Episode 3: Exploring Climate Change and Scope 3 Emissions

Full transcript

Ivy Kuo: Hello, I'm Ivy Kuo, Asia Pacific ESG leader at PwC, and you're listening to PwC’s podcast, ESG in Asia Pacific. The podcast for bite-sized updates on the latest ESG trends, from climate change to social and labour rights due diligence. The aim is to bring together ESG practitioners to discuss and solve today and tomorrow's sustainability challenges, which will reflect PwC's new equation strategy of building trust and making a lasting difference. This first series is all about sustainable supply chain, and I'm delighted to introduce you to PwC's Asia Pacific subject matter expert Jeremy Prepscius.

Jeremy Prepscius: Thanks Ivy for the introduction. In this podcast series we will be exploring the issues and changes driving the field of supply chain sustainability. This field is vast and there are many important parts of it, but we'll be focusing on a few key areas, particularly human rights, modern slavery, decarbonisation, and the governance aspects which will impact accountability. We have a great lineup of speakers, including a broad set of professionals, from those in the trenches of implementation to the top of corporate leadership. Let's get started with this episode.

Welcome to this third episode on sustainable supply chains. As we get started, just a short reminder, all opinions are our own and not reflective of any organisation with which we may otherwise be associated. I've been taking the opportunity in these podcast conversations so far to explore the big issues facing supply chain sustainability. Today's conversation is another big issue, possibly an existential one, climate change, and what supply chains have to do with this and can do about it. I'm very pleased to have three guests on this discussion who both understand the issue and can point to the future. My first guest is Lit Ping Low, a colleague of mine here at PwC in the Hong Kong office, who is the Asia Pacific climate change expert. Lit Ping, I'm really glad we have the opportunity to collaborate here. Your long experience and deep engagement on climate change are fundamental to our work. Tell us a bit about your journey to this topic.

Lit Ping Low: Thanks, Jeremy for having me here. I started as an economist working on policy and regulation about 20 years ago, and about 15 years ago I pivoted to work on climate change policy and regulations. Over the years I realised that it's not just about policies or what regulations businesses face or what they do within their boundaries, but it's also about working along the supply chain, doing so for two reasons. Firstly, it's about supply chain risks and resilience with respect to climate change. For example, how does your supply chain get affected by extreme weather events. And secondly, it's about how you can reduce your own carbon footprint as well as that of your supply chain? For many companies, their supply chain emissions can take up a significant proportion relative to their own operations. Very much so today, while working on climate change with organisations, a lot of the discussions have been about how we tackle the supply chain emissions that we have, our scope three emissions.

Jeremy Prepscius: We're definitely going to be diving into those. Before we do though, let's go to our second guest, Debanik Basu of APG Asset Management. Debanik, your journey to this conversation today has also been quite interesting and a new pathway you've recently embarked on. Tell us about your background and what's brought you to this conversation.

Debanik Basu: Thank you Jeremy for having me and everyone for joining. Indeed, it has been quite an interesting journey particularly in the past few years or so, and this whole focus in ESG has blown up. My own work in this space has been quite varied. First with a market regulator where I was looking at corporate restructurings and shareholder rights and other related stuff, and then with a couple of voting advisory firms. And in those early days, I think the spotlight was firmly on governance teams and conversations revolved around topics like board composition, audit quality, executive pay and so on. All of this changed some time in the middle of the last decade. Numerous studies started coming out linking ESG performance to financial results. At the same time, there were several research papers which also highlighted the impact of climate change and the need for the corporate world in general to adopt more sustainable strategies.

Suddenly overnight I was attending meetings where a large portion of time was being devoted to ESG issues. Companies, regulators, and investors all started questioning their own role in this transition and the impact this would have on them. Recently I moved to APG, which is an asset manager, and now I get to sit on a different side of the table. Being a large investor obviously has its own advantages, one of which is that we get more direct insights into the company's operations and therefore have a better understanding how their sustainability frameworks fit in with the status strategy. Personally, I've always believed in the long-term value of ESG. My entire career has been in this space and I believe now this is as good a place as any to put some of these ideas into action and see how they really impact real world outcomes.

