Viewpoint: Are sustainability standards a distraction?

‘How long is the coast of Britain?’ The shorter your ruler, the longer the coast. Similar ambiguities abound in sustainability.

A company can track its water or power usage. But what about its carbon consumption? The answer can vary with the granularity of the analysis, as the carbon may often be tucked away in the value chain – think of a meatpacking company with zero-emission trucks but full of beef from rainforest-bulldozing pastures, or a bank approving a new oil field loan in offices running on 100% clean power.

Unsurprisingly, companies cherry-pick what to measure and report: just 16% of EU banks and insurers provided ‘adequate’ disclosure of such ‘financed emissions’, per analysis from the European Central Bank, even as they fastidiously report employee flights whose climate impacts are orders of magnitude lower (malicious readers may find echoes of banks scrupulous about interns’ coffee expenses but lenient with boss bonuses after bailouts).

To cut through the confusion, calls for the standardised reporting of value-chain emissions (aka ‘Scope 3’ in the lingo) have increased – from industry networks (such as financial alliance Partnership for Carbon Accounting Financials), international standard-setters (such as the International Sustainability Standards Board, ISSB) and several national regulators, of which the most debated, and ultimately abortive, were those from the US Securities and Exchange Commission (SEC).

What is often lost in this debate is that the main challenge is less the absence of data, as not knowing what to make of it. And standards can, at best, help with the former, not the latter.

The fact that the Ordnance Survey puts the length of the UK coastline as 11,073 miles does nothing to address the deeper, mathematical point from Benoit Mandelbrot’s coastline paradox paper, namely that any such number is only one way among many of setting the ‘resolution’ of your measurement.

Similarly, attempts to lay down ‘carbon boundaries’ (include your suppliers up to this size, and your customers up to this size, etc.) inevitably retain an element of arbitrariness.

“The right way to think about value chain emissions is not in terms of responsibility, but of risk”

Iancu Daramus, sustainable investment specialist

Proponents see this as a price worth paying, given the much higher degree of randomness, fragmentation and cherry-picking around what companies currently disclose when it comes to their climate impacts. Opponents find this an undue burden.

Part of the pushback in the US came from the fact that, unlike with water or waste – where clear, unique and causal attributions are possible (had the company not existed, neither had its waste) – responsibility for carbon can be more diffused. Yes, the bank financed, but some other company drilled, and someone else altogether drove the gas-guzzler.

Nevertheless, if, say, internal combustion engines are banned, it will lead to losses for the petrol station operator, the provider of car loans, the automaker and the oil company – which likely stand to lose 100% of the associated revenues, not some per cent corresponding to their ‘responsibility’.

This shows us that the right way to think about value chain emissions is not in terms of responsibility, but of risk. The SEC proposals alluded to this in saying that, already, investors are requiring such information from companies – but less appreciated is why they (should) want this information in the first place.

The problem is that understanding this exposure to the carbon value chain is complex and inevitably requires judgment. If two companies have the same emissions ‘inside their factory gates’ (think smokestacks and the power plants they run on), they face, ceteris paribus, the same regulatory risk (in the EU, for example, there is a fixed amount paid per each tonne of carbon emitted). If, however, they have the same carbon in their value chain, we can say nothing about which faces the higher regulatory risk.

“Understanding which dominoes of demand would fall in which order is a task that cannot be outsourced to regulators”

Take oil majors. If every barrel of oil they produced was a ‘carbon liability’, this would only manifest indirectly. In a world which phased out oil, it would be others (say, airlines, or shipping companies buying fuel) that would take the first hit. And understanding which dominoes of demand would fall in which order is a task which cannot be outsourced to regulators – indeed, it is the first-order duty of investors who are observing the energy transition. Nor can we pretend that there is a single ‘correct’ way to think about this.

As a result of a shift towards lower-carbon transport, investors in the auto sector could be overweight in ‘pure-play’ EV makers (like Tesla), or in hybrids (like Toyota) or in hydrogen fuel cells cars (such as… well, that’s a different story). The point is that reasonable people can disagree on the speed of the transition; it will not be regulators to say who is right and who is ‘greenwashing’.

Sadly, this is occasionally lost, for example in proposals from the European Union that require that investors tracking certain benchmarks use an aggregated measure of emissions both inside and outside the factory gates, effectively lumping together carbon apples and oranges – with the net result of just introducing additional penalties on what we already knew were the most carbon-intensive sectors (like energy, materials, and transport).

To be clear – addressing emissions across the value chain is an essential measure. Companies, investors and policymakers should be observing this closely, and standards can help make some inroads. But we should not pretend it is the absence of data that is hindering action. If Moses came down from the mountain with tablets on which perfect Scope 3 data was written, the hard work would only just begin.