Author: Katherine Markova

Katherine Markova is a Consultant on 3Degrees’ Energy and Climate Practice consulting team where she supports companies, including financial institutions, to measure and reduce their greenhouse gas emissions and set climate goals.

SBTi Supplier Engagement Guide: It takes a village

An increasing number of companies are setting science-based targets using criteria set out in the Science-Based Targets initiative’s (SBTi) Net-Zero Corporate Standard. One criterion is that companies must set near-term targets on their path to net zero – and if scope 3 emissions make up 40% or more of a company’s total footprint, a near-term scope 3 target must be included. 

Companies that set near-term targets for their scope 3 emissions have a choice of two methods:  

  • Emissions reduction
  • Supplier (or customer) engagement target

As of today, less than 20% of companies with near-term targets have used the supplier engagement method. SBTi recently published detailed guidance about how to set a supplier engagement scope 3 target (“The Guide”), which is the first of its kind! This makes it more accessible – and perhaps more appealing – than ever to set a goal of this kind.

Supplier engagement targets may be particularly valuable for a company that: 

  • Has yet to identify levers for more specific reduction opportunities amongst its value chain partners, and/or 
  • Does not spend enough on individual suppliers to support collaborative reduction efforts

Most companies that have set a supplier engagement target to date have done so because they recognize that they cannot achieve their climate goals alone. 

 

Supplier engagement targets in a nutshell

The supplier engagement method calls for the reporting company to reduce their scope 3 emissions by influencing companies within their value chain to set a science-based target. The previous guidance for setting a supplier engagement target was fairly limited:

  • Supplier engagement can only be used for a near-term target
  • It must be achieved within 5 years 
  • Supplier targets must be in line with SBTi criteria

Now that more detailed guidance has been released, companies have a wealth of additional best practices, recommendations, and examples to consider when designing and implementing their supplier engagement strategy. 

The Guide does not mandate new provisions—it’s less about what one “must” do and more about what one “should consider” doing. It proposes that setting a supplier engagement target is a 5-step process.

 

Step 1: Select the right suppliers

Identify scope 3 categories to include in the target

After completing a scope 3 inventory and identifying hot spots, companies should:

  • Prioritize scope 3 categories for inclusion in the target
  • Choose supplier activities with which the company has credible engagement 

The target should state what percentage of emissions from relevant categories (or, in the absence of emissions data, percent of annual spend) is covered by the engagement target. 

Example: A biotech company commits that 73% of its suppliers spend covering upstream purchased goods and services and capital goods will have science-based targets by 2027.Example: A biotech company commits that 73% of its suppliers spend covering upstream purchased goods and services and capital goods will have science-based targets by 2027.

Identify individual suppliers to include in the target

Once the relevant scope 3 categories have been identified, companies should then work on supplier selection by:

  • Ranking suppliers according to their share of total emissions (or annual spend)
  • Selecting suppliers that cumulatively achieve desired scope 3 emissions coverage
  • Considering additional factors that may be relevant to supplier selection, e.g. the amount of leverage the company has, supplier’s greenhouse gas (GHG) program maturity, likelihood of the supplier setting an SBT, and whether the amount of business with the supplier is expected to grow

Once suppliers have been selected, they must set targets aligned with the current SBTi criteria. Validation by SBTi is recommended but not required. However, without validation, the onus is on the company to ensure they can count supplier SBTs towards their target, which would be practically challenging for most companies.

Companies are increasingly turning to software solutions to enable them to collect data from suppliers and track progress against targets. Selecting a GHG measurement and management tool can be a challenge as there are now over 150, so working with an adviser can help you find the best fit tool.Companies are increasingly turning to software solutions to enable them to collect data from suppliers and track progress against targets. Selecting a GHG measurement and management tool can be a challenge as there are now over 150, so working with an adviser can help you find the best fit tool.

 

Step 2: Secure internal buy-in

The Guide makes it clear that proceeding with a supplier engagement target should be a cross-functional decision. It provides an overview of the various stakeholders, their roles in the supplier engagement target process, their priorities, and tips on how to frame the initiative.

