Scope 3 Emissions

JULY 2023 Power of 3: why Scope 3 emissions matter What are Scope 3 emissions? In simple terms, they are the greenhouse gas emissions generated across a company’s value chain – both before and after its own operations. They include the emissions produced by suppliers as well as those generated by customers when using the company’s products or services. Though complex, measuring and managing Scope 3 emissions is – in our view – essential if net zero by 2050 is to be achieved. The good news? Solutions exist. Marie Rupp KEY TAKEAWAYS Senior Sustainability • Tackling Scope 3 emissions is necessary for all stakeholders to move the economy further Analyst towards net zero. • Mounting pressure from regulators and other stakeholders should help corporates to better understand and address their Scope 3 emissions. • The complex cascading system of emissions throughout the layers of the economy brings challenges as well as solutions. • Financed emissions are those linked to investment activities, and asset managers should look at e昀케cient ways to manage these as part of their net-zero commitments. Jingying Han US President Theodore Roosevelt famously How are the di昀昀erent types of emissions Sustainability Analyst said that “nothing worth having was ever categorised? The Greenhouse Gas Protocol achieved without e昀昀ort” – an axiom that Standard classi昀椀es a company’s greenhouse gas could be applied to the measurement and (GHG) emissions into three scopes (see Exhibit 1). management of Scope 3 emissions. This will Scope 1 emissions are the direct emissions from undeniably involve hard work on the part of a company’s owned or controlled activities, while stakeholders but will pay dividends on the way. Scope 2 emissions are indirectly generated from purchased energy consumed by a company. ALLIANZGI.COM

POWER OF 3: WHY SCOPE 3 EMISSIONS MATTER Scope 3 goes a step further to address indirect emissions consist of multiple stages of a product or service’s lifecycle – both “upstream” and “downstream” of the company’s which contribute to Scope 3 emissions, including material own activities. Upstream emissions might include those sourcing, distribution, and end-of-life-treatment. generated in producing the raw materials (eg, metals 1 and rubber) required to manufacture a car. Downstream The GHG Protocol Corporate Standard has developed a emissions are those generated after the car is produced, detailed accounting system that includes 15 categories of such as waste management or the emissions generated Scope 3 emissions covering business activities along the by the car when driven. In summary, the value chain may entire value chain (see Exhibit 1). Exhibit 1: Overview of GHG corporate value chain accounting Activities along the entire value chain of the company Upstream Reporting company Downstream Scope 3 Scope 1 Scope 2 Scope 3 Indirect emissions generated in the value Direct emissions from Indirect emissions from Indirect emissions generated in the value chain before the company’s gates owned/controlled purchased energy for chain after the company’s gates sources own consumption Purchased goods & services Investments Capital goods Franchise Fuel & energy related activities Leased assets Transportation & distribution End-of-life treatment of solid products Waste generated in operations Use of sold products Business travel Employee commuting Processing of solid products Company Company Purchased Leased assets vehicles facilities energy Transportation & distribution Source: Allianz Global Investors and Global GHG Corporate Value Chain (Scope 3) Accounting and Reporting Standard (page 5) 2

