Land-use conversion to produce agricultural commodities is the most significant driver of deforestation, accounting for an estimated 55 to 80% of global forest loss. Photo Photo by Kate Evans for CIFOR.
(This blog post originally appeared on the GLF blog)
A growing number of producers, traders and retailers have over the past few years made zero-deforestation pledges aiming to decouple production of palm oil, soy, beef and other commodities from deforestation impacts. The financial sector, however, has largely remained absent even though it is an important stakeholder as capital is a fundamental component of agricultural production systems. UNEP and the Natural Capital Declaration have now published a new report, which will help financiers to develop risk policies for loans and investments to reduce the probability that debt or equity will contribute to deforestation.
Thenew UNEP reportprovides a conceptual business case for banks and investors to develop soft commodity risk policies thereby reducing the probability of deforestation by requiring certain minimum standards and provisions from clients in the agribusiness sector. Furthermore, a newpractical, Excel-based toolby the Natural Capital Declaration enablesfinancial institutions to develop, update and strengthen their own risk policies for palm oil, beef and soy.
Land-use conversion to produce agricultural commodities is the most significant driver of deforestation, accounting for an estimated 55 to 80% of global forest loss. The countries that are the largest producers of soft commodities such as palm oil, soy and beef are mainly located in the Amazon Basin, South-East Asia, and increasingly the Congo Basin, all of which contain the largest continuous expanses of tropical forests in the world.
Deforestation and other environmental and social concerns have led a growing number of soft commodity producers, processors, traders and retailers to make pledges to reduce deforestation. This is driven by increasing consumer demand for products certified as deforestation free, pressure from non-government organizations, new or improved government regulations and other factors. For example, the board of the Consumer Goods Forum(CGF), an association of over 400 large retailers, manufacturers, service providers, and other stakeholders across 70 countries with combined sales of EUR 2.5 trillion (US$ 2.7 trillion) recommends to its members that they adopt a policy of “no net deforestation” in their supply chains by 2020 . Unilever, Wilmar, Cargill, Nestlé, Mars and a number of other major companies connected to soft commodity supply chains have made commitments to develop sustainable supply chains aiming to decouple production of vegetable oil, beef or other grown or produced commodities from forest impacts.
However, while agribusinesses are taking steps to understand their impacts and mitigate risks that can become financially material, the financial sector has largely remained absent from putting in place certain provisions to limit the probability that clients contribute to deforestation. Banks, traders and asset managers have a considerable indirect natural capital footprint by lending to or investing in companies involved in unsustainable production, trade or sale of soft commodities. These can become material if there is a probability that such risks affect standard financial metrics such as costs and revenue (see Figure 1).
Because it is at present difficult to calculate the value at risk to lenders and investors, developing soft commodity policies presents an (intermediate) way for banks and investors to better manage their lending to or investing in companies or projects that could have high deforestation impacts. Soft commodity risk policies may be aimed at reducing access to financing for the most harmful activities by a corporation that lead to forest clearing or forest degradation or stimulate or even mandate clients to move towards more sustainable operations and supply chains for example through sustainable certification standards for soft commodities (such as the Roundtable on Sustainable Palm Oilor the Roundtable on Responsible Soy).
A Soft Commodity Forest-risk Assessment (SCFA) tool was developed to enable financial institutions to assess the strength of their existing risk policies or to enable them to develop new policies. It is based on an existing framework by WWF and developed further with input from financial institutions, experts and academics. The SCFA tool was applied to 30 financial institutions, which revealed the following:
14 out of the 30 financial institutions evaluated encourage or require companies to avoid land use conversion in High Conservation Value (HCV) areas, and to respect the rights of local communities.
Half of the 30 financial institutions reviewed apply their policy to all of their financial activities, and 47% apply it to a subset of activities.
Of the 13 financial institutions that require or encourage certification, the majority of which are banks, five explicitly require companies to achieve or commit to a time-bound plan to achieve certification.
37% of financial institutions assessed refer to legal compliance in their policies. Some financial institutions include this requirement in agreements with clients rather than in public documents.
13% of financial institutions assessed have developed financial products and services aimed at promoting the production and trade of sustainable commodities.
However, even if a bank or investment firm has strict policies in place, this by itself is not a guarantee that it actually leads to a reduction in deforestation or forest degradation. Government regulation may be necessary to ensure a level playing field, whereby soft commodity producers will find it difficult to borrow money from banks, or otherwise obtain capital, without the same environmental (and social) conditions attached to it. Some evidence of a Central Bank regulation in Brazil where a condition was placed on rural credit in the Brazilian Amazon Biome, led to a 15% decrease in deforestation between 2008 and 2011.
Another potential lever is when companies that produce beef, soy, palm oil and other commodities in developing countries depend on capital from (franchises of) internationally operating banks with relatively strict soft commodity risk policies. In this case, these soft commodity producers may increasingly be required by their financiers to reduce their impacts on (primary) forests resulting from their activities (see Figure 2).
In countries where producers of soft commodities have other options to obtain capital in a relatively easy way, including from domestic finance institutions with little or no environmental risk requirements or through their families or the informal market, the expected positive effect in terms of a reduction in deforestation and forest degradation may be limited. A newUN-REDD Info Briefoutlines four steps for governments to assess if the financial sector can be a potential lever to stimulate a reduction in deforestation.
All in all, findings from this research has showed that a number of financial institutions have developed relatively robust soft commodity risk policies to reduce the probability of clients contributing to deforestation. In order to stimulate the broader financial industry to adopt similar stringent risk policies, though, beyond government regulation, it is crucial to develop a stronger business case linking deforestation impacts to effects on standard financial metrics such as EBIT (earnings before interest and tax), operational expenses or capital expenditure.
Brack, D., & Bailey, R. (2013). Ending Global Deforestation: Policy Options for Consumer Countries. Chatham House; Kissinger, G., Herold, M., & De Sy, V. (2012). Drivers of Deforestation and Forest Degradation: A Synthesis Report for REDD+ Policymakers. Vancouver: Lexeme Consulting
While RSPO and other standards require certain provisions that would in principle limit deforestation there is very little quantitative evidence that this is actually the case. The financial industry needs standardized frameworks like these certification schemes as individual due diligence is often too costly and time consuming. However, at the same time it is paramount to assess whether certification standards actually lead to lower levels of deforestation compared to conventional plantations without sustainability certification.
Assunção, J., Gandour, C.C., Rocha, R., 2013. Does credit affect deforestation? Evidence from a rural credit policy in the Brazilian Amazon. Climate Policy Initiative. Rio de Janeiro
UNEP press release: New Lending and Investment Tool Sets Agricultural Supply Chain on Sustainable Path, Reducing Deforestation Threat
UN-REDD Info Brief: Banking on REDD+: Can bank and investor risk policies on soft commodities benefit REDD+?
Ivo Mulder is the REDD+ Green Economy Advisor for UNEP on behalf of the UN-REDD Programme (an inter-agency initiative managed by UNEP, UNDP and FAO that works with +50 partner countries). He leads the work on the economics of REDD+ and supports the work on private sector engagement.