Jeremy Prepscius: So Dexter, Debanik and Lit Ping have both outlined careers that have started many years ago that are working through the issues of ES and G and are beginning to align, or in Lit Ping's case, directly focused on climate change. You've been at CDP for quite a while. How did that start? What brought you there in the beginning?

Dexter Galvin: Well, I'm a bit of a poacher turned gamekeeper actually. When I started out my career, I chartered Soviet rust buckets around Europe. I spent some time telling my friends that I had the largest carbon footprint in the room and I thought that was hilarious and then I started to read up about it and the more I learned about the issues of climate change back then, the more I realised that I couldn't actually continue in what I was doing.

I saw that CDP was starting up a piece of work on supply chains. It was the only thing that I really knew at the time, supply chain, and I knew that there was this thing called carbon that I needed to get a handle on. So I reached out to CDP and I joined them to help start their supply chain programme back in 2008. So very much a Damascene-conversion. And so I've spent my career since then trying to advance the issue of climate change and reducing emissions in corporate supply chains primarily. And now also in the corporate disclosures to CDP.

Jeremy Prepscius: Maybe to round out the introduction today, I bring a few interesting bits and pieces of field work on supply chain to this conversation, mostly in terms of engaging suppliers and working towards real on-the ground change. So I think between the four of us, we've got a pretty interesting interlocking experience set to talk about the issue of climate change and supply chains. So let's get started. As I do, I want to come back to what I mentioned in the intro. The issue today is of fundamental, possibly existential, importance. And while I'm assuming that most listening in will have a good understanding of climate change, let's put the basics on the table and Lit Ping, I'm going to start with you. Climate change. In simple terms, what does this mean and why is 1.5 degrees so important?

Lit Ping Low: That's a difficult question, but an easy one as well. Let's start with the basics. A large part of our supply chain comes with carbon emissions associated with it, and much of that is from energy. For example, we need energy to manufacture goods, we need energy to transport goods around the world and further convert them into finished goods and then they get sent out to customers. So all of that requires energy use and there are other sectors as well that require other forms of process emissions and so on. But let's just do the energy bit because that's easy to understand. A large part of our emissions come from fossil fuel, from coal, oil and gas, and that emits carbon dioxide and other forms of greenhouse gases. That has led to an increase in the concentration of greenhouse gas emissions and that leads to what we call climate change.

At the moment, scientists have estimated that the impacts of climate change will be quite catastrophic, especially if it reaches or exceeds a tipping point of global warming around 1.5 degrees celsius, and what that means is you will have more frequent and more severe, extreme weather events. It means that we will have impacts around heat and precipitation around the world, which affects things like agricultural productivity, heat stress, and human health. In short, quite a lot of nasty things that we don't want to happen.

So what does it mean then to try to limit our warming to below 1.5 degrees? It means that we'll need to drastically cut back on the carbon emissions that we're putting out into the air and ideally absorb some of the greenhouse gas that's already in the air. And for us at PwC, we have regularly tracked the carbon intensity of global economies for the last 20 years or so, and our net zero economy index that was out for 2022, estimated that we will need to reduce our carbon intensity, so carbon per unit of GDP by 15% year on year for the rest of the century to keep to 1.5 degree.

So that is a tall order and that means that we need to decarbonise our own operations and particularly our supply chain as well. And for many organisations, the supply chain, the supply emissions take up a significant proportion much higher than their own operations. So that is a critical path that every organisation needs to look at, not just their own operations but their supply chain. So Jeremy, a long and short answer to your question.

Jeremy Prepscius: A long, a short and important answer to the question because this lays out the imperative of 1.5 degrees. Debanik, let's come over to you because there's a few interesting pieces here for our audience to understand. Let's talk a little bit about APG. What is APG Asset Management and at the highest level, why is climate change important to an asset management company?

