Reasons why deforestation must be in the financial institution’s radar
In a short time, good practices in monitoring deforestation may no longer be a positive differential for brands and exporters and become mandatory or standard.
Much more than an environmental issue, looking at deforestation is a matter of economics and finance. With the Forest Code and the recent commitments involving the private sector, civil society and the public sector, such as the Soy Moratorium and the signing of a Term of Adjustment of Conduct (TAC) by slaughterhouses with the Federal Public Ministry of Brazil, among others, funders need to be increasingly aware of the risks related to deforestation.
This is because, in addition to direct threats, such as loss of vegetation, reduction of biodiversity and imbalance in access to natural resources, especially water, deforestation poses risks to the financial sector linked to agricultural production chains, either due to the possibility of a fall in production , or due to the difficulties of disposal due to non-compliance with more robust socio-environmental criteria.
An additional concern for the sector is the tendency in Brazil to hold responsibility not only for the agent causing environmental damage, but for the different links of production chains, including the financing agent. This is what is called legal co-responsibility. A recent example is Operation Shoyo, launched in 2016 by Ibama and MPF (Brazilian Federal Public Prosecutor), which identified planting and commercialization of grains in embargoed areas in the Amazon. In addition to the producers, at least seven tradings and one bank were blamed as beneficiaries of fraud in deforestation control.
In addition to the risks, compliance with the recent international commitment made by Brazil under the Paris Agreement on Climate Change requires the account to close. It is estimated that in order to achieve the goal of restoring 12 million hectares of forests by 2030, investments of more than R$ 50 billion (about 13 billions dollars) are needed. The objective is also to comply with the Forest Code, and much of the cost will have to be borne by the productive sector, with financial support.
According to data from the Brazilian Institute of Geography and Statistics (IBGE) and the Brazilian Ministry of Industry, Foreign Trade and Services (MDIC), agribusiness accounts for 23.6% of GDP and for almost half of Brazil’s exports. With the constant collection of civil society and international markets, especially in Europe, in a short time good practices in monitoring deforestation can no longer be a positive differential for brands and exporters and become mandatory or standard.
These are some of the motivators for financial institutions to observe carefully the risks of deforestation in the livestock, soybean, forest products and palm chains (read more in the tables below).
A study of the Getulio Vargas Foundation’s Center for Sustainability Studies (FGVces) for the Brazilian Federation of Banks (Febraban) raises this discussion, also supported by an earlier mapping carried out in 2016, which identified the risks and opportunities associated with natural capital for the financial sector.
The report concludes that the impacts of deforestation on the commodity supply chain can lead to financially material risks that in turn would affect banks. The consequences can lead to delinquency, devaluation of assets and fall in revenue, among others. In addition to mapping risks, the new research identifies monitoring tools that can assist financial institutions in assessing and monitoring the risk of deforestation of their credit customers.
The biomes most threatened by the activities addressed in the new study of FGVces for Febraban are the Amazon and the Cerrado. It occurs that, while the Amazon has been monitored for years and recorded a significant drop in deforestation from 2005 to 2012 (having recorded a new increase in 2015 and 2016), the Cerrado is not yet dedicated the same attention.
Monitoring by the federal government in a system that meets the characteristics of the Cerrado has recently begun (the so-called Prodes do Cerrado, in reference to the monitoring system of the Amazon), and public commitments to protect this biome are still timid. In 2017, environmental organizations launched the Manifesto of the Cerrado, with ambition to function as the Soy Moratorium in the Amazon – inducing the reduction of deforestation. By January of this year, more than 60 companies had already adhered to the commitment.
Recommendations to banks
The study of FGVces brings a series of recommendations to financial institutions in its rural credit granting policy. The first of these is that the banks verify the environmental regularity of the activity and the area to be financed, seeking the existence of embargoes for illegal deforestation, the overlap of the area of operation or limits of the rural property with Conservation Units and Indigenous Lands or Quilombolas, registration of the Rural Environmental Registry (CAR) and environmental license.
In addition to official databases, it is advisable to use geospatial tools, as an aid to socio-environmental risk analysis (more about the technology here). They should also define the scope of the analysis based on the evaluation of the exposure of the credit portfolio to the risks of deforestation. It is also recommended that financial institutions monitor socioenvironmental criteria set forth in the Rural Credit Manual, in addition to the amounts covered by the National Rural Credit System (SNCR).