As advisers to many companies setting credible climate goals, we have found that internal education is a critical early step in the target-setting process, especially given the number of stakeholders that need to be part of the overall process. As advisers to many companies setting credible climate goals, we have found that internal education is a critical early step in the target-setting process, especially given the number of stakeholders that need to be part of the overall process. 

Be prepared to get to know your organization – this will take a village! 

 

Step 3: Implement target

In order to successfully implement your target, it is critical to define team roles/responsibilities and expectations of suppliers, establish supplier communications, and select data collection and measurement tools. The Guide also suggests:

  • When reaching out to suppliers about setting an SBT, the message should come from a senior leader to demonstrate the company’s commitment and help to manage expectations, i.e. whether an SBT a “requirement”, “expectation”, or is merely “encouraged”
  • Choosing a data collection solution that minimizes the number of requests placed on suppliers and advocates with a standard questionnaire (while SBTi does acknowledge that standardization may come at the cost of perfectly meeting the company’s needs)
  • Putting appropriate controls in place to address suppliers’ concerns over confidentiality

If, as the Guide suggests, the program manager of the supplier engagement target is a member of the Sourcing or Procurement team, this individual will need to gain a strong understanding of the SBTi validation process and criteria. If, as the Guide suggests, the program manager of the supplier engagement target is a member of the Sourcing or Procurement team, this individual will need to gain a strong understanding of the SBTi validation process and criteria. 

 

Step 4: Enable and track supplier performance

In order to educate suppliers on measurement and reporting as well as track their performance, the Guide outlines some best practices:

  • Make training accessible and actionable 
  • Consider collaborating with peers to deliver joint training 
  • Encourage suppliers to conduct scope 3 screens immediately (addressing scope 3 emissions will ultimately be required to achieve long-term targets)

Companies must also consider the types of incentives or support they are willing to provide to suppliers to motivate and reward them. 

Options set out in the Guide include the entire carrot-to-stick spectrum, although from our experience, most companies prefer to motivate suppliers with positive reinforcement actions such as public recognition and provisioning various business benefits tied to climate-related performance.Options set out in the Guide include the entire carrot-to-stick spectrum, although from our experience, most companies prefer to motivate suppliers with positive reinforcement actions such as public recognition and provisioning various business benefits tied to climate-related performance.

 

Step 5: Monitor and report progress

Finally, companies need to decide how to monitor suppliers’ progress as they themselves need to periodically report to SBTi on the overall progress made. The Guide offers the following suggestions:

  • A central tracking tool that includes a full list of suppliers that are in scope, any relevant categorization or identification information, and their current SBT status
  • An annually refreshed scope 3 inventory and related supplier data over the target timeframe, to account for the fact that the supplier list is likely to fluctuate
  • Creating best practices for managing annual changes to the supplier list, e.g. inviting new suppliers to set SBTs each year if they enter the target threshold

If the supplier is provided with financial incentives or subjected to legal obligations as part of the process, financial and contractual arrangements will need to be regularly reviewed as part of this process as well.If the supplier is provided with financial incentives or subjected to legal obligations as part of the process, financial and contractual arrangements will need to be regularly reviewed as part of this process as well.

 

What this means for companies that set supplier engagement targets

The amount of effort and internal resources required to implement this target successfully should not be underestimated, but there are a number of examples where large companies have come together to collaborate with their peers and customers in order to share the burden. A successful supplier engagement program can result in multiple benefits across the supply chain, including product innovation, cost management, resource efficiency and higher resilience in the face of supply chain disruptions.

Please get in touch with us if you have any questions about the guidance or require support with any aspects of the target-setting process.  

SBTi is developing a Net-Zero Standard for Financial Institutions: what you need to know

The Science-Based Targets Initiative (SBTi) has recently released a package of consultation documents aimed at financial institutions, including the conceptual framework for the Net-Zero Standard for Financial Institutions (“FINZ”). The document is neither an exposure draft nor the final standard, but serves as an important milestone along the way to their expected publication in Q4 2023 and in 2024, respectively.

