Investors concerned about climate risk—a risk typically calculated using the imprecise measurements of Scope 3 emissions—may welcome a new metric that focuses on a company’s indirect climate risk exposure through its customers and suppliers.
Designed by Connecticut-based investment firm AQR Capital Management, the new method of measuring supply chain climate risks focuses on the overall climate exposure of a company’s customers and suppliers. “In other words, AQR measures the extent to which a company does business with partner firms that may suffer, or even go out of business, because of climate-related risks,” reports Bloomberg.
The traditional way of measuring climate risk with Scope 3 emissions—emissions the company is indirectly responsible for, outside its own operations—may end up underestimating risk, says AQR, even though Scope 3 emissions often represent the majority of an organization’s emissions.
AQR gives the example of a U.S. payment services company whose Scope 1, 2, and 3 emissions seemed to confirm it as a low climate risk compared to its competitors.
But things got riskier when AQR examined the company’s “economic linkages” and discovered that as recently as 2011, 21% of its consolidated revenue came from three large oil companies.
AQR’s new metric measures “an underappreciated risk,” writes Bloomberg, because a very green firm may be indirectly exposed to climate risks across its supply and customer chains. A company whose own emissions seemed a safe bet was anything but, with indirect climate risk from customers who themselves had large climate exposures.
A side benefit is that investors already have access to much of the data that AQR’s metric uses, whereas Scope 3 emissions data is notoriously difficult to gather and confirm.
While the new climate risk metric—which is already garnering interest from AQR’s clients—was designed to reassure investors, it can also be used to red flag a corporate cooking of the books known as “emissions offshoring,” thus helping in the climate fight.
With “offshoring”, “as investors pressure companies to become greener, corporate executives may respond by shutting down their most carbon-intense assets and instead buying the same ingredients from third party suppliers,” Bloomberg explains.
“This just shifts carbon across the supply chain, with no net effect for global emissions.”