Debanik Basu: Yes, thank you, Jeremy. APG, in a sense, is a pension provider. Our clients are pension funds and on their behalf, we manage the assets for around five million people. We, for the most part, pursue an active investment policy for our fund and manage more than 550 billion euros of pension capital. Now, as a responsible investor, we always try to look, not only at financial returns, but at doing our bit for society in areas like sustainability, values, diversity, climate change and human rights. Our goal at all times would be to generate a good sustainable income stream for our clients, which is why we have this unique privilege of having a very long-term vision for our investments, which is probably unlike some of the other asset managers. Now in the long-term context, we've listed out some pretty strong ambitions around climate change and the reasons resonate with what Lit Ping just said a while earlier.

We recognise the goals of the Paris Agreement and have been implementing a climate risk policy since 2019, which sets out how we measure, monitor and manage both climate risks and opportunities. We realise that a 2050 world will not be fully sustainable unless we act now. That's why we are members of the Net Zero Asset Managers initiative and have actively contributed to the development of the net zero investment framework. Within our teams, we have established a climate steering committee, which coordinates this approach of managing climate risks and is right now the driving force behind the implementation of the climate policy. What does this all mean? The net outcome from all of this is that the carbon footprint of our equity investments that we manage for our clients have decreased by around 40% compared with 2015. This is an active goal that we always try and pursue to reduce our carbon reductions. And this lower footprint is partly due to the fact that we now have a strict inclusion policy. So we are very careful of what companies are allowed in our investment universe, which has led us to sell some of our investments in a number of carbon intensive companies. In 2021 for example, we sold all investments in companies that derive more than 30% of their revenues from coal mines or more than 20% from oil sands. So we are taking a very proactive approach on these issues. We also take climate impact into account when voting on executive appointments and remuneration at shareholder meetings. For relevant companies that do not have a carbon reduction plan or do not link CEO pay to climate targets or climate performance, then we vote against and we have voted against director remunerations, nominations and also against approval of financial statements. In effect, we always want to make sure that the carbon footprint across our portfolio is neutralised as we go along and as we move closer to 2050.

Jeremy Prepscius: One of the things that I like about thinking about climate change from a pension fund perspective, is you have to have a long term perspective. And in the long-term, like not hitting 1.5 degrees is, as you said, not sustainable. So you've laid out the business drivers for change, why this matters for pension funds, pension funds investing corporates. By definition, why this begins to become a part of the imperative for corporates. And there's the old axiom, of course, what is measured is managed. So let's talk measured, managed data and disclosure. Clearly to drive change today and for the future, we need data. And this is where CDP, the Carbon Disclosure Project comes in. Dexter, what data are we talking about? What is actually disclosed to whom? And tell me why is this important?

Dexter Galvin: CDP is built around a pretty simple concept. Essentially we sent a letter to major listed corporations to get them to disclose what they're doing on carbon and climate change. And the idea was we would use the power of the big investors, the pension funds, the asset managers, the big banks, big sovereign wealth funds. We get them to sign this letter and say to listed companies, "Please disclose what you're doing on these issues". We started with a fairly straightforward request and it has ballooned somewhat since. There's a lot of data points in a typical CDP request these days, but the core principles remain the same. The idea is, we gather the company's carbon emissions, so scope one, scope two, scope three emissions, so direct, indirect and everything else emissions. We also look at what they're doing in terms of governance of climate change and Debanik mentioned some of the interests that they have in how boards actually manage these issues, so we have that data in our requests as well. We also look at the types of risks and opportunities that companies are facing from climate change. We look at the impacts of those risks on that organisation. And then very importantly, we look at what the companies are actually doing to manage that risk. So how are they actually reducing their emissions? Have they set targets? Have they set science-based targets? Are they reducing those emissions over time? So that's the main focus of the request. We also now ask companies about their water security and deforestation, but for this discussion, let's really focus on climate change.