POWER OF 3: WHY SCOPE 3 EMISSIONS MATTER Why do Scope 3 emissions matter? reduction targets. These requirements include a full GHG inventory of emissions, including Scope 3 emissions Scope 3 emissions account for over 70% of the average coverage of at least 67% for any near-term targets9 2 10 company’s total emissions. This highlights why, in our and 90% for long-term targets. With more than 5,600 11 view, addressing Scope 3 is key to reaching net zero by companies looking to take action in line with SBTi, 2050,3 thus limiting global warming to 1.5°C. Furthermore, there is clear momentum to tackle this topic. we believe that addressing Scope 3 emissions will help individual companies better mitigate the risks and seize Challenges for corporates the opportunities of the climate transition. Take the example of a car manufacturer. The emissions generated by the One key challenge for corporates is how to consider cars it sells are its largest source of Scope 3 emissions. Scope 3 emissions in the wider economic value chain By considering the market opportunity to produce (see Exhibit 3). The energy to power the economy 12 lower-emissions vehicles the manufacturer may appeal causes an estimated 73% of global emissions, and the to increasingly eco-conscious drivers while meeting more starting point for any value chain is the energy already stringent regulatory requirements. produced. Steadily, relevant emissions are passed down layer by layer through the value chain via products and Regulators across the globe are steadily pushing for services. These emissions combine with those caused by a mandatory climate disclosures, which would include company’s own operations. material Scope 3 emissions. Leading this charge are 4 the EU Commission, the US Securities and Exchange Commission,5 and the Hong Kong Stock Exchange.6 Each is looking to leverage existing standards like the 7 Taskforce for Climate-related Financial Disclosures and emerging standards like the International Sustainability Standards Board (ISSB).8 Furthermore, widely recognised initiatives such as the Science Based Targets initiative (SBTi) have very speci昀椀c requirements for validation of Scope 3 emissions Exhibit 2: De昀椀ning selected Scope 3 emissions categories and examples of target companies Scope 3 Category What it is Relevance by company type Purchased goods All emissions occurring in the production of goods and services Any company whose business is highly reliant on purchased and services purchased by the reporting company, up to the sourcing of raw goods and services eg, steel companies purchasing mined materials (ie, “cradle-to-gate” emissions). ores, food producers purchasing agricultural products, cloud service providers purchasing IT equipment, or apparel companies purchasing cotton. Transportation Upstream: emissions from third-party transportation of goods, Any company that needs to transport large volumes or heavy and distribution intermediate or 昀椀nished products contracted by the reporting goods during the production phase (upstream) or for 昀椀nished company, occurring at any step of the production. goods (downstream) eg, automotive manufacturers to bring sub-parts for 昀椀nal assembly (upstream), construction materials Downstream: emissions from transportation of 昀椀nished (up and downstream), shipment for online retail or food products which are not contracted by the reporting company. delivery companies (downstream). Use of sold Emissions either directly emitted or from the energy Any company whose products either directly emit GHGs or products consumption (fuel or power) over the entire use phase of consume energy in their use phase eg, fuel producers for the products sold by the reporting company. emissions from burning the fuels, car makers for the emissions derived from the energy to run the car (fuel for combustion engines or electricity for electric vehicles), any vendor of electrical appliances for emissions linked to their power consumption, food producers for emissions linked to energy to process food (cooking). Source: Allianz Global Investors and GHG Protocol Corporate Value Chain (Scope 3) Accounting Reporting Standard 3

POWER OF 3: WHY SCOPE 3 EMISSIONS MATTER The complexity of this 昀氀ow of emissions through the interdependencies for emissions reduction targets and economic value chain explains why the most signi昀椀cant of collective engagement through the layers of a sector’s the 15 categories are, “purchased goods and services” and value chain is critical to ensuring long-term alignment. “use of products sold”. Together these represent over 70% 13 of all reported Scope 3 emissions. Both categories are Help is at hand through initiatives like the Carbon 14 highly complex as they are di昀케cult to measure and manage Disclosure Project (CDP) Supply Chain Program and 15 and challenging to decarbonise. supplier engagement guidance from SBTi to help companies collaborate with suppliers in a structured way. Industrial associations – like the Cargo Owners for Zero 16 What are the solutions for corporates? Emission Vessels – can help companies in hard-to-abate sectors know where and how to start managing emissions. We believe there is a solution to these obstacles. As companies increasingly set targets for reducing their By the end of 2022, more than 16,400 suppliers were 17 Scope 3 emissions (or set general SBTi targets) they participating in the CDP Supply Chain Program following will engage collectively through the entire value chain, customer requests, resulting in collective reported 18 including with suppliers and customers. Over time, this emissions savings of 70 million tonnes of CO2e. While may solve Scope 3 data and complexity issues, and drive this is a good start, momentum needs to accelerate as decarbonisation in the real economy. Achievement of reducing Scope 3 emissions will take time because it often a company’s Scope 3 targets depends on its suppliers’ requires changes in business models and product design, and customers’ attitudes towards decarbonisation and and investment in the transition. their own progress towards it. Therefore, creating direct Exhibit 3: Cascading model of energy related emissions in the economic value chain Layers of economy Example electric appliance Fuels & Electricity Production of energy & power am e tr s p U Commodities Production of metals, plastics and chemicals to build the appliance and the production equipment Manufacturing of equipment and n Capital goods i machinery to produce the appliance a h c e u Production of 昀椀nished Production of parts and 昀椀nal assembly al goods & services of the appliance V Distribution & services Selling and transporting of the appliance by retailers am e tr s Power consumption of the end users n Use of products sold ow over the expected lifetime of the appliance D Emissions inherited from upper layers over the purchased product & services category Energy consumption at each layer Companies in each layer of the economy pass down the total carbon footprint of their products through emissions inherited from their suppliers in the layer above, combined with those caused by their own value-adding operational activities. Source: Allianz Global Investors 4

