Environmental finance firm Sustainable Investment Management (SIM) is launching a green bond initiative on the London Stock Exchange on July 4, 2019 for medium-sized farmers in an effort to reduce deforestation in the Cerrado, a large tropical savanna biome that covers more than 20 percent of Brazil and has seen high rates of deforestation since 2000. The initiative, called the Responsible Commodities Facility (RCF), is set to transfer USD 1 billion to more than 1,000 farmers, contingent on environmental and labour standards. Partners include the UK’s Partnerships for Forests and the UN Environmental Programme.

The initiative aims to trigger the expansion of soy production in the Cerrado on under-utilized or abandoned areas to discourage farmers from clearing forest to develop soy or other commodities. Altogether, this scheme could financially support more than 18 million tonnes of soy and corn output starting in 2020, safeguard one million hectares, and cut emissions by 250 million tonnes of CO₂ equivalent, according to SIM. In the Cerrado, deforestation fell last year, but 660,000 hectares were still cleared. Early signs point to deforestation rising again this year, and approximately 8.7 million hectares have been deforested there since 2010.

The bond program will likely prompt questions about whether a mechanism using low-interest funds can change the equation for zero deforestation in high-risk areas by tilting agricultural commodity industries toward more sustainable practices. The program seeks to complement the goals of the Cerrado Manifesto, which urges companies to implement their zero-deforestation agreements in the region. More than 50 institutional investors and 70 corporations have signed onto the Manifesto. The signatories are currently working to expand the Amazon Soy Moratorium to the Cerrado. However, despite this momentum, major traders in the region – ADM, Bunge, Cargill, and Louis Dreyfus – have not endorsed the Manifesto, elevating the possibility of being linked to deforestation, whether legal or illegal, in their supply chains.

Why medium-sized farmers?

The new bond is poised to provide “medium-sized” farmers – defined as having 1,000-6,000 ha — with financial vehicles to allow them to de-risk their activities and to not operate on newly deforested land. The RCF will offer bondholders risk-adjusted returns, and if successful, it could be replicated elsewhere in Latin America to provide direct finance to farmers. “Hopefully, following this initial push, we will see a significant increase in the supply of deforestation- and conversion-free soy, enabling a push for additional demand for it beyond Europe and the United States,” SIM’s CEO Pedro Moura Cost told Chain Reaction Research.

The RCF is targeting this group because smaller farmers already receive subsidies and are not equipped to enter contractual agreements and obligations. Larger farmers, meanwhile, already have direct access to international finance and would likely not be interested.

The RCF will rely on “aggregators” – traders, agricultural cooperatives, and agriculture input providers – to select prospective farmers based on their portfolios, conduct environmental assessments, and issue funds to applicants that met eligibility standards.

Monitoring and enforcement

Stakeholders understand that monitoring and enforcement of the financial tool will be crucial to its success. A group formed by NGOs, industry, and financial actors will independently monitor operations. Participating farmers will have to provide their Cadastro Ambiental Rural (CAR) numbers – provided by the federal government’s Rural Environmental Registry – which are linked to satellite imagery and databases that track environmental impact and supply chain activity. SIM will also deploy teams that are on the ground to randomly inspect farms to make sure they are meeting environmental objectives.

Outlook for soy in Brazil

The launch of the green bond is taking place against the backdrop of high soy production and looser environmental enforcement in Brazil. Brazil’s soy production has quadrupled since the late 1990s. In the past year and a half, increasing exports to China amid the U.S.-China trade dispute have kept soy output high, contributing to elevated deforestation rates. Shipments to China have fallen recently due to the outbreak of African swine fever, but the ongoing trade war between Washington and Beijing means that exports should remain relatively high. The U.S. Department of Agriculture says Brazilian soy exports should rise by 8.7 percent this year, and total production is estimated at 124 million ha, a seven percent annual increase. The recently inked Mercosur-EU trade deal will likely also underpin soy production, and possibly drive an increase in deforestation.

On top of global market fundamentals prompting agricultural expansion, Brazilian President Jair Bolsonaro has favored agribusiness over environmental protections and rights for indigenous peoples since he took office at the beginning of the year. This has created a situation in which private sector actors along commodity supply chains are a critical line of defense against deforestation.