We have gleaned two major takeaways from the FINZ conceptual framework. First, much work lies ahead for SBTi before a FINZ draft will be ready for exposure. Specific definitions, metrics, methods, and examples are still works in progress and will need significant fleshing out before publication of the final standard. The consultation document is also full of optionalities that are open for comment, such as whether financial institutions should aim for 90%, 95%, or 100% net zero-aligned finance.

More important, though, is our second takeaway – regardless of the decisions SBTi makes with the minutiae of the final validation criteria, this conceptual framework makes the ultimate destination clear: full decarbonization of the economy by 2050. SBTi acknowledges that the financial sector will be a key player in that transition, and has repeatedly noted that reducing exposure through divestment or portfolio shifting will not be adequate. Engaging portfolio companies to drive decarbonization will be the only credible path forward.

In this article, we’ll examine what the concept of net zero means for the financial sector and what financial institutions looking to set a science-based target (SBT) should consider. 

Transition to net zero will mean a paradigm shift for the financial sector

A transition to net zero will require financing to be diverted out of high-emitting activities (such as oil and gas) and into new and emerging ones (such as carbon removal). This presents a complete business model redesign, particularly for asset managers who operate in accordance with client mandates and banks that have diversified lending policies due to lending limits and liquidity requirements.

Practically, financial institutions considering setting an SBT or otherwise adopting a 1.5C-aligned strategy should start taking the following steps:

 

Most sustainability professionals at financial institutions are currently focused on the sustainability performance of their products (e.g., ESG funds) and/or climate risks (e.g., the insurance sector). Financial institutions will need to develop deeper sustainability bench strength, expanding their capabilities to include management of the environmental impact of their portfolios and, to a lesser extent, their own operations and value chains. And they will have to do so with a structural sustainability skills deficit in the workforce, with the demand for green skills now outstripping supply by a factor of 2:1[1].

With that being the case, financial institutions may have to look to new opportunities to get the needed education. They could take the lead from other industries (e.g. food and agriculture) that have found ways to successfully collaborate to build sustainability depth in their value chains. Asset managers might consider a similarly collaborative approach to educating their portfolio companies by developing customized “climate academies” to help accelerate their portfolio’s transition in a scalable fashion.

Going one step further, as many financial institutions have the same underlying investments, collaboration at the sectoral level with the help of industry bodies would benefit all players. A leaf can be taken out of the playbook developed by the investor group Climate Action 100+ to help businesses transition to a net-zero economy.

 

Greenhouse gas (GHG) emissions measurement tools and approaches have been improving recently, although challenges remain. Despite that, measurement should be seen as a stepping stone to enable your organization to start taking action. This phrase is becoming a cliche in the GHG accounting sphere, but bears repeating – don’t let perfect be the enemy of good.

The objective of GHG accounting is to identify hot spots in your portfolio to enable prioritization of decarbonization opportunities, in parallel with improving the quality of your GHG data over time. That prioritization could include assessments of which sectors/asset classes/investments in your portfolio you have the greatest amount of influence over, as well as which have the greatest emissions or most reliable data.

 

With over 150 commercial GHG accounting software tools available, it is imperative to select the best-fit software solution that can help:

  • Streamline data collection
  • Measure emissions
  • Track target-setting, decarbonization initiatives, and emissions reduction progress across a dynamic portfolio
  • Integrate with other ESG tools

 

Carbon removal technologies and permanent carbon storage solutions are critical to achieving societal net zero. Nascent and emerging technologies can present attractive investment opportunities given burgeoning demand, which includes advance market commitments of over $1B from corporate carbon credit buyers. If you are not already familiar with this sector, now is the time to start learning about it.

 

An integral part of decarbonizing portfolios involves new tools and protocols to enable your organization to screen potential investments in or out, depending on their environmental performance and potential for decarbonization. Private markets firms in particular will have to assess GHG emissions intensities, reduction targets, and transition plans as an essential part of their due diligence process.

