Study shows that many companies are still not disclosing their carbon emissions but are relying on inaccurate estimation data. Mandatory disclosure standards could play a key role in fixing this issue.
New research from index provider FTSE Russell has identified material and persistent gaps in the disclosures of carbon emissions from corporations around the world.
The paper finds that, in contrast to the common perception that the disclosure gap is closing rapidly, progress has been incremental at best. Though 98 per cent of the FTSE 100 discloses Scope 1 and 2 emissions, for example, disclosure drops to only 10 per cent for the Russell 2000, and 11 per cent for the FTSE China A Share market.
Where data is lacking, companies are often forced to use estimated data. However, the report finds that there are major accuracy issues with estimation models, and there is no industry or scientific consensus on the best method for estimating data.
The report finds that almost half of estimated values diverge from reported data by a range of plus or minus 100 per cent, and more than a quarter of values are off by at least plus or minus 200 per cent, regardless of the estimation strategy or specifications used.
So how can companies improve their disclosure of carbon emissions, and could mandatory disclosure standards help?
Major disclosure gap
Over the past few years, many investors have increasingly encouraged companies to disclose emissions data by supporting publicly backed standards and frameworks, such as the Global Reporting Initiative and the Climate Disclosure Standards Board. Moreover, investor-backed organisations, such as the Transition Pathway Initiative and Climate Action 100+, have created pressure for companies to disclose emissions alongside a broad set of consensus climate metrics.
However, according to the report, there is a material disclosure gap overall and considerable variation in reporting levels according to company size, region, and sector. Of the 4,000 or so large and mid-sized constituents in the FTSE All World index, more than half currently disclose operational emissions data, but 42 per cent of large and mid-caps still do not disclose both scope 1 and 2 emissions.
Larger companies are far more likely to disclose, with more than two thirds reporting their operational emissions, compared with only half of mid-cap companies. Disclosure rates in the technology and healthcare sectors also significantly lag those of the telecoms, utilities, and oil and gas sectors.
Eva Cairns, head of sustainability insights and climate strategy at investment firm Abrdn, says: “There are obvious regional differences in terms of emissions disclosures, with companies based in Europe tending to take the lead on this.”
She says the data gets a lot more patchy in emerging markets. “Although there has definitely been an improvement over the years, we are still having to use estimation methods to fill these gaps – which are sector-based, therefore based on peers.”
The report finds that 89 per cent of companies in developed Europe disclose, compared to 11 per cent of FTSE China A firms and around 23 per cent of Chinese companies overall. Despite impending mandatory reporting requirements, US firms are also less likely to disclose, with only 53 per cent of companies in the Russell 1000 and 10 per cent in the Russell 2000 doing so.
Bad estimates
In the absence of universally and consistently reported corporate emissions, investors must routinely use estimated emissions data to bridge the disclosure gap when making investment decisions.
Despite extensive research efforts by the industry and academics over the past two decades, significant challenges remain in estimating carbon emissions data.
The report outlines four main challenges. Firstly, there is no industry or scientific consensus on the best estimation strategy for imputing unreported carbon emissions. Further, the predictive power of the resulting estimates tends to be low irrespective of the methodology used. Estimations tend to diverge materially from each other, with differences significant enough to sway results for large diversified portfolios. And opportunities to systematically improve the quality of estimates are intrinsically limited by the heterogeneity of firms, the high variability of observed carbon intensities and sample size restrictions.
Cairns says: “Estimates are never ideal. Actual data gives us much better insight into what is happening at the individual holding level and also, just as importantly, the direction of travel for that holding. If you are basing the data on estimates, the leading companies will be bringing that estimate down. Generally the leading companies are the disclosing companies and therefore – possibly incorrectly – the non-disclosing companies could be benefiting from that.”
Steven Gray, legal director at DLA Piper and a specialist in climate-related policy and regulation says: “In the absence of real actual data on emissions, estimates can be helpful. However, any such limitations in data must be communicated clearly and transparently, including the method that was followed for the estimation.”
Need for regulation
The report finds that the one market where the disclosure gap has closed markedly is the UK. Following the implementation of mandatory greenhouse gas reporting for listed UK firms in 2013, the disclosure rate increased significantly with accompanied by improvements in the quality and completeness of reporting.
Nearly all companies in the FTSE 100 (99 of 101) disclose material carbon emissions, and the UK returns the highest disclosure rate for large and mid-cap stocks in aggregate. These findings suggest the need for mandatory economy-wide disclosure to give investors the emissions data they require to transition their portfolios.
Jaakko Kooroshy, global head of sustainable investment research at FTSE Russell, believes there is a significant role for regulators to help close material disclosure gaps for Scope 1 and 2 emissions.
“The Securities and Exchange Commission disclosures, if implemented as proposed, will have a significant impact – given the size of the US market, currently low disclosure rates (especially among small-caps) and the ambitious implementation timeline,” he says. “Importantly, the SEC rules build on [the Task Force on Climate-Related Financial Disclosures], so encourage international alignment, and could set a further precedent for many other jurisdictions to implement similar rules.”
Kooroshy believes the European Financial Reporting Advisory Group’s consultation on sustainability reporting standards could have a similar effect in Europe. The proposal builds on a solid base, since disclosure rates are higher in Europe and EU businesses have “deep experiences in reporting sustainability-related data over the years”.
He adds that the International Sustainability Standards Board’s proposals can act as an “important multiplier” as they would offer a new authoritative global standard. “The adoption of the standards by regulators in individual jurisdictions will promote consistency across international markets over time. We see ISSB as an important lever to improve disclosures in markets with less developed sustainable reporting regimes, including emerging economies,” he says.
Gray agrees mandatory disclosure standards are urgently needed – adding he has been “saying the same thing for over 15 years”. He welcomes the work of the ISSB, the Efrag consultation and the SEC proposals: “The more harmonised standardisation, the better.” With this, he expects disclosures to improve year-on-year.
Kooroshy also notes that generally, even after new rules are implemented, it can take a few reporting cycles for disclosed data to become available to investors. “The EU Taxonomy is a good example of that dynamic. Taxonomy disclosures have not yet become widely available, even though the regulations came into force in 2020,” he says.