The role of investors in reversing deforestation

Commodity-driven deforestation poses significant risks to companies and their investors, write Ingrid Kukuljan and Sonya Likhtman

The importance of the Amazon rainforest in tackling climate change and biodiversity loss is widely acknowledged. Forests absorb carbon dioxide from the atmosphere, providing a valuable carbon store. They produce oxygen during photosynthesis, which is why the Amazon rainforest is often referred to as 'the lungs of the planet'.¹ It is one of the most biodiverse ecosystems on Earth, providing abundant ecosystem services that sustain our economies and societies.

Biodiversity is intrinsically linked to the biological, chemical, and physical processes that underpin all life on Earth. The Amazon rainforest represents nearly a third of all the tropical rainforest remaining on Earth. It is the habitat for approximately 10% of known species on Earth, though the figure is likely to be higher as many species are still being discovered.² It also plays an important role in regulating local and global precipitation patterns, with 20 billion tonnes of water released from trees into the air every day.³

Deforestation and biodiversity loss in the Amazon rainforest

Clearing and burning the Amazon rainforest destroys vital habitats and releases carbon dioxide back into the atmosphere. Despite the immense value of the Amazon rainforest, deforestation has continued and increased in recent years under the Bolsonaro government in Brazil, in part due to the weakening of policies and limited law enforcement.⁴ Alarmingly, research shows that large ecosystems, such as the Amazon rainforest, may collapse quickly once critical tipping points are reached.⁵

The challenge of measuring biodiversity is frequently raised. The Natural History Museum (NHM) in London has developed the Biodiversity Intactness Index (BII) using the most comprehensive evidence base of its kind, alongside robust, peer-reviewed methodology.⁶

The BII contains a sample of 58,000 species across birds, mammals, plants, fungi and insects, which have been mapped in around 46,000 locations around the world.

BII is an indicator of the 'health' of nature, with a value between 0% and 100%. A BII value of 100% is what we would expect to see if an area has not been impacted by humans. Though 100% is not always a suitable or realistic target, it helps to put existing BII values into context and inform decisions.

The NHM can project how the BII is likely to change in response to future management decisions, which can help companies evaluate the effectiveness of different interventions and strategies.

Researchers have suggested that if the BII of an area falls to below 90%, it is below what is considered a safe space for humanity within the planetary boundaries concept.⁷ Crossing this boundary increases the risk that the area and ecosystem can no longer be relied upon to provide key ecosystem services such as clean air and water, food, and fuel.

In these cases, substantial human intervention may be needed to restore the resilience of the ecosystem, once again.

Risks of deforestation

Commodity-driven deforestation poses the following significant risks to companies and their investors.

1. Reputational risk: Companies found to be contributing to deforestation face significant reputational risks. For instance, supermarkets in the UK have continuously faced pressure from consumers, NGOs and investors to address deforestation in animal feed supply chains. In some cases, they responded by ending relationships with suppliers that had links to deforestation in the Amazon rainforest.⁸ 
2. Regulatory risk: Regulation related to deforestation is increasing, especially within the EU and the UK. Proposed regulation in the EU9 would require commodities placed in the EU market to be deforestation-free, produced in accordance with laws in the country of origin, and covered by a due diligence statement. In the UK, following the Environment Act 2021, large companies that source commodities will be expected to conduct due diligence to ensure their products are free from illegal deforestation and conversion.
3. Physical risk: Deforestation exacerbates climate change and biodiversity loss, causing more frequent and severe physical climate change impacts and creating risks to the provision of ecosystem services such as water and climate regulation. In addition, many companies are dependent on products derived from the Amazon rainforest, such as for pharmaceuticals or cosmetic products. Destruction of the Amazon rainforest may jeopardise the availability of nature-based inputs to businesses over the short or long term.
4. Systemic risk: Deforestation poses a systemic risk to the financial system and the global economy, in part through the physical risks mentioned above. The planetary boundaries framework highlights that transgressing any of the boundaries – but especially those for biodiversity loss and climate change – greatly increases the risk that the whole earth system will shift irrevocably away from the stable state that has characterised the last 11,000 years.⁹ 

The role of investors

Investors have a critical role to play in halting and reversing deforestation, especially through engagement with companies and capital allocation. Federated Hermes Limited signed the Commitment on Eliminating Agricultural Commodity-Driven Deforestation¹⁰ ahead of COP26 in Glasgow.

The commitment focuses on increasing engagement to reduce exposure to deforestation in portfolios. A collaborative initiative called Finance Sector Deforestation Action (FSDA) has been launched to support investors in delivering on this commitment.

We expect companies that source or produce soy, beef and leather, which are commonly linked to deforestation in the Amazon rainforest, to commit to deforestation by 2025, with 2030 as the latest possible cut-off date.¹¹

The commitment should cover all commodities, regions, and suppliers, including indirect suppliers. We also encourage a commitment to full traceability of commodities to source, across all tiers of the supply chain, in order to demonstrate that the company's value chain is deforestation and conversion-free.

Ingrid Kukuljan is head of impact and sustainable investing at Federated Hermes. Sonya Likhtman is an engager in EOS at Federated Hermes. Her thematic focus areas are climate change, biodiversity and board effectiveness.

For more information, see: federatedhermes.com

Sources:

1-World Economic Forum, The lungs of the planet' are on fire.
2-WWF, The Amazon.
3-WWF, Top Facts about the Amazon.
4-World Resources Institute, 2021 Must Be a Turning Point for Forests.
5-Cooper, et al. Regime shifts occur disproportionately faster in larger ecosystems. Nature Communications 11, 1175 (2020).
6-The BII has been included as an indicator within the post-2020 "Global Biodiversity Framework" and been reported within the recent "Living Planet Report 2022" and the "IPBES: Global Assessment Report on Biodiversity and Ecosystem Services".
7-W. Steffen et al., "Sustainability. Planetary Boundaries: Guiding Human Development on a Changing Planet," Journal Article, Science347, no. 6223 (2015): 1259855, https://doi.org/10.1126/science.1259855.
8-Grocery Gazette, Tesco Suspends Supply from Deforestation Farms in Wake of Recent Report.
9-European Commission, Proposal for a regulation on deforestation-free products.
10-Race to Zero, Tackling Deforestation + Scaling Nature-Based Solutions (NbS).
11-FSDA, Investor expectations of companies.