I was reading about the Securities and Exchange Commission launching their formal review of climate disclosure rules last week, on March seventeenth, and it feels like the voluntary era of corporate responsibility just hit a brick wall. Today is March twenty-third, twenty twenty-six, and the landscape has shifted almost overnight. Today's prompt from Daniel is about the shift from voluntary to mandatory Scope three carbon reporting, and it specifically asks if it is even reasonable to hold a company responsible for what their suppliers are doing three steps down the line.
It is the defining question of corporate finance for the next decade, Corn. My name is Herman Poppleberry, and I have been buried in these regulatory filings all morning. What the Securities and Exchange Commission did last week is a massive signal because they had previously backed away from defending their twenty twenty-four climate rule. Now, they are coming back to the table, seeking public input on updates to Regulations S-K and S-X, just as the August twenty twenty-six deadline for California's Senate Bill two fifty-three is looming over every major corporation in America. We are moving from a world where companies could brag about their green initiatives in a glossy brochure to a world where they have to swear to their carbon numbers under penalty of perjury.
It is funny how we call it the California mandate when it effectively governs any company with over one billion dollars in annual revenue that does business there. That is over four thousand companies. But before we get into the legal friction and the massive compliance costs, we should probably clarify what we are actually talking about when we say Scope three. Most people understand Scope one, which is the fuel you burn in your own trucks or the gas in your own boilers. Scope two is the electricity you buy for your office or factory. But Scope three is this massive, sprawling shadow that most companies have been able to ignore until now.
Shadow is a good way to put it. Scope three covers fifteen different categories of indirect emissions. It is essentially everything else in the value chain. It includes everything from the carbon footprint of the steel your suppliers bought to make your parts, which is Category One, to the electricity your customers use when they plug in your product at home, which is Category Eleven. In industries like manufacturing or retail, Scope three usually accounts for seventy-five percent to ninety percent of a company's total footprint. If you are a giant tech company, your own offices and data centers are a rounding error compared to the carbon emitted by the factories in Asia making your hardware or the power consumed by the millions of devices you have sold globally.
That brings us to Daniel's first question. Is it fundamentally reasonable to hold a company liable for emissions they do not directly control? If I run a global clothing brand, am I really the one responsible for the methane emissions from a cattle ranch in Brazil that sold leather to a processor who sold it to my shoe factory? It feels like we are asking accountants to become private investigators or international diplomats.
That is exactly where the friction lies. Proponents argue that if you have the purchasing power, you have the leverage to force decarbonization down the chain. If the clothing brand says they will only buy leather from low-emission ranches, the market shifts. But the technical reality is that most companies have no idea who their suppliers' suppliers actually are. Right now, only twenty-nine to forty-eight percent of public companies disclose any Scope three data at all. And the data they do disclose is often based on what we call the carbon math paradox.
We did a deep dive on that back in episode thirteen forty-seven, the idea that two companies can report wildly different numbers for the same physical activity based on which database they use. If you want the full technical breakdown on why those formulas are so broken, that is a great one to revisit. But Herman, for this current shift, how are companies actually filling in those gaps when they do not have the real numbers? Because if you are only reporting forty percent of the data, you are basically guessing the other sixty percent.
They use what is called spend-based accounting. Instead of knowing how many kilograms of carbon were emitted to make a specific bolt, they look at their accounting software and see they spent ten thousand dollars on steel. Then they multiply that ten thousand dollars by a generic industry average factor. It is a financial proxy for a physical reality. The problem is that if the price of steel goes up because of inflation, your reported carbon footprint goes up too, even if you did not buy a single extra gram of metal. It makes the reporting almost useless for actual climate action because you could be decarbonizing your process while your reported numbers go up just because of market fluctuations. It is a technical failure of the highest order.
And that is why regulators are starting to lose their patience. The European Financial Reporting Advisory Group, or E-F-R-A-G, recently tried to simplify things by cutting sixty-one percent of the mandatory datapoints for their sustainability standards. They were trying to reduce the burden on businesses. But just last week, on March eighteenth, the E-U Platform on Sustainable Finance warned that this simplification actually risks putting Europe below the global baseline set by the International Sustainability Standards Board, or I-S-S-B. We are seeing this tug of war between making reporting easy enough to actually do and making it rigorous enough to actually mean something.
