Global Investor Engagement on Meat Sourcing (II)

Progress Briefing: Engaging QSRs on climate and water risks to protein supply chains

Section 1

Executive Summary

The Global Investor Engagement on Meat Sourcing, initiated in 2019, consists of dialogues between six of the largest quick-service restaurant (QSR) brands and institutional investors with over $11 trillion in combined assets. Investors have urged the QSRs to analyse and reduce their vulnerability to the impacts of climate change, water scarcity, and pervasive threats to water quality driven by animal protein production.

Companies have made notable progress in addressing these concerns. All six target companies have now publicly stated they will set or have already set global GHG reduction targets. Five of the six QSRs have now set, or committed to setting, emissions reduction targets approved by the Science-Based Targets initiative (SBTi) that would align their businesses with the Paris Agreement’s goal to limit global temperature rises to well below 2°C.

However, progress towards mitigating risks related to water scarcity and pollution has been limited. In addition, only two of the six companies have disclosed plans to conduct a 2°C scenario analysis, a key recommendation of the Task Force on Climate-Related Financial Disclosures (TCFD). While the progress to date is encouraging, there are critical elements yet to be addressed around climate and water-related financial risks.

Section 2

The Case for Engagement

Prior to the start of this engagement in 2019, many institutional investors had come to appreciate the materiality of climate and water risks posed to quick-service restaurants through their livestock supply chains. More details on the business risks to QSRs associated with these environmental threats can be found in the engagement’s January 2020 Progress Briefing and the sample letter sent to companies by this investor coalition in 2019. In 2020, we saw an increasing number of calls for enhanced climate change-related disclosures and new academic evidence underscoring the materiality of these issues to the meat sourcing value chain.

Investors are increasingly adopting ambitious climate change targets and are engaging with portfolio companies on plans to align with limiting warming to 1.5 degrees celsius. The investor participants in the Net Zero Asset Owners Alliance and Net Zero Asset Managers Initiative have committed to supporting the goal of net-zero greenhouse gas emissions by 2050, in line with global efforts to meet the Paris Agreement; and to supporting investing aligned with net-zero emissions by 2050. The targets are increasingly becoming a priority for large, conventional asset managers: these initiatives are supported by 33 investor signatories with $5.5 trillion in assets under management (AUM) and 87 signatories with $37 trillion in AUM respectively.

New guidance and regulations to improve climate-related disclosures and financial stability will likely continue to drive this trend. In November 2020, the UK announced that companies will be legally required to report on climate risks in line with the Task Force on Climate-Related Disclosures (TCFD) recommendations by 2025. The new rules will apply to a wide range of companies, including listed commercial companies, UK-registered large private companies, banks, building societies, insurance companies, UK-authorised asset managers, life insurers, FCA-regulated pension schemes and occupational pension schemes.

The US does not yet have binding regulations on reporting climate risks, but calls for regulatory advancements are growing. The US Commodity Futures Trading Commission’s Market Risk Advisory Committee (MRAC) released a report detailing 53 recommendations to mitigate climate risks to the financial system. Noting that climate change presents “a major risk to the stability of the US financial system”, the report recommends that US regulators must “move urgently and decisively to measure, understand, and address these risks” and that the finance industry must direct capital towards accelerating the net-zero transition. The US Federal Reserve has acknowledged that climate change increases financial stability risks and is calling for increased disclosure against these risks, as well as further research to help incorporate climate risks into financial stability monitoring.

New environmental regulations directly impacting the livestock industry may increase operational costs and disrupt protein producers’ business models, increasing risk to quick-service restaurant supply chains and potentially reducing profit margins. Water quality and quantity transition risks are a significant concern. In the US, the Biden administration has signalled its intent to implement regulatory changes that could directly impact meat supply chains. Biden’s $2 trillion climate plan may include broader regulation and updated nationwide standards, while increased enforcement of the Clean Water Act (CWA) – the primary federal law controlling and preventing water pollution in the US meat supply chains – could lead to stricter effluent discharge guidelines and penalties for CWA violations at the factory farm level, causing a potential increase in reputational and financial risk. QSRs could also face significant impacts from legislative reforms. For example, if adopted the Farm System Reform Act (FSRA) would immediately prohibit the creation and expansion of concentrated animal feeding operations and require a total phase-out by 2040. Legislative proposals like the FSRA indicate that the environmental impacts of large meat producers are drawing more attention from lawmakers.