POWER OF 3: WHY SCOPE 3 EMISSIONS MATTER Exhibit 4: Limited disclosures of Scope 3 emissions across sectors Energy Utilities Consumer Staples Consumer Discretionary Industrials Materials Real Estate Communication Services All sectors Information Technology Health Care Financials Percentage of issuers 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Scope 3 upstream and downstream emissions reported Low coverage of reported Scope 3 emissions No Scope 3 downstream emissions reported No Scope 3 emissions reported *Low coverage of reported Scope 3 emissions means less than half of the MSCI estimation. Source: Emissions data from MSCI as of 7 June 2023 applied to MSCI ACWI Index by GICS® sectors How can investors contribute to solving Scope 3 challenges? little data coverage, it is good practice to be transparent by disclosing the level of data coverage and quality. This topic becomes more complicated when considering Allianz Global Investors’ (AllianzGI) PAI Statement 2022 Scope 3 “昀椀nanced emissions” – those that are linked is available on our website. to the investment and lending activities of 昀椀nancial institutions (such as investment managers). Signi昀椀cant The discussion on 昀椀nanced emissions invariably ends resources are required to aggregate and report 昀椀nanced up with the question of whether Scope 3 emissions emissions, as evidenced by the fact that less than 20% metrics include double counting, which occurs when of companies in the MSCI ACWI Financials sector report GHG emissions are counted more than once in the Scope 3 downstream emission categories and even fewer 昀椀nanced emissions calculation.24 It is true that di昀昀erent report 昀椀nanced emissions (see Exhibit 4). companies within a value chain can claim the same emissions in their respective Scope 3 accounting. Given these challenges, we have identi昀椀ed the following However, the GHG accounting system was designed potential ways forward for investors seeking to capture to represent each entity’s emissions responsibility, and reduce Scope 3 emissions: and aggregated numbers are not meant to estimate emissions of the global economy but can help investors • Seek guidance from initiatives and standard setters to steer their climate strategies. We welcome last year’s 昀椀nalisation of the Partnership for Carbon Accounting Financials Global GHG Accounting • Engage with investees collectively and individually 19 and Reporting Standard which provides accounting At a time when understanding the data can be standards for 昀椀nanced emissions. Additionally, in challenging, collective engagement with companies December 2022, the ISSB decided on a core requirement covering every part (or most) of the value chain is a 20 21 for 昀椀nancial 昀椀rms to report 昀椀nanced emissions. Lastly, critical and powerful tool for investors. Collaborative the European Union Sustainable Finance Disclosure bodies like the Ceres Food Emissions 50 Initiative, 22 25 Regulation requires 昀椀nancial institutions to report of which AllianzGI is an active member, produces quantitative metrics on the carbon footprint of their comprehensive scorecards on Scope 3 disclosures and investments in their Principal Adverse Impact (PAI) target setting. 23 statements. Within 昀椀rms’ PAI statements, even with 5

