INTERVIEW with Pei Chi Wong, Global Canopy
| What risks are financial institutions exposed to in terms of deforestation?
Financial institutions that are unable to identify and manage deforestation exposure in their portfolios are increasingly exposed to four key risks: financial, reputational, credit and regulatory. To avoid falling behind, they need to be aware of due diligence and know how to adopt it.
〉Financial risk; the value of their investments in companies involved in forest risk supply chains could fall
〉Reputational risk; being linked to instances of deforestation or human rights abuses that could tarnish their brand and sustainable investing credentials
〉Credit risk; the companies they lend to which are in forest risk commodity supply chains could default on their loans
〉Regulatory risks; if they do not comply with new regulations, they could face fines or other punishment
They are also exposed, indirectly, to the risks faced by the companies they finance or invest in. This includes:
〉Physical risk; e.g. biodiversity loss, droughts, flooding, lower crop yields
〉Market access risk; e.g. consumer and retail preferences move towards sustainably sourced goods
〉Policy risk; e.g. where land can lose value and potentially become a stranded asset that can’t be used or sold as a result of new deforestation policies
As these risks materialise for companies, they can result in lower profitability, reduced cash flow, increased liabilities and stranded assets, which in turn increases the risk to the financial institutions who fund them.
| What opportunities can tackling deforestation bring for financial institutions?
Financial institutions with strong commitments and implementation mechanisms to tackle deforestation will be equipped to focus or redirect financing towards companies that are compliant or making good progress towards deforestation-free supply chains. They will also be better able to support clients or holdings to improve their performance in mitigating deforestation risks, thus reducing risks of non-compliance, conflict or price volatility.
| Should halting deforestation be seen as a fiduciary duty by asset owners and fiduciary managers?
Yes – halting deforestation is not only crucial for achieving global net zero targets but also to support long term investment returns. Physical, regulatory and reputational risks can reduce a supply chain actor’s profitability and cash flow or result in increased liabilities, thus affecting company asset values.
Furthermore, fiduciary duties that require managers to act in the interests of their beneficiaries are consistent with taking into account long-term ESG issues, including deforestation. Therefore, ignoring it would be against the best interests of asset owners, both environmentally and financially.
| How does the Deforestation, Conversion and Abuse-Free (DCAF) Investment Mandate help investors get started?
The DCAF Investment Mandate is a practical how-to guide that brings together different tools, resources and examples of best practice, so family offices and foundations can task their asset managers with identifying and mitigating deforestation risks. It provides them with a blueprint of how to engage asset managers, and gives investors the power to drive positive change through their investments. The mandate is part of a suite of guidance created for the finance sector. This includes the recently released due diligence guidance for financial institutions, the Finance Sector Roadmap on Eliminating Commodity Driven Deforestation launched at COP26 and the Deforestation-free pensions guidance launched in 2022. Collectively they show the clear steps needed to ensure investments are not driving destruction.
| What about availability of data and tools: should investors tackling deforestation expect it to be the elephant in the room?
Financial institutions can no longer cite lack of data and tools as a reason for not tackling deforestation. The Finance Sector Roadmap highlights many datasets and tools, covering country-level data, company risk exposure, geospatial data and human rights risk data. In fact, given the amount of data and tools that are available, Global Canopy’s Forest IQ project is working to capture and distill as much data as possible into some key metrics which can in turn be cross-referenced by ISIN, to make it even easier for financial institutions to assess companies.
| What actions and steps do you consider relevant for successful engagement and stewardship with clients and holdings?
Successful engagement relies on proactive and regular conversations with clients and holdings, taking a firm but fair tone to set clear expectations and monitor progress. It should follow the “SMART” principle; i.e. companies should be pushed to take ambitious action which is specific, measurable, achievable, relevant and time-bound. Where insufficient progress is being made, continued engagement should be prioritised and the ultimate ramifications of continuing to make no progress, whether or not this includes redirecting capital, should be clearly communicated to the clients and holdings.
An example of how to establish and communicate such expectations is the set of investor expectations published by the Finance Sector Deforestation Action initiative, a group of financial institutions who have publicly committed to achieve deforestation-free financial portfolios by 2025.
| What should asset owners pay attention to in order to properly assess asset managers’ approach when it comes to working towards deforestation-free portfolios?
Asset owners should use the five stages of the Finance Sector Roadmap as the time bound guide for the progress that asset managers should make. The initial mapping of deforestation risk should be completed within 9 months of starting, followed by setting an effective policy and managing risk within 15 months of starting. Then, the first cycle of monitoring, engagement and disclosure should be complete within 2.5 years of beginning. Ultimately deforestation should be eliminated within 4 years of beginning the process. Different asset managers will be at different stages in their journey and the Finance Sector Roadmap can be used to benchmark where each firm is and how comprehensively they are following best practice. Where some firms may still be lagging behind and perhaps haven’t even started, the most important thing is to set ambitious time-bound goals and then monitor the progress they make towards these commitments.
Global Canopy is a data-driven not for profit that targets the market forces destroying nature. It does this by improving transparency and accountability. It provides innovative open-access data, clear metrics, and actionable insights to leading companies, financial institutions, governments and campaigning organisations worldwide to help them make better decisions about nature, forests and people.
Pei Chi Wong is a Senior Research Associate at Global Canopy. Her work drives guidance around deforestation-free finance – from pension funds, to private wealth and due diligence guidance. Before moving to the UK, Pei Chi spent 14 years in risk management and corporate treasury roles in the banking sector in Singapore.
| All opinions expressed are those of the author and/or quoted sources. investESG.eu is an independent and neutral platform dedicated to generating debate around ESG investing topics.