But, how does a law firm go about calculating carbon emissions, also referred to as greenhouse gas (GHG) emissions, which is the first of many topics that U.S. regulators among others are starting to require? The process for quantifying this is known as carbon accounting.

Components of carbon emissions

The most common elements of the firm’s operations that are key to calculating carbon emissions are categorized in Scope 1, 2 and 3 type emissions.

Scope 1 emissions overview — Law firms are office-based and usually serve as tenants. Direct emissions (known as Scope 1) come from activities under control of the firm. Not surprisingly, law firms generally have smaller amounts of Scope 1 emissions. Typically, these emissions will come from any fuel and gas related to the operation of the building as well as from refrigerants (i.e., refrigeration, air conditioning) and fall into several areas of combustion:

• • • stationary (fuel and gas onsite);
    • mobile (firm-owned vehicles using fossil fuels); and
    • fugitive emissions (vapors directly released, like refrigerants, fire suppression).

Details of Scope 2 and 3 — Law firms will have most of their emissions come from Scope 2 and 3 categories. For Scope 2, indirect emissions come from purchased energy in the form of electricity, steam, heat, and cooling. Purchased electricity is the biggest emissions area in Scope 2.

For Scope 3 the most common indirect emissions are in the categories of measuring business travel, commuting, and purchased goods & services, including paper and waste. In the commuting category, some firms will include remote work by staff. Remote work emissions include emissions generated by equipment, such as lights, laptops, and other office equipment at home.

Key factors in carbon emissions calculations

Quantifying GHG emissions can get complicated pretty quickly, and this is why it is important to identify the subcomponents by Scope and focus on data collection first.

For Scope 1 and Scope 2, law firms will use their metered (or sub-metered) data, such as utility bills or purchase receipts and contracts. If they don’t have this, estimates based on square footage by region is the next best option.

For Scope 3, travel data can usually be found with the firm’s corporate travel agency or in the expense management system with purchase records. Commuting data and data related to remote work emissions can be obtained through surveys to employees.

In the area of purchased goods and services, it’s best to first try to obtain the data from the provider, but if the data is not available, using external databases, such as the data from the Intergovernmental Panel on Climate Change (IPCC), is the next best option. For water, the data can be obtained through sub-metered data or water bill. For waste, it is best to work with the building management.

Gather a multidisciplinary team for emissions data gathering & calculation

Compiling a cross-functional team within the support functions of the firm is necessary for the most efficient way to initiate and complete the data gathering process.

• • • Real estate, facilities & operations — Facilities and operations need to work with the building management to obtain critical data for utility data, water, waste, etc. The internal real estate department can be helpful as well.
    • Procurement & finance — Members in the procurement and finance function can help to view and track spending within the supply chain to gather Scope 3 data. Many positions within the procurement team now encompass the responsibility of emissions and decarbonization.
    • Technology — The firm’s IT group also play a role in emissions management by providing more insights on data centers, energy usage, life-cycle assessments, etc. from the procurement and e-waste perspectives.
    • Human resources — HR has a critical role to play in obtaining commuting data, sending out surveys, helping to determine remote work emissions, and other items related to the workforce.

Doing the calculation

Combining the carbon emissions is the next step once the Scope 1, 2, and 3 data sources are collected. The challenge in this step is understanding what emission factors to apply — not surprisingly, this is the point when some organizations choose to hire a consultant.

Some of the emissions factors, which is a representative value that attempts to relate the quantity of a GHG being released to the atmosphere with an activity associated with the release of the GHG, can be found on the Environmental Protection Agency (EPA) web site in the U.S., and on the U.K.’s departmental websites for the Department for Business, Energy, and Industrial Strategy; and the Department for Environment, Food & Rural Affairs. For other jurisdictions, the IPCC also has an emission factor database.

Measuring emissions will continue to evolve with the ability to gather more emission factors to create higher quality baselines. While it is important to start with the data collection, it is imperative for law firms to prioritize the biggest areas of emissions, such as travel, with low-quality data. This is where there is the opportunity for significant improvements, and law firms can refine the calculation over time.

Driving the need for continuous improvement in the calculations are the RFP requests to measure and disclose carbon emissions data from clients. Indeed, this number is likely to increase exponentially, and there will be increasing pressure for third-party verification and assurance.

An enhanced reputation is a huge benefit of carbon accounting and is a big driver to making meaningful change. Striving for this incentivizes law firms to find better ways to do things to reduce inefficiencies, waste, and consumption, which benefits everyone.

This means that only products that have been produced on land that has not been subject to deforestation or forest degradation after December 31, 2019 may be placed on the E.U. market or exported.

This is just one more sign of the ongoing expansion of regulations focused on risks related to environmental, social & governance (ESG) issues — in this case, those with a focus on the E. However, E is not the alone in this regulation, as respect for human rights will be considered an obligation for a product to be considered deforestation-free.

While this regulation would not ban any country or commodity specifically, companies will not be allowed to sell their products in the E.U. without this type of statement. This means that companies will also have to verify compliance with relevant legislation originating out of the country of production, including those on human rights and the rights of concerned Indigenous peoples.

