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The Food Industry and ESG (Intensive Production of Protein) Meat, Fish, Eggs and Dairy

The Food Industry and ESG (Intensive Production of Protein) Meat, Fish, Eggs and Dairy

The and ESG (intensive production of ) , , eggs and

Context

Ensuring that the growing global population has access to adequate, sustainable and nutritious food is one of the greatest challenges facing the world today. The global is under increasing pressure to meet this challenge. Rising healthcare costs, change and a range of other catalysts are adding to this pressure, presenting potential material investment risks for companies and investors alike. These material risks are particularly evident in production, given its substantial negative external impacts, which coupled with the growing global demand for meat, fish, eggs and dairy products will only intensify.

Intensive livestock (and associated product) production is the dominant system with 70% of all animal produced in this way. This trend is expected to continue as many Asian countries, including China consolidate their farming operations to reduce fragmentation and increase production efficiencies.

Investors who integrate analysis of environment, social and governance (ESG) issues into their investment approach must look across and food value chains, particularly as the magnitude of financial risks is likely to increase over the long term given current food production trends. Companies directly involved in animal factory farming are most exposed to key ESG issues. However, consumer-facing companies at the end of the value chain – such as food retailers and – are also exposed to these risks. The magnitude of risks to companies involved in animal factory farming and industrial food production are likely to increase as a result of rising costs, the shifting gravity of production to developing countries with less robust , the impacts of and increasing social concerns over and .

Defining the sector

The intensive production of livestock and associated products (meat, fish, eggs, dairy) is “the Sector”, so for investors, understanding where exposure to investment risk may occur is key. Arguably this is easier where an investment is clearly being made directly into the Sector (e.g. a ). It can be more challenging and the risk more easily overlooked where an investment is made indirectly into the Sector (e.g. to a supplier – such as pharmaceuticals - or to a purchaser of the products – such as restaurants and retailers). Mapping a portfolio to help identify those investments most exposed to the Sector (in its broadest sense) might help a GP when screening prospective investment opportunities, undertaking due-diligence and/or in prioritising engagement. The following highlights those industries linked to the Sector (more detailed information provided in Annex A):

The livestock industry and its universe of companies (indicative by industry type)

INDUSTRY TYPE Direct link to Animal factory farm Breeding (stud) farm Fish farm Slaughterhouse Animal processing Indirect (Suppliers) Pharma ( for ) Pharma (growth promoters) Animal or fish feed producers Animal or fish tagging Live animal Infrastructure manufacture (gestation crates, milking systems, feedlots) Indirect (End Users) Restaurants Food producers (meat, fish, egg, dairy) Processors of animal by-product or waste (bone meal, sludge) manufacture /processing manufacture/processing or wholesale (food) Retail or wholesale (Pet Food) Retail (clothing/fabrics)

The relative importance or materiality of ESG (higher, moderate and lower importance) in each portfolio company might then be considered. Further might involve discussion of the bespoke ESG factors (risks and opportunities) associated with each company (deep dive review).

Given the Sector is typically impacted by a multiple number of ESG factors, establishing the relative materiality of such factors can be a challenge. In many cases almost all ESG factors might be relevant. To help understand the suite of ESG factors that are most relevant to a portfolio, an approach that is often adopted is a combination of top down analysis (e.g. SASB) and bottom up (e.g. site or farm level) questioning and analysis (noting that the reality on the ground might be very different to what was envisaged through top down sectoral analysis).

It’s important to note that many firms in the Sector are privately owned, especially those in the supply chain (e.g. animal feed, pharmaceuticals) and end-users of products (e.g. restaurants, food manufacturers, pet food). When we ran our own analysis in-house for example we found our own exposure was primarily to end-users such as restaurants and food production.

Risk profile of the sector

Several ESG issues may be material to the long-term value of impacted companies, depending on specific circumstances and geographies. Weak of these issues may negatively impact a company’s financial performance. Conversely, good management of these issues are likely to improve a company’s reputation, access to investors and overall performance.

