The race for net zero — a balance of zero between greenhouse gases released into the atmosphere and those taken out — is becoming a priority for governments, municipalities, and corporations alike. Investments in clean and green energy have increased significantly in recent years. BNEF, a leading research firm, stated that in 2021, global investment in clean energy technologies was $755 billion — an increase of 27% from the prior year.
It is common to highlight investment figures related to climate change mitigation and adaptation. Financial flows, particularly into renewable energy generation or sustainability-related activities, also receive a lot of attention. But much less consideration is given to financial flows into high-emission generating activities or the depletion of natural resources such as deforestation.
Calls for ending deforestation are well underway at COP27, with 14 food firms announcing a roadmap to eliminate deforestation.
The amount of greenhouse gas emissions due to deforestation or crop burning is smaller than the greenhouse gases from fossil fuels and energy use in buildings, transportation, and industry. Yet, it is still significant, as deforestation has another effect: tree cover loss. Global Forest Watch estimated that between 2001 and 2019, 386 million hectares (or roughly 10%) of global tree cover was lost. And with every hectare of forest that is destroyed comes a reduction in the Earth’s vital carbon sink — that is, things that absorb more carbon than they release.
Numerous studies have calculated the percentage of deforestation emissions in total greenhouse gas emissions. Depending on the study, estimates of deforestation emissions range from between 10% to 15% of total emissions. Perhaps the most memorable study, using data from Global Forest Watch and the World Resource Institute, states that if deforestation were a country, it would be the third largest producer of greenhouse gas emissions, behind the United States and China.
Although the media mainly talks about deforestation in Brazil, it is worth pointing out that deforestation is occurring globally at a rapid speed. In fact, countries such as Côte d’Ivoire, Nigeria, and Indonesia fare much worse than Brazil, which has lost 15% of its forests in the last 30 years. For example, Global Forest Watch claims that Indonesia lost 36% of its primary forests from 2002 to 2021.
Calls for ending deforestation are well underway. For example, on Nov. 7, 2022, 25 countries vowed to end deforestation by 2030 during the ongoing 2022 UN Climate Change Conference, more commonly referred to as the Conference of the Parties of the UN Framework Convention on Climate Change, or COP27. Fourteen food firms also launched a roadmap to eliminate deforestation from their supply chains for soy, beef, and palm oil by 2025. But to understand and combat illegal deforestation, the focus needs to be on both the operators involved and the institutions providing the financial support that has encouraged deforestation.
According to data from the World Resources Institute, commodities such as cattle, palm oil, soy, cocoa, rubber, coffee, and plantation wood fiber accounted for 57% of tree loss between 2001 and 2015. Burning down forests and converting them into farmland for cattle is by far the largest single driver of deforestation, accounting for 36% of tree loss. Even though cattle remains in high demand, lawmakers in the largest economies are creating regulations to combat illegal deforestation.
Regulations are focused on holding companies and financial institutions whose actions have led to deforestation accountable by incurring both reputational costs and financial risks. And this is where the combination of stricter regulations and environmental, social, and governance (ESG) data can serve as an important amplifier to combat this problem. While regulatory measures create the legal boundaries of operation, the publication and usage of relevant ESG data provide transparency and give insight into how companies deal with deforestation.
Last month, the European Union voted in favor of regulation on deforestation-free products. Since the EU is the leading consumer of cocoa, soy, coffee, and beef, this law will have a large impact. Technology will play a significant role, as operators will be required to collect geographical information on the country and region where the commodities are produced. Traceability and transparency of supply chains, which are already dominant areas of technological innovation in the production of goods and services, can easily be applied to agricultural commodity value chains as well. Geolocation is proven to be the easiest way of monitoring since commodity production is stationary and conducted in a geographic location that can be easily mapped.
In the United States, elements of deforestation are currently regulated through the Lacey Act, which was enacted in 1900. The Lacey Act bans the illegal trafficking of wildlife, fish, and plants. Timber was added to this list in an amendment in 2008. Deforestation, however, is mainly carried out to create arable land for harvesting other commodity value chain products. Therefore, a much stricter and broader approach (like the one adopted by the EU) is necessary to prevent deforestation activities. Enter: the Forrest Act.
