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APRIL 22, 2022


THE EU DEFORESTATION PROPOSAL: ARE KEY SECTORS READY?


Kachi Nwanna
Moody's ESG Solutions
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Deforestation and forest degradation are two of the major contributors to
biodiversity loss and climate change. The United Nations Framework Convention on
Climate Change has set out that forests act as a net carbon sink accounting for
about 20% of the estimated annual carbon emissions. The Task Force on
Natural-related Financial Disclosures, which recently launched a disclosure
prototype, has identified deforestation as a driver of nature loss and a
significant source of carbon emissions. According to the World Resource
Institute (WRI), deforestation was responsible for approximately 8.3 gigatonnnes
of carbon emissions between 2001 and 2020. The WRI also states that the major
causes of forest cover loss are large-scale forestry operations, wildfires,
shifting agriculture, and commodity-driven deforestation. Commodity-driven
deforestation entails the permanent conversion of forests for commodity
production including agriculture, mining, and oil & gas production, and it is
associated with 103 million hectares of forest cover loss between 2001 and 2020.
Products associated with deforestation are finding their way into end markets. A
2020 study found that 20% of soya exports and 17% of beef exports from the
Amazon and Cerrado to the EU were likely to be “contaminated with illegal
deforestation”.

Recognition of the need for action has been increasing globally. SDG 15 aims to
protect forests, reverse land degradation and halt biodiversity loss. Forest
management certifications such as the Programme for the Endorsement of Forest
Certification (PEFC) and Forest Stewardship Council (FSC) have been developed to
ensure forests are being managed in a sustainable way, preserving its
biodiversity and mitigating climate change impacts. For stakeholders involved in
palm oil, The Roundtable on Sustainable Palm Oil (RSPO) aims to transform the
market in order to produce Certified Sustainable Palm Oil. Beyond that, the RSPO
created a joint steering group, “No Deforestation Joint Steering Group”, which
is a collaboration with the High Carbon Stock Approach to ensure requirements
around No Deforestation are aligned and harmonized. Elsewhere, in 2017, a number
of investors came together with global brands in a statement of support for the
Cerrado Manifesto to halt deforestation and incentivize sustainable land
management in the Brazilian Savannah. Governments and lawmakers, though
criticized by environmentalists around Europe for lack of activity on this
topic, are also beginning to take action. For example, at COP 26 leaders
representing over 85% of the world’s forest pledged to halt and reverse
deforestation and land degradation by 2030.

In November 2021, the EU published a legislative proposal which aims to tackle
global deforestation and forest degradation by preventing the import of
commodities linked to deforestation from certain countries which highly
contribute to global deforestation (see Figure 1). The specific commodities
mentioned in the proposal are beef, palm oil, cocoa, coffee, wood, and soy as
well as derived products such as leather, chocolate, and furniture.

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This proposal is in line with the EU Commission’s commitment to “assess
additional demand side regulatory and non-regulatory measures to ensure a level
playing field and a common understanding of deforestation free supply chains”.
The proposal recommends establishing a benchmarking system to identify countries
presenting different levels of risk of producing commodities which are not
deforestation free. This system will determine due diligence requirements;
simplified for low-risk countries and enhanced for high-risk countries. In
addition, it also proposes a partnership with producer countries to “address
root causes of deforestation” and international cooperation with major consumer
countries to “promote the adoption of similar measures”.

Key sectors that will be most impacted by the proposed upcoming regulation are
likely to be food & beverages, luxury goods & cosmetics, pharmaceuticals &
biotechnology, biomass energy generation, home construction, paper, and other
forest products. Companies in any of these sectors may be labelled producers,
traders or retailers as defined by the proposal, depending on their interaction
with the relevant commodities in their value chain. They are likely to face
potential market access risk, reputational and legal risks when the new
legislation comes into force. For example, companies involved in producing paper
products may encounter problems with sourcing raw materials essential for
serving their markets, and luxury goods companies may face public backlash
regarding the origin of the leather used in their products.    

Moody’s ESG Assessment data allows us to examine the preparedness and resilience
of key sectors to the impact of any potential regulation on deforestation.
Figure 2 below shows results of our analysis of three sectors at risk:
Beverages, Food and Forest Products & Paper.  

