17 March 2017

Comment: Deforestation presents a material risk for investors

NGOs and investors are increasingly pressing companies to take action against deforestation, say Mindy Lubber and Fiona Reynolds

Gabon is one the world's most biodiverse nations. Its vast tropical forests cover an area larger than the state of Minnesota, house thousands of species and serve as a critical carbon sink, sequestering an estimated one to five gigatonnes of carbon annually.

"The majority of companies' deforestation pledges don't go far enough

But Gabon's forests are rapidly being cleared to make way for palm oil and rubber plantations, harming its rich biodiversity and local communities, while also contributing to global climate change.

That's why Olam International's recent commitment to suspend all forest clearing for one year in the West African country, while it works out a framework for responsible agricultural development, is so significant.

Olam is but one of many global agribusinesses grappling with deforestation in its supply chain.  Worldwide, deforestation accounts for 10% of global warming emissions, and much of that is driven by commodities production. 

Forest destruction is also associated with myriad other environmental and social impacts, from ecosystem degradation to land rights violations, that create operational and other material risks for companies and their investors.

Last year, a leading global integrated palm oil player, IOI Group, lost its certification from the Roundtable on Sustainable Palm Oil after failing to comply with certification requirements. The conglomerate's share price consequently dropped 7% as 26 customers, including major brands Unilever, Kellogg and Nestlé cut supplies sourced from the IOI Group.

Reputational risks are especially a concern, as an increasingly aware consumer base and environmental organisations press companies, like Olam, to adhere to international certifications and standards for the ethical sourcing of their products.  

Fiona Reynolds, PRIStudies show that one-third of consumers now choose to buy from brands they believe are doing social or environmental good.

A sustained campaign led Brazil's largest grocery chain, Pão de Açúcar, to pledge last year to stop selling beef produced on deforested land in the Amazon rainforest, as well as beef produced by workers living in slave-like conditions and cattle produced on land grabbed from local communities.

Similarly, a month after a Greenpeace report revealed that British bank HSBC was providing loans and financial services to palm oil companies destroying Indonesian rainforests, the bank unveiled a new, updated policy for deforestation-free palm oil financing. Now, to receive lending from HSBC, companies must publicly commit to protect high-carbon stock and peat areas, and independently verify these commitments.

Expect more such campaigns, as environmental organisations become increasingly sophisticated at tying company supply chains to on-the-ground deforestation.  Mighty Earth, for example recently combined satellite imaging with supply chain mapping data to link the traders Cargill and Bunge to deforestation in Bolivia.

Regulatory and legal risks are also a concern as companies may be exposed to liabilities for products illegally produced in their supply chains. A 2014 Forest Trends report found that a startling 24% of tropical deforestation was associated with illegal conversion of forests for export markets.

With an increased focus on data disclosure and material factors impacting the value of a business, these risks will ultimately be included in analysts' research to assess a company's value and its expected stock return and ability to service interests and debt payments. Specifically, the inclusion of deforestation related risks in financial analysis has the potential to dramatically change assumptions related to revenue growth drivers, operational costs, profitability, litigation risks and cash flow generation.

"Investors can drive corporate attention to deforestation, beginning by pressing companies to disclose their supply chain emissions and their plans for reducing them

Hundreds of consumer brands have already made pledges to end forest destruction in their supply chains.  Unilever, for example, takes a comprehensive approach, collaborating with multiple stakeholders throughout its supply chains, and focusing on high conservation forests and peatlands. The company's robust performance appeals to consumers and enhances its brand.

The majority of companies' deforestation pledges, however, don't go far enough.  Commitments typically address a small segment of the palm oil market, but very few cover cattle or soy, the leading drivers for deforestation globally. Most companies have yet to set a timeline, or lay out even basic metrics for measuring implementation.

Investors can drive corporate attention to deforestation, beginning by pressing companies to disclose their supply chain emissions and their plans for reducing them, in addition to their deforestation policies. Investors should further press companies to adopt more comprehensive policies to end destruction of forest and carbon-rich peat lands across all major commodities, including by setting time-bound, quantifiable goals.

Mindy Lubber, CeresFinally, investors can help stop deforestation by investing in public private collaborations aimed at rejuvenating tropical forests.  At the World Economic Forum this year, the Norwegian government spearheaded a $400 million fund that aims to leverage investments up to $1.6 billion in deforestation-free agriculture. The Tropical Forest Alliance 2020 is convening similar such collaborations.

But investors must move swiftly.  Rapidly losing forests affects the Earth's ability to remove carbon from the atmosphere. The current rate of deforestation threatens our ability to hold temperature rises to 2°C and avoid global warming's worst impacts.

Mindy Lubber is the president of the non-profit sustainability organisation Ceres. Fiona Reynolds is managing director of the Principles for Responsible Investment (PRI). Ceres and the PRI are partnering to tackle widespread commodities-driven deforestation.