Cop26 Perspectives

Heeding Red Flags to Halt Deforestation

Due diligence gaps across the food and agriculture supply chains must be closed to support COP26 deforestation pledge.

Institutional investors in the food production and retail sectors are still struggling to avoid financing deforestation, even as governments intensify efforts to curtail the activity.

One of the main problems is that many are confused over the red flags to look for when doing due diligence on supply chains.

According to the World Wildlife Fund (WWF), agriculture is the leading driver of deforestation globally. Other key drivers include logging, human migration and population increases, extractive industries, transport and infrastructure projects, and expanding urban areas.

The supply chain for the food and agriculture sectors is awash with animal products that have been raised on illegally-cleared land.

Two-thirds of global forest cover loss is occurring mainly in the tropics and sub-tropics. Over 43 million hectares, an area roughly the size of Morocco, was lost in these “deforestation fronts” between 2004 and 2017, according to WWF.

With staggering amounts of illegal deforestation still taking place, asset owners can take action to improve supply chain due diligence to avoid criminal practices and greenwashing.

Deforestation pledge

The deforestation pledge signed by 141 countries at COP26 in Glasgow is intended to stop some of the world’s biggest carbon sinks from being lost and target the root causes of deforestation.

The COP26 pledge commits governments to “emphasise the interdependent roles of forests of all types, biodiversity and sustainable land use in enabling the world to meet its sustainable development goals,” and to “Reaffirm respective commitments to sustainable land use, and to the conservation, protection, sustainable management and restoration of forests, and other terrestrial ecosystems”.

Aarti Ramachandran, Director of Research & Engagements at FAIRR, an agriculture-focused investor network, is hopeful about the pledge, but less convinced that it will look at the full picture.

“There is a lack of root cause analysis,” she told ESG Investor, referencing issues around poverty in rural populations, which often drives deforestation. “Food and agriculture is not emphasised in discussions even when it contributes to a third of global greenhouse gas (GHG) emissions. The livestock sector is one of the biggest contributors to biodiversity and forest loss.”

Last week, a report by Brazil’s space research agency (INPE) revealed that deforestation increased by 22% in a year. The data showed that deforestation in the Amazon rainforest was at its highest level in over 15 years.

Brazil was a signatory of the deforestation pledge. According to INPE data, some 13,235 square km was lost during the 2020-21 period, the highest amount since 2006.

Around 90% of world forests are covered by the countries that have signed the pledge.

Others share the feeling that the pledge is not going far enough. “It’s a good thing, but when you reflect on it, are we being too optimistic?” says Will Disney, Research Analyst at World Benchmarking Alliance (WBA). “We’ve been here before in 2014. There was a similar meeting in New York, but then deforestation continued afterwards.”

Disney calls for an accountability mechanism and a wider scope to encompass broader causes and supply chains.

Loopholes and blind spots

There are several areas where the investment community is lacking the rounded vision needed to identify ESG risks in food and agriculture supply chains.

Disney lists three major red flags. The first is the lack of traceability of commodities or products.

“We go through companies’ reports, and they often don’t know where the products are coming from, the regions or suppliers, or how is it getting moved to their factory,” he explains.

Disney lists this as a major issue in food and agribusiness.

“It’s entirely to do with traceability,” agrees Graham Stock, Emerging Markets Senior Sovereign Strategist at BlueBay Asset Management, lamenting the industry’s lack of supply chain due diligence. Stock adds that transparency around data is essential to identifying where products are coming from and if they have been sustainably sourced.

“Let’s use beef as an example: being able to track the cow from birth through to table – that’s where a lot of beef producers fall down,” he says. If the supplier cannot track the beef through their production process, then they can’t then prove where it came from, which exposes the company and its investors to risk.

Last year, a Greenpeace investigation showed that Tesco, Asda, Lidl, Nando’s and McDonalds were selling meat, sourced from a UK supplier, which had been fed on soy that was grown on farms built in deforested areas of Brazil.

“That’s one of the concerns around some of the certification that the suppliers themselves are producing – it’s not thorough enough,” Stock says.