Obviously as we're talking about supply chain, we have a huge growth in the focus of big corporations on managing their supply chain, and we'll talk a little bit more about that later. But I think we also gather a lot of data around what organisations are actually doing to manage emissions in their supply chain. And our big investors and the organisations that actually use CDP data are more and more interested in those data points, looking at what companies are doing outside their own four walls in their supply chain and in their value chain more broadly.

Jeremy Prepscius: I'm going to come back to you on the same question and begin to drive this a little bit deeper. So we've teed up the imperative, we've teed up the need for business drivers and ability to count and measure, but we're talking about supply chains. So Dexter, why is it so important that companies look at their supply chains and what is so difficult about how companies need to look at carbon emissions within their supply chains?

Dexter Galvin: We've been gathering this data since the early 2000's from companies and one of the biggest things that we've identified is the massive shift to emissions outside the boundaries of the corporations themselves. So for example, when we produced our first supply chain report back in 2008, we looked at the total scope three, the supply chain emissions, of the organisations that were disclosing to us and we saw that on average four times the average companies emissions were outside their direct operational boundaries in their supply chain. We redid that analysis in 2020, I think the data was on our 2019 disclosure cycle and we saw that it had actually shifted to 11.4 times the average company's emissions are in their supply chain. So this is an absolutely critical area of focus, and that rings true on other environmental areas that impact climate change as well, like water security and deforestation. So the supply chain is the thing that we really need to focus on.

Jeremy Prepscius: If you think about it, you buy a widget. Where is that material for the widget mined, created, grown, how is that processed and moved through its supply chain? How is it finished, packaged and sold? And all of that creates energy emissions. All of that are the scope three carbon emissions that come from the supply chains. So, Debanik, then coming back to talking to corporates about their scope three, how is APG engaging with corporates, of course about their corporates own footprint, scope one and two, but even more so about those scope three issues?

Debanik Basu: I think what we've tried to do is, and Dexter alluded to this, that the bulk of the emissions these days are outside the company's own boundaries and you need to therefore have a complete discussion around climate change, you need to include the supply chain, otherwise you are not talking or you aren't going to make any meaningful progress. For me in particular, my primary area of coverage is the emerging markets. What we find there, is that companies have just started to embed the tools and processes that they're required to measure and monitor their only issue performance. So they've just started the journey when it comes to their own operations. Very rarely do these trickle down to the rest of the ecosystem, which means that a large part of the overall processes is covered and multiple stakeholders as a result get left out of the assessment.

Very recently, I was talking to a hotel company in India and they own around 50% of the properties that they manage and they have already set carbon reduction targets for this part of the portfolio, but the rest of their managed properties are owned by other parties. And the view was there is very little that the company can do to ensure that these entities stick to the same decarbonisation agenda, and while the company's been trying to get these other parties to sign up, there is a lot of hesitation and reluctance. This is a concern for investors and for us at APG in particular, because like I said, we realise that meaningful change can only be brought about if there is a concerted effort to encourage vendors and suppliers to adopt and implement some of the initiators which are aligned with the company's sustainability strategy.

At the same time, we have to be cognisant and recognise the fact that there are various constraints, some of which are very real, that we need to work around. It's going to be a long process driven by engagement and discussion and that's what we primarily try to do. But with the understanding that we need to be patient to see tangible outcomes, it's a long drawn out process. Change is not going to happen overnight and we need to therefore work with the companies to ensure that they start taking incremental steps towards that journey, but we'll have to be patient.

Jeremy Prepscius: Lit Ping, you've been working with some of these companies to start mapping understanding engagement. What are some of the lessons and learnings that you've had from doing this work specifically?

Lit Ping Low: I think one of the potential misconception that many companies have is that you can't manage what's not in your boundary, and thinking that you can't influence what your suppliers do and therefore the focus has been on, just a bit of jargon here, but in what you call scopes one and two, which is your own emissions. But if we all think that way, then I think it's pretty hard to get round to the client problem. What I have found with some of my clients, whether they're in the retail space or in the hospitality sectors or real estate, across different sectors, when they start to engage with their suppliers, yes there will be some that find it difficult and have constraints, but there will also be a fair few who are willing to put in the effort and collaborate.

