The Chain: Deforestation as a Climate Risk for Investors

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June 21, 2019

Institutional investors, asset managers, and other financial actors are increasingly considering certain climate-related risks and opportunities in their investment decisions. They have particularly focused on energy, fossil fuels, and pollution, but the significance of deforestation to climate change is becoming more relevant to the sector. Currently, and in the coming decades, investors have to grapple with the full range of risks that companies in the agricultural sector face from climate change, including deforestation. Deforestation is an all-encompassing Environmental (climate and biodiversity), Social (land grab), Governance (supply chain management) risk.

Deforestation is a less obvious but crucial part of the climate narrative. Approximately 70 percent of deforestation is connected to agricultural commodity production, and deforestation alone accounts for approximately 15 percent of global emissions. Deforestation has also contributed to the current biodiversity crisis. In its report published last October, the Intergovernmental Panel on Climate Change (IPCC) highlighted that sustainable development in the land sector, including reduced deforestation, is vital for curbing climate change. All IPCC pathways to limit global warming to under 1.5 degrees require a global halt to deforestation. Forests are a natural carbon sink that sequesters carbon, removing 10-15 billion tonnes annually from the atmosphere. Some estimates suggest that forests’ ability to sequester carbon could account for 23 percent of global climate change mitigation by 2030.

The variety of deforestation-related risks that agricultural companies encounter includes stranded land, operational, reputation, legal, market access, regulatory, and financial. Shifting consumer preferences to more sustainable products also pose threats to agricultural companies’ long-term profitability. The agriculture industry is attractive to investors, as global demand for food is forecast to grow by more than 50 percent from 2010-2050 to feed 10 billion people, and projections say that supply is likely to be tight in the coming decades. For instance, in 2017, the number of agriculture and food funds totaled 440, up from just 38 in 2005. But moving forward, the various sector risks could become material for investors as they may negatively influence share price, cost of capital, and asset valuation.

Key investor groups have highlighted climate risks tied to deforestation and have taken efforts to influence companies operating along agricultural supply chains. These include the PRI investor working group on sustainable palm oil (USD 7.9 trillion AUM), the PRI/Ceres working group on deforestation in Latin America (USD 6.3 trillion AUM), signatories to the Cerrado Manifesto (USD 5.6 trillion), and a group of Dutch investors supporting sustainable palm oil development (USD 466 billion AUM). Some large asset managers, such as BNP Paribas, are engaging with companies about deforestation through both dialogue and proxy voting. Notable investors that have incorporated “detailed, time-bound” policies to curb deforestation risks include HSBC, Rabobank, and Credit Suisse. Meanwhile, the largest pension fund in the United States, CalPERS, has included deforestation in its investment policies. ESG investing has risen sharply in recent years and is mainstream. Globally, sustainable investing totals USD 31 trillion, about 10 percent of global wealth, with Europe in the lead. As ESG investing grows, the awareness of deforestation as a climate risk will likely increase too. As CRR recently highlighted in a report on reputation risks, not meeting the 2020 deadline of zero-deforestation commitments could lead to financial risks for investors in FMCGs. Investors can use their influence, through shareholder resolutions and the threat of divestment, to pressure companies to manage these deforestation risks by implementing effective policies to eliminate forest loss in their agricultural supply chains.

Despite the growing awareness, attention to deforestation-related risks among investors has been limited. As a whole, financial institutions lag behind companies in developing zero-deforestation policies. The top 10 asset managers in the world, which have approximately USD 25 trillion of assets under management, have not incorporated detailed zero-deforestation commitments with timelines. These include Blackrock, Vanguard, State Street Global Advisors, Fidelity Investments, BNY Mellon, Capital Group, JPMorgan, PIMCO, Amundi, and Prudential Financial. Five of these institutions were the recipients of letters earlier this year from U.S. Senators who called on them to address deforestation risks in their portfolios. Chain Reaction Research (CRR) recently noted that U.S. investment bank JPMorgan failed to take into account deforestation in its climate risk assessment, despite its exposure to major players in agricultural commodities. Similarly, BlackRock, which has identified deforestation risks in the past, did not mention forests in a large study on investors “underappreciating” climate risks in their portfolios. The bank has also been the target of numerous NGO campaigns. But this group is making some progress on awareness around deforestation. For instance, State Street recently released a report on effective climate-risk disclosure in the agricultural and forestry sectors, and French Amundi has repeatedly highlighted deforestation as a risk, partnered in forest initiatives, and engaged with companies over the issue.

Meanwhile, in China, where financial institutions are now dealing with deforestation risks through increasing trade with Brazil and overall higher exposure to agricultural commodities, investors focus mostly on pollution rather than greater climate risks such as deforestation. At the end of 2017, institutional investors in China held more than USD 1.5 billion in companies that may be linked to deforestation.

Curbing deforestation can address multiple climate and financial challenges for the investment world. Climate change risks are poised to become more important in the coming years and decades – ignoring them may “imperil” investor returns. Not addressing deforestation risks as an important part of the climate narrative could lead to material risk for investors.

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