21 January 2025
The Corporate Sustainability Reporting Directive
The Corporate Sustainability Reporting Directive (CSRD) is recent EU law that will increase the requirements on EU companies and companies with substantial EU operations to disclose and improve their disclosure on a wide variety of sustainability topics. The aim is to allow stakeholders such as investors and consumers to better evaluate the sustainability performance of organisations and to support achievement of EU sustainability targets. The first round of reporting will begin in 2025 on 2024 data and will be phased in over the next few years for organisations of different sizes.
What does CSRD say about Internal Carbon Pricing?
CSRD reporting requirements are currently a hot topic. This EU regulation is coming into effect in stages and stipulates reporting requirements related to a host of sustainability topics. CSRD has a wider remit covering ESG (Environmental Social and Governance) topical standards including for example Pollution, Affected Communities, and Business Conduct. Internal Carbon Pricing is covered in the “Climate Change” standard ESRS E1. Internal Carbon Pricing gets its own section within the standard: “E1-8 -Internal Carbon Pricing”.
E1-8 requires that organisations disclose whether they use Internal Carbon Pricing (ICP). Further to that disclosure, the organisation must provide details of the Internal Carbon Pricing scheme. Including:
Type, use and impact
It’s type, e.g. shadow or tax1, and how it is used, so is it in business travel, or research and development, or just monitored by the sustainability function for example? The organisation will be asked to disclose how the use of ICP supports decision making, implementation of policies, and achievement of targets.
Boundary of use and greenhouse gas coverage
How much of the organisation’s activities are covered by the use of ICP, so is it just applied to scope 1&2? Are there geographical boundaries to its use etc.? The quantified greenhouse gas (GHG) emissions that are covered or impacted by the use described here must also be stated and what proportion of the organisation’s GHG emissions that represents.
Carbon price and calculation
The carbon price used and how it was derived. Including whether it was set using “scientific guidance” and relates to a Science Based Carbon Price.
These requirements are likely to have some ripple effects as the legislation comes into effect for different organisations. There has been a lot of space for use of ICP in myriad ways, some of which are very light touch and yet still allow an organisation to say “yes, we use ICP”. Now when organisations disclose under ESRS E1, they will have to disclose details, and therefore there are some issues that may show up relating to those three areas above.
Low impact uses
Is the use of ICP focused on the big challenges that the organisation faces? Is it being used in decision making or communication processes that impact the footprint? (for example research and development, strategy, capital approval). And we might even question if ICP is actively used at all? There will be some organisations who have calculated an implicit price and used this in some reporting and monitoring practices, but little else. Previously an organisation could say they use ICP, but in reality it may only be seen by a few people perhaps in the sustainability function.
Low coverage uses
Has ICP been used on something material withing the organisation, or with any significant coverage of emissions? ICP can be very useful in a business travel process, and impactful within that scope area. However, if business travel is a very small part of the overall footprint, then this lack of coverage will be apparent in the disclosure.
Low carbon prices
Does the price reflect a true and relevant cost of carbon? This is perhaps the biggest issue that organisations may face in disclosing the prices currently used. Reviewing the CDP data on prices used with Internal Carbon Pricing systems to date shows a wide range of prices use, some of which are very low and may be assumed to represent a token value rather than the actual cost of decarbonisation or the value of avoiding carbon emissions to that organisation.
What is a Science Based Carbon Price?
More recent discourse has started to introduce the term “Science Based Carbon Price” into the lexicon. And indeed, it is also referred to here in the E1-8 section of ESRS E1. The appendix does not provide guidance on what would be considered a Science Based Carbon Price, and it can be difficult to find a fixed definition. In the recent SBTi publication on BVCM2, some definitions were offered that a Science Based Carbon Price has to represent the economic value of GHG emissions, extrapolating from the SBTi guidance we can say that a science-based carbon price should be based on:
- A Social Cost of Carbon or marginal damage approach which represents a “robust scientific assessment of the external cost of GHG emissions” or in other words, the costs that would face governments and societies in dealing with the effects of climate change from floods, droughts, extreme heat etc.; What will it cost us if we don’t decarbonize?
- A price based on a Mitigation Cost approach, or Target Consistent approach such as an implicit price which represents a “robust scientific assessment of the expected costs associated with achieving a 1.5°C pathway”, or in other words, the costs associated with the range of projects and investments needed to get to Net Zero for that body or organisation; What will it cost us to decarbonize? and/or
- “The true and complete cost to fully and permanently abate a given GHG emission”. This last one may have some wider interpretations, it could be seen as similar to the one above, but in the spirit of the SBTi BVCM document, it relates more to the use of external reduction or removal credits. To make this a more comprehensive list, we could also include participation in market-based trading schemes (purchasing certificates) or investment in Carbon Capture and Storage (CCS). What will it cost us to pay someone else in order to account for our lack of decarbonisation?
Ultimately, these three ways of calculating a Science Based Carbon Price represent three ways of looking at the challenge put to us by Climate Change and understanding the true value of carbon reductions.
All categories of Science Based Carbon Price listed above, but the last one in particular, should also take account of how those costs will change over time as urgency, demands for credits, and societal and legislative pressure increases.
Will the legislation have any negative impacts on use of ICP?
A huge positive of the CSRD legislation and ESRS E1 is that it encourages best practice in target setting, data collection, and climate strategy. The details of the disclosure standards make clear what are the acceptable levels of activity that are expected from organisations in terms of climate strategy and targets.