Selected material ESG factors associated with the industry sector (Source: Coller FAIRR Protein Producer Index, 2018)

ESG factor driver(s) Timeline for financial materiality Governance issues Food provenance The ability to provide safe, good Short term: issues can lead to (safety) food is fundamental to the business of animal culls, recalls, demand impacts and food production and food . price volatility in the short-term. Environmental issues Climate change Livestock production represents 14.5% Likely long-term: Companies with carbon- of all global anthropogenic gas (GHG) intensive (e.g. beef and dairy) are emissions (FAO, 2013) and exposure to most at risk from potential regulation or regulatory and economic impacts as taxation targeting the livestock sector. the is implemented to keep global temperature rises <2°C. Water Access to water is an increasingly Medium term: As water resources come significant issue for intensive farming under more pressure, companies that as large amounts are required (both derive revenues primarily from water- directly and for feed production). intensive proteins (e.g. beef and dairy) could be exposed to feed price volatility, regulation, and protests. Waste & Poor leaves animal Medium term: Companies could face more protein producers exposed to potential community advocacy and litigation for poor financial, regulatory or social impacts. practices (fines or curbs on expansion). & Many investors see deforestation and Likely long-term: Company business models loss biodiversity loss as a systemic risk. that depend on land-use changes could face constraints from competition for land and . Also, a shorter term risk for companies that source from or operate in ecologically sensitive areas like the Amazon. Social issues Antibiotics misuse The growth of antimicrobial resistance Medium term: As more food companies (AMR) poses a serious threat to global transition to phase out routine public health. use, livestock companies without robust may lose out on contracts, and are exposed to regulatory changes, as more governments develop action plans to manage growing AMR. Working conditions Poor worker health and safety presents Medium term: Companies face potential significant operational and reputational productivity issues, product boycotts and risks for the sector. damage to reputation. Animal welfare Animal welfare is increasingly viewed Short term: Animal welfare is rapidly as an important aspect of a well- evolving into a magnified reputational risk managed food business. The issue is and could result in the loss of contracts increasingly regulated and something from customers under pressure from customers increasingly expect. consumers and advocacy groups.

Engagement

We’ve observed investors adopt the following when seeking to focus on ESG issues applicable to the sector:

 Sectoral investment focus (exclusions)  Side letter provisions to address the Sector and its ESG issues, including animal welfare  Broader scope of ESG factors (e.g. animal welfare, antibiotics) within formal responsible investment/ESG policies  Specific due diligence questions on ESG in the sector  Reference to available resources and tools  Follow up visits/deep dive reviews at underlying portfolio companies  Workshops for GPs/companies to highlight the sector and associated ESG factors

Resources and tools

Selected examples of the resources and tools available include:

Ceres (https://www.ceres.org/) Engage the Chain: An Investor Guide on Agricultural Supply Chain Risk: Engage the Chain overviews the environmental and social risks and impacts of 8 commonly sourced agricultural : beef, corn, dairy, fibre-based packaging, , , sugarcane and . These commonly sourced commodities are among the most prominent drivers of deforestation, emissions and water depletion and pollution. The interactive report also clarifies actions investor and companies should take to reduce agricultural supply chain exposure. Feeding Ourselves Thirsty: Tracking Food Companies Progress Toward a Water-Smart Future: In this report, Ceres ranks over 40 of the largest food sector companies on how they are responding to water risks and how performance has shifted since the first round of benchmarking. This analysis provides company and industry level data on four industries most at risk: packaged food, beverage, agricultural products and meat. This analysis also provides insight on the water and climate risks food sector companies are exposed to and how these risks impact their current and future profitability. FAIRR (http://www.fairr.org/) Coller FAIRR Protein Producer Index: The first ever benchmark to look comprehensively at the animal protein sector through the lens of ESG issues. Assesses 60 global , dairy and livestock companies across geographies on issues such as antibiotics, deforestation and biodiversity loss, working conditions, water, food safety, animal welfare and GHGs. Antibiotics: Antibiotics use in the sector: FAIRR’s collaborative antibiotics engagement, backed by 76 institutional investors with $2.5 trillion AUM, targets 20 global companies to phase out the routine use of antibiotics in livestock supply chains. This progress report profiles how fast food giants such as McDonald’s Corporation and Yum! Brands are responding to the investor engagement. Global investor statement on antibiotic stewardship: Currently supported by 68 signatories collectively managing over $3trillion of assets. Sits alongside FAIRR’s best practice antibiotics , which is intended as guidance for food companies and is also a useful and insightful tool for investors engaging individually with companies. Superbugs and super risks: A briefing produced in collaboration with Aviva Investors, setting out the investment risks associated with farm antibiotic misuse, and the key ways in which investors can engage companies to mitigate this risk and drive improvements within the food, farm and pharmaceutical sectors. Sustainable Protein (Investing in sustainable proteins): FAIRR’s sustainable protein engagement, backed by 57 investors with $2.4 trillion AUM, engages with 16 large global food companies to meet protein needs sustainably to manage related risks, and take advantage of the opportunities through diversifying protein sources. This briefing is a progress report on how companies such as Nestle, Walmart and Unilever are developing sustainable proteins, and provides investors with resources on how to engage food companies on this issue. Asia: Investment risks in the Asian livestock sector: Asia’s meat, and dairy industries face a range of badly managed sustainability risks – including extensive misuse of antibiotics. FAIRR’s latest report highlights how Asia’s routine use of antibiotics – many of which are critically important in human medicine – is contributing to an alarming increase in antibiotic resistance. CDC Toolkit for Fund Managers (https://toolkit.cdcgroup.com/about-this-toolkit) Useful information related to agriculture and aquaculture and fisheries PRI (https://www.unpri.org/) Various publications related to food, farming and agriculture BBFAW (Business Benchmark for Farm Animal Welfare) (https://www.bbfaw.com/) 2017 BBFAW Report: The Business Benchmark is the first global measure of company performance on animal welfare and, since its inception in 2012 has established itself as a catalyst for influencing change in corporate practices on animal welfare management and reporting. The 2017 Benchmark was released in February 2018 and assesses 110 food companies on their policies and performance on animal welfare.