“What we would like is full transparency at the national level in a database, where you can see where every head of cattle came from. This would mean you can link that farm of origin to the national database and say, ‘Yes, this farm has been there for 30 years, following the law. It wasn’t on illegally cleared land.’”

Other commodities, such as soybeans, can be more challenging as they come from larger numbers of suppliers. Stock says this area could be trickier as it requires more paperwork to show that loads came from farms that have always been free of deforestation, but he argues that current efforts must be persevered with.

Governance issues

The second red flag that WBA’s Disney gives is the lack of coordinated governance systems and structures within many companies to hold the business to account and to oversee supply chain issues.

“Departments are not integrated as well as they could be. You have the sustainability team, which is doing the reporting on these topics, and then you have the logistics and supply chain team, which is contracting and working with the suppliers, and they are often not integrated at all.”

In terms of integrated supply chain due diligence, Disney adds that the element of ESG risk management that has been practised the longest is social issues, such as human rights, with environmental now getting attention. However, governance has only recently begun to see action taken.

“If you’ve got an illegal smallholder, who cleared land in the Amazon, the authorities don’t know he or she is there in the first place,” he explains, “You don’t know if they are paying their workforce properly or using slave labour because it’s happening outside the legal sphere.

“Like deforestation, once the company gets to the stage where it’s raising equity finance or debt finance, it will almost certainly have appropriate policies in place, the ability to scrutinise. But it’s the hinterland of their supply chain that is the challenge.”

The third ‘flag’ Disney raises is how companies in the food and agriculture sector define the relevance and applicability of sustainability principles to products or commodities.

“I’ve seen in reports where the major commodity being sourced is palm oil and the company will use certifications or have traceability,” he explains. “But then they say, ‘We source cocoa too but because it’s only a small amount, we don’t see the need to report on its sustainability.’”

This, Disney says, is a recurrent and widespread issue, which shows a fundamental lack of understanding by firms of their ESG risks.

New solutions

For institutional investors to understand environmental risks in general – and deforestation risks in particular – there needs to be more sources of independent and verifiable data throughout food and agriculture supply chains.

“It comes back to traceability,” says Stock. Availability of data and the ability to cross-reference different databases is key, he adds. In the meat supply chain, the only way this can be achieved is with a full animal passport that goes right back to the animal’s birth. “If there are gaps, or if it’s coming into the supply chain further down the line from the point where there’s transparency, this is a red flag,” he says.

“I don’t think it’s enough for individual companies to say they are clean on this issue. We need to be able to check that through other sources,” Stock says. “We have satellite imagery of areas that are at risk, and you can see the pace at which deforestation is occurring. You can see detailed localities, and that’s what the authorities should be doing. They should be publicising it so that illegal activity can’t be financed.”

Technology and innovation, he says, is central to efforts on due diligence, so that produce from illegal activity cannot find its way into the supply chains.

Ramachandran sees the potential to close many of the existing loopholes as well as new ways to incentivise those in the supply chain out of illegal practices in the future. She cites a credits system that would pay ranchers to leave their land forested rather than to turn it into farmland.

As well as this Ramachandran highlights the resource sustainable intensification discussion in countries like Brazil as a possible solution. The idea involves land that is used for pasture being made more productive so companies can intensify existing supply chains instead of clearing forests for more pastures.

“There’s a lot of movement towards sustainable intensification,” adds Ramachandran. “But we caution against any sustainable intensification if it comes at the expense of welfare, biosecurity and increases the use of antibiotics. All of these have been the pitfalls of intensification in other countries.”

While the COP26 deforestation pledge showed collective political will, some jurisdictions are more advanced in reforming their legislative framework to combat environmental risks. In 2020, the European Commission (EC) launched a briefing paper outlining a mandatory system of due diligence for supply chains for companies.

The European Parliament backed Commission plans to initiate a legal framework to reverse EU-driven deforestation based on mandatory supply chain due diligence, including for those companies bringing forest and ecosystem-risk commodities to the EU.

The Commission is currently preparing the regulatory proposal and considers a mix of mandatory rules and voluntary partnerships, such as trade agreements, to promote deforestation-free supply chains.

For the COP26 pledge to have teeth, it will need to be accompanied by further measures to ‘beef up’ due diligence all along the supply chain.

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