The financial sector faces growing pressure to cut support to companies involved in deforestation. With researchers arguing that banks are in a unique position to encourage sustainable practices among clients and across supply chains, John Basquill examines how emerging technology is opening new opportunities for trade finance lenders looking to go green.

 

Deforestation remains a major challenge for financial institutions, particularly those involved in supporting exports from rainforest-covered areas of South America.

Though most lenders have overhauled policies on environmental issues, researchers continue to uncover examples of companies involved in forest destruction – either directly through their own activities or indirectly through their supply chains – that are still heavily financed by major banks.

In December 2020, for example, allegations arose around Brazil’s beef production industry. Global Witness, an influential campaign group with a focus on environmental protection, published a report accusing three meat traders of continuing to source cattle from ranches directly responsible for deforestation.

The three companies – JBS, Marfrig and Minerva – had previously signed sustainability agreements with Brazilian prosecutors and environmental groups, and issued audited statements claiming full or near-full compliance. However, by comparing satellite imagery to the companies’ licensing arrangements, Global Witness showed large-scale deforestation was still happening throughout their supply chains.

The report also examined the money trail behind that activity, finding that the three companies received more than US$9bn in funding between 2017 and 2019, facilitated or provided by 250 financial institutions. Nearly half of those are headquartered in the US, EU or UK, it said.

It urged all financial firms that deal with those companies to suspend any business dealings “until, at a minimum, conditions are put in place to undertake basic due diligence on the companies, including full supply chain transparency”.

At the same time, however, Global Witness acknowledged there remain serious issues around the reliability of credit agencies and company self-reporting, as well as the lack of laws and regulations that could protect forest areas – leaving trade finance lenders in a difficult position.

 

Banks under fire

The scale of funding for Brazilian agriculture is substantial. The Netherlands division of Fair Finance International, a network of environment-focused civil society organisations that concentrates on the banking sector, published a case study in 2020 examining the role of Dutch financial institutions’ activities in the Amazon rainforest.

Taking a sample of 59 companies active in beef and soy production, the report found every Dutch bank bar one – De Volksbank – had financial relationships with one or more.

Loans to those companies totalled over US$12bn between 2015 and 2020, it said, with another US$2.7bn raised through share and bond issuance programmes.

World Animal Protection, a London-based campaign group, also examined funding provided by European financial institutions to 60 “high risk” Brazilian beef and soy producers over the same five-year period.

It found that the top 10 banks provided financial support to those companies totalling nearly US$100bn, through loans, shareholding, bondholding and underwriting.

Other commodities have also been flagged as an issue. In a 2020 report, the University of Cambridge Institute for Sustainability Leadership (CISL) said that as well as beef and soy, palm oil and timber products “are responsible for the majority of deforestation caused by commercial agriculture”.

“Banks provide a variety of finance and financial services to enterprises along soft commodity supply chains, from term loans, trade finance and revolving credit facilities, to bond and fund structuring, capital raising, project finance and more,” it said.

A further flashpoint has been oil extraction from the Ecuadorian Amazon. Two campaign groups, Stand.earth and Amazon Watch, said in a January 2021 report that BNP Paribas, Credit Suisse and ING had confirmed in writing that no new transactions will be executed that involve the sale of such oil.

The trio had been responsible for financing sales of Amazon oil to buyers in the US worth a total of US$5.5bn since 2009, equivalent to more than 50% of all financing provided for such trade, the report said.

That report followed a 2020 investigation that found that BNP Paribas, Credit Suisse, ING, Rabobank, UBS and Natixis together had facilitated 85% of all bank-financed trade linked to Amazon oil since 2009 “despite having policies on advancing human rights, sustainability, and climate change”.

Natixis was only one of the six banks highlighted that continued to fund trade in Amazon oil after the publication of last year’s report, providing trade finance for 5.5 million barrels of oil in the second half of the year – more than double the amount from January to June.

A spokesperson for Natixis said at the time the bank has “declined to finance any new clients involved in oil exports from Ecuador since mid-2020 and has reduced the number of existing clients it works with in this area”.

GTR understands that the reported increase in volumes in the second half of 2020 was the result of a single customer drawing down larger amounts on an existing facility, rather than the bank entering into a new transaction.

Natixis is named as the lead bank on that facility, but it is also backed by two other lenders that are not among the six top funders identified by Stand.earth. The facility is due for renewal this year, though as of press time no decision had been made on whether to continue it.

 

Technology and transparency

For banks keen to ensure they are funding sustainable operations, experts believe developments in technology and data science could significantly improve their level of oversight of their customers’ activities and supply chains.

That, in turn, could allow trade finance lenders to offer better terms to companies that can prove their sustainability credentials. The key is collecting and making sense of data from multiple different sources.

“Historically, financial institutions’ supply chain due diligence needed to rely on self-reporting, sometimes backed up by certification,” says Grant Rudgley, project manager for CISL’s Banking Environment Initiative, speaking to GTR.

“Today, those institutions don’t have to rely on one or two sources of information. They can use different methodologies to triangulate around the actual reality of what’s happening on the ground, using technology like satellite data or remote sensors in the field.

“When that data is gathered alongside input from the producers and certifiers carrying out in-field assessments, you begin to build up a bigger and bigger data pool. It then becomes possible to use data science to make sense of all that.”

Dirk-Jan Verdonk, World Animal Protection’s Netherlands country director, agrees that financial institutions should also look to “triangulate the data with civil society organisations”.