Opportunities for investors

Animal protein producers face a range of business risks related to environmental and social impacts (business resilience and sustainability risks). It is evident that these pressures are likely to intensify as global demand for animal protein continues to grow. Some of these issues could potentially be mitigated with appropriate or a change in management practices. However, constraints including access to freshwater and will eventually restrict expansion. Therefore, diversifying protein sources towards lower emitting and less resource intensive sources is key to mitigating supply chain risks and to capitalise on changing consumer trends.

Innovation in is accelerating and is creating new protein production opportunities with the potential to disrupt the sector. For intensive animal protein producers, a failure to engage with this is a risk and diversification into producing alternative (non-animal) proteins is therefore important for both managing the risks of resource-constrained supply chains and for seizing opportunities for market growth. Protein diversification is therefore a financially material factor that can impact a company’s core business value proposition – including its growth, profitability, risk exposure and ability to compete and innovate.

Annex A: Industries linked to the sector

Direct Investment

1. Livestock rearing of any animal and/or fish species for human consumption at scale and which employs one or all of the following characteristics:  Close confinement e.g. gestation crates, battery cages  Engages in the practice of routine mutilation to facilitate close confinement  Excessive use of chemicals and medicines (e.g. growth promoters, excessive (prophylactic) use of antibiotics)  Use of highly selectively bred/genetically engineered/cloned breeds of animals, to enable unnaturally fast growth 2. Any animal farming business that might be operating on a smaller scale or used for more niche purposes (such as breeding ) but which adopts the same poor practices above 3. Any animal farming business that meets the criteria above but which rears any animal, and/or fish species for non-human consumption (e.g. pet food) 4. Processors of any of the above (animals and/or fish for human and/or non-human consumption)

Indirect (Suppliers)

Suppliers involved in the manufacture and/or provision of “critical” services to the above industries and including in particular: 1. Manufacturers and suppliers of antibiotics and/or growth promoters, or anti-fungal agents and (chemical agents) to the intensive farming sector 2. Producers and processors of feed for the factory farming industry (e.g. soy, corn – usually high calorie feeds) 3. companies and suppliers of small wild fish species and/or krill//crustacean species as for example food for farmed carnivorous fish species 4. Companies involved in the transport of (live) livestock for the industry (, rail, air, sea) 5. Manufacturers of factory farm infrastructure and machinery e.g. layer cages, intensive feeding and milking systems

Indirect (Buyers)

The customers and ultimate buyers of the products from the industry and including in particular: 1. Restaurants 2. Retailers and wholesalers (food for human consumption) 3. Food producers (food for human consumption) 4. Caterers 5. Retailers and wholesalers (food for non-human consumption) 6. Food producers (food for non-human consumption) 7. Leather and other food animal by-products (e.g. down) for garments and accessories (gloves, bags …) 8. Processors and suppliers of bone meal, fish sludge and other waste streams from factory farms (e.g. for use as conditioning/) 9. Others (other farms, glue companies)

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