The I-S-S-B is really trying to be the gold standard here with their I-F-R-S S-one and S-two frameworks. They are pushing for what they call the global baseline. But even they are feeling the pressure of how hard this is. They have included a one-year transition relief for Scope three. Basically, they are telling companies they can have an extra year to figure out their supply chain because everyone knows the data is currently a mess. However, many firms are interpreting this transition relief as a loophole. They are using it as an excuse to delay the hard work of primary data collection, hoping that the standards might soften before they actually have to report.
Speaking of data being a mess, I wanted to ask you about this A-I-washing crackdown. I saw that regulators started targeting firms on March sixteenth for making unverified claims about their carbon tracking. There was that huge collapse of firms like Builder dot A-I, where they were essentially promising that their algorithms could magically see through the supply chain and calculate emissions with perfect accuracy without ever talking to a supplier.
That collapse was a massive wake-up call for the industry. It was a one point five billion dollar reality check. These companies were selling a black box. They would tell a Chief Sustainability Officer, do not worry about auditing your five thousand suppliers, just feed your invoices into our A-I and it will give you a verified carbon score. But there was no transparent data lineage. Regulators are now saying that if you cannot show the primary data, the A-I estimate is just a sophisticated guess. You cannot audit a hallucination, Corn. If the A-I says a factory in Vietnam emitted ten tons of carbon, but the factory does not even have a smart meter, where did that number come from?
It reminds me of the old saying that if you cannot measure it, you cannot manage it. But in this case, we are trying to measure things that are physically happening thousands of miles away in jurisdictions that might not even have electricity meters, let alone carbon sensors. It costs the average company about five hundred thirty-three thousand dollars a year just to comply with these disclosures. If you are spending half a million dollars a year to produce a sophisticated guess, you have to wonder if that money would be better spent actually installing solar panels or upgrading machinery. That is a lot of capital being diverted into the pockets of auditors and consultants.
That is the core of the conservative critique of these mandates. Is this just a compliance tax that benefits consulting firms? Or does it actually drive change? There is a really interesting conflict happening right now inside the Science Based Targets initiative, or S-B-T-eye. They are the primary body that validates whether a company's net-zero target is actually legitimate.
I heard about this. There is a huge internal rift over carbon offsets, right? It seems like the scientists and the board are at each other's throats.
It is intense. The board of the S-B-T-eye suggested that companies might be allowed to use Environmental Attribute Certificates, which are basically carbon credits or offsets, to meet their Scope three targets. The board's logic is pragmatic: Scope three is so hard to reduce directly that if you do not give companies an out, they will just stop participating. But the actual staff and the scientific advisors at S-B-T-eye are revolting. They sent a letter saying this would completely undermine absolute decarbonization. They argue that if you let a company buy offsets for ninety percent of their footprint, which is what Scope three is, then they never actually change their supply chain. They just pay for the right to keep polluting.
It feels like the S-B-T-eye board is trying to be realistic about the business world, while the scientists are holding the line on the physics of the atmosphere. It is the classic struggle between the boardroom and the laboratory. And while this fight happens in the non-profits, the states are moving ahead regardless of the drama. California is the real mover here. Even if the Securities and Exchange Commission stays stuck in court or gets slowed down by political shifts, California's Senate Bill two fifty-three is moving toward that August twenty twenty-six deadline for Scope one and two, with Scope three following in twenty twenty-seven.
And do not forget New York. Their Senate passed Senate Bill ninety seventy-two A, the Climate Corporate Data Accountability Act, and it is currently moving through the Assembly as we speak in late March. If that passes, you will have the two largest state economies in the United States mandating Scope three reporting for any company making over a billion dollars. At that point, it does not matter what the federal government does. If you want to sell products in Manhattan or Los Angeles, you are doing Scope three accounting. It creates this de facto national standard because most billion-dollar companies cannot afford to be locked out of those two markets.
