, and quite frankly corporate financial risks due to climate!
We are using the atmosphere the same way people dumping raw sewage in the streets did in the 1600s. Waste management improved because its impacts— disease and smell—were direct and observable. People are finally waking up to the impact of treating the air like a landfill for centuries. It will take a mix of sticks and carrots, but the push to quantify carbon emissions is finally happening. And you can't manage without measuring! In response to these pressures, companies are beginning to take proactive steps towards understanding and mitigating their carbon emissions. This emerging trend is accompanied by the rise of a new industry centered around carbon accounting. A burgeoning ecosystem of software and consulting firms specializing in carbon management is now offering solutions to help businesses navigate the complexities of measuring, reporting, and reducing their carbon footprint.
Net Zero Goes Mainstream
As someone that is working on personal growth goals, it turns out making a commitment to change in the future is very different than actually changing (and proving you did)! The good news is the number of companies and governments that recognize climate change are in the majority. According to the Net Zero tracker, 1,083 companies across the globe have announced net zero ambitions and are at various stages of roll out. This is up 156% since 2020 as more and more companies make pledges. This represents over 88% of emissions which is a fantastic start.??
So what does net zero mean exactly? And how are these goals established?
Two major initiatives set the stage for tracking net zero goals, the Carbon Disclosure Project (CDP) and the Science Based Targets Initiative (SBTi).? Founded in 2000, the CDP was established in London with the primary goal of encouraging companies and cities to disclose their environmental impacts and strategies to reduce them. The idea was that by making this information available, investors, companies, and governments could make better-informed decisions that would lead to a reduction in greenhouse gas emissions and mitigate climate change. Over the last few decades, the CDP developed sophisticated scoring systems for companies and cities to report their carbon emissions, ultimately becoming the one of the world’s largest repositories of environmental data. In response to the Paris Agreement in 2015 that set a global target to keep warming below 1.5C of pre-industrial levels, the SBTi was created in conjunction with the CDP to set science based emission reductions initiatives in line with the Paris targets.?
Companies reporting through CDP are prompted to disclose whether they have set or committed to setting science-based targets, linking the disclosure process with scientifically grounded climate action. This collaboration ensures that the push for transparency (CDP) is directly tied to the push for ambitious, actionable targets to mitigate climate change (SBTi), fostering a comprehensive approach to corporate environmental responsibility.
SBTi works with companies on a 5 step process in developing a plan for Net Zero:
Through this process, companies develop and communicate their plans to reach net zero. Put simply, net zero is achieved when the balance of the amount of greenhouse gasses we emit is in line with the amount we remove. Net zero puts a hard focus on removing Scope 1, 2, and 3 emissions from operations. Illustrated below, Scope 1 are direct emissions generated from operations. Scope 2 are indirect emissions generated from energy usage. Finally Scope 3 emissions are everything else, basically all upstream and downstream emissions generated from a company’s supply chain.?
A company reaches net zero emissions when it has deeply reduced its greenhouse gas (GHG) emissions across all scopes (1, 2, and 3) in line with the 1.5°C pathway, and has neutralized the impact of any residual emissions by removing an equivalent amount of atmospheric carbon dioxide.?
The primary focus for companies looking to achieve net zero is achieving deep reductions in GHG emissions across all scopes at least 90-95% before 2050 depending on sector. For the remaining emissions that cannot be eliminated through reduction efforts, companies must neutralize their impact. This involves investing in measures to remove carbon dioxide from the atmosphere, ensuring that the amount of CO2 removed is equivalent to the amount of the company's residual emissions.?
The SBTi emphasizes that neutralization should be achieved through credible carbon removals, which can include nature-based solutions (like reforestation) or technology-based solutions (like direct air capture and storage), with a preference for permanent removal mechanisms. This has created the emergence of the voluntary and compliance carbon offset markets where companies can sell credits to companies looking to offset emissions to get in line with their targets.?