Scope of legislation

The products covered by the new legislation include cattle, cocoa, coffee, palm-oil, soya, and wood, as well as products that contain, have been fed with, or have been made using these commodities (such as leather, chocolate, and furniture). The MEPs also successfully added rubber, charcoal, printed-paper products, and a number of palm oil derivatives to the list. In addition, the legislation also allows for the addition of new commodities to the list.

Additionally, all banking, investment, and insurance activities of financial institutions are required to take additional action around due diligence in the legislation. Specifically, financial services firms would only be allowed to provide financial services to customers if it concludes that there is no more than a negligible risk that the services potentially provide support directly or indirectly to activities leading to deforestation, forest degradation, or forest conversion.

This is just another global regulation that reinforces the need for companies to conduct ongoing due diligence with respect to their business partners and make every attempt to map their supply chains to the lowest tier possible.

The competent E.U. authorities will have access to relevant information provided by the companies, such as geo-location coordinates, and be able to conduct checks. They can, for example, use satellite monitoring tools and DNA analysis to check where products come from. The final text of the regulation also includes the obligation to precisely geo-locate the specific plot of land involved in the production or farming of the commodities and products in question.

The European Commission (E.C.) will classify countries, or part thereof, into low-, standard-, or high-risk categories within 18 months of this regulation going into effect. Also, the proportion of checks on operators will be performed according to the country’s risk level: 9% for high risk, 3% for standard risk, and 1% for low risk. For high-risk countries, member states would also have to check 9% of total volumes.

​​​​​​​Penalties for non-compliance and lack of due diligence shall be proportionate and dissuasive, and the maximum amount of a fine is set for at least 4% of the total annual turnover in the E.U. of the non-compliant operator or trader. All products linked to deforestation will be required to be withdrawn from the market if they are already present in the E.U. market.

Although the final technical details of the exact wording are still being worked out, the goal is to introduce mechanisms to avoid duplication of obligations and reduce the administrative burden. The final text will also include language that small operators will be able to rely on larger operators to prepare due diligence declarations. This is another example of how the E.U. is taking smaller businesses into consideration when drafting these new requirements.

Next steps

The MEPs and Council will need to formally approve the agreement, which is anticipated. The new law will come into force 20 days after its publication in the E.U. Official Journal, but some articles will apply 18 months later.

The E.C. will step up dialogue with other big consumer countries and engage multilaterally to join efforts, so companies should monitor how these discussions proceed and to what degree these requirements could apply outside the E.U. in the future. For example, a new bill was introduced in the current U.S. Congress in November 2022 that is seen as a response to the E.U. legislation.

While this regulation would not ban any country or commodity specifically, companies will not be allowed to sell their products in the E.U. without this type of statement.

This is just another global regulation that reinforces the need for companies to conduct ongoing due diligence with respect to their business partners and make every attempt to map their supply chains to the lowest tier possible. As the first reports will likely be due to the E.C. by April 2024, putting solid due diligence practices in place now are part of a responsible sourcing strategy. Tools to certify that small suppliers of raw materials are sourced from areas that are not degrading forests no doubt will be required. Moreover, tools that allow users of raw materials in their products to monitor them on an ongoing basis is equally important to ensure compliance is maintained.

At the same time, uncertainty remains. Currently the regulation avoids a clear directive for producer-countries to require standards for human rights or to define what the term deforestation means. Without this, companies may seek to source products from jurisdictions in which relatively weak legal frameworks exist, and thus, could undermine the E.U.’s intent with the regulations.

The need for the E.U. to seek input from all stakeholders— including producer countries; local communities in producer countries; small land users that produce in-scope materials and products and mostly reside in Southeast Asia; local buyers of raw materials that sell them to small-, medium-, and large-sized companies; and multinational companies that purchase the in-scope materials — is necessary to effectively achieve the intent of the overall legislation, which is to ensure sustainable sourcing and avoid deforestation or forest degradation.

The Carbon Disclosure Project estimates that Scope 3 emissions account for an average of three-quarters of a company’s emissions, according to the World Resources Institute. “Other studies show that the supply chains of eight sectors account for half of the world’s [greenhouse gas] GHG emissions and provide evidence that Scope 3 emissions from energy-intensive industries are increasing faster than their Scope 1 and 2 emissions.” Indeed, counting Scope 3 emissions is of paramount importance.

Variations in carbon emissions regulations make reporting murky

In the U.S., the Securities and Exchange Commission (SEC) mandates the disclosure of Scope 1 and Scope 2 emissions. According to the United Nations Global Compact, Scope 3 emissions account for approximately 70% of the average corporate value chain total emissions and are 11-times higher than Scope 1 emissions. Under SEC rules, Scope 3 emissions are only required to be disclosed if they are material or if the companies have Scope 3 emission targets. Currently, around 7,000 publicly traded companies are covered by this regulation.

By contrast, the Corporate Sustainability Reporting Directive (CSRD) in Europe is much broader. It includes 49,000 medium and large companies, covering all private and public companies with at least 500 workers. The European regulation affects more than 10,000 non-European companies, of which 30% are U.S. companies, according to data from Refinitiv.

