An Environmental, Social, and Governance (ESG) ranking with a deforestation lens
Key takeaways from Climate Advisers Deforestation Risk Rankings:
- Companies with high rankings have policies in place to mitigate material risks of being linked to ESG issues, and specifically, deforestation. Meanwhile, companies with low rankings should consider conducting an ESG risk assessment and strengthening policies to prevent negative ESG impacts.
- Material financial risk is a key driver in the grey to green shift: Companies are improving deforestation policies, disclosures, and actions at differing paces and in line with regional dynamics and supply chains.
- In North America, above-average rankings in consumer-facing companies operating in industries closely associated with commodity-driven deforestation likely reflect company actions to mitigate financial risks related to changing consumer preferences and reputation damage.
- In Latin America and Asia (excluding Japan), subsidiaries of Western companies tend to have above-average rankings, which correspond to faster adoption of ESG investing and reporting in parent countries.
- Upstream producers in Latin America and Asia (excluding Japan) show mixed results: Some may be benefitting from a lack of transparency in global supply chains, lower scrutiny from consumers, and leakage markets, while others have been under pressure to improve policies and disclosures.
- Large companies may have stronger policies in place, while still having an outsized impact on deforestation in supply chains, due to the materiality of risks and current gaps in traceability.
In collaboration with S-Network Indexes, Climate Advisers created the Deforestation Risk Rankings to combine a holistic picture of a company’s ESG policies and disclosures with a specific deforestation focus. Deforestation has historically received comparatively less attention than other ESG issues in ratings, primarily due to the research-intensive nature of supply chain transparency and monitoring data. However, as transparency increases, companies are under growing pressure to mitigate deforestation risk. Advancements in the quality and availability of satellite imagery are quickly increasing transparency into real-time deforestation activities at commodity suppliers, leading to more informed customers, financiers, campaigners, journalists, and eventually, end-consumers. These technological innovations are emerging in the midst of disruptive change in consumer preferences and investor priorities. The growing consumer demand for sustainable products is exemplified by a survey of 18,980 consumers in 28 countries: 57 percent were willing to alter purchasing habits to prevent environmental harm, 77 percent rated sustainability as important, and over 70 percent were willing to pay an average premium of 35 percent for sustainable products.
Similarly, financiers are incorporating ESG issues into decision-making priorities. The scale of the change can be seen through the USD 103 Trillion in assets managed by signatories to the UN Principles of Responsible Investment, up 75 percent since 2015. ESG funds have grown at a record-breaking pace since 2015. In the 2020 McKinsey Global Survey, C Suite leaders reported being willing to pay about a 10 percent medium premium for an acquisition with a positive record in ESG. Interestingly, leaders from consumer-facing companies were more likely to agree that ESG programs drive shareholder value than business-to-business companies by about 10 percent, indicating that changing consumer preferences are having a ripple effect on supply chains and likely impact the pace of change depending on supply chain role.
As company leaders grow increasingly concerned about ESG impacts, the financial risks associated with deforestation are materializing. After a 12-year record in deforestation rates in the Brazilian Amazon between August 2019 and July 2020, companies with operations in the region face especially high risks of being linked to deforestation and encroachment onto indigenous territories. In fact, some financiers have expressed concern around intensifying country-level risk, due to rising deforestation rates, citing “widespread uncertainty about the conditions for investing in or providing financial services to Brazil.” Financial risks for companies linked to deforestation vary from market access to increasingly regulated European supply chains to reputational damage to stranded assets in countries with plans to meet Nationally Determined Contributions outlined in the Paris Agreement. Consumer-facing companies face escalating risks of being left behind as consumer preferences favor more sustainable alternatives, and their suppliers face market access risk as customers tighten policy requirements. Moreover, as financiers increasingly incorporate deforestation into risk assessments, companies without policies and mechanisms in place to prevent deforestation are exposed to financial risks.
According to the Intergovernmental Panel on Climate Change (IPCC), deforestation is responsible for about 15 percent of greenhouse gases. When tropical forests are conserved, they act as a carbon sink and play a vital role in mitigating the worst impacts of climate change. However, rampant deforestation rates lead to greenhouse gas emissions, biodiversity loss, infectious disease emergence, and changes to water cycles that impact energy production and the availability of clean drinking water. Companies, shareholders, and consumers all have a role to play in ensuring that sourcing, financing, and consumption practices are consistent with the goals of the Paris Agreement, and these actions have a reverberating impact as government and private sector policies are likely to further increase the financial risk of deforestation linkages. Disruptive change is gaining momentum, and this ranking can be seen as a regional indicator of company progress in policy and disclosures that mitigate ESG risk. For companies with low rankings, it is the perfect time to improve policies and conduct risk assessments. On the other hand, the high achievers have the opportunity to shape industry ESG practices and to share best practices.