The Forrest Act focuses on the same commodities that the EU has identified, which are cocoa, soy, coffee, and beef. It would prohibit these commodities from entering the United States if they have contributed to illegal deforestation. For example, a Brazilian beef manufacturer using former rainforests as cattle-feeding land would now be prohibited from selling their products, among other measures. But is the Forrest Act alone the answer?
WHO IS FINANCING DEFORESTATION?
Various data providers collect information on corporations’ ESG factors. The financial materiality of ESG factors that drive financial performance and/or reduce risk has become an accepted fact. As shown in numerous meta-studies, high ESG scores drive financial performance. For instance, a recent meta-study carried out by NYU and Rockefeller Asset Management revealed a positive correlation between financial performance (measured by return on equity or return on assets) and high ESG scores.
ESG disclosures and questions need to expand on the origin of commodities through certifications and geolocation data. For example, wouldn’t it be useful to have a geolocation label about harvesting on your coffee or palm oil?
ESG data providers offer visibility into deforestation activities. For example, in its disclosure questionnaire for companies, Refinitiv asks about whether the company is producing, sourcing, or distributing wood or forest products that are labeled by the Forest Stewardship Council, which provides information about the origin of the materials used. The certification ensures that products come from responsibly managed forests. Other data providers specialize in material data from public sources and stakeholders using topic tags, such as forest burning, illegal logging, and impacts on landscapes, ecosystems, and biodiversity. Combining disclosures with controversial and adverse media stories related to deforestation from nongovernmental organizations and other news providers allows for greater visibility into the actions of market participants.
The recent Forest 500 report listed the most influential companies driving deforestation. The report states that 72% of all companies listed (which includes companies involved with timber, palm oil, beef, leather, paper, and soy) have exposure to deforestation but have not yet given a deforestation commitment in their supply chains. The report also states that more than $5.5 trillion in finance has been given to companies with supply chains that risk forests. In fact, of the 150 financial institutions surveyed, 93 institutions do not have a deforestation policy that covers their investments in and loans to companies in key forest-risk supply chains. And yet, these firms alone provide $2.6 trillion in finance to companies with the highest exposure to deforestation. These examples show that more ESG data on the origin of certain commodities is needed.
ESG factors, however, are becoming vital elements of performance and fiduciary duty in the growing field of sustainable investing. The new EU regulation may amplify additional transparency in commodity supply chains and financial institutions that finance them. As we have seen with the recent anti-slavery regulation, the Uyghur Forced Labor Prevention Act in the United States, supply chain transparency is an implication of this law. Lack of transparency in supply chains can lead to reputational and financial risk. There is reason to think that the regulation of deforestation has a positive impact on the data collected in ESG datasets.
Stewardship and shareholder engagement, a form of exercising influence by the largest institutional investors, could also play a role. Institutional investors are using their influence to engage with companies and ensure that sustainable policies are implemented, making corporate engagement and shareholder action the third largest form of sustainable investing in recent years. For example, the Norwegian Sovereign Wealth Fund has divested from over 30 palm oil companies. Similar activities by other large asset owners, acting either individually or collaboratively, can put pressure on companies with unsatisfactory policies and oversights regarding deforestation in their value chains.
INACTION IS NOT AN OPTION
With illegal deforestation becoming part of a regulatory framework in the United States and Europe, the stakes are getting higher. ESG disclosures and questions need to expand on the origin of commodities through certifications and geolocation data. For example, wouldn’t it be useful to have a geolocation label about harvesting on your coffee or palm oil?
The definition of deterrence is discouraging an action or event by instilling doubt or fear around the consequences. ESG can also play a role in amplifying illegal deforestation.
Ingo Steinhaeuser works for Thomson Reuters Corporate Investigative. He is a member of the Anti-Corruption Advocacy Network, the ESG Working Group and a contributor to the Thomson Reuters Institute.