Adding to the complexity of regulation is that specific rules within the regulation across countries and states or provinces can vary widely. As of August 2020, at least 40 countries required facilities or companies to measure and report their emissions periodically. With this list growing, it is good news that the GHP is the go-to resource for calculations and that additional harmonization of emission standards is ongoing.

Double counting not really a concern

When it becomes a legal requirement, accurate and homogenous collection, standardization, and reporting of Scope 3 emissions will be critical for both reporting companies and those using the data to make investment decisions.

Collecting data on Scope 3 emissions requires information from multiple sources, such as suppliers, customers, and other stakeholders, making it difficult to obtain accurate and reliable data. This affects the quality of the data, as it can vary or be incomplete or inaccurate. To combat this, companies may need to use multiple methods to collect data from various sources, which can come at a cost, especially for those with complex value chains.

While, as mentioned, the GHP has developed the corporate value chain accounting and reporting standard methodology for measuring and reporting Scope 3 emissions, one of the main criticisms around universal counting of Scope 3 emissions is the potential for double counting. This is because one company’s Scope 1 emissions are another company’s Scope 3 or Scope 2 emissions — and in some industries, the possibility exists for multiple companies to use the same supplier.

Collecting data on Scope 3 emissions requires information from multiple sources, such as suppliers, customers, and other stakeholders, making it difficult to obtain accurate and reliable data.

Double counting may occur when a manufacturer and a retailer both account for Scope 3 emissions resulting from the third-party transportation of goods between them. This only becomes problematic when claims are made that these emissions are offset with credits or provide a monetary value and when the same activity, such as the transportation of goods, is offset by another company. There are many other examples of double counting; for example, it may be acceptable to double count when a specific emissions goal is tracked over time and its progress needs to be reported.

Clear communication of reporting boundaries and emissions calculations can help identify potential overlaps and ensure that each company reports only its own emissions. This approach can provide a more accurate picture of a company’s carbon footprint and more fully support efforts to reduce emissions across the value chain.

Further, the GHP understands the need for additional clarification and is working towards the harmonization of U.S. and European disclosure rules. Additional guidance on this important subject is expected to ensure any double-counting concerns are alleviated.

Through taxes, governments can finance public initiatives and subsidize private investment in green industries and other initiatives, incentivizing a shift in private capital towards activities that will further the transition to net zero emission goals. Such investments will help prevent us from breaching our planetary boundaries and mitigate physical risks such as extreme weather, droughts, floods, and wildfires.

Tax credit investments

Investment tax credits at the federal level incentivize business investment. They let businesses deduct a certain percentage of investment costs from their taxes. In the context of green energy, tax credit investments return financial capital to companies to deploy directly into investments such as renewable energy, which boosts the investor’s ESG credentials and helps align the business with a low-carbon economy. Tax credit investments, which is a method used by corporations to provide funding for a project in exchange for the right to claim the available tax credit, enable corporations to use their access to capital to pursue their own path towards a sustainable economy in accordance with their risk/return assessments.

An increasingly popular option as part of an organization’s ESG strategy, tax credit investment has been and is set to become even more popular with the ambitious climate and energy policies of the Inflation Reduction Act (IRA), most of which relate to its more than 24 available tax credits. The IRA, which imposes a 15% corporate minimum tax, will drive $380 billion of investment into renewable energy and sustainable technologies, opening up new areas for tax credit investments such as electric vehicle charging infrastructure, bio-gas, green hydrogen, battery storage, and nuclear energy.

One significant change the IRA made to the clean energy tax credits is to make them refundable and transferable. Transferable tax credits allow companies to sell their tax credits to other entities for cash Refundable credits allow cash payment for tax credits if the amount owed is below zero.

Many U.S. companies need RECs in order to make progress towards their publicly stated goals, such as the country’s commitment to be net zero by 2050.

The Financial Accounting Standards Board, however, is now developing new guidance to clarify and smooth the process, and the Internal Revenue Service will be publishing guidance on the transferability of investment tax credits by mid-2023. Under the new rules, corporations can offset up to 75% of their federal income tax liability and roll this back three years, effectively gaining a rebate of taxes already paid to reinvest in ESG-positive opportunities.

Finally, renewable energy credits (RECs) are “tradeable, market-based instruments that represent the legal property rights to the ‘renewableness’ — or all non-power attributes — of renewable electricity generation,” according to the US Environmental Protection Agency (EPA). In effect, RECs assign ownership for the renewable aspects of the energy creation to the owner, allowing consumers to offset some of their carbon footprint.

Many U.S. companies need RECs in order to make progress towards their publicly stated goals, such as the country’s commitment to be net zero by 2050. Such credits provide a market and revenue stream for renewable energy-producing organizations. These opportunities enable companies to align themselves with a sustainable, green, low-carbon economy, which in turn, will likely lower companies’ transition and liability risks and their cost of capital.

