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How to eliminate the deforestation risks of palm oil imported to China?

A new report shows Chinese firms are unaware that deforestation risks associated with buying palm oil endangers their business. The solution starts with transparency.

The ongoing Covid-19 pandemic has highlighted the role nature has to play in supporting sustainable development. Forests are key ecosystems in this regard. They provide raw materials and ecological services for social and economic development. They are also crucial to preserving biodiversity and tackling climate change.

But we are losing these precious resources. One of the main reasons forests are being cut down is to make way for the cultivation of commodity crops such as oil palm. The coronavirus outbreak may exacerbate the problem: a new policy briefing from the UN’s Food and Agriculture Organisation warns that the economic slump the pandemic is expected to cause may increase the felling of forests. There is already evidence the virus has weakened local law enforcement and monitoring, resulting in a sharp increase in felling in the first quarter of 2020.

Over the past decades, large expanses of tropical rainforest in Southeast Asia have been cleared to meet increasing global demand for palm oil. Deforestation has been greatest in Indonesia and Malaysia, which together account for 85 per cent of the world’s palm oil output.

Deforestation driven by palm oil leaves all businesses facing greater risks from climate change, which could reduce output as a result of natural disasters and changes in climate patterns. But companies trading in palm oil also face reputational, market, policy and technological risks. Therefore, if those companies want to improve their environmental, social and governance (ESG) performance, managing deforestation risks in their value chain is crucial.

The coronavirus epidemic has shown how vulnerable global public health systems, markets and supply chains are. This may prompt firms in the palm oil sector to: reevaluate and change how they manage all types of risks including those arising from deforestation; increase supply chain resilience; and promote sustainable development.

Gravely underestimated risks

In 2019, CDP, a non-profit working on environmental information transparency, on behalf of 525 institutional investors and 14 institutional buyers, invited companies across the world to report information related to the production and consumption of forest-risk commodities such as timber, palm oil, beef, soy bean and rubber. In total, 543 companies reported to CDP.

CDP’s new report, The Hidden Commodity: how China’s palm oil imports can help halt deforestation reveals that, globally 146 firms report they used palm oil directly in 2019, or that it was used in their supply chains. Of these, 63 per cent (92 firms) identified forest-related risks with the potential to have a substantive financial or strategic impact on their business, including physical, reputational, market, regulatory and technological risks.

One-quarter (36 firms) not only identified risks, but also reported their potential financial impact, which totalled US$7.6 billion. And three-quarters (110 firms) either failed to identify any risk, or didn’t report the financial impact of those risks. Of course, many other companies across the world made no report to CDP about the commodities they handle.

Ranked by nation, China is the world’s second-largest importer and third-largest consumer of palm oil, and relies entirely on imports for its supply. The country’s palm oil businesses are generally positioned in the middle or at the end of the supply chain, engaged in importing and trade; manufacturing edible oils, processed foods and household products; and catering and retail. Although China is a vast market, but in 2019, only 3 Chinese firms reported palm oil-related information, 2 of these identified forest-related risks.

The report also found that China’s downstream palm oil firms may face increased production costs due to physical risks – primarily increased procurement costs or supply chain interruptions due to extreme weather events or ecosystem vulnerabilities arising from climate change. Meanwhile, firms in the middle of the value chain could see market access risks due to buyers instituting zero-deforestation policies.

For example, many international buyers of Chinese products containing palm oil (such as French supermarket group Carrefour) have put such policies in place and promised that by the end of 2020 they will only buy palm oil products certified as sustainable by the Roundtable on Sustainable Palm Oil (RSPO). If Chinese suppliers do not comply with these policies, they may see contracts terminated and business lost.

Opportunities for sustainable development

Taking into account forest issues and sustainability in business models and strategies will help firms reduce and manage deforestation risks effectively – and also provide opportunities. Demand for greener products is increasing, while investors and financial institutions are highly supportive of sustainability policies.

More than 70 per cent of Chinese consumers already have an awareness of sustainable consumption, according to a 2017 survey by China Chain Store & Franchise Association. Meanwhile, investors are encouraging companies to implement sustainable development policies – in 2018, 90 institutional investors representing more than US$6.7 trillion in assets called for the RSPO to strengthen its standards.

In April this year, MSCI, a provider of investment decision support tools and services, published an article on the performance of its ESG indexes during the coronavirus crisis. It found that ESG indexes in various regions and markets did better during the first quarter of 2020 than their parent index. Many financial advisors are already seeing investing in ESG funds as a Covid-19 recovery tool.

Moreover, the CDP report shows that firms on the palm oil value chain have reported forest-related opportunities, such as increased brand value, costs savings, and increased R&D and innovation opportunities. Thirty-two firms valued these benefits at a total of US$2.38 billion.

The first step is greater transparency

With the impact of commodity-driven deforestation going global, the markets are becoming more aware of the risks. Meanwhile, China has issued a series of policies in recent years requiring companies to manage the environmental risks of their operations. That regulatory pressure is encouraging more and more Chinese firms to tackle the physical and transitional risks arising from climate change (as well as deforestation), and to improve transparency.

More transparency is crucial if companies are to manage and remove deforestation risks from their supply chains. Transparency of environmental information allows firms to identify, measure and manage the risks they face, but also to find and take advantage of market opportunities.

Forest policies and targets, sustainable procurement and traceability schemes can reduce deforestation risks throughout the supply chain. That foundation then allows for communication and cooperation with suppliers and other stakeholders and integrating forest issues into corporate governance, both preventing deforestation and displaying leadership.

The coronavirus is still spreading globally. This is the time to consider how we can better protect biodiversity and forest ecosystems, and promote sustainable development. Cooperation between producer and consumer nations in the promotion of sustainable palm oil is crucial.

China’s “Green Belt and Road” and the recent inclusion of certified sustainable palm oil in a new draft list of projects eligible for green bond could further close the gap between Chinese and international standards, and promote interaction between Chinese companies and producer-nation suppliers.

This will in turn allow for action on removing deforestation risks. China should play a leading role in the prevention of deforestation worldwide, and more Chinese firms should import and use palm oil in a resilient, risk-resistant and sustainable manner.

This story originally published by Chinadialogue under a Creative Commons’ License.

 

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