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‍

We see uneven performance in commitments companies make towards the promotion of
sustainable agriculture and prevention of forest degradation. As of March 2022,
80% of companies in the forest products & papers sector have published such
commitments compared to 47% and 53 % of the beverage and food sectors
respectively.

     

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Example: Mondi Group discloses targets alongside its deforestation commitments

Mondi Group, an integrated paper and multi-packaging solutions provider,
published policies that commit to maintain zero deforestation in their wood
supply by sourcing from healthy and resilient forests. The company also
committed to responsibly sourcing 100% of its fiber with 75% FSC- or PEFC-
certified fiber by 2025.

--------------------------------------------------------------------------------

‍

Article 10 of the EU legislative proposal outlines risk assessment and
mitigation steps to be undertaken by companies on relevant commodities and
products placed in the market. In general, Moody’s ESG Solutions assesses the
risk mapping and the environmental impact assessment that companies carry out to
determine the impact of overall operations on biodiversity. Given rising
scrutiny, we should expect to see an improvement in the disclosure and quality
of disclosure of the environmental impact assessment carried by these companies
in the coming years. However, at present, lack of action by certain key sectors
suggests a large gap to improve overall practice. For example, currently only
22% of companies in the food sector disclose the presence of environmental
impact assessment or risk mapping within their own operations.

We also see that despite the high share of companies in the forest products and
paper sector publicly committing to preventing forest degradation and
deforestation, they lag behind significantly in disclosing steps taken to do so.
None of the sectors highlighted have a majority of the companies disclosing the
specific means put in place to prevent deforestation or promote sustainable
agriculture within their business activities and supply chain. These means may
include implementation of sustainable agricultural practices and the procurement
of certified forest products in its supply chain.

 

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Example: Danone Group and certification of forest products

Danone Group reports that 95% of its palm oil sources were certified by the
Roundtable on Sustainable Palm Oil (RSPO). In addition, the company reports that
98% of its paper and board packaging are made of recycled fiber or virgin
certified fibers (Forest Stewardship Council, Programme for the Endorsement of
Forest Certification, Sustainable Forestry Initiative). Danone also reports on
conducting environmental impact assessments and deforestation risks mapping.
Danone communicates on a risk map for all its commodities, conducted with the
help of an environmental consulting agency and a list of high-risk countries of
sourcing has been developed with NGOs/consulting agencies.

--------------------------------------------------------------------------------

‍

Furthermore, the proposal specifically mentions due diligence requirements on
relevant commodities and products supplied by each supplier. This implies that
companies will have to perform an audit of their suppliers on deforestation
risks. Our ESG Assessment covers the presence and the quality of dedicated
environment audits in the supply chain. Across the major sectors that are
exposed to the relevant commodities and their derivatives, few companies carry
out such dedicated audits (Figure 3). Less than 30% of the companies in the
pharmaceuticals & biotechnology, home construction, food, and beverage sectors
disclose that they carry out dedicated supplier audits. Disclosure in the luxury
goods & cosmetics sector (intensive users of soy, cocoa, palm oil in cosmetic
products as well as leather for luxury goods) is slightly higher, at 37%. But
overall low prevalence of dedicated environmental audits reflects a lack of
understanding of supply chain deforestation risks and impacts.

‍



‍

Our analysis finds that the key sectors at risk under the upcoming EU rules on
deforestation lack the appropriate management and reporting frameworks to meet
potential requirements to address deforestation risks despite overall better
reporting on commitments to the issue. Addressing this imbalance and building
further capabilities will be important, not least because the potential
regulation may include more specific reporting requirements, such as reporting
on geo-location coordinates of all land where the commodities and products are
produced. To sum up, the proposed EU legislation highlights the need to fight
inaction, expose poor practices and reward those who have taken steps to define
and identify key material information that may be necessary to assess and
mitigate inherent deforestation risks across business activities.  

‍

Moody’s ESG Solutions provides insights and analyses on ESG themes and
multi-stakeholder performance, climate-related risks and opportunities and
global sustainable finance trends.

For more information, visit esg.moodys.io/esg-measures

‍

Contact US
Moody’s ESG Solutions
Understand our comprehensive ESG offering
MESG@moodys.com
Media:
Julian Knapp
SVP, Corporate Communications
Sustainability and ESG
julian.knapp@moodys.com
Moody’s Investors Service:
Understanding ESG in credit ratings
Brian Cahill
MD, Global Head of MIS ESG
brian.cahill@moodys.com
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