I think it is very much about the willingness to take that first step and to do that first level of engagement to find willing partners to embark on this journey. So that's the first lesson that I have experienced from clients across different sectors. Then I think the second thing is, as you start collaborating or as you start acting on reducing your own emissions, there will be that catalytic effect because your supplier reducing their emissions through their collaboration with you will also be reducing the emissions to their other customers and vice versa. So that can then start to trickle through the ecosystem and the whole industry itself.

To put a couple of examples out there, in the auto sectors, there have been some of the large automakers claiming that they would like to embark on a journey where they have phasing out internal combustion engines as well as creating carbon neutral cars. So that will have a large impact through the auto supply chain. A typical car has 20,000 parts, comes from all around the world, many, many countries. So that trickles through the entire ecosystem and each part of that component and each of those manufacturers, as they embark on that same journey, will bring about change in their respective economies and local communities as well. So I think we should not undermine the power of that first level of engagement and early commitments that have been made by some of these companies.

Jeremy Prepscius: I think one of the key lessons here is something that's normal and part of all supply chain procurement, everything that is bought comes with standards and depends on the industry you are some of those standards are about the inherent product, whether it's on product safety, product componentry, testing and quality. And over the last 20 years we've also tried to integrate things like social compliance within the relationship engagement here. And so this idea about the relationship, the idea about positive and negative incentives and tying them together to try to drive long term outcomes when term comes to carbon reductions, not just company X but X plus suppliers, one through 400. If we can do that, we can drive change. And Debanik, that's also where I think we move from slow to fast and we have to be able to get there. 

So taking that thesis of moving from slow to fast and thinking about the next five years, because the next five years are going to be critical when it comes to supply chains and decarbonisation, what do we need to see? What would you like to see take place between corporates and their supply chains? And, Debanik, maybe start with you this time.

Debanik Basu: I think like Lit Ping mentioned, this will have to be in the form of a trickle-down approach. I think regulators and investors like us need to push companies who in turn will then be forced to list out and adopt supplier requirements and supply standards. And this is, in many ways, the first step to ensure responsible vendor selection, but the buck can't and the buck doesn't stop there. Companies would also need to enforce these processes, which would mean conducting periodic audits to ensure that the suppliers are actually meeting these requirements. Very often it's very easy to draft policies around this, but unless you have real enforcement and real mechanisms to track and monitor, you're not going to get real world results and therefore this would need to be therefore supplemented by supplier training and maybe creating the necessary awareness around climate change. I understand that a lot of the suppliers in emerging markets are usually small and medium size enterprises and their levels of expertise and knowledge around some of these issues that we are talking about may not be as mature as the listed companies whom they serve. So there needs to be that process as well, wherein they get familiar with the narrative that we are proposing and companies could also, on their part, maybe chip in and help them with the transition and on a case-to-case basis, even share some of the resource burden that this would entail because these things would come at a cost and therefore that's the first step I think, which makes a lot of people hesitant to take that initiative because they know that they might lose out on their competitive edge. 

So the story that we need to push is that embracing these standards, one would be non-negotiable going forward, but also in this new paradigm that we are talking about, actually instead of creating a cost for them, would give them an edge in a competitive landscape. Because once you have these things as a supplier, then you are going to be able to attract some of these other clients who will then look up to you and you can then kind of pave the way for the rest of the industry to follow. So I think that would be the way forward for us.

Jeremy Prepscius: Change, standards, differentiation, data. Dexter, what are the things that you want to hope to see evolve over the next five years? Building on what Debanik has already started laying out?

Dexter Galvin: In the next five years, in this space, I see a lot of change. We've eight years to reduce emissions by 50% and that number keeps changing, where we keep reducing the amount of time that we have to solve this problem. So we need to make more efficient and effective interventions in this supply chain. When we started to develop scope three standard back in 2008, 2009, one of the biggest challenges that we had was how to get a good picture of supply chain emissions. So you had, what we called the company level allocation methodology. We're getting a bit geeky here, but bear with me. So that's engaging your key suppliers, getting them to disclose their emissions at a company level. But there's also a very important piece of the pie that has been missing for a long time, which is lifecycle data.