One approach is to use temperature rating scores sourced from data aggregators or developing methodologies in partnership with GHG accounting experts. Another approach is to use taxonomies, either existing (e.g., EU taxonomy) or proprietary.

 

In order to make the net zero transition a Board-level issue, governance structures may also require updates. Below are some examples of measures that financial institutions have been taking:

  • Introducing Board-level oversight of processes and controls over GHG measurement as GHG emissions data is starting to make its way into financial statements
  • Tying executive compensation to ESG performance, and the same approach could be considered, where appropriate, at the portfolio company level
  • Calling on asset managers to incorporate decarbonization and other ESG priorities into their fiduciary duty

Continue to make progress on your climate journey

While these steps can make for a long to-do list, financial institutions should continue to push forward quickly on each of these fronts. With emerging regulation (e.g., new SEC disclosure requirements), global trends like protectionist investment policies, and increasingly clear climate risks and opportunities, financial institutions that fail to act now risk being left behind.

Consultation on FINZ closes on August 14. Please get in touch if you would like to discuss anything that we have covered in this article.

Sources
[1] LinkedIn Global Green Skills Report 2023

 

What every company needs to know about climate risk assessment

It is valuable for every company to have familiarity with the framework set out by the Task Force on Climate-Related Financial Disclosures (TCFD), and with climate-related risks and opportunities more generally. In this article, we’ll explain why. 

The cascading effect of climate reporting

Over the past few years, we have been witnessing voluntary sustainability reporting frameworks becoming increasingly mandatory in markets where regulation did not previously exist. Governments and regulators all over the world have been responding to investor-led demands for climate risks to be disclosed and quantified, with TCFD rapidly becoming the disclosure framework of choice in the EU, US, and UK (to name just a few jurisdictions), along with global standard-setters such as the International Financial Reporting Standards (IFRS) Foundation. 

For a company monitoring these developments, the intuition is to start by asking a simple question – are we in the scope of these rules? And while that is a logical question to ask, we should begin with investigating the drivers. Regulators such as the U.S. Securities and Exchange Commission (SEC) and the EU Commission1 are mainly responding to the wider demands of investors. 

At 3Degrees, we’ve been calling this view of starting at the top, “the cascading effect of reporting,” which is currently underway and at this point, irreversible.

Every time another bank or financial institution makes a decision to report its climate risks and opportunities in response to regulatory changes, the next step is to start scanning the asset portfolio for its climate risks and opportunities, as well as existing mitigation actions or opportunities. Investors are also asking for the total financial impact, which is leading to more concerted integrated reporting with more than 2,500 companies across the globe having issued integrated reports to date2.

A lot of companies are still understandably weary of disclosing the potential price tag associated with their climate risks in their main financial statements. However, it’s clear that the risks of climate change come at a significant cost, with some companies’ CDP reports revealing eye-watering estimates. One insurer has estimated that losses from nature-related catastrophes could increase its annual exposure by almost $3BN, and that the cost of response (reinsurance) was likely to be in the order of $0.5BN.  

Climate risk is a risk like any other

What is Enterprise Risk Management (ERM)?

ERM involves assessment of risks facing the organization, classifying them by their impact and probability, and determining which actions to take to mitigate, transfer, avoid or accept them.

With such potentially high costs on the line, every company, whether impacted by the recent and upcoming regulation or not, should develop the internal capability to understand and assess climate-related risks. Evaluation of climate risks that your company faces is an important part of its overall corporate governance. TCFD advocates for such an evaluation to be included in each company’s Enterprise Risk Management (ERM) framework. 

ERM has been around for decades, but, until recently, climate risks did not make their way into this valuable risk management tool due to a perception that they were too remote in the future. It is abundantly clear now that this is no longer the case as climate risks have been materializing within investable timeframes.  

What are some of the benefits of including climate risks in the ERM? 

