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How data helps investors target deforestation risk management

New data on deforestation risk exposure helps investors identify the risk hotspots in their portfolios, enabling more focused risk management efforts.

6 Oct 2020

Investor engagement on deforestation is rising, as the financial risks of nature loss are becoming clear. Leading investors seek to influence the companies or banks they are invested in, pushing them to change their policies and practices. Divestment is typically a last resort. Nordea Asset Management only sold off their shares in JBS, the world’s largest meat producer, in July 2020 after they deemed that engagement with the company had failed to tackle the deforestation risk in their supply chain. Investors armed with detailed data on deforestation risks can engage more efficiently with the companies in their portfolio, and in turn reduce their own deforestation risks.

Focus on risk hotspots

Investors are exposed to deforestation via their investments in companies that produce, trade or use forest risk commodities, such as soy, beef and palm oil. Ideally, deforestation engagement should be applied systematically throughout an investor’s portfolio. In practice, investors often select a subset of investee companies to target, as engagement can be an arduous process requiring extensive interaction between investors and investee companies. To maximise results, investors can target efforts where their influence could have the largest impact. Trase data shows that deforestation risk is highly concentrated in production regions, commodity traders and even within specific assets and subsidiaries. This provides an opportunity for targeted action by investors, if they identify precisely where the deforestation risk in their portfolio is concentrated.

Engagement enabler #1: Identify priority assets

As a first step, an investor can screen their whole portfolio to identify which companies have the highest deforestation risks. Investors can use a combination of quantitative deforestation risk indicators, policy indicators and sourcing practice indicators summarised using Red, Amber, Green (RAG) flags to rank engagement priorities. Trase Finance allows investors to look at all these indicators in one place.

Importantly, such a portfolio-wide assessment shouldn’t be a one-off exercise, but a periodic routine that can capture any changes in deforestation risks.

As part of their portfolio-wide assessment, financial institutions may also want to rank and benchmark the companies in their portfolio against competitors and peers.

Engagement enabler #2: Identify the most high-risk subsidiaries

Once they have identified key companies to engage with, investors can benefit from gaining more granularity on which arm of the company holds the highest deforestation risk. Many companies are complex. Large commodity traders, such as US agribusiness company Bunge, can have hundreds of subsidiaries. Many large companies are also diversified, which means only a subset of activities may be linked to deforestation risk. For financial institutions holding shares in corporate groups with a large number of subsidiaries, targeting specific subsidiaries can maximise results: Trase Finance data shows that deforestation risk is often not evenly distributed throughout a group’s legal structures.

For example, Golden Agri Resources is the largest exporter of Indonesian palm oil, a key forest risk commodity. Trase Finance estimates that Widjaja’s palm oil exports in 2015 were associated with 50,868 hectares of deforestation risk, and as such had the highest deforestation of any exporter. As much as 47 percent of that deforestation risk is associated with the exports of its subsidiary Sinar Mas Agro Resources and Technology. This particular subsidiary accounts for a disproportionate share of Golden Agri Resources’ total deforestation risk, as they only make up 26 percent of the company’s total exports. If armed with this knowledge, an investor in Golden Agri Resources looking to engage with the company on deforestation would focus on improving the deforestation risk exposure of Sinar Mas Agro Resources and Technology.

Action beyond engagement: ESG funds and green bonds

Beyond targeted direct engagement, how can investors use data to tackle their deforestation risks?

To address the deforestation risk exposure in their passive investments, investors can strengthen their Environmental, Social and Governance (ESG) criteria to cover deforestation. They can push fund providers to ensure ESG-labelled funds exclude companies with high levels of unmanaged deforestation risk.

Data on deforestation risks can also inform investors’ interactions with green financial products such as green bonds. Investors can push for financial products labelled as green to carry zero deforestation risk.

Already, green bond issuers have attempted to limit deforestation risk by excluding activities with high deforestation risks from the use of proceeds. For example, earlier this year, the Norwegian salmon producer Grieg Seafood, excluded purchasing from commodity trader Cargill from the use of proceeds of their green bond, due to the high deforestation risk associated with their soy. But excluding only the highest-risk supplier can still leave the green bond proceeds exposed to deforestation risks through other suppliers.

Investors can push issuers like Grieg Seafoods to instead incorporate quantitative deforestation risk thresholds into the design of the green financial products, committing proceeds that will only finance activities with zero deforestation risk (or a minimal level, if the investor considers that acceptable). Crucially, the investor would then be able to see data in the green bond reporting that proves the issuer has followed through on this commitment. Investors could use their influencing power to push issuers in this direction.

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