So we need to understand rapidly the carbon emissions over the life cycle of products around the world and we need to support that transition. Because you asked me about a five year horizon here, and I think in maybe four to five years time, I think product level data will be increasingly meaningful. In the past it's been built around secondary data and a lot of out of date estimations, which hasn't really been very helpful. But actually I think the key thing here is engaging with your supply chain across product level and company level data, getting them to disclose this information in the most standardised format possible because the last thing we want is a proliferation of standards and different ways of gathering this type of information, because what will end up happening, is that the suppliers will be inundated with myriad different requests for essentially the same information.

So we need to make a very serious effort to drive more standardisation in the market. I think Debanik and Lit Ping have both mentioned something very important, which is how SMEs engage in this journey. I think we need to come up with a very straightforward and mutually reinforcing method to support SMEs on this journey so that it's not just a one way demand for data, that actually that data comes with opportunities to reduce emissions and suggested areas of support. One of the things that we've been involved in that we like very much is the SME climate hub, the idea is that suppliers can go there, get ideas around what to do and to implement in their own operations. We need to see more of that. A lot of our big member organisations are investing a lot of time and effort in supplier training, building out supplier academies to share best practice with those suppliers.

So I think the sense of outrageous urgency isn't actually lost on very many people right now. So I find even with the procurement teams, when I started out in this space in '08, '09, it was very evangelical. You'd have to convince procurement that this was important. Now, it's like, "Okay, how do I take action? Can you give me the data to allow me to take action?". So that's why the data is so important because organisations, if we want to empower individual buyers for example, we're going to have to give them the information to say, "Okay, I am going to work with that company.” “I'm not going to work with that company because they're not taking it seriously. They don't have a science-based target in place." "I am going to buy that product because I know that the emissions profile is lower than that product." And the key is that we don't need every procurement professional in the world to be an expert on this topic, but we need to give them the tools to make informed choices.

Jeremy Prepscius: Lit Ping, would you like to build on that? And I think of this as supplier or buyer down, but also thinking about communities and jobs and suppliers up. And maybe you could build on some of what we're talking about.

Lit Ping Low: Thanks, Jeremy. In fact, I was thinking along the lines of communities. I think one thing that Debanik has raised, and that's just started to point to us as well, is we all know we need to transition really quickly and really rapidly and with the help of data technology that may get us closer to our targets. But I think one important thing in the next five years is how do we make this transition responsible and just transition? How do we support communities? How do we support small and medium enterprises? How do we support the informal economy, as part of this journey? And I think this is potentially where a lot of things that have been mentioned are helpful around training, around tools, but also policies. How does the government step in here? What is the role that the governments can provide in terms of upskilling, reskilling?

I think all those are important as we transition to a low carbon economy and bring along the communities and the supply chain along with us. So I think that's possibly the one point that I would want to stress that I can't stress enough, the urgency of moving towards a low carbon economy, but we have to do it responsibly and take the communities with us.

Jeremy Prepscius: And recognising the value that's embedded by the supplier, big, small, deep in your supply chain or not. It's created through the decarbonisation process and then passing that along the value chain to your buyer. And that's why the supply chain processes here are so interesting. So I'd really like to thank you three, Lit Ping, Debanik, Dexter. I really appreciate the discussion today and as always, I always learn a lot. 

In brief summary for our audience listening in, as supply chains evolve over the next decade, how they integrate environment and social factors, governance and accountability, these are going to directly relate to the world we inhabit from the impacts of climate change to the opportunities for inclusion to good jobs and a just transition. These will create the world we live in and hopefully will create the world we want.

In our next podcast, we'll be exploring the aspects of governance and oversight with a new set of discussions. Please join me as we continue to explore the changing imperatives driving sustainable supply chains.

PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details.
This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.