Sustainability disclosures: The high cost of doing the right thing

Not long ago my esteemed colleague Robert Carmichael aptly set out some of the challenges facing companies that have joined the mad dash to set net zero targets. A couple of developments since have thrown into stark relief just how problematic that quest is going to get - particularly for the tech sector, which has powered so much of the growth of recent decades.

The first was the release of the US Securities and Exchange Commission (SEC)’s proposed rules on climate-related disclosures. In theory this is relevant mainly to public companies in the US, but in practice will, along with the Corporate Sustainability Reporting Directive (CSRD) taking shape in the European Union, serve as a pillar of the broad rules-based international order emerging around corporate sustainability commitments.

As expected, the SEC is aiming for mandatory reporting of direct (Scope 1) greenhouse gas emissions, as well as emissions generated from electricity or other forms of energy usage (Scope 2). Perhaps more surprising were the planned requirements on Scope 3, which could be loosely defined as emissions from ‘everything else’ connected to the business - in the SEC’s words, “from upstream and downstream activities in its value chain.”

Since for a sizeable company this could span everything from emissions generated from air travel (relatively straightforward to calculate) to the day to day activities of partners in the farthest-flung reaches of the supply network (not straightforward to calculate at all), Scope 3 reporting has been, to put it kindly, pretty controversial. More than a few business lobbies were hoping the SEC wouldn’t mandate anything around Scope 3 at all. In the end, the regulator walked an interesting line, suggesting that companies will be required to report on Scope 3 if they’ve explicitly set specific targets around it, or if such emissions are material to their operations - but (so far, at least) leaving what constitutes material largely up to others to decide.

This could create an awkward dynamic in that the more sincere and ambitious an enterprise is with its emissions targets, the more likely it is to face punishment in the form of hefty compliance and reporting obligations. At the same time, any organisation that wants to be perceived as genuinely and credibly committed to net zero will have no choice but to grapple with Scope 3 calculations and disclosures. Even then, as some observers have already pointed out, they’re unlikely to get there - at least if we take ‘zero’ in the literal sense of the term.

Running to stand still - or slip backwards

For a glimpse of what this means in practice, consider the case of poor old (okay, perhaps not so poor) Microsoft. Dutifully doing its part for the environment, it managed to slash emissions from its own operations by an impressive 17% in 2021. However its Scope 3 emissions, which are a much bigger proportion of its emissions overall, jumped 23%, meaning the company (technically) ended the year far worse off. Unfortunately, as Microsoft took pains to point out, a lot of what happens in Scope 3 is out of its direct control, given it extends to things like the embedded emissions in purchased equipment, even the energy consumed by its Xboxes in millions of homes (I’m staring admonishingly at mine now).

Realistically, any successful technology company is going to run into precisely the same dilemma. And equally realistically, most will employ the same method to resolve it: purchasing emissions reductions, or offsetting. As the basic premise is to pay someone else to cut emissions on your behalf, offsets have stirred a lot of debate, viewed in some quarters as a form of greenwashing or even an out-and-out scam. But as true net zero without some kind of offsetting looks increasingly hard to reach, more companies are learning to distinguish offsets in terms of quality, with those that actually remove carbon from the atmosphere (through newly planted trees, or technologies like direct air capture) seen as more legitimate than ‘avoidance’ offsets, which prevent more carbon from being emitted (by for example preserving an existing forest).

Microsoft’s net zero plans specifically target the former, and in this and some other respects the firm is proving a good model to follow.

The public furor that accompanied the UN Climate Conference last year and changing investor priorities have sparked an avalanche of corporate emissions reduction pledges. The risk now is that as the true costs of net zero start to come into focus we’ll see companies suddenly going quiet - or worse, enough frantic backpedaling to power the entire Fortune 500. But the scrutiny around sustainability means any perceived attempts to duck out of promises will almost certainly come at an even higher price.

Far better to opt for the Microsoft approach: Reporting faithfully on progress towards commitments even when performance is mixed; being frank about the barriers that can arise as any organisation feels its way towards an ambitious target; and setting out clearly and concisely the solutions you’ll adopt to break past them. As the tech giant’s sobering sustainability report makes clear, the road to net zero is likely to be a rough one. But at least it’s being honest about that, and in doing so turning what could be a cause for concern into an example of sustainability communications done right.