POWER OF 3: WHY SCOPE 3 EMISSIONS MATTER • Vote at Annual General Meetings Beyond engagement, there are increasing options to escalate climate strategy and disclosure shortcomings through proxy votes. Last year, AllianzGI voted against the approval of a climate report by an Australian 26 energy company because it lacked a Scope 3 emissions reduction target. Such stewardship requires a full understanding of value chain emission transmission mechanisms and hotspots. We have a tool to support this: our proprietary sector materiality matrix covers 24 industry sectors – illustrated in Exhibit 5. Exhibit 5: Excerpt of AllianzGI emissions sources materiality matrix for six sectors GHG Utilities Metals & Construction Information Consumer Healthcare & emissions sources mining materials, technology services pharmaceuticals materiality building products & homebuilding Scope 1 Scope 2 Scope 3 Scope 3 Upstream 1. Purchased goods and services 2. Capital goods 3. Fuel- and energy-related activities 4. Upstream transportation and distribution 5. Waste generated in operations 6. Business travel 7. Employee commuting 8. Upstream leased assets Scope 3 Downstream 9. Downstream transportation and distribution 10. Processing of sold products 11. Use of sold products 12. End-of-life treatment of sold products 13. Downstream leased assets 14. Franchises 15. Investments Materiality levels: Highest Medium to high Lower Source: Allianz Global Investors In summary, we believe that investors and corporates should view measurement and management of Scope 3 emissions as an opportunity rather than a problem. The evolving standards and regulations can be met with a pragmatic approach of identifying and prioritising emissions categories to help promote 6

POWER OF 3: WHY SCOPE 3 EMISSIONS MATTER a speci昀椀c decarbonisation pathway. Detailed frameworks are evolving for the value chain of each sector. Over time, we believe this could allow for a genuinely connected alignment of emissions reductions targets from the top of the value chain to the bottom, which is critical to achieving net-zero goals. 1. Source: GHG Protocol Corporate Value Chain Reporting Standard 2. Source: sciencebasedtargets.org, Scope 3: Stepping up science-based action 3. See: Headine statements from the Summary for Policymakers: Global Warming of 1.5C 4. Source: europa.eu, Corporate sustainability reporting 5. Source: SEC.gov, SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors 6. Source: HKEX, Exchange Publishes Consultation Paper on Enhancement of Climate Disclosure under its ESG Framework 7. Source: Task Force on Climate-Related Financial Disclosures, TCFD Recommendations 8. Source: IFRS, Exposure Draft IFRS S2 Climate-related Disclosures 9. Source: SBTi’s stated requirement for a Scope 3 target: If a company’s relevant Scope 3 emissions are 40% or more of total Scope 1, 2, and 3 emissions 10. Source: sciencebasedtargets.org, SBTi Corporate Net-Zero Standard 11. Source: sciencebasedtargets.org, Companies Taking Action – as at 25 July 2023 12. Source: Our World in Data, Emissions by sector 13. Source: sciencebasedtargets.org, Catalyzing Value Chain Decarbonization 14. Source: CDP – Supply chain 15. Source: sciencebased targets.org, New Supplier Engagement Guidance: Unlocking the Power of Supply Chains for Decarbonization 16. Source: coZEV, About coZEV 17. Source: CDP, Scoping out: Tracking nature across the supply chain 18. For reference, we collectively emit around 50 billion tonnes of CO2e each year, Our World in Data, 2021 19. Source: Global GHG Accounting & Reporting Standard, Financed Emissions Part A 20. The ISSB referred speci昀椀cally to Asset Management & Custody Activities, Commercial Banks and Insurance 21. Source: IFRS, Climate-related disclosures - Financed and facilitated emissions 22. Source: European Commission, Sustainability-related disclosure in the 昀椀nancial services sector 23. Source: European Insurance and Occupational Pensions Authority, July 2022, Principal adverse impact and product templates for the Sustainable Finance Disclosure Regulation 24. Source: Global GHG Accounting & Reporting Standard, Financed Emissions Part A, page 41 25. Source: Food Emissions 50 | Ceres 26. Allianz Global Investors Sustainability and Stewardship Report, page 92 Investing involves risk. The value of an investment and the income from it will 昀氀uctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. 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