The major challenge with the approach today is companies have largely utilized offsets as Plan A instead of focusing efforts on internal decarbonization. It is much harder to fundamentally change operations than just write a check. The problem with this approach is the offset market is going through significant growing pains around verification and creditworthiness. While you don’t want to throw the baby out with the bathwater, many offsets purchased are worthless which ultimately accomplishes nothing. Offsets are meant for the hard to decarbonize parts of the economy (think cement production, aviation fuels, food production) that are extremely difficult to decarbonize or where there is not a current solution in the market.?
Finally, to meet SBTi standards, companies must report their progress towards net zero in a transparent and verifiable manner. This includes regular public disclosure of GHG emissions, the steps taken to reduce emissions, and the measures implemented to neutralize residual emissions.
Much like everything else, the devil is in the details!?
The Greenwashing Problem
As we began the previous section with some encouraging news regarding company Net Zero commitments, we should note that these commitments are largely voluntary. So while slick marketing campaigns might appease customers pushing for sustainability initiatives, companies policing themselves historically haven’t ended well. And so far the follow through has been lacking according to the 2023 Net Zero Stocktake report :??
Despite continued progress on the quantity of corporate target-setting, the NZT warns that the integrity of company mitigation targets should urgently improve if they are to be achieved in line with the Paris Agreement’s temperature targets. The last Net Zero Stocktake, published in June 2023 showed that:
There are a number of ways for companies to greenwash their sustainability claims, some examples:
Dubious Marketing Campaigns - The most common form of greenwashing is pretty straightforward. Companies market their products or services as sustainable only to be called out that they are grossly overstating or just straight up lying. An example of this is Nike’s sustainability product line that “capitalized on consumers’ capitalize on consumers’ preference for “green” products by falsely claiming that certain apparel tagged with ‘sustainable’ claims and marketed as supporting the retailer’s waste- and carbon-reducing ‘Move to Zero’ initiative are, unbeknownst to the public, made from non-biodegradable plastic-based materials.” The class-action found that of the company’s 2,452 products in the “Sustainability” Collection, only 10% made with any recycled materials.
Limited Scopes - As we have touched on, there has been a significant growth in developing Net Zero which is a good thing, but only 37% fully cover Scope 3 or “supply chain” emissions. This ultimately won’t move the needle as a significant majority of a sector’s emissions come from Scope 3. Companies like Walmart stated Net Zero goals on only Scope 1 and 2, which only made up 5% of their total emissions. When broken down by sector, you can see how without Scope 3 these pledges are largely meaningless.?????
"Renewable Investment" - As companies make claims of their investment into renewable sources, watchdogs are catching on to shoddy accounting techniques. In 2021, Shell claimed to be investing 12% of capital expenditures in its Renewables and Energy Solutions division, a webpage littered with pictures of solar and wind projects. Turns out only 1.5% of Capex went into renewable projects. The remaining 10.5% was capital invested in natural gas development. Natural gas, while cleaner than the dirtiest sources of energy like coal, is definitely not renewable.?
Outsource to offsets - Voluntary carbon credits and offsets have gone through a rollercoaster of a couple of years. Touted as a transitory solution for companies to finance carbon dioxide removal solutions while they focused on decarbonizing operations, too often offsets have been a crutch for companies to outsource decarbonization problem to others. Rather than investing in efforts to change, companies can meet sustainability goals by paying for credits. While on paper, you might think that’s better than nothing, the issue is around the quality of credits and whether the projects they back actually sequester carbon. Credit standards are starting to converge and formalize standards providing a better path forward to increase quality offsets but credits that don't meet additionality, permanence, overestimation or multiple claim standards not only don't benefit the climate, they can create greenwashing liabilities for companies themselves.
Climate activists are starting to put pressure on companies in various ways. The most effective "stick" to force emissions reductions are regulations from governments. This is almost always met with pushback from corporates, lawyers, and lobbyists that can water down laws before they are put into place. While changes in the law are also at risk based on how political trade winds blow, some of the most effective pressure is from within. As greenwashing risks to corporations are escalating, shareholder pressure can be an interesting tactic for environmental activists to align company risk with climate risk to pressure companies to change.???
Remember, corporations are beholden to the almighty shareholder, so they are forced to listen when the “call is coming from the inside”. More recently, environmentalists are using this tactic to force proxy votes on climate proposals and pressure companies to change.