  • Promote a common understanding of climate issues between the Board, senior management, and managers of key risks and opportunities
  • Encourage a culture of transparency where risks are openly discussed and not swept under the carpet (and hence, reduce chances of surprises)
  • Serve as a basis for the organization’s climate mitigation and adaptation strategy/roadmap
  • Help prioritize financial and human resources

Climate is as much about opportunities as it is about risks

Before you get the impression that it’s all doom and gloom, let’s remind ourselves that climate assessments can highlight climate opportunities as well as risks. One tech company pinpointed in its CDP report that the likely introduction of carbon taxation would lead to demand for its carbon-neutral products and could add up to 1% of its global revenue; another tech company reported it could equal to 1% of its market cap. These are significant numbers. 

Opportunities abound in the areas of energy and resource efficiency, energy cost savings, and supply chain resilience. Identifying climate risks can help companies turn them into opportunities, e.g., by diversifying their sourcing to include jurisdictions less likely to be impacted by climate change in the future. Climate risk analysis should capture both mitigation and adaptation opportunities.

Value of climate-related risk and opportunities according to reporting to CDP3

The recently passed Infrastructure Investment and Jobs Act and the Inflation Reduction Act, as well as local tax incentives can help both soften the blow of costs involved in the energy transition along with helping organizations to capitalize on those energy efficiency, electrification, renewable energy adoption, opportunities. 

Back to school

The rise of integrated reporting is leading to more cross-functional cooperation. If organizations are going to make the best of what’s inevitable and chart the course for their risk mitigation and adaptation initiatives, there will need to be comprehensive level-setting around the concept of climate risks and opportunities paired with the corporate governance required to monitor them. Sustainability teams who have to date focused on assessing their company’s impact on the environment (“impact materiality”) will need to become familiar with the concept of financial materiality (impact of the environment on the company).

As part of this process, multiple transfers of knowledge will need to take place in organizations over the next few years as both voluntary and mandatory frameworks get embedded: 

  • Sustainability departments will need to educate finance teams on the process involved in identifying climate risks and opportunities
  • Finance teams will need to educate their sustainability colleagues on the principles of financial reporting 
  • Both will need to work together to quantify and disclose risks
  • Risk management groups will need to educate Sustainability teams on ERMs, and 
  • Sustainability will need to educate risk management and internal auditors on how to incorporate climate risks into the ERM

Once the initial knowledge transfer has happened, sustainability, renewable energy procurement, finance and tax professionals will need to continue coming together on a regular basis to provide input into on-going monitoring and mitigation of risks as well as identification and leveraging of opportunities.

If you have questions about your organization’s climate-related risks and opportunities, please get in touch.   

 

Sources

1 The Corporate Sustainability Reporting Directive will impact not only EU-headquartered companies but also US companies with EU revenue of €150M

2 IFRS Foundation

3  CDP article September 20, 2022

Our prediction: 2023 will be a big year for greenhouse gas accounting, reporting and target-setting for the financial sector

GHG accounting and target setting for the financial sector

Greenhouse gas accounting, reporting, and target-setting: Current state of play for the financial sector

For many years now investors have been requesting information on climate-related governance and risks from their investees, through means such as the CDP questionnaire. More recently, financial institutions – and their emissions, climate commitments, and performance – have started coming under the microscope.

The UN Principles of Responsible Investing’s membership increased 35% between 2021 and 2022 [1]. Additionally, over 550 companies are members of the Glasgow Financial Alliance for Net Zero[2]. These figures indicate that many financial institutions are now more committed than ever to playing their part in the transition to net zero through sustainable investment.

The reality on the ground is somewhat different though. At the end of 2022, only 47 financial institutions had their climate goals validated by the Science-Based Targets Initiative (SBTi), and of those, only 2 were headquartered in the US[3]. According to the Partnership for Carbon Accounting Financials (PCAF), only 107 financial institutions have reported their GHG emissions under the PCAF Standard[4]. This represents a tiny percentage of the global financial sector.

Challenges remain but guidance is coming out rapidly

Last October the Task Force on Climate-Related Financial Disclosures (TCFD) published the results of a 2022 survey[5] that sought to gain insights into financial institutions’ efforts to implement TCFD recommendations, including general challenges they faced in reporting climate-related information.

