Preparing for the coming wave of risk and regulation related to land conversion
Keeping forests alive is one of the most influential and cost-effective ways to mitigate climate change — halting biodiversity loss, and ensuring other important ecosystem services. Yet deforestation continues at breakneck speed. In 2022 alone, an area the size of Switzerland was cleared from the Earth’s most pristine rainforests, according to the World Resources Institute.
This should matter — a lot — to investors and financial institutions. A stunning 55% of global GDP, or $58 trillion, is dependent on nature, exposing risks relating to nature loss and degradation. Climate-related risks could cause asset prices to fall sharply and spike uncertainty, destabilizing the financial system.
With enough cleared land available to feed a growing population for decades, continuing to cut down forests is both ill-considered and unnecessary.
For many producers of agricultural commodities, such as cattle, oil palm, soy, cocoa, rubber, wood fiber, and coffee, which are the main drivers of deforestation, and other economic actors like extractive companies, the expectation of future profits from developing forested areas justifies the investment.
With enough cleared land available to feed a growing population for decades, continuing to cut down forests is both ill-considered and unnecessary.
This is where investors and financial actors have a crucial role to play. Clearing land from pristine forests is not cheap, and producers often obtain financial support through debt or equity capital. Despite growing awareness among investors and financial actors of the need to avoid deforestation, too many investment and financing portfolios remain exposed to land use change risks and associated nature- and climate-related risks.
Investors and financial institutions need to act now to assess and disclose deforestation risks in their portfolios and set a short-term goal of eliminating financed deforestation.
Let’s look at the five main reasons why this call to action is so critical.
- Reputational risks are becoming increasingly material.
Financial institutions may be aware that the capital they provide is used for deforestation, but deals are generally approved as long as it is legal. Other times, financial institutions may be unaware that their clients source ingredients from areas at high deforestation risk. This can lead to significant reputational risk for the bank if such practices come to light, especially for those that have made net-zero or nature-protection commitments.
- Stakeholders expect climate-and nature-related risks to be disclosed.
With emerging carbon accounting standards and net-zero target-setting guidance for the agriculture and land use sector, we can expect increasing demands by investors and other stakeholders to require businesses and financial institutions to report climate risks related to land use change and agriculture, according to the Task Force on Climate-related Financial Disclosures. Moreover, disclosure of nature-related risks following the Taskforce on Nature-related Financial Disclosures may soon become a necessary condition for accessing investors’ capital.
[F]inancing or investing in companies that could be fined due to their links to deforestation increases credit or investment risk.
- Legal compliance issues increase credit and investment risks.
New regulation aimed at preventing deforestation is on the rise, like the new European Union (EU) regulation on deforestation-free products. Similar pressures are evident in other regions, such as the United States with the Forest Act legislation and the UK’s Environment Act. Even when laws don’t apply to financial institutions, financing or investing in companies that could be fined due to their links to deforestation increases credit or investment risk.
- Material climate-related risks are exacerbated by deforestation.
Deforestation is a growing material risk for investors. On the one hand, deforestation is responsible for at least 11% of greenhouse gas emissions. On the other hand, deforestation impacts local climate and can lead to negative impacts in agricultural productivity. Both types of risk threaten global economic stability and the lives of millions, and are increasingly being addressed by policy interventions. Consumer preferences, such as the rise in plant-based diets, are also reacting to a warming world.
- Net-zero isn’t possible without ending the financing of deforestation.
Accounting for climate emissions due to deforestation and setting no-financed deforestation targets is critical to achieve net-zero goals. Both the Net Zero Banking Alliance, representing over 40% of global banking assets, and the Net-Zero Asset Owner Alliance are committed to transition their investment portfolios to net-zero GHG emissions by 2050.
Accounting for climate emissions due to deforestation and setting no-financed deforestation targets is critical to achieve net-zero goals.
In closing, the financial sector has an enormous opportunity to help end deforestation. They can do this by engaging with clients on deforestation risk, linking financing conditions to clients’ measurable action on reducing deforestation, and divesting from companies that do not show sufficient progress towards no-deforestation.
Collaboration is key to making progress.
Tackling deforestation requires a collaborative effort. To that end, a group of financial institutions, investors, land use change monitoring and climate- and nature-related financial risk disclosure experts have formed the Forest Finance Risk Consortium, launched by the US Department of State and hosted by the World Business Council for Sustainable Development (WBCSD).
The FFRC seeks to foster widespread and better assessment and disclosure of exposure to deforestation and other land use change risks in investment and lending portfolios. The ultimate objective is to help financial institutions eliminate financed emissions and nature loss driven by deforestation.
By joining forces, we aim to help stop financed deforestation before the end of the decade.