To incorporate a deforestation focus into company ESG scores, the Climate Advisers Deforestation Risk Ranking weights 80 percent of scores to ESG policies and disclosures and 20 percent to reputable deforestation-specific ratings and certifications. From an overall ESG perspective, the companies are evaluated against 93 of the 424 indicators available from Thomson Reuters Asset4 ESG data. The selection includes 25 “social” indicators, 33 “environmental” indicators, 25 “controversy” indicators, and the published Thomson Reuters/S-Network ESG Best Practices Governance Score. On the deforestation front, Climate Advisers has calculated universal and commodity-specific scores using reputable ratings like Forest 500, CDP, and SPOTT, along with relevant company participation in the Roundtable on Sustainable Palm Oil (RSPO), the Roundtable on Responsible Soy Association (RTRS), and the Global Roundtable for Sustainable Beef (GRSB) certifications. The Climate Advisers Deforestation Risk Ranking is calculated by region for companies in Latin America, North America, and Asia (excluding Japan). Particular consideration was given to company actions, policies, and certifications in palm oil, soy, timber, and beef supply chains.
This research is intended to encourage low performing companies to incorporate more robust efforts to limit deforestation and other climate risks, produce commodities legally and sustainably and protect local communities. Companies ranked highly are more likely to have integrated supply chain best practices into their operations and have lower incidences of public controversies than those ranked lower. The rankings consider companies in a wide variety of sectors, including: Beverages, chemicals, construction & engineering, construction materials, containers & packaging, diversified retail, food & drug retailing, food & tobacco, holding companies, homebuilding & construction supplies, hotels & entertainment services, industrial conglomerates, paper & forest products, personal & household products & services, pharmaceuticals, real estate operations, specialty retailers, and textiles & apparel. Companies not covered in reputable deforestation ratings from peer organizations or commodity certifications were excluded, due to a lack of relevance.
The results are included by region below:
Figure 1: Latin America Deforestation Risk Rankings
In Latin America, the risk of exposure to deforestation can be high because the Amazon rainforest stretches across nine countries. Cattle ranching is responsible for about 80 percent of deforestation and has significant impacts on ecosystems, soil erosion, and drinking water supplies. Brazil, in particular, is home to about 88 percent of the cattle in the Amazon, followed by Peru and Bolivia. The three largest meatpackers are JBS SA, Minerva SA, and Marfrig Global Foods SA. All three companies have made significant efforts to exclude direct suppliers linked to deforestation. However, they have a long way to go to achieve transparency and mitigate deforestation risk in indirect supply chains and have been linked to both deforestation and fires in the Amazon. One takeaway here is that large companies may have stronger policies in place, while still having an outsized impact on deforestation in supply chains, due to the materiality of risks and current gaps in traceability.
Brazil is also home to the Cerrado biome, which has become a hotspot for soy production after the Amazon Soy Moratorium in 2006 drastically reduced soy-driven deforestation in the Amazon. Notably, many soy producers and traders do not have No-Deforestation policies in place for soy production, primarily due to the prevalence of legal deforestation in the Cerrado.
Figure 2: North America Deforestation Risk Rankings
In North America, higher rankings likely reflect the increased risk of reputation damage as a result of involvement with deforestation and other negative ESG impacts. According to the Governance & Accountability Institute, 90 percent of companies in the S&P 500 publish sustainability reports, up from 20 percent in 2011. Consumer-facing companies are under particular pressure to prioritize sustainability to keep up with changing customer preferences.
Figure 3: Asia (Excluding Japan) Deforestation Risk Rankings
The companies ranked in the Asian (excluding Japan) region primarily have links to palm oil and timber commodities. Roughly 85 percent of palm oil comes from oil palm plantations in Indonesia and Malaysia. Combined, these countries have lost about 800,000 ha of primary forest per year for the past decade. Palm oil groups operating in Indonesia and Malaysia have often been linked to deforestation and human rights abuses, and many have used complex ownership structures to mask ESG issues. However, increasing financial pressure for market access to customers with No Deforestation, No Peat, and No Exploitation (NDPE) policies has prompted some groups to improve sustainability policies and practices to meet customer requirements.
We would like to express our sincere appreciation and gratitude to the Norwegian Agency for Development Cooperation (NORAD) who funded this analysis and report.