Internal Carbon Pricing is a powerful tool to support organisations in implementing climate strategy and achieving Net Zero targets. ICP works particularly well with organisations who have improved their understanding of their GHG footprint including scope 3, and who are starting to develop a transition plan with costed and quantified actions. ESRS E1 incentivises this target setting, transition planning, and climate strategy activity. Therefore, it also ultimately, incentivizes the use of Internal Carbon Pricing.
However, there are a couple of potential downsides. The first is that carbon pricing is a very flexible tool, that when used in an Internal Carbon Pricing model should be very much tailored to the needs of the organisation using it. An ICP model does not need to be punitive, and it does not need to be overly prescribed. It does need to have impact, and it does need to correctly represent the cost benefits or risks of decarbonizing (or not decarbonizing). But there are multiple ways in which this can be achieved, with multiple models. ESRS E1 does just ask for details of how ICP is used, but in the way the request is structured and particularly in the appendix additional detail, particular uses are presumed. ICP is most powerful when organisations have the freedom to apply it where it is needed, rather than to apply it in what feels like a prescribed or standardized way. There is no one “right way” to utilise ICP.
The other potential downside is that ESRS E1 requires an organisation to disclose details of their ICP process if they use it. Therefore, ESRS E1 could discourage organisations from using ICP, given that they are then protected from disclosing the required information. For many organisations, the cost of decarbonisation can feel like a highly sensitive metric. If you are in a sector with a very high cost associated with achieving each tonne of carbon reduction (your implicit price), it may be that you do not want that information to be published. And, if you don’t calculate it, then you don’t have to disclose it. Of course, as much as this logic follows, it is clear that any organisation who is going to manage to survive and thrive in a low carbon economy needs to understand metrics such as their implicit price and weigh that up against other economic and strategic decisions.
Overall, ESRS E1 and CSRD is likely to have a positive impact on the take-up of ICP, particularly from how it will encourage more rigour in all aspects of organisational climate strategy, but also just from increased awareness and discussion of it as a relevant implementation tool to support decarbonisation.
Where can I find the specific requirements for ESRS E1-8?
The updated standard has been available since December 2023, though it isn’t as easy to locate as the Draft standard3. In the updated standard, the only change relating to E1-8 Internal Carbon Pricing is that where in the draft standard a requirement was included to declare the scope 3 emissions (in addition to scope 1&2) covered by an internal carbon price, this has now been changed to scopes 1&2 and scope 3 “where applicable”.
What can I do to prepare for ESRS E1-8?
If an organisation already has a carbon pricing system in place, it would be worth a review ahead of having to make declarations under the CSRD framework.
Review the price that is being used
It is always useful to understand the implicit price of an organisation. The implicit price being a metric that represents the cost of carbon reduction for that organisation. An implicit price is tied to the achievement of a particular target. The cost of all the required carbon reduction measures to meet that decarbonisation target is divided by the tonnes of CO2e that will result from implementing those measures.
Clearly, some organisations will not have a view of what carbon reduction measures they will need to implement, some will only know a subset of what measures are needed, and some will know what measures could be used to achieve the target but may feel those measures are unrealistic. While the data supporting this calculation may currently be insufficient, other parts of the ESRS E1 standard will compel organisations to improve information and disclosure on how carbon targets are to be achieved so getting ahead in this matter will not be wasted effort.
It is worth calculating the best version of the implicit price that you can and aim to refine it and improve it over time. It can also be useful to understand what the implicit price is currently for the decarbonisation challenges you have in different footprint scopes. The implicit price does not have to be used in your ICP process, but it is vital information for understanding how you will achieve your target and for understanding the scale of a realistic carbon price for your organisation and sector.
Do also look at external price sources such as those published by governments (particularly if they are a key stakeholder), the World Bank, and the OECD.
Examine how effective the ICP scheme has been
What have been the impacts? Has the price resulted in people making different decisions and ultimately in reducing carbon? Talk to the users and get feedback and suggestions for any improvements.
It is also worth looking at what % of your GHG footprint is currently covered by ICP, use your current footprint and an understanding of what scope area is impacted by ICP. Look at what is required in terms of disclosure on E1-8 and consider how the presentation of the current system will be viewed by internal and external stakeholders.
Consider expansion of the ICP scheme to other decision and communication processes
If the ICP scheme has been relatively focused and minor in its impact to date, it can be used as a learning process and applied in other parts of the organisation. Many of the organisations who make most successful use of ICP started with a focused single use e.g. starting with just scope 1&2 before tackling scope 3, or using it only in capital approval before expanding to a wider procurement remit.
In conclusion, review the use of ICP in terms of:
- Type, use and impact
- Boundary of use and GHG coverage
- Carbon price and calculation
Where you find elements that can be improved, it is entirely reasonable to iterate and build on existing learnings and progress. For those who haven’t implemented ICP, note that the more that you comply with the other areas of CSRD and ESRS E1, the more suitable, beneficial, and easy to implement ICP will become.
References
1 "Shadow Pricing" is a way of using a carbon price in business decisions to take account of the financial value or penalty that would result from carbon reductions or increases in processes like Capital Approval or R&D. A "Carbon Tax" system in ICP terms would involve charging individual business units, or geographies a financial charge based on their contribution to the company's GHG footprint, the money often goes into a centralised fund.
2 Beyond Value Chain Mitigation - which relates to the purchase of offsets and removal credits: projects and investments that do not directly sit in your scope 1,2, or 3 emissions.
3 EFRAG have helpfully separated out the finalised CSRD annexes.
View the ESRS E1 Climate Change Standard
Charlotte Challis
Visiting Fellow, Centre for Business, Climate Change and Sustainability