Pension funds are working to identify and mitigate the deforestation-related risks in their portfolios, as new frameworks and regulations take shape.
Forests are natural carbon sinks, and therefore a key nature-based solution that can contribute to efforts to limit global warming to 1.5°C by 2050.
Research shows that forests absorbed twice the amount of CO2 they emitted between 2001 and 2019, sequestering 7.6 million metric tonnes of CO2 a year – one and a half times more CO2 than annual emissions in the US.
But the increasing rate of global deforestation threatens to upset the balance.
Since 1990, around 420 million hectares of forest has been destroyed, with ten million hectares a year cleared between 2015-2020 alone. In Q1 2022, forest destruction covered 941 km², which is a 64% increase compared to Q1 the previous year.
As a growing number of asset owners commit to transitioning their investments to net zero, they are becoming increasingly aware of how deforestation threatens the realisation of their decarbonisation targets.
“We can’t achieve net zero without looking into forests and the role they play in mitigating the effects of climate change,” says Alison Lee, Responsible Investment Manager at London CIV, one of eight UK local government pension schemes.
“How can we achieve real world decarbonisation without also slowing down and eventually stopping deforestation?”
Forests further play a vital role in maintaining the world’s biodiversity, with deforestation leading to the extinction of wild species of plants and animals. Continued deforestation will also expose the human populace to new zoonotic diseases.
However, with 95% of deforestation taking place in emerging markets, such as Brazil and Indonesia, it can be difficult for asset owners based elsewhere in the world – the UK, for example – to fully understand the extent to which their investments are contributing to the degradation of forests.
More than £300 billion of UK pension money is currently invested in companies and financial institutions with high deforestation risk, according to a report by Make My Money Matter (MMMM), Global Canopy and SYSTEMIQ. This equates to 31% of pension funds’ public equity and corporate bond investments, the report said.
With so much capital tied to deforestation-related risks, it’s more important than ever that UK pension funds gain visibility of investee companies’ exposure to deforestation, both directly and along supply chains, it added.
This is easier said than done. Data on deforestation is patchy, as investee companies’ visibility of deforestation-related activities lessens the further down supply chains they look, making it difficult for the investor, in turn, to quantify their portfolio’s overall exposure to deforestation risks.
New standards and expectations are slowly taking shape in a shifting regulatory landscape, but more immediate guidance for pension funds and other asset owners is needed to help them protect the forests the world has left, experts tell ESG Investor.
Changing their ways
When it comes to identifying and measuring deforestation-related risks in their portfolios, where do pension funds even start? Organisations are introducing new tools and guidance.
Global Canopy, MMMM and SYSTEMIQ recently published new guidance for UK pension funds, outlining how they can integrate a ‘deforestation-free’ policy into their investment and stewardship strategies. It provides further recommendations on how pension funds can more actively channel capital into sustainable solutions, such as reforestation projects.
“Like other parts of the finance sector, pensions are currently part of the problem by contributing to deforestation,” Huw Davies, Senior Finance Adviser at MMMM, tells ESG Investor.
“They now have a really important role to play by engaging with companies and financing positive change.”
Building on the financial sector roadmap for eliminating deforestation, which was launched at COP26, the new online guidance sets out six phases, from identifying and mapping deforestation and its associated human rights risks within portfolios, to introducing a ‘deforestation-free’ policy and ensuring asset managers’ engagement efforts are aligned.
MMMM, SYSTEMIQ and Global Canopy consulted with 12 UK pension funds to put together the framework.
London CIV, which was one of the pension funds involved in the consultation process, called for the guidance to prioritise “practicality”, says Lee.
“A problem with a lot of existing guidance from regulators or other organisations is that they publish big and complex documents that take a lot of time [for trustees] to understand. [This guidance] provides helpful and practical resources and tools which pension funds can use to identify their [deforestation] exposure.”
Alongside London CIV, other pension funds involved include the Environment Agency Pension Fund, Nest and Phoenix Group.
Nonetheless, MMMM’s Davies acknowledges that challenges around measuring and mitigating deforestation-related risks remain, which will require intervention on the international stage from policymakers.
“The data is imperfect and there are so many moving parts to effectively address deforestation, but investors and companies must roll up their sleeves and get started, because we’re running out of time,” he says.
