The link between deforestation and climate change is increasingly recognized in, for example, the 2015 Framework Convention on Climate Change’s Paris Agreement and elsewhere. This recognition is particularly important, as the planet has lost about 129 million hectares of forest since 1990. As deforestation is largely driven by specific economic activities and is thus a sector-specific risk, investors and banks must now pay far greater attention.
In four Latin American countries (Brazil, Colombia, Ecuador and Peru), over 70% of combined deforestation is linked to cattle ranching. In two African countries (Liberia and DRC), large-scale and subsistence agriculture are the primary drivers. Palm oil and other agricultural commodities, as well as mining and the exploitation of oil and gas are threatening forested areas in various countries. Logging is a recurrent factor in all forests, while infrastructure and hydropower contribute to deforestation in several countries.
Banks and investors can be exposed to deforestation risks directly, by investing in (multinational) companies operating in the identified sectors in these countries. But they can also be exposed indirectly, through downstream companies that buy commodities from these countries, or through governments and public banks that make infrastructure developments possible.
Direct and indirect exposure to deforestation risks could impact banks and investors in different ways:
- The reputation of financial institutions with sustainability policies is at risk if the companies they invest in do not comply with their policies.
- If deforestation is tackled more seriously on international and national levels, the profitability of companies active in these sectors – or their buyers – could be at stake. Their financial stakeholders could then experience lower returns on investments, higher risk profiles and even defaults.
Deforestation related financial risks:
- Lost price premium when unable to sell higher-margin certified products.
- Loss of customers when producers are noncompliant with customers zero-deforestation procurement policies.
- Increase of costs of goods sold for sellers when they must find substitute buyers when sellers violate buyers zero deforestation policies.
- Loss of banking and investor relationships due to noncompliance with their sustainability policies.
- Fines and other costs due to noncompliance with government and buyers policies.
- Concessions being revoked for illegal deforestation and land grabbing.