Deforestation and its role in net zero
As the business risks of deforestation become more apparent, policymakers are tightening demands on both companies and investors.
On 13 September, the European Parliament voted in favour of a regulation that would force companies to provide guarantees that their products sold in the EU do not come from deforested or degraded land anywhere in the world.
The proposed law, which expands on the European Commission's original proposal in November 2021, covers cattle, cocoa, coffee, palm oil, soya and wood, including products that contain these commodities. European parliamentarians also want to include pork, lamb and goat meat, poultry, maize, rubber, charcoal and printed paper.
For investors in the EU and further afield, the policy represents a broadening of the regulator's environmental remit, but, all the while, funds continue to flow towards businesses with deforestation risk exposures.
Deforestation is historically niche, but it's coming further into the mainstream as more investors appreciate how critical it is to global emissions and biodiversity.
Financing deforestation
UK-based non-governmental organisation Forest 500’s Global Canopy report found that financial institutions gave more than $5.5trn in finance to companies in forest-risk supply chains in 2021, and simultaneously, fell short in ensuring they are not driving deforestation.
Of the 150 financial institutions most exposed to deforestation, 93 did not have a deforestation policy covering their investments and holdings with key forest-risk commodity supply chains.
In total, the 93 financial institutions without deforestation policies provided $2.6trn in finance to deforestation risk-exposed companies, while only 23 of these financially reported on their progress in implementing the strategy.
"Deforestation is historically niche, but it's coming further into the mainstream as more investors appreciate how critical it is to global emissions and biodiversity,” says Helen Bellfield, deputy director at Trase, which aims to bring transparency to global supply chains.
She points to the UN’s Race to Zero campaign, and its focus on agricultural commodity-driven deforestation, as a driver for greater awareness of deforestation risks amongst financiers and investors.
Similarly, in 2021, the UN’s Principles for Responsible Investment (PRI) launched the Sustainable Commodities Practitioners’ Group (SCPG) – a cohort of investors cooperating to address deforestation as a systemic risk. Currently, 59 individuals from 45 investors, representing $29trn of assets under management, participate in the SCPG.
Despite recent efforts, deforestation increased by 12% between 2019 and 2021, according to the UN Climate Change High-Level Climate Champions research group. But from the investors’ standpoint, transitioning that awareness into portfolios “can be tricky,” Bellfield adds.
As such, asset managers are turning to data and insight tools to “screen and score companies” and “prioritise them for targeted engagement”, says Bellfield who gives the example of the Norwegian Government Pension Fund placing Brazilian multinational beef producer Marfrig under observation for its links to cattle deforestation.
Satellite imagery is another source of data for measuring the rate of deforestation.
“Satellite image processing keeps improving all the time even as more and more raw images become available, enabling more comprehensive and granular data and an ever-growing range of metrics. says Antoine Rostand, president of climate data company Kayrros.
Such data can be used to check the history of the land, map supply chains, and verify information provided by suppliers.
“We are delighted that our technologies can let legislators tackle deforestation effectively, consumers weed out greenwashing and responsible growers show they are producing food in a way that protects the environment,” he says.
Regulatory front
Yet collective action across the sector will be needed to make “a really significant impact,” says Bellfield. The EU’s latest regulation may be a catalyst for investors to ramp up their deforestation considerations with Bellfield saying this policy move reflects a “likely trend” of greater regulatory scrutiny across importing jurisdictions.
“Public demand for action is strong and financial institutions would do well to get ahead of the curve by grappling with the issue now,” she adds.
Richard Broadbent, environment director at law firm Freeths says the policy demonstrates “an interest in requiring businesses to go further” in terms of sustainable supply chains, “despite recent criticisms of ESG as the world economy moves into recession”.
For UK investors and financiers, Broadbent says it is “unlikely” such a provision would be introduced, “given the Prime Minister’s interest in deregulation,” but businesses and investors may “voluntarily adopt this approach” as the idea gains traction and “takes on the status of a global standard”.
But net-zero ambitions will not be met by 2050 unless deforestation is ended this decade, according to the UN’s Race to Zero campaign.
While the EU’s proposed regulation still needs approval from the Council of the EU and the national parliaments of the 27 nations in the bloc, its passage through the European Parliament is hugely significant.
The business case for reviewing risk exposure to deforestation is now gathering momentum – a stance that may soon trickle down into portfolios as net-zero deadlines draw nearer.