There are also upsides as investors, lenders, and consumers recognize companies’ ESG-credentials. These opportunities for ESG-aligned investment will have notable social impacts around investments in infrastructure, human capital, and research & development. Job creation is a key outcome of investment in renewable energy, contributing to a just transition away from fossil fuels.

Under the IRA, a two-tiered system for renewable energy investment tax credits provides a base credit equal to 20% of the maximum credit and a bonus credit equal to an additional 80% of the maximum credit, but only if certain prevailing wage and apprenticeship requirements are satisfied in connection with the relevant project.

In addition, there are three adder credits that can be stacked on top of underlying credits for: i) meeting specific, domestic content requirements; ii) placing projects in the IRA’s defined energy communities; or iii) undertaking certain low-income solar activities.

While bringing more manufacturing jobs to the U.S. will strengthen employment overall, specifically selecting rural communities for large solar investments, for example, will provide an economic boom to those areas and enrich them through tax equity. There are further social benefits to community solar investments, which will have the ability to sell more than 50% of electricity generated to low-income families at discounted rates.

On the horizon

ESG alignment is the future of corporate investment, and companies should take advantage of the numerous investment opportunities that are emerging in the green transition.

In order to understand how companies can improve their status as social and environmental citizens and mitigate ESG-related risks, accurate measuring and reporting is needed as the first step. And tax credit investments are a direct, straight-forward way to turn this knowledge into a business upside.

In a time of economic and stock market uncertainty, tax credit investments offer a clear opportunity to grow and strengthen a company’s business strategy, while aligning it with the green transition.

This article was written for the Thomson Reuters Institute blog site by Foss & Co. For more information, contact ir@fossandco.com.

The potential mandate of Scope 3 disclosures, which includes reporting of carbon emissions of external suppliers, and the short time frame to comply could leave many companies underprepared. With the rules likely to commence in either late-2023 or 2024, companies have little time to waste in preparing themselves.

Important parts of the proposed SEC rules include:

• • • The reporting scope and subsequent timeline is broken down into four categories: Large accelerated filers, accelerated filers, non-accelerated filers, and small reporting companies, the latter of which need to engage fully with Scope 1 and 2 reporting but not Scope 3.
    • Depending on where they land in the above-mentioned categories, companies will begin reporting from between 2023 through 2025, based on the SEC’s current proposed rules. Most critically, companies must ensure that their entire value chain is engaged to meet the demands of Scope 3 reporting.
    • International companies will be subject to the proposal, and foreign private issuers also will be subject to almost the exact same rulings.

The urgency for companies to prepare is increasing

The tight window for companies to start reporting their Scope 1, 2, and 3 carbon emissions is creating an urgent need for public companies to take action, in particular for large accelerated filers, but many still are waiting. Indeed, many U.S. firms do not currently report on their greenhouse gas (GHG) emissions and only a small minority report on Scope 3 emissions, according to Reuters Insight data, which notes that only 30% of U.S. organizations are reporting Scope 1 and 2 emissions.

Even more worrying is that only 21% of U.S. organizations are reporting Scope 3 emissions. Overall, 32% of U.S. organizations currently have no GHG reporting at all, and another 16% don’t know if they report on GHG emissions, as of the time of Reuters’ survey conducted between August and October 2022.

Greenhouse gas reporting filtered by respondents from U.S. organizations

Understanding how the SEC’s rules apply is not straight forward — Deciphering the SEC’s climate proposal is the key needed action at present for public companies in order to give them the opportunity to prepare. Indeed, understanding the reporting scope under which your company falls is the first challenge to interpreting the appropriate timeline to follow for emission reporting.

With the reporting timeline potentially spanning from 2024 to 2027 and with a legal obligation to report, companies need to consider the full timeline and regulations with which they’ll have to comply under the SEC’s climate rules, once they are finalized.

The requirement for assurances adds to the need for action now — Additionally, this urgency is underscored because it takes time for companies to collect, aggregate, review, and report all of the emissions data across Scope 1, 2, and 3. In addition, large accelerated filers and accelerated filers are required to provide both limited and reasonable assurance — which often includes third-party verification — for the data, Specifically i) for large accelerated filers, limited assurance for the financial year 2024 to be filed in 2025, and reasonable assurance for the financial year 2026 to be filed in 2027; and ii) for accelerated filers, limited assurance for the financial year 2025 to be filed in 2026, and reasonable assurance for the financial year 2027 to be filed in 2028.

Scope 3 data is poor and the time to collect is insufficient — For organizations that are required to report Scope 3 data, a long lead time to collect and gather data is key. However, this data is usually poor. Of those U.S. companies that are already engage with Scope 3, most rate their Scope 3 data management negatively in terms of ease (63% of survey respondents say it is poor); effectiveness (62% poor); and efficiency (68% poor). This indicates that current practices for managing Scope 3 data require considerable improvements.

Advancing time for gaining approval for additional resources may be necessary — The primary cost expected from the SEC proposal are compliance costs. Companies may need to shift personnel and hire or retain additional staff to meet these demands. Data gathering, verification, and integration of new software will all also have to be considered by companies, along with outsourcing or partnering with third parties that can link internal upskilling with external support. The SEC estimates that the first-year cost of complying with the proposal will be $640,000 for companies not in the small reporting companies category.

