Recent progress on sustainability in the finance industry has been encouraging. Initiatives such as the Task Force on Climate-related Financial Disclosures (TCFD) and the Principles for Responsible Banking (PRB) together have enlisted hundreds of financial institutions from across the globe as signatories that commit to financing practices in line with the Sustainable Development Goals and the Paris Agreement.
However, efforts at tackling climate change have not been balanced. Within the spectrum of sustainability themes, fossil fuels and renewable alternatives usually take the spotlight, while deforestation (along with forest protection and restoration) has not received nearly as much attention despite being the second largest contributor of greenhouse gas emissions after the energy sector.
The Soft Commodities Compact that aims for zero net deforestation through financing of supply chains has been signed on by only 12 banks since its launch in 2010.
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Banks at present are the true laggards in the global economic transition to sustainability. They make little to no use of practical financial interventions, especially on the issue of deforestation, rendering their podium promises worthless.
In Southeast Asia — the region that drives the world’s deforestation problem, alongside Central Africa and the Amazon — only 9 per cent of banks have adopted No Deforestation, No Peat, No Exploitation (NDPE) policies in varying forms, according to a study by the World Wide Fund for Nature (WWF). Even then, the implementation of these policies has been slow and patchy.
Banks least concerned about deforestation
In violation of formal commitments, their own policies and international pressure, banks with prior exposure to forest sector businesses (palm oil, pulp & paper, rubber and timber) continue to finance companies linked to deforestation and a range of related environmental, social and governance (ESG) issues such as illegal fires, land rights conflicts, tax avoidance and corruption.
A Forest 500 report of 2019 found that more than a third of 150 financial institutions assessed had no policies on deforestation whatsoever; a few banks, in fact, retrogressed by removing previously available disclosures.
And yet, commitments on paper mean little in the absence of tangible positive changes in the financiers’ portfolios. A case in point: between 2017 and August 2019, Japanese banks accounted for the largest single chunk (22 per cent) of new financing to publicly traded forest-risk companies that totalled USD23.1 billion, according to Forest & Finance.
During the same period, megabanks Mitsubishi UFJ Financial Group, Mizuho Financial Group and Sumitomo Mitsui Financial Group — all of which have specific forest sector policies in place — extended funding to several companies implicated in major NDPE offenses in Indonesia, including Sinar Mas Group, Royal Golden Eagle Group, and Salim Group: USD1.3 billion channeled to these groups amounted to 26 per cent of the Japanese banks’ aggregate financing of USD5.1 billion.
In essence, by keeping financing accessible to forest-risk companies regardless of their ESG track record, banks are sustaining and, by implication, legitimising their clients’ involvement in deforestation and related illegalities.
This tacit approval puts banks at a serious risk of reputational damage, especially when their stated commitments run counter to their actual financing decisions. In general, financial risks arising due to nonconformity to sustainability standards are becoming increasingly more material as regulatory and multi-industry initiatives in sustainable finance spread and take hold across the globe.
Banks’ influence over forest-risk companies left unutilised
In Southeast Asia, large forest-risk companies are mostly private entities with family-oriented structures that depend on debt to sustain their operations. Publicly listed corporations among them are mostly small-to-medium cap stocks that trade thinly at very low values. On Bursa Malaysia, for instance, only 8 out of 44 listed plantation companies are large cap.
Overall, forest-risk companies maintain high debt profiles. For companies operating in breach of NDPE policies, bank financing and underwriting often become the only funding channels.
BLD Plantations Berhad (BLD) is one example, a Malaysian palm oil corporation that is a non-member of the Roundtable on Sustainable Palm Oil (RSPO) and one of the top deforesters in the region.
Despite being a publicly traded company, BLD clearly does not derive significant value from equity. Capitalised at just MYR561 million(USD132 million), it is effectively owned by its directors who indirectly hold more than 90 per cent of company shares; trading volume, as a result, is negligible.
Day-to-day operations are covered by bank loans in their entirety considering that the cash balance does not cover short-term liabilities. With leverage ratios above 60 per cent, the company is continually rolling over its debt to stay afloat and fight negative margins.
For as long as banks continue to finance deforesters like BLD without regard to their offenses, forest-risk companies will lack motivation to lift their ESG performance.
On the other hand, if banks were to conduct critical sustainability checks, such companies could be sanctioned with higher financing costs or face the risk of losing funding avenues altogether. This would threaten their going concern given the near absolute reliance on bank loans.
A call-to-action for banks
The annual period of forest fires and haze in Southeast Asia is once again upon us. Last year’s devastation should have served as yet another wake-up call for the financial community to alter their business-as-usual practices.
Banks at present are the true laggards in the global economic transition to sustainability. They make little to no use of practical financial interventions, especially on the issue of deforestation, rendering their podium promises worthless.
Banks are, thus, failing to fulfil their fiduciary responsibilities to multiple stakeholders, despite the fact that they possess substantial leverage over most forest-risk companies in their portfolios. There is a reason to believe that stricter loan criteria could stimulate positive change in borrowers to a much greater extent than pure investor-led initiatives.
Gulzhan Musaeva is a financial analyst who writes about high-growth companies, responsible investing and enablers of sustainability.
