As the European Union's (EU) new zero-tolerance law on deforestation looms, several major investors told Reuters they were worried about their exposure to the problem, with some predicting they could abandon commodity producers with "risky" supply chains.
In December, the EU agreed to a new rule that prevents companies from selling coffee, beef, soy, rubber, palm oil and other products linked to deforestation into its market. Companies must prove that their supply chains do not contribute to deforestation or face fines of up to 4 percent of their turnover in an EU member state.
Last year, the German "Union Investment" approached a certain number of companies that produce raw materials, i.e. products for mass consumption. The aim was to educate them more about the new rules regarding deforestation and to check the way of production in their supply chains.
"Penalties may pose a risk to the stock market performance of these companies," said Henrik Pontzen, head of ESG (Environmental, social, and corporate governance) at Union Investment.
An internal Union Investment document seen by Reuters shows that the firm received only 30 responses, out of the 56 it addressed.
Of those, only 14 companies said they have zero deforestation goals, Reuters reports.
"This is very atypical," Pontzen said. "Usually, we get a response from any company we write to. Maybe the reason for the low response is because they don't have anything to say."
Lawmakers expect the law to be implemented by the end of 2024 for "large operators". While raw material producers are particularly exposed, other sectors that import goods derived from deforestation, including department stores and industrial companies, will also face scrutiny.
"Companies need to be more environmentally friendly given the fact that there is such a high penalty," said Jonathan Toub, manager of Aviva.
Norway's sovereign wealth fund NBIM, one of the world's largest investors, said the rules will affect companies that have not prepared for it.
"It can affect market access, potentially lead to fines for non-compliance or impose increased costs," said Snore Gjerde, NBIM's investment management manager.
Manufacturers are counting on artificial intelligence
The UN Food and Agriculture Organization (FAO) estimates that 420 million hectares of forests, an area larger than the EU, were lost to deforestation between 1990 and 2020. Consumption in the EU amounts to about 10 percent of global deforestation, according to data from the European Parliament.
Palm oil and soybeans account for more than two-thirds of this amount.
The new rule will require companies to submit electronic forms to customs officials to prove that their supply chains do not contribute to deforestation.
Consumer goods manufacturers are counting on technology such as satellites and artificial intelligence to help eradicate deforestation in their supply chain, they believe. But the efforts may not be enough to follow the rules, said EU lawmaker Kristof Hansen.
Several major consumer goods companies say they are close to meeting their ambitious zero-deforestation goals.
Nestle, the world's largest food company, aims to completely exclude deforestation for cocoa and coffee only by 2025.
Unilever, maker of Dove soap and Ben & Jerry's ice cream, has the same goal of producing palm oil, paper and cardboard, tea, soy and cocoa by the end of 2023.
"Maybe a bit ambitious plan"
Companies will have to show when and where the products were produced and provide "verifiable" information confirming that the production material was not grown on land reforested after 2020.
Magdi Batato, head of operations at Nescafe and Kit Kat owner Nestle, the world's largest food producer, thinks the rules are "perhaps" a little ambitious.
Artificial intelligence, however, can speed up the process.
"AI is definitely part of that solution," David Croft, Reckitt's head of global sustainability, told Reuters.
Reckitt, which has not yet publicly disclosed that it is considering using artificial intelligence to reduce deforestation, buys certain goods whose production damages forests, including rubber for Durex condoms.
Unilever announced at the end of last year that it, too, is "using artificial intelligence and satellites to detect changes in tree cover to warn of potential forest depletion."
But these actions are not putting all investors at ease.
"If things don't change, we can shut down the companies," said Arild Skedsmo, a senior analyst at Norway's largest pension fund KLP. "EU rules make deforestation a financial risk as well as an environmental risk.
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