Deforestation: Key Steps for Asset Owners

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    Stockholm (NordSIP) – The Intergovernmental Panel on Climate Change (IPCC) 6th assessment report concluded that the “Agriculture, Forestry and Other Land Use (AFOLU)” sector accounted for 13-21% of global greenhouse gas (GHG) emissions over the last decade.  Almost half of these emissions are being caused by deforestation.  COP26 in 2021 brought 140 countries together in making the Glasgow Leaders Declaration on Forests and Land Use.  These positive intentions were reiterated and consolidated the following year at COP27 with the Forest and Climate Leaders Partnership and the Finance Sector Deforestation Action Plan.  2022 ended with the Global Biodiversity Framework adopted at Montréal’s COP15, including the pledge to protect 30% of the planet’s surface area by 2030.  The European Union (EU) will by next year require companies doing business in the bloc to prove that their supply chains are not contributing to deforestation.

    Good intentions will not reverse the trend

    Unfortunately, as we reported earlier this week, deforestation is continuing apace around the globe despite these high-level commitments.  In 2011, CDP (formerly known as the Carbon Disclosure Project) began collecting forestry-related data from companies to help measure and manage forest-related risks and opportunities.  We asked CDP Europe’s Associate Director of Capital Markets Torun Reinhammar, Cardano’s Senior Responsible Investment Officer Arjan Ruijs, and Manulife Investment Management’s Global Head of Timberland Investments Tom Sarno what asset owners and managers can do to help reverse this negative trend and contribute towards restoring and preserving the world’s forests.

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    Ruijs begins with a welcome note of optimism to place the negative statistics in context: “The increase of deforestation over the last years is to a large extent due to Brazil, where Bolsonaro had removed many of the barriers to reduce deforestation.  With the new Brazilian government, it is to be expected that deforestation will now start to decrease.  Secondly, the new EU no-deforestation regulation is likely to be impactful as it gives companies the obligation to make sure that their products imported in the EU are deforestation free.”  He is nevertheless concerned that the EU requirements may simply cause companies to shift more business to China and other less strict jurisdictions.

    What should asset owners do to address deforestation?

    “For investors, a first step is to understand which business activities are connected to deforestation risks, looking at both direct operations and supply chains of portfolio companies.  Investor signatories of CDP have access to data we collect from companies and the subsequent scores assigned by CDP. Asset managers and owners can use these to identify companies potentially exposed to deforestation,” explains Reinhammar, adding that signatories can also assess their portfolios’ exposure to deforestation risk through the CDP Forest Champions Initiative.  The availability of data is constantly improving, with a record-high 68% of European companies disclosing some or all of their deforestation-related risk.

    Ruijs agrees that proper analysis and research should precede any concrete steps: “We know which sectors that are most exposed to deforestation.  We also monitor how well these companies manage these deforestation risks.”  It is important to analyse the entire supply chain, explains Ruijs: “We also monitor whether companies downstream in the supply chain are assessing their deforestation related risks and implementing the necessary strategies.  With the new EU no-deforestation policy, companies will put this higher on their agendas and it is likely that more information becomes available such that we can distinguish frontrunners from laggards.”

    Manulife’s long track record in timberland investing has helped them build up in-house monitoring capabilities to detect potential sustainability issues.  “We use our sustainability toolkit to assess every acquisition to ensure that we can operate the timberlands in accordance with our sustainability principles,” says Sarno, adding that their vertical integration approach helps them keep control of most aspects of the value chain.

    Company disclosures are not matched by action

    Improvements in reporting levels have sadly not been accompanied by concrete actions, despite the looming EU Deforestation-Free Products Regulation.  CDP’s latest Global Forest Report, released on July 6, 2023 reveals that almost 90% of surveyed companies have no strategy in place to stop deforestation.  For Reinhammar, this is the second step that investors must take in addressing the problem: “They must set out expectations for companies by developing no-deforestation policies with a clear compliance framework, cutoff date, and target year.  Data disclosed through CDP by financial institutions can serve as a guide and benchmark for policy development.”  The third step should be to review the whole portfolio to assess the forestry-related risks within it: “CDP forest scores give a quick overview of a portfolio company’s awareness of environmental issues, its management methods, and progress towards environmental stewardship.  CDP has developed 15 forest-related KPIs that provide a more detailed assessment of the raw data disclosed by companies, which help understand what essential actions are needed.”