Investors are driving the need for rules

The transparent disclosure of both aggregated and disaggregated GHG emissions will allow investors to access decision-useful information. This information can be broken down to allow them to identify risks posed by each unique greenhouse gas — for example, methane or carbon dioxide — while also showcasing total GHG emissions by either Scope 1, 2, or 3.

Using the full value chain of emissions also allows investors to make quantifiable voting decisions to aid their investment decision-making.

This blog post is based on a report that was originally published on Reuters Insight Sustainable Business.

Further, these findings were recorded before the U.S. Securities & Exchange Commission (SEC) proposed that public companies begin reporting their carbon emissions for Scopes 1, 2, and 3. Since then, the ESG regulatory landscape has changed dramatically with an increased likelihood that the percentage of legal buyers viewing ESG as important is much higher.

The question remains, however, whether or not U.S. companies will be ready once the rules are finalized. Indeed, only 30% of U.S. organizations currently are reporting Scope 1 and 2 emissions and only 21% of U.S. organizations are reporting Scope 3 emissions. Overall, 32% of U.S. organizations currently have no greenhouse gas (GHG) reporting at all as of October 2022, according to Reuters Insights Sustainability research.

Tech tian Intel falls into that 21% of companies that are already reporting on carbon emissions throughout their supply chain (Scope 3 emissions). In fact, Intel has committed to some level of corporate social responsibility reporting since the 1990s. Adam Schafer, Senior Director of Supply Chain Sustainability at Intel, who has been in the role since 2017, explained how the company’s industry collaboration enables more efficient and effective management of its supply chain sustainability programs.

In his role, Schafer says he oversees Intel’s complex supply chains — which include manufactured outsourcing, direct manufacturing and fabrication, and equipment and indirect materials — to ensure due diligence and global compliance in the company’s human rights, code of conduct, responsible minerals, and Scope 3 supply chain commitments. Intel’s effort also includes operational components of supplier diversity, equity & inclusion (DEI) and the company’s green chemistry program.

Schafer describes Intel’s ESG program as mature and complex with a commitment to staying ahead of the curve when compared to its peers. The foundation of the company’s ESG strategy concerns transparency and ethics, he says, adding that to enhance transparency, the company unified its ESG goals around its RISE (Responsible Inclusive, Sustainable and Enabling) framework in 2019, which outlines 27 goals and targets for achievement by 2030. And to simplify how it communicates its ESG strategic progress to its stakeholders, Intel integrated its reporting mechanisms across its annual and quarterly SEC filings in 2021 as well as its corporate social responsibility report.

Driving compliance in complex supply chains

One of the most time-consuming and complex areas of sustainability compliance across Intel’s supply chain is its responsible minerals program. As a semiconductor company, Intel uses several raw materials that need to be traced to the source of their extraction.

One of the key mechanisms that helps Intel’s ability to trace its raw materials to their source is its leadership in the responsible mineral initiative (RMI), which is part of the Responsible Business Alliance (RBA), the largest industry coalition dedicated to corporate social responsibility in global supply chains.

By using RMI requirements as the centerpiece of its program, Intel set its due diligence requirements in responsible minerals around the ability to track and trace down the origins of their minerals from which smelters these raw minerals were extracted down to the mine from which they came. The RMI outlines the requirements for certification of smelters for hundreds of companies which use these raw minerals. And last year, 98% of smelters for these materials that Intel used were RMI-certified, Schafer says.

Part of the challenge for Schafer is keeping up with the evolving expectations of stakeholders on carbon emissions and responsible minerals while maintaining rigor in the areas for which he is responsible. For example, the responsible sourcing movement has expanded beyond minerals quickly over the last 5 years. “The regulatory demand signal is shifting, but one important point to underscore is that the standards aren’t necessarily changing, but the degree of traceability — to be able to understand as a company what are you making, where it all comes from, and how was it made — are evolving,” Schafer explains.

“Using responsible minerals as an example, going to the smelter-level and doing our due diligence and reporting is getting more detailed,” he adds. “Right now, we know the percentage of our responsibly sourced minerals, but where it is going is [for us] to identify where every kilogram of particular material comes from. This is traceability — and this is the real challenge across our supply,” he elaborates.

Participation enables efficient monitoring

An important but often overlooked element of creating ESG due diligence and compliance programs is collaboration with industry participants for better efficiency among both the suppliers and the buyers. Indeed, Intel’s participation with the RBA makes responsible minerals compliance many times more efficient compared to having Intel use its own framework, notes Schafer.

One of the key drivers for Intel’s leadership in the RBA is the fact that 75% to 80% of its revenue is represented through the RBA membership. Participation in the RBA enables the company to demonstrate the importance of being a responsible business to its customers and suppliers, which are two key ESG stakeholders. It also helps the company stay up to date on the materiality of these two key stakeholder groups.

“We can’t make progress alone, and we can’t accelerate achievement of our goals alone,” Schafer says. “If we tried to do this alone, it would be less effective and more expensive, so we have to work with others to get them on board, and make sure they understand their obligations and what it is that we all need to meet those stakeholder demands.”