Through this survey, 57% of asset owner respondents and 71% of asset manager respondents cited a lack of methodologies to calculate GHG metrics as a challenge. Asset owners reported that it was the greatest challenge of all. This either suggests a lack of familiarity with the principles established by the Greenhouse Gas Protocol and PCAF, or difficulties in applying these principles to real-life financial arrangements. Different types of financial institutions may have struggled to apply the PCAF Standard as well since it was developed primarily for banks.

It was very timely then that in December 2022, PCAF launched the second edition of its GHG Accounting and Reporting Standard for the Financial Industry[6]. This came hot on the heels of the release of the first GHG Accounting and Reporting Standard for Insurance-Associated Emissions[7], so PCAF guidance now covers all major sectors of the financial industry.

Those of us who work in this space are also giddy with anticipation for the release later in 2023 of the Exposure Draft of the Science-Based Target Initiative’s Net-Zero Standard for Financial Institutions.  Once this Standard is published, the industry will have the required tools to accurately measure its financed emissions (using PCAF) and set appropriate targets (based on SBTi guidance).

Greenhouse gas accounting, reporting, and target setting for the financial sector.

 

Financial institutions play a critical role in the transition to a low-carbon economy

The latest IPCC report concluded that current financial flows fell short of the levels needed to achieve 1.5C pathway mitigation goals across all sectors and regions. Unsurprisingly, the challenge of closing the gap was the largest in developing countries, with the consequent environmental and social justice implications[8]. According to Bloomberg, global investment in the low-carbon energy transition is now on par with investment in fossil fuel projects[9].

However, three times that investment is required in order for us to reach net zero by 2050. 

In addition, many financial institutions have developed and are actively marketing “green” products (such as impact investing and ESG funds) or have issued “green” instruments, such as sustainability bonds. For these financial institutions, having robust science-based climate targets in place is a matter of market credibility (for more on setting credible climate goals, read our whitepaper). Money is fungible and consumers have an expectation that ESG products they invest in are not indirectly funding fossil fuel infrastructure, even indirectly. They increasingly want to know where their money sleeps at night and financial institutions need to be able to demonstrate that.

Given its size and its importance to the global economy, the financial sector must move quickly to close the gap between the status quo and alignment with a net zero future.

How 3Degrees can help your organization’s greenhouse gas accounting, reporting, and target-setting efforts:

We have supported a large number of climate leaders and financial institutions develop climate targets, create implementation plans, and select best-fit greenhouse gas accounting software to support the data collection process. In response to increasing interest from financial institutions in particular, we have developed two academies tailored to their unique needs that provide practical guidance on GHG accounting and target-setting.

With the imminent publication of the Exposure Draft of the first Net-Zero Standard for the financial sector, the SEC’s climate-related disclosure rule expected to be released in March and new regulations in the EU and the UK already in force, now is a great time to make a start on your journey to net zero. One of the many takeaways from our recent projects is that there are multiple nuances and differences between the various pieces of guidance, some of them hidden in footnotes, from which we can draw out the key takeaways for your financial organization.

Even though the Net-Zero Standard for financial institutions is still in development, the key guiding principles of the net zero concept are widely known and some of the technical criteria can be anticipated with a good degree of certainty, e.g., scope coverage and the use of carbon credits. Other reference frameworks are also available to guide companies along the way, such as the UN’s recent recommendations for companies setting net zero targets[10]. We know from our work with clients that the target-setting process can take anywhere between 6 and 24 months from kick-off to target validation, so act now – our planet does not have time to wait. 

For guidance on how to account for GHG emissions and design a credible climate strategy, get in touch today

Sources:

[1] UNPRI
[2] GFANZ
[3] SBTi
[4] PCAF “Financial Institutions Taking Action”
[5] TCFD 2022 Status Report
[6] PCAF announcement
[7] PCAF Insurance-Associated Emissions
[8] The IPCC AR6 Summary for Policymakers
[9]BNEF  
[10] UN High-Level Expert Group on Net-Zero Commitments of Non-State Entities