    Companies that sit on their hands face the axe, according to Ruijs: “As a result of our strict sustainable investment policy, those with too negative impacts on land use are excluded from investment, especially if engagement is unsuccessful or if we expect that engagement will not lead to the requested change.”

    Investor engagement on deforestation is crucial

    Once the investor has gathered all the necessary portfolio information and clearly communicated its deforestation policy to investee companies, the time comes for action.  Reinhammar continues: “Investors can contribute to halting deforestation by engaging with companies and requesting them to take action.  Portfolio engagement should be a key component of the asset owners’ strategy, as once investors are divested their influence over a company ceases.  If the company is not disclosing through CDP on its exposure to and management of deforestation the investor is driving blindly, so that would always be the first topic for engagement.  We encourage investors to engage collectively through CDP to drive more disclosure by being a signatory and taking part in our yearly Non-Disclosure Campaign.”  Providing the companies are disclosing, asset owners can then use their influence to urge them to take the next steps: setting a no-deforestation policy along with implementation targets (e.g., traceability, certification), beginning to monitor compliance with policies and commitments, assessing legal compliance, and engaging with their suppliers.  They can also take positive steps in supporting the restoration and protection of forest land related to their value chains.

    Sarno is also an advocate of collective engagement, with Manulife working on several fronts in this respect: “We are one of the founding members of the Forest Investor Club – an alliance initiated by the US State Department and now facilitated by the World Business Council for Sustainable Development (WBCSD) to promote investment in primarily emerging market forestry.”  The group was founded at COP26 and is still in the process of drafting its investment principles.  “These will provide a common set of guardrails allowing the development of a pipeline of potentially investable opportunities that are geared toward afforestation and responsible forest management,” adds Sarno.

    Cardano is involved in multiple collaborative engagement programmes, according to Ruijs: “We have initiated the Satelligence programme with around 10 other investors using satellite data to monitor deforestation among investee companies.  We have also initiated a programme with two other investors to pilot bio-acoustics methods, and have co-founded the Partnership on Biodiversity Accounting for Financials (PBAF).”  Cardano is also active in the Nature Action 100+, the Finance for Biodiversity Pledge and other nature-related initiatives.

    Technology is an asset when tackling deforestation, as Ruijs explains: “We have used satellite-based information to confront palm oil producers with potential cases of deforestation in their concessions. The Satelligence programme is currently supported by around 10 investors, where we collaboratively help food processing companies, and primary soft commodity producers, to improve their monitoring and disclosure.  The satellite data gives us an easy entry point to initiate talks with these companies and helps to discuss with them their efforts to halt deforestation among their suppliers or on their own concessions.”

    Enormous potential return on investment

    Increased compliance with reporting requirements is a positive development but will not solve the crisis in itself.  1,043 companies disclosed their forestry-related data to CDP last year, a 300% increase on 2017 levels.  CDP estimates the annual economic gain from a deforestation-free future to be $895 billion by 2030, which vastly outweighs the costs of addressing the identified problems.  For Reinhammar, companies and their investors must now urgently take action: “Forests are at the heart of our economy.  Forest loss is contributing to climate change and the loss of biodiversity and other vital ecosystem services on an unprecedented scale.  Immediate action to halt deforestation is required and there are signs it is rising up the agenda, but more action is needed from companies and investors.  Exposure to deforestation risk represents considerable financial, regulatory, and reputational risks to investors with deforestation seen by many as the ‘new coal’ in financial portfolios.  Institutional investors can play a key role in incentivising companies to act and they face significant risks themselves if they fail to do so.  The integration of forest-related metrics into portfolio analysis to address exposure to deforestation risks is more important now than ever before.”

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