Companies won’t get to net zero without taking a hard look at their supply chains

December 8, 2021, 8:41 PM UTC

The push to be stronger on environmental, social, and governance (ESG) issues is placing increased pressure on corporate leaders, who are seeing the effects of that pressure from consumers and labor, and even in investment markets.

“Companies are coming to realize more and more that their cost of capital is increasingly at stake when it comes to managing ESG risk,” Linda-Eling Lee, managing director of MSCI Research, said in a recent research briefing with the press.

This trend is changing how companies’ leaders, including their boards of directors, approach not only future investments and disclosures, but also their operations. An operational level of change is badly needed, given the current rate of temperature change, to avoid increasing the rate of climate disasters. Wildfires and major weather events are likely to continue and increase, which means spending on climate adaptation also needs to increase significantly, MSCI said.

“Today we really are very far from net zero,” Lee said, adding that only 10% of public companies “are currently on track to stay on or under the one-and-a-half degree temperature rise that we need” to keep the planet from warming to dangerous levels. “It’s not clear at the moment, really to anyone, how exactly that path is going to be for achieving a net-zero portfolio,” she continued.

One area where MSCI analysts see increased need and effort against climate change is in companies’ production process.

“We see the supply chain is very much in the limelight,” Meggin Thwing Eastman, executive director of MSCI Research, said in the briefing. “It’s no longer really acceptable to their investors or to stakeholders, and increasingly also to regulators, to only be accounting for and reporting your direct emissions and energy emissions.”

Lee noted that the largest companies have an opportunity to drive change across the business world on this front.

“If these giants are able to reduce their emissions, it really does actually have a trickle-down effect that really will impact and benefit everyone’s value chain emissions,” she said.

They can do so by moving beyond Scope 1 and Scope 2 (company operations and company purchases, or direct and indirect) for reporting and net-zero promises, to encompass Scope 3, which entails the entire production chain’s direct and indirect impact.

“Companies can expect that their business customers are going to be asking not only for lower prices and faster deliveries, but they’re going to want those things with a lot less carbon emissions in the process,” Lee said.

MSCI also addressed the differences between public companies and private as they relate to investments or divestments, and the fact that in some cases organizations can maintain “bad” climate investments in private funds that do not need to disclose as much information.

“Many of the top-10 private equity funds now report on emissions from their own operations. They also have a smattering of reporting about their business travel, but none of them except for one is really reporting on something that is much more consequential, which is the emissions of the assets that they own or the portfolio companies,” Lee said.

MSCI sees that changing as well, estimating that private equity funds are about 10 years behind public companies, but catching up fast.

Divestment has also been proven to be an incomplete strategy. Getting out of, say, investment in oil and energy companies would help your portfolio get closer to net zero, but Thwing Eastman called that “a pretty short-term view,” advocating for “less divestment, more engagement” with those kinds of companies to encourage them to improve the climate impact of their operations.

“Cleaning up a portfolio just doesn’t do that much good if the overall economy is still dirty,” she said. “We’re really trying to achieve a net-zero economy and not just a net-zero portfolio, and that linkage to real world emission really matters.”

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