Asset managers are wary about putting pressure on the companies they invest in to meet new rules to report on Scope 3 emissions, even as research suggests most firms are unprepared for the rules and could risk fines, amid limited support among asset managers for the changes.
The European Corporate Sustainability Reporting Directive (CSRD) this year means from 1 January 2024 a broader set of large companies, as well as listed SMEs, will now be required to report on sustainability.
Approximately 50,000 companies in total are affected, including UK companies that trade in the EU.
They will have to report on Scope 3 emissions, meaning those that are the result of activities from assets not owned or controlled by the reporting organisation, but that the organisation indirectly affects in its value chain.
Recent research suggests thousands of UK businesses, up to 60% of those that come under the rules, are not ready to report on Scope 3 emissions, despite the threat of fines and reputational damage if the reporting standards are not met.
Asset manager stewardship on Scope 3
ESG Clarity asked several commentators what role asset managers were taking in pressing the companies they invest in to get ready for the rules this year.
Lindsey Stewart, director of stewardship investment research at Morningstar, said while it’s “broadly fair to say” European asset owners are keen to see better disclosures on Scope 3 emissions so they can better assess the climate-related risks they are exposed to in their investments, their views “are more fragmented on whether mandatory Scope 3 disclosures, as required under CSRD, are the right choice at this time”.
Stewart said: “[Asset managers’] recent voting and engagement activity has reflected that fragmentation.
“Further, we see that, on the whole, support by asset managers this year for resolutions calling for more granular emissions disclosures is largely in the same place as last year – sizeable support but usually far from a majority.”
Morningstar in the second half of last year highlighted that although most large asset managers agree on the need for mandatory Scope 1 and 2 disclosures, similar support for mandatory Scope 3 reporting was limited to a sizeable minority with eight out of 20 managers in support.
Firms including BNP Paribas, Capital Group, Fidelity International and LGIM believe that Scope 3 disclosures are essential to a full understanding of climate risks and opportunities, Morningstar found.
But several large US managers believe that Scope 3 reporting isn’t yet sufficiently robust to be required by a broad swathe of companies – and this includes the “Big Three” index houses: BlackRock, State Street and Vanguard, which Morningstar found advocate for a more flexible approach to disclosure, focused on financial impacts on companies.
Scope 3 data reliability
Gemma Corrigan, head of policy and ESG integration at Federated Hermes Limited, said greenhouse gas emissions data, including Scope 3, is important information for investors, but raised concerns about the reliability of the data available, and the pressure on companies to collect it.
She said: “We recognise significant uncertainty still remains in the calculation of emissions data, particularly for Scope 3, and so believe a pragmatic approach to the regulation is needed to not overly penalise or burden companies as they build capacity.”
One purpose of requiring Scope 3 emissions reporting as part of the CSRD rules is so companies turn their engagement into action. Investors need accurate data and not presenting this risks divestment.
However asset managers would not be drawn on the consequences if the businesses they invest in fail to meet the requirement of the new rules.
A spokesperson for Liontrust said the asset manager “would like to see how companies progress and manage their obligations under the new reporting requirements, rather than worrying about their facing fines for non-compliance”.
Asked to what extent Liontrust is using its stewardship role to focus the companies it invests in to comply with the rules on time, the spokesperson added that while the asset manager sees stewardship as “certainly including compliance to regulations, we also see it as a way of understanding how investee companies are managing those aspects of their businesses that are the focus of our investment processes”.
They added they “engage with the management of our holdings on compliance matters”.
CSRD is the most comprehensive reporting standard to date as it requires companies to report in a doubly material way, on their own environmental and social impact as well as sustainability risks to their business.
It should significantly increase the amount of data available to investors, enabling better informed company analysis and investment decision-making.
However Sophie Brodie, associate director for sustainable investing at Fidelity International, said the timeline for adoption by companies, where the first report for 2024 is due in 2025, is “ambitious”.
Brodie said: “There are [reporting] areas that will be new for many firms, e.g. biodiversity and value chain reporting, requiring more extensive data collection. We recognise that the extent of reporting and the time and cost involved could be challenging to begin with.
“We plan to engage with in-scope companies in the UK and elsewhere on how they are preparing to meet the requirements of CSRD (and International Sustainability Standards Board) with a view to identifying potential gaps.”
Fidelity also expects further guidance from the EU, which companies would have to adapt to again.
Earlier this year, the EU Commission asked the European Financial Reporting Advisory Group, the body behind the CRSD (also known as the European Sustainability Reporting Standard), to prioritise helping companies to implement the initial CSRD standard over developing a second sector-specific standard, due in June 2024.
Brodie said: “We expect further clarification on the European Sustainability Reporting Standards metrics are mandatory and voluntary, and which will be subject to a materiality assessment and phased in over longer periods. We are engaging with EU associations on how this will develop.”
Fidelity believes the changes should create opportunities for companies to scale up activities that align with the EU taxonomy and become sustainability leaders.