It is the California Effect in action. We saw it with auto emissions, and now we are seeing it with carbon accounting. But I keep coming back to the technical difficulty of it. Herman, if I am a mid-sized supplier and one of these billion-dollar giants comes to me and says I need your carbon data by next month or we are dropping you as a vendor, what am I supposed to do? I do not have a five hundred thousand dollar compliance budget. I have a shop floor to run.
This is where we see the secondary effects, and they are not all positive. We are likely going to see a massive consolidation of supply chains. Large corporations will stop working with hundreds of small, diverse suppliers and move toward a few large vendors who have the administrative capacity to provide this data. It is an unintended consequence that could really hurt small businesses and minority-owned businesses that do not have the overhead for a sustainability department. The only way to avoid this is to move from spend-based data to activity-based data in a way that is actually scalable.
Explain the difference there for people who are not deep in the spreadsheets. Why is activity-based data the holy grail?
Spend-based is what we talked about earlier, using dollars as a proxy. It is easy but inaccurate. Activity-based means you are actually tracking the physical units. Instead of saying we spent ten thousand dollars on shipping, you say our carrier moved fifty crates over two thousand miles using a specific grade of marine fuel on a specific vessel. It is much harder to collect because it requires every link in the chain to be transparent. But it is the only way to get an accurate audit. If you use spend-based data, you are basically reporting on the state of the global economy. If you use activity-based data, you are reporting on the actual physical reality of your business.
We talked about something similar regarding impact-weighted profits in episode thirteen thirty-eight. The idea is to eventually put these environmental costs directly onto the balance sheet alongside the dollars. If we can get to a place where a ton of carbon is treated with the same accounting rigor as a dollar of revenue, then the whole system changes. But we are clearly not there yet. We are in this messy middle ground where the law says you must report, but the tools to report accurately do not really exist for most people.
We are definitely not there. And there is a legal hurdle we should mention that is very current. California's Senate Bill two sixty-one, which is about climate risk reporting, is actually under a Ninth Circuit injunction right now. The courts are looking at whether these mandates violate the First Amendment by forcing companies to make what some consider to be political statements about climate change. However, Senate Bill two fifty-three, the one that specifically mandates the emissions numbers, is still on track. The legal distinction seems to be that reporting a physical fact, like tons of carbon, is different than being forced to report on your "climate risk," which involves more speculation and opinion.
That is an important nuance. It is easier for a court to say you have to report your emissions than it is to say you have to report your feelings about the future of the planet. But even the emissions numbers are speculative when they are Scope three. If I am using an industry average for a supplier in a country that does not report data, is that a fact or is it a guess? If I put that guess in a regulatory filing, am I lying to investors?
It is what I call a "regulated guess." And that is why the I-S-S-B and other frameworks are so focused on data lineage. They want you to disclose your methodology. If you are using a guess, you have to say exactly where that guess came from, what database you used, and what the margin of error is. The goal is to move the needle from forty percent accuracy to seventy percent, and then to ninety. It is an iterative process. They are not expecting perfection in twenty twenty-six, but they are expecting transparency about the imperfection.
It feels like we are in the "ugly teenager" phase of carbon accounting. It is awkward, it is expensive, and nobody is really happy with how it looks. But the transition from voluntary to mandatory is the point of no return. You can't just put out a glossy sustainability report with pictures of trees and children playing in a field anymore. You have to put a number in a regulatory filing that a Chief Executive Officer has to sign off on, carrying real legal liability.
That legal liability is the game changer. When the Chief Financial Officer becomes responsible for the carbon numbers, the sustainability department stops being a marketing wing and starts being a core part of the finance team. We are seeing a huge hiring surge for people who understand both accounting and environmental science. They call them carbon controllers. They are the ones who have to bridge the gap between the physical world of emissions and the digital world of the balance sheet.
I like that title. It sounds like something out of a science fiction novel. But for the people listening who are actually working in these companies, what is the practical move right now? If you are staring down that August twenty twenty-six deadline in California, where do you start? Because it is only a few months away in the grand scheme of corporate planning.