Taking a stand
There has been a clear “momentum shift” towards introducing deforestation laws on the international stage, which could ultimately help to provide clarity for pension funds, says Joe Dabrowski, Deputy Director of Policy at the Pensions and Lifetime Savings Association (PLSA), citing efforts across the UK, EU and US.
“There have been a few false starts in the past, but we’re beginning to see efforts that could lead to the corporate transparency investors need to be able to comprehensively identify and measure deforestation-related activities in their portfolios and secure the relevant data,” he tells ESG Investor.
The UK government’s Environment Act – a piece of legislation first proposed last year that sets out the country’s independent environmental standards following Brexit – includes measures that require companies to conduct due diligence to ensure their supply chains are free of products sourced from illegally deforested areas. Qualifying companies will be required to publish information on these due diligence efforts.
It’s not perfect. Many organisations have argued that these provisions don’t go far enough, failing to address human rights and the protection of Indigenous communities’ land rights.
It also undermines the COP26 Glasgow Leaders Declaration on Forests and Land Use by failing to tackle much of the UK’s deforestation footprint abroad, according to analysis by NGO Global Witness.
The EU is still debating its proposed Corporate Sustainability Due Diligence directive, which would require companies to identify and mitigate adverse impacts on biodiversity – such as deforestation – in their supply chains. But the EU Council did recently announce its support for mandatory due diligence rules for all operators and traders involved in products such as beef, timber, soy and palm oil.
In the US, the Fostering Overseas Rule of Law and Environmentally Sound Trade (FOREST) Act Bill is under review. Similarly to the UK and EU, the bill will outlaw commercial products linked to illegal deforestation from entering the US. In April, President Joe Biden signed an executive order reiterating the country’s commitment to delivering on the aforementioned COP26 pledge.
“Despite leaving some room for companies on how they should implement risk assessment and mitigation measures, the upcoming regulations represent a strong push for standardising environmental reporting on deforestation risks,” says Tomasz Sawicki, Associate Director of Forests and Land at environmental disclosure platform CDP.
Although these new requirements may prove challenging for corporates to adjust to in the short term, Sawicki notes that improved consistency in reporting and due diligence practices in the longer term will “allow investors to better assess ESG risks”.
While laws in the UK, US and EU are welcome, much of the world is looking to Brazil, which is home to around 60% of the Amazon rainforest.
In October, elections will be taking place. Depending which candidate is selected as President, Brazil will either become a major contributor to efforts to slow down the rate of deforestation, or it risks becoming a spanner in the works that slows down global efforts to protect the forests the world has left, warned the Inevitable Policy Response, a climate forecasting consortium supported by the UN-convened Principles for Responsible Investment (PRI).
Waiting in the wings
The Taskforce on Nature-related Financial Disclosure (TNFD) guidelines and the Global Biodiversity Framework (GBF) are highly anticipated pieces of the puzzle which will help to harmonise existing nature and deforestation-related frameworks and standards.
Following in the footsteps of TCFD, TNFD is developing a reporting framework that aims to ensure maximum global cohesion and alignment around the nature-related risks organisations are measuring and disclosing.
Expected to be finalised next year, TNFD published its second iteration of the beta framework in June, which outlines its approach to metrics and guidance for market participants to start pilot testing. The first beta framework, published in March, introduced key science-based concepts and definitions, disclosure recommendations and guidance on nature-related risk and opportunity analysis for both companies and investors.
“TNFD will play an important role in mainstreaming nature-related disclosures – that includes forests, but also other global realms such as freshwater and oceans,” says CDP’s Sawicki.
“It has the potential to do for nature what TCFD has done for climate-related disclosures in increasing scale, quality and consistency of reporting.”
Despite slow progress, policymakers will also be gathering at COP15 in Montreal this December to finalise the GBF. As the nature-related equivalent of the Paris Agreement, the GBF will “act as a lighthouse for the collective response of society, not only governments, to work together towards a 2050 vision of living in harmony with nature”, Elizabeth Maruma Mrema, TNFD Co-Chair and Executive Secretary of the UN Convention on Biological Diversity, has said.
But pension funds shouldn’t wait for total harmonisation to begin making a positive difference, says MMMM’s Davies.
He says: “If we waited for everything to be aligned and perfectly consistent across countries, between asset managers and pension funds, between investors and corporates, then it will be too late. By working collaboratively and using the tools already at their disposal, pension funds can have a positive real-world impact and begin addressing deforestation-related risks today.”