In 2023, there were 122 proposals at annual shareholder meetings focused on climate change specifically, part of 540 proposals across all ESG categories.?
While most resolutions are non-binding, they’re becoming an effective tool. According to Ceres in 2022, shareholders negotiated 110 climate related agreements in exchange for withdrawals leading to real change. Another 15 climate resolutions went to vote and won a majority of support from shareholders. Examples include electric utilities setting Scope 3 targets beyond 1 and 2, consumer companies developing SBTi backed goals hardening their commitments, and companies agreeing to report on anti-climate lobbying.
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There are a number of tactics to battle greenwashing and holding companies to account. Whether its public pressure calling out marketing campaigns, shareholder proxy votes, or setting Net Zero goals based on science, all can be effective in driving change. All however are largely voluntary and face strong pushback from those who profit on the status quo.?
Unless companies are forced to change, we won’t move quickly enough on climate. In come the sticks, in alphabet soup form!
Alphabet Soup
TCFD, GHGP, IFRS, CSSB, SEC, ISO 1400s, SASB…woah what now??
When I started my Climatebase Fellowship and started learning about the regulatory bodies, standards, frameworks, and protocols, I will admit I was very overwhelmed. And for good reason! As the climate regulatory landscape has evolved, basically from scratch, it has created an “alphabet soup” problem for companies trying to navigate the compliance landscape. The slightly good news here is that the patchwork of mandatory disclosures is not a brand new set of rules, but rather built on top of one another, evolving over time.??
We've touched on two organizations, the CDP (originated in 2000) and SBTi (2015) who aligned reporting frameworks with the Paris Agreement standard of keeping global warming under 1.5 C. I want to focus mostly on the latest announcements in the U.S. regarding the SEC and California's mandatory compliance legislation that will directly affect companies over the next few years, but I think it's helpful to provide a bit of historical context.
TCFD: In 2017, the Task Force on Climate Related Financial Disclosures (TCFD) was created by the Financial Stability Board an organization tasked with creating a global framework for climate disclosures. This disclosure was voluntary and focused on four key pillars: Governance, Strategy, Risk Management, and Metrics & Targets.
While the TCFD was voluntary, the standard was widely adopted as the first sets of regional mandatory disclosures emerged.
ISSB: The International Sustainability Standards Board (ISSB) was created by the International Financial Reporting Standards (IFRS) Foundation in response to a global consultation in 2020 . It confirmed the growing and urgent demand among investors and key stakeholders for a consistent, international set of sustainability reporting standards and disclosures. While the TCFD was in place for voluntarily reporting on sustainability-related information, the reporting landscape was still too inconsistent for mandatory global compliance. So the ISSB released a global set of standards called IFRS 1 and IFRS 2 that were built upon the TCFD voluntary framework consistent with the thematic pillars, but requires more detail:
So with an increasing convergence of global frameworks, corporations have a better understanding of the information they will be required to provide and governments have frameworks to build regulations upon. Essentially they aren't having to recreate the wheel.
As a result of these frameworks coming together and mandatory compliance coming down the pike, more and more publicly traded companies started voluntarily disclosing sustainability reports. Still this created the need for a true "apples to apples" measurement between corporations to ensure accuracy.
U.S. Based Mandatory Compliance - SEC
Which brings us to the latest (U.S based) news in the space: The Securities Exchange Commission (SEC) and California rules being enforced over the coming years.
On March 6th, 2024, the SEC voted to adopt new climate disclosure rules after two years and 24,000 public comments after the new rules were originally proposed. They come with a watered down version from the original proposal, most notably the requirement to disclose Scope 3 emissions being struck from the final rule. Despite numerous lawsuits that will likely take years to resolve, the new rules will go into effect for all publicly traded companies in the U.S. starting in 2025. Companies must disclose Scope 1 and 2 GHG emissions, climate-related risks, board oversight and management of those risks, and climate-related goals which could have a material impact on the business.
