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The Chain: Cracks in Financial Institutions’ Responsibility Status in Deforestation Regulation

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July 11, 2023

Internationally, financial institutions (FIs) continue to be exempt from crucial regulations to raise their efforts and responsibility to halt deforestation and human rights violations linked to supply chains they finance. Recently, however, some initial steps were proposed in Brazil to change this situation, and a report on Rabobank showed that the environmental and social damage linked to the bank’s financing of forest-risk sectors in Brazil is material.

On May 29, the Brazilian banking association (Febraban) introduced a new self-regulation that limits financing to slaughterhouses that ask their customers to implement a traceability and monitoring system which allows for demonstrating the exclusion of (direct and indirect) suppliers linked to illegal deforestation. The regulation has been voluntarily adopted by 21 banks, including large ones such as Itaú Unibanco, Santander, Bradesco, Banco do Brasil, Caixa, Safra, and BTG Pactual.

The regulation creates a step that complements some existing requirements by the Brazilian Central Bank when providing credit to agribusiness companies and rural producers. However, it has several shortcomings. Importantly, it only covers illegal deforestation and is limited to the Legal Amazon and Maranhão, leaving out the largest area of native vegetation of the important and rapidly disappearing Cerrado biome. Moreover, it asks for full traceability for slaughterhouses not until December 2025 and exempts indirect suppliers below 100 hectares.

EU regulations

In the European Union (EU), FIs have been excluded from accountability and reporting in the EU Deforestation regulation (EUDR), as well as in the European Parliament’s negotiating position (June 1, 2023) on the Corporate Sustainability Due Diligence Directive (CSDDD). They are excluded at a time their financing is enabling companies to continue their business activities in the Amazon and Cerrado biomes. These activities have contributed to deforestation, climate, and biodiversity damage, as well as health damage and damage to Indigenous populations. The CSDDD will underpin the Sustainable Finance Disclosure Regulation (SFDR), which mainly regulates investment funds and portfolio managers. These funds, owned by FIs, can choose to be non-sustainable if they do not adopt SFDR.

The EUDR says that the present initiative will not specifically target the financial sector and investments. The reason is that existing initiatives in the area of sustainable finance, such as the implementation of the EU Taxonomy Regulation and the future Corporate Sustainability Reporting Directive (CSRD) (successor of the current Non-Financial Reporting Directive, NFRD), are believed to be well suited to address the deforestation impacts of the finance and investment sectors, thereby complementing and supporting this legislative initiative on deforestation.

In the EUDR, the EU authorities will evaluate the current position of the FIs. This is also because the role of banks and investors in financing forest-risk sectors is material. From 2010 to 2022, EU27 banks and investors provided in total USD 44.6 billion (Forests & Finance) in financing (identified and adjusted) to global forest-risk sectors. The largest providers among banks were Rabobank, Santander, and BNP Paribas, and the largest investors were Crédit Agricole, PFZW (Pensioenfonds Zorg en Welzijn), and Deutsche Bank. Banks in the Netherlands, Spain, and France were by far the largest financiers.

Report on Rabobank’s environmental and social damage in Brazil

A report on Rabobank, a Dutch commercial cooperative bank active around the world with a focus on agriculture, calculated the bank’s environmental and social damage. The report concluded that its financing of forest-risk activities in Brazil and financing of Dutch soy-sourcing livestock activities led to material environmental and social damages in the 2000-2022 period. Rabobank’s total financing from these two activities increased sevenfold from 8.8 billion euros from 2000 to the end 2022. The company saw a gross result (net interest income plus fees minus operational costs) on these activities of 717 million euros in the 2000-2022 period.

However, the estimate for environmental, health, and social damage caused by these financial flows to Brazilian forest-risk sectors is much higher: at least 66 billion euros in a “low” scenario, and 459 billion euros in a “high” scenario. Rabobank did not pay for these costs, but they were external costs to society: climate costs, ecosystem costs, and health costs from air and water pollution. A total of 387,700 hectares (66 times the area of Manhattan in New York, or 23 times Amsterdam) of deforestation can be linked to Rabobank’s share (adjusted for enterprise value share) in financing forest-risk activities. Not included in the cost estimates are damage to the intrinsic value of nature plus the social and cultural damage on Indigenous populations losing their land. These cannot be calculated.

Financiers will need to prepare for eventually being included in EUDR and EU CSDDD, with civil society increasing the pressure on them. They could face financial risks if they default on implementation and compliance efforts. This is in addition to the risks of the assets they finance: These risks consist of loss of revenues, loss of EBITDA, financing risks, and reputation value loss. Various reports by Chain Reaction Research have demonstrated that the costs of execution and monitoring — for instance, no-deforestation policies or laws such as NDPE (No Deforestation, No Peat, No Exploitation) and EUDR — are much lower than the financial risks, particularly for downstream sectors.

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