Biodiversity & why it’s important

The fight against the loss of biodiversity — defined as the variety of animals, plants, fungi, and microorganisms that make up the natural world and work together in specific ecosystems to maintain balance and support life — has been around for more than 30 years. Only now, however, are the devastating effects of biodiversity loss being felt by humans in everyday life through such cataclysmic activities as deforestation for the cultivation of meat, or the use of chemicals in the production of fruit and vegetables that causes soil loss and other related harm.

Many scientists think the huge current loss of biodiversity could be the start of a new mass extinction, and new research indicates that ecosystems will collapse in the future, if significant action is not taken to reverse these losses.

Governments & business collaborating

As a result of these scientific predictions, governments are now paying more attention, and global agreement on how to best mitigate biodiversity risks through multilateral mechanisms is growing. Although the United Nations has been meeting on this issue through the Convention on Biological Diversity since the mid-1990s, only recently did it set time-bound goals for 2030 and 2050 to build a global guide to reverse nature loss.

About the same time, biodiversity losses gained steam as an ESG-related business topic in 2021 with the launch of the Taskforce on Nature-Related Financial Disclosures (TNFD), a financial services industry advisory group whose members represent more than $20 trillion in assets. The TNFD provides guidance on how to identify and mitigate nature-related risks for companies’ business operations around the globe, principally through its Nature-Related Risk & Opportunity Management & Disclosure Framework, building on the work done by the Taskforce on Climate-Related Financial Disclosures.

New versions of the TNFD’s Framework are released at least once a year, and revisions are intended to ensure that the Framework is applicable and used by corporations, borrowers, and financial institutions of different sizes and in different contexts as well. Most recently, it released its fourth and final beta framework in late-March.

Since the inception of the TNFD, the group has crafted draft disclosure recommendations to incorporate dependencies and impacts on nature alongside risks and opportunities to organizations. The TNFD Framework does not seek to set standards, but instead hopes to develop an integrated framework for the management of these risks and opportunities as well as disclosures which can all feed into the specific standards and disclosure requirements being developed by other organizations, such as the International Sustainability Standards Board.

The release of the TNFD’s third iteration of its beta framework in Fall 2022 included proposals relating to: i) new disclosure recommendations related to supply chain traceability, the quality of stakeholders, engagement, and the alignment of an organization’s climate and nature targets; and ii) draft guidance on target-setting developed with the Science-Based Targets Network and draft disclosure guidance for financial institutions.

Collaboration between governments and the private sector is key to halting and reversing the losses in biodiversity ecosystems. To truly make a difference, engagement with private sector entities is necessary “to make sure that money is going to nature-positive events rather than nature-negative ones,” says Simon Walsh, special counsel in the global litigation practice of Cadwalader, Wickersham & Taft. Walsh has experience in helping financial services companies launch sustainability-linked financial products that align with pro-biodiversity principles.

Partnership in this space between the public and private sectors took a giant leap forward when Germany joined existing states (including the United Kingdom, The Netherlands, and Switzerland) in announcing their funding support for the TNFD at the Convention on Biological Diversity held in December.

Biodiversity legal work increasing

As the financial sector evolves to identify and mitigate nature-related risks more effectively, it is also innovating to expand sustainability-linked financial products. As a result, Walsh says he sees biodiversity loss growing as a concern for litigation risk. “There is a lot of litigation risk around green products, if they’re not correctly labelled or described, or if they’re not achieving the targets that people think they’re meeting,” he explains, adding that in this emerging space, it is important for these products to be “de-risked” and for lawyers to stay current with ESG regulation.

Beyond the financial sector, businesses whose operations interact with nature or contain some dependency on nature are vulnerable to biodiversity risks. In fact, Sukhvir Basran, partner at Cadwalader’s financial services group and ESG practice, says it has become a growing concern for her clients. Basran helps clients integrate the myriad of benchmarks and standards into governance, compliance, and investment processes.

Indeed, Basran says she has a front-row seat to see how banks, private debt clients, mid-market borrowers, and sponsors are considering how to integrate biodiversity principles — as well as climate and social issues more broadly — into their business operations and investment decisions.

On the horizon

The momentum to take action against biodiversity losses is here to stay, according to Basran and Walsh. The TNFD’s work is significant because financial institutions help drive money flows and investment.

At the same time, whether or not the TNFD’s disclosure framework will remain voluntary or if the strong interest from policymakers and regulators indicates regulatory action is imminent remains to be seen. “Either way, it is going to move to a stronger legal footing at some stage,” says Basran. That’s why it is important for business and lawyers involved with ESG matters to get educated now.

The necessity to focus on Scope 3 emissions, in particular, is evident from the Reuters Insight Sustainability Survey 2022, which surveyed senior sustainability practitioners and C-Suite executives. Results showed that 79% of respondents were concerned with their Scope 3 emissions, demonstrating an incentive for companies to invest in improving their emissions data. This increased concern, in part, is because of growing pressure from investors for further granularity in disclosures but also from internal pressure from corporate boards to make more informed decisions.