Reporting timelines depend on the type of filer you are, with only large accelerated filers (LAFs) and accelerated filers (AFs) have to disclose material Scope 1 and 2 emissions, while smaller companies do not. Materiality can be somewhat subjective and each company will need to make a determination based on its own circumstances. To determine materiality companies generally need to apply US Supreme Court's tests : Would the information be important to the reasonable investor in making an investment or voting decision? Would omission of that information substantially alter the total mix of information available to investors??Companies will also have to provide assurance in future years depending on size.
As it relates to Scope 3, the requirement from the SEC was removed as the regulation of private companies is left to the states. It would have created a legal problem when it comes to reporting, as it requires publicly traded companies to seek out information from privately held companies, basically creating an indirect regulation of private companies.
All companies, however, will have to disclose their climate-related financial risks in line with the TCFD. This includes any risks likely to have a material impact on your business strategy, operations, financial condition, or business model and outlook. The rule also requires you to share information about your efforts to mitigate or adapt to risks — efforts like transition plans, scenario analysis, and carbon pricing. You’ll also need to disclose any climate-related targets and goals, as well as details about board oversight and risk assessment processes (ironically this could disincentivize companies from setting climate targets and goals in the first place). Lastly, companies will have to report on the impacts of severe weather and climate events have on their business losses and the costs and expenses related to carbon offsets and renewable energy credits.
California, Europe and Scope 3
While climate activists where disappointed the SEC did not keep mandatory disclosure on Scope 3 it might not really matter. In 2023, California passed The Climate Corporate Data Accountability Act (Senate Bill 253) and the Climate-Related Financial Risk Act (Senate Bill 261) requiring public and private businesses operating in California with with $1B or more in revenue operating in California to report Scope 1, 2, and 3 GHG emissions. They will start reporting in 2026 on 2025 data — and the law mandates that these reports receive third-party assurance to ensure their accuracy.
SB 261 broadens the net by requiring large US businesses with annual revenues over $500M USD operating in California to publicly disclose climate-related financial risks and mitigation strategies, irrespective of their operational jurisdiction within the United States. As with SB 253, this law applies to both publicly traded and private companies.
So if you want to do business in California, you need to comply with the more stringent California mandates. Roughly 73% of the Fortune 1000 will be subject to California's laws whose reporting will meet new SEC requirements. In total about 5,000 companies would be subject to SB 253 and 10,000 companies subject to SB 261 .
This doesn't include European requirements which includes a significant number of US companies as well. It should be noted that both the SEC and California rules only require financial materiality which report on the climate risk impact on the company. In Europe, the CSRD standards require companies to provide an assessment of double materiality which includes information on the company's impact on the environment as well.
Lastly, these changes in disclosure require just that, disclosure. As of today companies don't actually have to do anything to improve their carbon footprints or are not at risk for fines related to exceeding cetain GHG thresholds. You can't manage what you don't measure, so first governments are focused on the measure part. The management is likely to follow down the road, however.
Winners: The Climate...and the accountants
Publicly traded companies have been well aware these rules were coming, and have had a couple of years to fully implement carbon accounting operations to comply with the new rules. These changes create a significant opportunity for the compliance industry as these companies invest in reporting and tools. According to a 2022 survey from Deloitte , the significant majority of companies across all industries were preparing for increased disclosure requirements.
Rigorous climate reporting creates a new opportunity across the value chain of accountants and auditors. The big four (Deloitte, EY, KPMG, PwC) fill the need in helping companies assess materiality and audit their climate-related disclosures, and software companies (e.g. Watershed,?Persefoni, Sweep, Carbon Direct) streamline the tracking of emissions and climate risk data. By the end of 2023 startups focused on carbon management had raised over $730m in venture funding and at least 18 companies had raised more than $15m.
Wrapping up
Needless to say, this is where I see the world moving. Decisions in the future will need to be made with carbon as a variable. We can no longer ignore the cost to the environment and we are in the very early innings of the changes in reporting needed to get there. While the road will be bumpy, primarily in calculating Scope 3 emissions and legal/political battles, the world is starting to recognize the need to quantify carbon and minimize climate risk. In theory, aligning financial risk with climate risk should catalyze change. Hopefully we'll all be better off in the future decisions made today will actually benefit future generations rather than increase their climate risk.