Why transition pathways are critical to net-zero success

The sector is dominated by multinational firms and global products, but smaller players and local variations are important, too. Branding is key, with firms under pressure from consumers to cut emissions and pollution. Transition goals range from upgrading factories and distribution fleets to more complex challenges, such as developing innovative new green forms of flexible packaging.

Context

Some of the consumer goods industry’s most notable features are:

• Vulnerability to consumer sentiment, given high levels of substitutability and the strong link between personal opinions and purchasing decisions
• A mix of standardized, globally available products and others tailored to local demand and preferences
• Thin profit margins, which mean that achieving scale is crucial to supply, manufacturing and distribution
• Vital importance of branding, with packaging a crucial element alongside the products themselves their pricing and availability

Current trends

The sector is experiencing several trends as it seeks to address climate change and other environmental risks, including:

• Consumers around the world are increasingly willing to alter their purchasing decisions over environmental concerns and other sustainability issues. However, this varies hugely between different generations, geographic regions and local markets
• Growing public expectations for consumer goods companies (and large retailers) to take the lead in admitting to, and proactively addressing, historic environmental failings
• Increasing consumer concern over plastic pollution, which will soon make non-recyclable or non-biodegradable packaging unacceptable. The biggest challenge is flexible plastic, which is harder to recycle than other categories owing to its multiple layers, pliability and high levels of contamination
• Growing vulnerability to accusations of greenwashing, with its attendant reputational and branding risks
• Increasing readiness of governments and public bodies to regulate consumer goods packaging through bans, taxes and other incentives

Transition initiatives

Some of the most common initiatives being pursued by consumer goods companies to reduce environmental risks are:

• Enhancing carbon footprint of inputs in partnership with suppliers, including animal and plant products, chemicals and synthetic materials
• Improving the efficiency and environmental profile of manufacturing processes
• Reducing carbon footprint of onward delivery to retailers in partnership with distributors
• Making commitments to reduce the use of plastic, to increase reuse and recycling, and to innovate packaging — for example, by making more use of biodegradable materials

Financing challenges and solutions

Some of the industry’s financing requirements are relatively straightforward, such as the need to finance the construction or leasing of new, cleaner and more efficient manufacturing facilities.

Other financing needs are more complex, but offer potential for financial institutions to leverage existing relationships across the value chain – by financing and insuring greener transportation solutions in partnership with suppliers, distributors and retailers, for example.

A third area – financing the transition of packaging onto a more sustainable footing – is much more challenging. In part this is due to the expensive, unproven nature of new technologies such as chemical recycling and bio-derived packaging. This, together with the need to meet local regulatory requirements, makes it hard to pick an area for investment at scale.

Financing innovative packaging is also made challenging by the need to develop closed-loop recycling systems, and the importance of consumers’ willingness to take responsibility for waste disposal. Solving these financing challenges is likely to require complex, innovative partnerships involving non-profits, governments, universities, consumers, regulators and competitors.

While there are significant challenges to surmount in the technology industry, particularly around how technology assets are cooled, there are envisaged solutions to these problems (e.g., in terms of use like advances in data storage to require less power and with it less cooling, or innovation in cooling approaches using natural methods) and the technology industry is relatively well-placed to execute such plans. Most sub-sectors feature a handful of leading companies with deep pockets and a strong culture of innovation. Some goals – such as greener manufacturing – are familiar to other industries. However, tech firms are also pursuing cutting-edge schemes to reduce emissions, pollution and energy requirements.

Context

Some of the most notable features of the global technology industry are:

• A concentrated landscape in which each subsector (online retail, social media, search, cloud, device manufacture) is dominated by a small number of global hyper-scalers
• Highly liquid companies, funded by strong margins and positive cash flow, with deep pockets for investment
• High levels of R&D investment together with a strong culture of innovation
• A crucial role as the enabler of innovation and change in other industries, including facilitating the global transition

Current trends

The sector is experiencing several key trends as it seeks to address climate change and other environmental risks, including:

• A growing need to balance continual and rapid innovation with greater sustainability and lower environmental risks – for example, when growing 5G networks and building 6G
• Increasing pressure from consumers and other stakeholders to reduce the carbon footprint of cloud servers and other energy-intensive activities
• Greater levels of government intervention in a wide range of areas, including network coverage, data privacy, pollution, antitrust and fake news

Transition initiatives

Technology firms are pursuing environmental initiatives in a number of key areas. Some are very similar to those of other industries, but some are more unique and forward looking:

• Improving the environmental profile and efficiency of manufacturing plants and day-to-day operations
• Establishing that key manufacturing inputs such as rare earths are sourced ethically, while minimizing greenhouse gas emissions and environmental pollution
• Working to improve recycling rates for old or unwanted devices
• Exploring innovative approaches to reducing the energy consumption and carbon emissions of server hubs – such as situating them deep in the ocean to harness natural cooling
• Using cutting-edge advances in chemistry to reduce the environmental impact of device manufacturing

Financing challenges and solutions

Some of technology firms’ financing requirements – like funding investments in new production lines and other operational infrastructure – are relatively conventional.

Other requirements, such as funding cutting-edge R&D, have more niche characteristics – for example, it is typically hard to finance research with debt. Totally new innovations can also pose challenges of understanding for financial institutions, making it harder to identify and arrange appropriate financing. Set against that, many technology companies choose to finance these activities internally.

Another factor for financial institutions to monitor is the possibility that elements of the technology industry could be vulnerable to swings in sentiment and reputational damage if they are perceived as failing consumers – as seen in the recent collapse of some cryptocurrency businesses.

Conclusion

These analyses are simplified snapshots. The reality is far more complex, and transition pathways will evolve continuously in response to changing conditions and stakeholder views. For example, the latest EY Future Consumer Index shows “planet first” consumers gaining ground, even if rising food and energy prices mean that affordability remains the leading consumer priority in markets such as Scandinavia, Australia and the US. The Index also reveals significant gaps between consumers’ intentions and actions on sustainability.

Our new transition planning framework aims to capture nuances like these, providing financial institutions with a dynamic source of insight, and helping them to develop new and more sophisticated approaches to client engagement and decarbonization. In our next article in this series, we’ll share how the framework:

• Reflects how transition pathways are influenced by consumer preferences, governments actions and the evolution of technology
• Explores the current transition status and future initiatives of specific sectors
• Considers how investors, credit providers and risk carriers should react to, and enable, the transition to net zero

Given increasing concern about biodiversity loss, habitat destruction and plastic pollution, our new framework will also aim to address a growing set of environmental goals while avoiding social harm and protecting value for the planet. 

It’s becoming essential for financial institutions aiming to meet their net zero commitments to be curious about environmental science, to understand the circumstances and challenges of different sectors, and to apply this knowledge and insight to their strategy and operations. We look forward to revealing more about our new framework for financing the transition during the months leading up to COP27 in Sharm el-Sheik.

Summary

Understanding transition pathways is critical to decarbonizing financial services and achieving net zero, as it allows financial institutions to identify customers’ current and future transition activities along with the related financing requirements. Now that we’re months away from COP27, and we’ve explored transition pathways for the agriculture, consumer goods and technology sectors, financial institutions should be able to develop new and more sophisticated approaches to client engagement and decarbonization.