Viewpoint explaining the proposed federal requirement’s potential for error and its outsized negative impact on Canadian SMEs
Plans to mandate scope three emissions reporting would be detrimental to small businesses, finds this new report published by the Montreal Economic Institute.
|Small business should not suffer from new federal climate standards (Sun Media Papers, December 9, 2022)
Let’s not kill small business in the name of ESG (True North, December 11, 2022)
This Viewpoint was prepared by Krystle Wittevrongel, Senior Policy Analyst and Alberta Project Lead at the MEI. The MEI’s Environment Series aims to explore the economic aspects of policies designed to protect the natural world in order to encourage the most cost-effective responses to our environmental challenges.
There has been growing pressure of late to include environmental, social, and governance (ESG) information in reporting and public disclosure.(1) This is due both to interest from investors(2) and to a focus on new sustainability requirements from governments and regulators.(3)
Currently, there are no Canadian regulations requiring businesses to publicly disclose ESG information or sustainability reports, but this could soon change.(4) Indeed, establishing disclosure standards on sustainability and climate change is a federal policy priority. To meet its net-zero goals, the federal government has clearly stated its commitment to pushing ahead with mandatory reporting of climate-related financial risks across a wide range of the Canadian economy.(5)
The Canadian Securities Administrators coordinate and harmonize regulation for Canadian capital markets(6) and are working to establish requirements for publicly traded companies to make climate-related disclosures.(7) In fact, a new Canadian Sustainability Standards Board (CSSB) is set to launch in 2023 and has been tasked to work with the International Sustainability Standards Board (ISSB) to ensure that sustainability disclosures are standardized.(8)
The ISSB’s goal is to “deliver a comprehensive global baseline of sustainability-related disclosure standards that provide investors and other capital market participants with information about companies’ sustainability-related risks and opportunities.”(9) Accordingly, it has proposed a set of IFRS Sustainability Disclosure Standards(10) to regulate ESG reporting. These are what the CSSB will be adopting.(11)
The Problem with Scope 3 Emissions
In a 120-day public consultation, draft IFRS Standards received feedback from more than 700 respondents,(12) including more than 80 Canadian organizations.(13) Yet while the IFRS Standards have clear support according to the ISSB, there are a number of topics that deserve further deliberation.(14) One of these is the inclusion of Scope 3 greenhouse gas (GHG) emissions and the practical challenges of collecting and calculating that data.
Scope 3 emissions are often a company’s largest source of emissions.(15) Also called “value-chain emissions,” these arise from activities or assets not owned or controlled by the reporting organization.(16) They are “the fatal flaw in GHG reporting,”(17) since the Scope 3 emissions of one company are the Scope 1 and 2 emissions of another organization (see Table 1).
Scope 3 emissions are notoriously difficult to quantify, and the requirement for an entity to monitor and report on every interaction and relationship along the value chain, between multiple suppliers and customers, introduces a real risk of measurement error.(18) The inclusion of Scope 3 emissions in GHG reporting also presents a risk of duplication in accounting such that emissions are counted several times over, which does not provide an accurate representation of climate risk.(19)
Creating Artificial Winners and Losers
Moreover, the inclusion of Scope 3 GHG emissions in reporting represents an onerous burden. Many entities lack sufficient resources to be able to fully comply,(20) especially small and medium-sized enterprises (SMEs).(21) The U.S. Securities and Exchange Commission estimates that a similar disclosure proposal in the United States costs between US$490,000 and US$640,000 on average for the first year of compliance—although some believe that “actual costs may be substantially higher.”(22)
In addition, although the proposed standards would apply to publicly listed companies, there are implications for smaller, private companies as well. For instance, an SME that supplies products to a larger, public company is part of the latter’s value chain and can expect disclosure demands as part of the larger Scope 3 disclosure. It follows that companies required to disclose will choose suppliers able to help them meet their obligations. This requirement is therefore likely to create an obstacle for private companies not large enough to have a compliance department.(23)
SMEs are significant contributors to the Canadian economy, but they have been weathering a particularly difficult storm for the past few years. In 2021, small businesses were more likely to have lower revenues than in 2019, and in the first quarter of 2022 were found to be more likely to have decreased sales in the short term.(24) Increased costs to remain a part of the supply chains of public companies are the opposite of what SMEs need to remain viable as Canada teeters on the verge of recession.