The first step is to audit your Scope one and two immediately. You have to get your own house in order before you can ask your neighbors to clean theirs. But for Scope three, the move is to identify your top ten suppliers by spend and start the conversation now. Do not wait for twenty twenty-seven to ask them for data. You need to find out today if they even have the capability to track activity-based data. If they don't, you might need to help them build that capacity or start looking for new vendors who can meet the reporting requirements.
And I would add, be very careful with the software tools you buy. Given what happened with the A-I-washing crackdown this month, if a vendor tells you their A-I can solve your Scope three problems without you having to talk to your suppliers, they are probably selling you a liability. You need tools that focus on data collection and verification, not just estimation. You need to be able to show the auditor exactly where every number came from.
Transparency is going to be the only defense against an audit. If you show your work, even if the work shows that the data is imperfect, regulators like the California Air Resources Board, or Carb, are much more likely to be lenient during this transition period. But if you hide behind a black box algorithm and that algorithm is found to be flawed or biased, you are in serious trouble. We are entering the era of the carbon audit, and it is going to be just as rigorous as a financial audit.
It is interesting to see how this connects back to our earlier discussion in episode thirteen forty-eight about why accounting usually ignores the planet. We are essentially trying to patch a bug in the global economic operating system. For five hundred years, we have accounted for every cent of profit but treated the environment as an infinite resource with zero cost. Now, we are trying to retroactively account for that cost, and it is proving to be the most complex accounting challenge in human history.
It really is. And it is not just a technical challenge; it is a geopolitical one. When the E-U sets a standard that is higher than the United States, or when California sets a standard that affects companies in Texas or Florida, it creates these massive points of friction. But the momentum is clearly toward more transparency, not less. Even with the legal challenges and the simplification debates in the E-U, the direction of travel is set. The "voluntary era" is dead and buried.
It makes me wonder if we will eventually see a world where a product's carbon footprint is as standard as its price tag. Imagine walking down an aisle and seeing two identical shirts, but one has a Scope three verified tag that is twenty percent lower than the other. That is the dream of these frameworks, but we are a long way from that level of granular accuracy. We need to get the corporate reporting right before we can ever hope to get the consumer reporting right.
We are, but the mandates are the first step. You cannot get to the consumer level until you have the corporate level figured out. And once the big players like Apple, Walmart, and Amazon are forced to report these numbers, they will force everyone else to follow. They have the scale to create the infrastructure that smaller companies can eventually use. They are essentially building the roads that the rest of the economy will eventually drive on.
So, to answer Daniel's question, it might not feel reasonable to hold a company responsible for its entire supply chain today, but the regulators have decided that it is necessary for the survival of the system. It is a massive experiment in using corporate transparency to drive global policy. Whether it works or just creates a mountain of expensive paperwork is what we will be watching over the next two years.
It is the ultimate test of the "sunlight is the best disinfectant" theory. If we shine enough light on these supply chains, will the carbon actually disappear? Or will we just have a very clear view of how much we are emitting as we head toward a warmer future? I tend to be optimistic that once the costs are visible and they start affecting the stock price, the engineers will find ways to bring them down. Money has a way of focusing the mind.
I hope you are right, Herman. It is definitely going to keep us busy on this show. If you want to dive deeper into the specific math of this, definitely check out episode thirteen forty-seven on the Carbon Math Paradox. It covers a lot of the foundational stuff that makes these current mandates so tricky to implement.
And if you are interested in the broader movement of how we value non-financial impacts, episode thirteen thirty-eight on impact-weighted profits is the perfect companion to this discussion. It really looks at the philosophy behind why we are doing this in the first place. It is about more than just carbon; it is about what we value as a society.
Well, that covers the shift from voluntary to mandatory. It is going to be a wild ride toward twenty twenty-six and beyond. Thanks as always to our producer, Hilbert Flumingtop, for keeping the gears turning behind the scenes.
And a big thanks to Modal for providing the G-P-U credits that power the generation of this show. We could not do this deep dive without that technical backbone.
This has been My Weird Prompts. If you are finding these deep dives helpful, please consider leaving us a review on your favorite podcast app. It really does help other people find the show and join the conversation.
We will be back next time with whatever Daniel or the rest of you send our way. Until then, keep digging into those details.
Goodbye, everyone.
See you later.