Likewise, addressing Scope 3 data accuracy sits within the top three of organizations’ priorities as it requires engaging with their supply chains, aids in the reduction of organizations’ climate or carbon impacts (in other words, their decarbonization efforts), and enables further granularity within sustainability reports.

Scope 3 data, however, is difficult to collate as it requires gathering data outside of the company’s four walls. By concentrating on improving the data quality of Scope 3 emissions, organizations can move toward achieving their net-zero transition plans as well as developing the credibility of their reporting and disclosures.

Enhancing supplier engagement is one way to tackle the Scope 3 data challenge by using a spend-based approach, using questionnaires, or calculating emissions by product. Whatever the method, enforcing supplier engagement as a condition of business and the use of contract clauses to mandate data collection can ensure organizations maintain continued dialogue with the intention to improve data quality and reporting.

The challenge does not stop there, however. Achieving sustainable supplier engagement also requires a number of stages which begins with confirming a unanimous commitment within the organization and with the collaboration and cooperation of all internal teams. Investing in data management improvements as part of supplier engagement will also ease the resource burden of aggregating and reporting Scope 3 emissions. Yet, 54% of those currently engaging in their Scope 3 emissions were using a manual process, including using Excel spreadsheets, according to a Reuters Insight survey.

Manually gathering information, however, is not scalable and requires scarce resources and additional bandwidth on activities that are more easily automated. More than 50% of respondents who said they use a manual process to manage Scope 3 emissions described the process as being poor in all three categories of ease (57%), effectiveness (52%), and efficiency (52%).

Management of Scope 3 data

Still, there is investment taking place. In fact, the top three technologies in which Scope 3-engaged organizations already are investing include clean energy (67%), data analytics (44%), and more efficient IT solutions (37%). Although investing in clean energy technologies is more widespread in order to combat Scope 1 and 2 emissions, investing in data analytics and more efficient IT solutions contribute towards the overall improvement in emissions measurement and reporting.

Since Scope 3 emissions are considered to be the most difficult emissions to accurately disclose, technology investment in this area will be especially beneficial to this category of emissions. Organizations’ planned investment across the next 24 months follows a similar pattern, with analytics and more efficient IT solutions remaining within the top three investment areas.

Technology investment for those engaging with Scope 3 emissions

Organizations should determine which software works best for them to create a more streamlined process that reduces errors and further establishes traceability for audits in the future. Data platforms foster mutual benefit in streamlining the internal greenhouse gas (GHG) data management process for organizations, but they also helping other organizations to report on their Scope 3 emissions.

The ultimate aim to improve the quality of Scope 3 emissions data and reporting is likely to result in greater confidence within organizations, discouraging the trend of green-hushing, and preventing further greenwashing.

This is an abridged version of a report that was originally published on Reuters Insight Sustainable Business.

Potential regulatory requirements around Scope 3 greenhouse gas (GHG) emissions, which often represent between 80% to 95% of an organization’s corporate carbon footprint for companies in such industries as consumer packaged goods, electronics, packaging materials, and chemicals, are a current area of particular interest.

The biggest challenges for companies in accurately reporting their Scope 3 emissions are two-fold, according to Mark Evans, Director of Business Development and Sustainability Consulting at Sphera, an ESG solutions software, consulting and data firm. These two challenges to accurate reporting involve: i) determining the most valuable method for calculating GHG emissions emitted from upstream value chains or as defined by the GHG Protocol Scope 3-Category 1 (Purchased goods and services); and ii) identifying how to actually gather this data, whether it be from within the organization itself, its suppliers, third-party databases or elsewhere.

Evans, whose team specializes in helping corporations with complex supply chains — those with hundreds or even thousands of suppliers — calculate their Scope 3 GHG inventory, indicates that there are three main ways companies approach this challenge.

1. Spend data

The most common method of calculating GHG emissions is using spend-based data. Typically, companies determine their level of emissions by using an online calculator that estimates their carbon footprint based on procurement spending.

2. Supplier surveys

In this common approach, companies estimate their emissions by sending questionnaires to their suppliers and vendors about their own GHG emission data and then collecting that data throughout their supply chain.

3. Product life-cycle assessment data

This third way, life-cycle assessment (LCA), is becoming more mainstream as requirements for more precise data develop. LCA is a methodology for assessing environmental impacts throughout the lifecycle of commercial products, processes, or services, by quantifying the amount of energy, materials, and waste discharge. Further, these data sets are governed by ISO 14044 and ISO 14067, globally recognized standards that outline requirements and guidelines for how to conduct product life cycle assessments.

These datasets provide granular GHG emissions data for understanding the cradle-to-gate impacts of a product or process, from extraction of raw materials through processing and production to distribution. LCA data can also be used for Scope 3-Category 11 (Use of sold products), which is the major emissions source-point for the automotive and industrial equipment industries, which see 85% of their Scope 3 emissions in the use-phase of their products.