In addition to the proposed requirement’s potential for error and its outsized impact on Canadian SMEs, it should be noted that companies which can afford higher compliance costs will inevitably pass these along to consumers. The federal government should be critical of a policy that will be overly burdensome and artificially create winners and losers, while ultimately increasing the cost of living for Canadians. As such, the mandatory reporting of Scope 3 emissions should not be included in ESG disclosure requirements.
- Sarah Keonhane Williamson and Ariel Fromer Babcock, “Investors and Companies Can Drive ESG Metrics Forward Together,” Harvard Law School Forum on Corporate Governance, August 17, 2020.
- Among 325 global investors, 79% stated that ESG risks were an important factor in investment decision-making. PwC, PwC’s Global investor survey: The economic realities of ESG, December 2021, pp. 2-3.
- Stephen D. Wortley et al., ESG in Canada: What We Learned in 2021 and Looking Ahead to 2022, McMillan, March 2022, p. 2.
- Current securities regulation generally requires companies to disclose certain climate-related information if it is deemed “material.” Conor Chell and Laura Roberts, “Worried About Mandatory ESG Reporting? Read This,” MLT AIKINS, July 25, 2022; Accountancy Insurance, “New ESG Rules To Hit Small Canadian Businesses,” August 1st, 2022.
- Emma Cox et al., “Time to get serious about the realities of climate risk,” PwC, May 2022, p. 2; Government of Canada, Budget 2022: A Plan to Grow Our Economy and Make Life More Affordable, 2022, p. 106.
- Canadian Securities Administrators, “Canadian securities regulators strongly support the establishment of the International Sustainability Board in Canada,” press release, October 7, 2021.
- Conor Chell and Laura Roberts, op. cit., endnote 4.
- Financial Reporting & Assurance Standards Canada, “Accounting, Audit and Assurance Standards Oversight Councils Announce Canadian Sustainability Standards Board,” press release, June 15, 2022.
- International Sustainability Standards Board, About the International Sustainability Standards Board, consulted November 22, 2022.
- “IFRS” stands for “International Finance Reporting Standards.” One standard includes general sustainability-related disclosures and the other specifies climate-related disclosure requirements. IFRS, “ISSB delivers proposals that create comprehensive global baseline of sustainability disclosures,” press release, March 31, 2022.
- Financial Reporting & Assurance Standards Canada, op. cit., endnote 8.
- ICAEW Insights, “ISSB reviews feedback on proposed standards,” ICAEW, October 24, 2022.
- Mathieu de Lajartre, “ISSB exposure drafts: ‘Sustainability will be core to a CPA’s role in the future’,” CPA Canada, October 13, 2022.
- ICAEW Insights, op. cit., endnote 12.
- Evergreen Action, “What Are Scope 3 Emissions? It’s Critical the SEC Requires Companies Disclose Them,” May 10, 2022.
- Greenhouse Gas Protocol, FAQ, The World Resources Institute, consulted November 22, 2022; United States Environmental Protection Agency, EPA Center for Corporate Climate Leadership, GHG Inventory Development Process & Guidance, Scope 3 Inventory Guidance, May 12, 2022.
- Robert S. Kaplan and Karthik Ramanna, “Accounting for Climate Change,” Harvard Business Review, November-December 2021, p. 5.
- Ibid., pp. 5-6.
- Elisabeth Jeffries, “Emissions reporting : taking stock of indirect emissions in Scope 3,” IPE magazine, June 2022; Robert S. Kaplan and Karthik Ramanna, op. cit., endnote 17, p. 6.
- Robert S. Kaplan and Karthik Ramanna, ibid., p. 5; ICAEW Insights, op. cit., endnote 12.
- Marc Hafstead et al., “Indirect Emissions Disclosures Are Important but Tricky,” Resources, May 4, 2022.
- Kenneth Rivlin et al., “Scope 3 emissions and the SEC’s proposed disclosure rules: Key takeaways from the public comment process,” Allen & Overy, August 2, 2022.
- Stephanie Tam, Shivani Sood, and Chris Johnston, “Analysis on small businesses in Canada, first quarter of 2022,” Statistics Canada, Analysis in Brief, March 3, 2022, p. 6.
- Ibid., p. 5.