“In our experience, that can help financial institutions to ask the right questions and press companies on addressing weak or blind spots,” he tells GTR, pointing out that data from producers can lack reliability, clarity or contextual nuance.

Technology can also help beyond collecting and analysing data, however. A report by Capco, a tech-focused management consultancy, suggests that banks could use tokenisation to add traceability to products and services.

It gives the example of distributed ledger technology (DLT) in the precious stones and metals sector. Ethically sourced goods can be tokenised, registered on a blockchain-based system and recorded as they move along the supply chain and towards their final destination. The nature of this technology means records cannot be tampered with or deleted once created.

“The potential for tokenisation or similar DLT technologies to make an impact on ESG measurement is vast, especially around supply chain,” Capco says.

The company also suggests financial institutions use sentiment analysis tools to scan news and other online sources in order to gain a sense of whether a potential client has a reputation for responsible practices.

Though historically a time-consuming, manual task – particularly for complex supply chains – Capco says artificial intelligence can detect whether reporting around a company’s activities is largely positive or negative.

Coupled with “traditional” secondary research, funders can create “a more holistic view of an ESG investee”, it says.

 

Sustainable finance

Once sustainability claims made by recipients of funding can be validated, technology can also help lenders structure trade finance products.

CISL suggests that for producers that can demonstrate adherence to anti-deforestation standards, banks could provide extended debt financing terms, reduce the cost of capital for loans or project finance, and improve the pricing or tenor of trade finance programmes.

Its 2020 report, titled Banking Beyond Deforestation, says banks could “agree types of producer finance that could effectively transfer benefits… and create legally viable standardised templates, eg discounted invoice financing”.

Financial institutions should “mobilise and structure funds that channel finance and incentives to soft commodity producers in exchange for commodities that are deforestation-free or forest restorative”, it adds.

That lets banks act as intermediaries, using their access to producers and their expertise in structuring “to connect producers with capital that incentivises sustainable production”.

Though margins may be tight, it says those producers would likely see longer-term profit and resilience improve thanks to regenerative agriculture techniques. That, in turn, would prompt ratings agencies to upgrade their status and increase their ability to obtain further financing programmes.

As a result, banks should understand technology-driven sustainable finance “is somewhere they can create opportunities, rather than just risk avoidance or mitigation”, says Annabel Ross, senior programme manager for CISL’s Banking Environment Initiative.

Rudgley adds: “Given banks’ role in financing trade along supply chains, they are in a unique position to have access to data and knowledge that they can combine with their financial structuring expertise.

“It may be that as trade finance evolves and digitises more, using that unique position to incentivise sustainable supply chains actually becomes a value add.”

For Verdonk of World Animal Protection, sustainability-linked financing mechanisms “can be a very useful tool to incentivise and support company sustainability improvements. When money is at stake, both parties have an interest in actually following up and monitoring progress.”

There are some challenges, however. CISL’s Rudgley points out there is “still work to be done around making this technology as accessible and low-cost for as many people as possible”.

One obstacle today is a lack of alignment of standards around data flows, which makes it difficult to share information across institutions. As a result, each bank faces a cost burden associated with acquiring and analysing data.

“When each bank is navigating this on its own, without an alignment of standards, it can end up becoming an overwhelming policing effort on the part of that bank,” adds CISL’s Ross. “We need to be careful and make sure we’re narrow in terms in what we’re asking of the financial sector.”

 

Why does it matter?

Deforestation worsens climate change in several ways. Perhaps the best known is the role of plant life in extracting carbon dioxide (CO2) from the atmosphere, which in turn slows the rise of global temperatures.

The planet’s last mass extinction event, around 66 million years ago, was caused by a rise in global temperatures after volcanic activity released vast amounts of CO2 into the atmosphere, killing around 90% of all life.

Today the threat is from human activity, with BBC research estimating that CO2 emissions from burning fossil fuels are greater than all current volcanic activity combined.

As forest is removed, the amount of CO2 emissions drawn from the atmosphere decreases. Already, World Animal Protection estimates that in the Amazon, around 20% of forest has been destroyed – an area twice the size of Germany.

DR Congo, Indonesia and Bolivia follow Brazil in terms of how much tree cover has been lost to deforestation, while in Madagascar, as much as 80% of original forest has already been destroyed.

Deforestation also has a secondary effect on CO2 emissions. The Rainforest Alliance warns that agriculture, forestry and other land use, including rearing livestock, accounts for almost a quarter of all greenhouse gas emissions deriving from human activity. Agriculture, it says, drives an estimated 75% of deforestation.

A further rise in global temperatures would be catastrophic for life on earth, with landmark research by a UN panel of experts estimating in 2019 that 1 million animal and plant species are currently at risk of extinction. Natural disasters, such as wildfires and storms, are also expected to become more common and more severe.

There are further warnings that climate change will be a catalyst for pandemics, with the World Health Organization warning several years before the Covid-19 crisis that “changes in infectious disease transmission patterns are a likely major consequence of climate change”.

Harvard University’s public health school says in a 2020 paper that there has been a greater emergence of infectious diseases

in recent decades, often spreading to humans from wild animals. The loss of habitat, it says, means animals “find food and shelter where people are, and that can lead to disease spread”.

Rising temperatures increase the transmissibility of water-borne and mosquito-borne infections, it adds, while deforestation in particular is singled out as a risk factor in expanding breeding grounds for disease-carrying insects.

The 2015 Paris Agreement – a legally binding treaty on climate change – aims to limit global warming to 1.5 degrees celsius compared to pre-industrial levels.