As the above chart shows, there are pros and cons of each of the main methods for collecting emissions data. For example, companies have seen reductions of up to 90% in their Scope 3-Category 1 GHG emissions after moving away from using the spend based-methodology to the product life-cycle assessment methods, largely due to the use of far better data granularity.

As far as the use of supplier surveys go, companies are dependent on the data supplied to them by their vendors. For example, if a company makes an emissions data request of its T-shirt manufacturer in Indonesia, asking for the GHG emissions generated from within its four walls, any data received is likely to be incomplete and not representative of the actual cradle-to-gate GHG emissions from that supply chain. That is because, essentially, energy consumption at that sewing facility is limited to operating sewing machines and running UV lights. What will not be captured are the upstream impacts from the textile mill, the ginnery, the cotton farm, international transportation and more. As such, GHG emissions associated with this Tier 1 supplier won’t represent a significant piece of the broader emissions picture.

Conversely, an LCA dataset for a cotton T-shirt definitionally captures the impact of each of these production steps from the cotton farm itself and can be adjusted to reflect particular characteristics of a company’s value chain. In addition, LCA data can be used to explore decarbonization pathways through modeling the reduced impacts of bio-based materials, more recycled content, and different production locations.

On the horizon

Improved methods for tracking Scope 3 emissions data will enhance transparency, auditability, and traceability for GHG reporting. This in turn will enable the digitization of carbon footprints versus the most current practice of using a manual approach with data collected in Excel sheets.

These evolving data capture methodologies eventually will enable companies to produce efficient, granular product-level and Scope 3 reporting at scale both internally to management and outwardly to consumers, regulatory agencies, and industry associations.

For more information about how corporations are implementing and executing their ESG initiatives, download our latest white paper, Building a Foundation for ESG here.

While these contract clauses are not yet commonplace, companies should be aware that adding these provisions will introduce a host of new concepts, terminology, and practical implications, which may make their contract drafting and review process more complex.

There are two basic issues to consider when drafting or reviewing climate-conscious clauses in supply chain contracts, such as sale of goods contracts. First, the parties must consider the enforceability of the clauses; and then, the parties must draft the clauses to work well together with the rest of the contract.

Enforceability of climate-conscious clauses

When drafting or reviewing climate-conscious clauses, counsel must first consider their enforceability. For example, the parties should pay attention to climate-conscious clauses that set out their own contractual remedies, such as liquidated damages provisions. A liquidated damages clause requires the breaching party to pay a predetermined amount to the non-breaching party for the types of breaches that are specified in the clause. The predetermined amount can be a fixed amount, or an amount based on a predetermined formula.

Liquidated damages clauses are only enforceable if they reflect the parties’ compensatory rather than punitive intent. The primary purpose of these clauses must be to compensate the non-breaching party for losses, not to punish the breaching party. This means that climate-conscious liquidated damages clauses that require the breaching party to make payment to the non-breaching party’s favorite environmental nonprofit organization (rather than directly to the non-breaching party) may be unenforceable.

Before inserting any new clauses into a contract form, counsel first should check how well they work together with the contract’s existing clauses.

The enforceability of liquidated damages clauses also generally requires that the clause specifies that the liquidated damages are the exclusive remedy for the specified type of breach.

Internal consistency in contracts

Before inserting any new clauses into a contract form, counsel first should check how well they work together with the contract’s existing clauses. For example, most contracts include a general termination provision that allows a party to terminate the contract if the other party breaches it. The provisions are typically tailored to include different notice, cure period, and other requirements for different kinds of termination-triggering events. In addition to breach of contract, these may include, for example, a party’s insolvency or change in control.

Broadly drafted general termination provisions typically include catch-all language to capture all breaches of contract that are not more explicitly set out as a termination-triggering event in the clause. Many broadly drafted general termination provisions may therefore already cover breaches of newly included climate-conscious obligations.

Problems can arise if, in addition to a general termination clause, the contract also includes a dedicated clause providing early termination rights for breach of climate-conscious obligations with its own requirements. Unless climate-related breaches are specifically carved out from the general provision, it may be unclear which provision applies.

A thorough review and comparison of the contract’s climate-conscious and other clauses will enable the parties to detect these and other unintended inconsistencies. Indeed, other unintended inconsistencies can arise if the contract includes such items as:

• • • Different standards to determine whether different types of breaches have occurred. For example, the contract might include a materiality qualifier for the breach of the supplier’s delivery obligations but not for the breach of the supplier’s climate-conscious obligations.
    • A dedicated limitation of liability clause that aims to limit the types or amounts of damages recoverable for the breach of climate-conscious obligations in addition to a general limitation of liability clause.
    • A dedicated indemnification provision for breach of climate-conscious obligations in addition to a general indemnification provision.
    • Special price adjustment provisions that are triggered by climate-related events as well as a general price adjustment clause.

As climate-conscious clauses in supply chain contracts become more commonplace, companies should make themselves aware of how adding these provisions may make their contract drafting and review process more difficult and prepare now for that.

This article was written in conjunction with the Practical Law Commercial Transactions group. For more information on including climate-conscious clauses in supply chain contracts, you can contact Practical Law here.