Calls for a ‘meat tax’ have grown, especially in Europe. The tax would increase the price of livestock products. FAIRR’s report, The Livestock Levy, identifies several steps that led to the implementation of behavioural taxes on tobacco, carbon and sugar, and argues that the first step for a meat tax may have already been taken.

While meat taxes are not yet a reality, some of the companies in this engagement recognise this as a material transition risk. McDonald’s identifies potential regulation impacting franchisees and suppliers as a climate-related risk that could increase raw material costs, and is likely to emerge in the medium term. Yum! Brands also recognises environmental regulation impacting franchisees and suppliers as a material risk, but ranks this as a long-term, unlikely risk.

There is mounting scientific research demonstrating the high environmental impact of meat and dairy products and the vulnerability of livestock production to climate and water risk. The latest academic work on this issue further underscores the impact these risks will have on the animal agriculture industry. A report issued in 2020 by the United Nations Environmental Program Finance Initiative (UNEP FI) suggests that, under an ambitious transition scenario, intensively grazed beef will have the highest transition costs amongst the whole agricultural and forestry sector. The report suggests these costs will arise from tightly controlled land-use practices, carbon taxes, shifts to plant-based diets, increases in meat substitutes, and rising prices for resource-intensive crops.

A recent study from the University of Minnesota underscored the meat supply chain’s vulnerability to water stress in North America. The analysis found that 78% of irrigated feed is consolidated in just six companies. The study also found that the largest meat companies have the highest proportion of their feed sourced from areas facing chronic or seasonal water shortages. National Beef, Cargill, JBS, Smithfield Foods and Tyson Foods all have over half of their feed sourced from these vulnerable areas. These companies are critical to the supply chains of the six focus QSRs of this engagement.

Step 1: Scientific evidence of negative societal impacts culminating in international consensus, backed by a UN body.WHO’s International Agency for Research on Cancer ranks processed meats as Group 1 carcinogens and identifies red meat as a probable cause of cancer (2015). The IPCC Special Report on Climate Change and Land concludes that reductions in meat consumption and deforestation are likely to be required to solve the climate crisis.
Step 2: A compelling financial public benefit case to justify the imposition of a tax. This usually justifies cost incurred now (tax) to avoid the risks of more severe consequences in the future.Research by Oxford University concludes that a health tax on red and processed meat could save over $40 billion in global healthcare costs (2018).
Step 3: The emergence of evidence and/or political support that a tax can help lessen the societal/environmental harm being caused.The case for whether a ‘meat tax’ would result in the desired environmental and health outcomes is unknown.
Step 4: Current state of taxation levelsProposals for some form of ‘meat tax’ have been discussed in Sweden, Denmark, Germany, New Zealand and the Netherlands.

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Section 4

Next Steps for Engagement

Supply chain water use and quality

While several QSRs have formed partnerships with meat processors, the QSRs have yet to set strong targets related to the water use or quality of their meat and dairy supply chains. Strong water targets should focus on absolute as opposed to normalised reductions, while considering the local context and focusing the most aggressive reductions in use or discharge in watersheds that are the most impaired. To determine which watersheds are both critical to their meat sourcing and are facing high stress conditions, companies should conduct water risk assessments leveraging the many third-party tools and resources available.

As the QSRs begin to implement efforts to meet their emissions reduction targets, they have an opportunity to address water use and quality simultaneously. By promoting agricultural practices, such as cover cropping, reduced tillage, and fertiliser optimisation, the farmers that ultimately supply the QSRs can also improve the water retention of their soil, reducing nutrient runoff and enhancing their resilience to droughts and flooding.

TCFD-aligned scenario analysis

As of April 2020, none of the six target companies have completed and disclosed a climate scenario analysis aligned with TCFD recommendations. Now that all companies have set or are in the process of setting GHG targets, companies should push forward on assessing climate risks – especially given livestock production’s high vulnerability to these impacts.

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