Essential ESG Reporting and Compliance Insights for Government Contractors

A proposed environmental, social and corporate governance (ESG) ruling will impose new reporting requirements for government contractors. The new rule, to be incorporated into FAR subpart 23, intends to protect the government supply chain from climate-related financial risk. Businesses with significant and major contracts should familiarize themselves with these requirements and begin implementing reporting procedures to stay ahead of the curve when regulation is finalized.

The new ruling will impose a contract-specific requirement to be incorporated into contracts that are $7.5 million or higher. Those with contracts between $7.5 million and $50 million are considered “significant” federal contractors and must report on Scope 1 and 2 emissions. “Major” contracts are those above $50 million. In addition to Scope 1 and 2, major contractors must report on Scope 3 emissions, which is a more complex task. Further, major contractors must disclose climate-related financial risks, report to the Carbon Disclosure Project (CDP), and set science-based emissions reduction targets (SBTi). 

The ESG reporting requirements that apply to a major or significant contractor will also apply to their subcontracts of $7.5 million or higher.

Direct emissions from company-owned and controlled resources are categorized as Scope 1. There are four categories:

Indirect emissions that result from purchased energy, such as electricity, steam, heat and cooling are classified as Scope 2. These emissions occur at the power plant or other energy sources but are accounted for by the organization because they are a consequence of its energy use. To quantify scope two emissions, consider the kilowatts of electricity purchased (as indicated on your utility bill) and multiply it by the EPA’s emission factor specific to electricity generation.

Scope 3 emissions comprise all indirect emissions that originate in the business’s supply chain, including upstream and downstream emissions. Upstream activities are those that occur before or go into creating your deliverable. For professional services firms, there are significant upstream emissions resulting from employee commuting and business travel. Downstream activities occur after your deliverable has been created and begin once your product leaves the warehouse. The resulting emissions vary depending on the type of product; professional services firms don’t typically experience many downstream activities.

There are two main methods of calculating Scope 3 emissions. One is to ask your vendors about the emissions that result from their services. The second and most common is the spend method, in which a business would take the total spent on purchased upstream and downstream activities and multiply by appropriate factors for the relevant industry and products. As some businesses can have thousands of vendors, this process is often the most efficient route.

Federal and regulatory bodies ask most government contractors to follow the Greenhouse Gas (GHG) Protocol. The GHG Protocol provides standards for businesses to measure and manage climate-warming emissions. For corporate reporting, there are two distinct approaches to determine what emissions are included when consolidating GHG emissions: operational and financial control and equity share.

Under the control approach, a company accounts for 100% of the GHG emissions from operations under its control. There are two types of control approaches: operational and financial. Operational control is the most common approach. Under this method, an organization takes responsibility for emissions based on its operational control over specific activities or processes. Examples include situations where a company operates its own facilities, manages its operations and directly influences emissions. Even if the company doesn’t own the physical assets (like a leased office space), it still assumes full responsibility for the emissions associated with those controlled activities.

Under the equity share approach, a business accounts for GHG emissions according to its equity share in the operation. This approach is commonly used for joint ownership scenarios. Emissions are divided proportionally based on each company’s equity ownership. Calculating emissions through this approach can be complex, especially in cases of intricate ownership structures involving subsidiaries.

As mentioned, major contractors are required to disclose climate-related financial risks. The Task Force on Climate-Related Financial Disclosures (TCFD) has developed a framework to effectively disclose climate-related risks and opportunities. Here are the key components of the TCFD framework:

Major contractors must also report their ESG data to the CDP, a global environmental impact non-profit that runs the global disclosure system, via a lengthy questionnaire. The CDP will provide businesses with a score that compares them to their peers, impacting competitive standing in the market.

Lastly, the Science Based Targets Initiative (SBTi) sets recommended emissions reduction targets necessary to meet the goals of the Paris Agreement. Participating businesses commit to, develop, submit and announce a compliant emissions target and disclose ongoing progress.

The complexity of ESG reporting necessitates expertise in both federal contract laws and emissions calculations. Consult with members from Withum’s Sustainability and ESG Services Team and Government Contracting Services Team to better understand your reporting requirements per your contract and relevant regulatory bodies and for assistance with tracking, calculating and reporting your ESG emissions.