In cases where operations are classified as higher risk, by the amount required or by the incidence of deforestation in the region or production chain, it is recommended that financial institutions carry out a more in-depth analysis, taking into account risk management criteria by the borrower as well as issues of governance and traceability and monitoring, with indicators for deforestation risk management. In addition, involvement with public commitments to end deforestation, engagement in multistakeholder forums and purchase of certified commodities should be taken into account.
There are a number of challenges for these recommendations to be met, but financial institutions are a relevant agent for accelerating more robust monitoring measures. The chains addressed in the study present particularities and involve many links, with asymmetry in the conditions of monitoring and in the capacity to comply with legislation and additional commitments. Even the public data bases present some limitations, which go through problems such as the lack of periodicity in the update and the lack of integration of some local systems with the national one (more here).
Among the geospatial tools for free public access, the main advantages are free and easy access, but some do not cover all Brazilian commodities and biomes. In addition, most of them only analyze socio-environmental information of the municipality, and not of the polygon to be financed. Certain paid tools offer more detailed socio-environmental information of the researched areas and possibilities of customization.
In order to adopt a robust risk monitoring strategy, banks would have to go beyond the legal obligation, applying rules of the Rural Credit Handbook even in cases where the amount used is not subsidized by public resources, for example. The greatest opportunity to induce change may be in their areas of service to large corporations, which in turn must engage their chains to adopt more robust measures beyond what the law requires.
The study Financing the Forest Recomposition presents the issue also as an opportunity for the financial sector, especially with the entry into force of the Forest Code, effectively. Once owners comply with legislation, their legal risks and market barriers will be reduced, as well as the environmental risks that may lead to a fall in production and inability to afford financial commitments, to avoid losses due to water supply deficit and other ecosystem services, for example. As public resources will not be sufficient for recovery, it should also be of interest to private financial institutions to circulate more money for this purpose.
Not that it is an easy task: it is necessary to allow the financing to be viable through credit lines, which are still relatively few. Demand is also low, which can be attributed to the scarcity of information on more sustainable and economically viable production arrangements, but also to the postponement of the requirement to comply with legislation, especially the CAR. In addition to the legal insecurity – expressed, for example, in Direct Unconstitutionality Actions that questioned the Forest Code and were only judged by the Brazilian Federal Supreme Court this year – other challenges are the high indebtedness of the productive sector in Brazil and the high costs for monitoring and implementation of recomposition. The lack of collateral for taking this type of loan is yet another barrier.
In the study on recomposition, the FGVces research team presents a model for feasibility analysis of recomposition financing and brings recommendations, together with Febraban, to improve the ABC Program, which involves simplification of document requirements and standardization of environmental licensing requirements , in addition to the creation of a new financing line aligned with the objectives of the Program.
The other recommendations concern changes in the Rural Credit Manual, for more flexibility in the ceiling of resources that can be used for this purpose, reduction of credit risk, from access to international resources, for example, and training and all involved in this process, from technicians and producers to the financial institutions themselves.
Realities: RISK MANAGEMENT
The country has the largest cattle herd in the world, close to 210 million head of cattle. This animal population is distributed in 167 million hectares, concentrated in the states of Mato Grosso, with 13.6%, Minas Gerais (11.3%) and Goiás (10.4%). In the Legal Amazon alone, there are 85 million head – 40% of the national herd. Most, therefore, in a region covered by the Amazon or Cerrado biomes.
The refrigerators, in turn, are concentrated in Mato Grosso do Sul, Goiás, Rondônia, Pará, Mato Grosso, Minas Gerais, as well as Northern Paraná and São Paulo. According to a study by the Institute of Man and Environment of the Amazon (Imazon) of 2017, in the region of Legal Amazon are 128 slaughterhouses of 99 companies, which influence practices of about 390 thousand farms with a herd of approximately 80 million head of cattle. About half of these slaughterhouses signed the TAC with the Federal Public Ministry, whereby they undertake not to buy cattle from deforested areas as of 2009 or from properties where slavery or slavery is carried out.
Some data point out that corporate collections may have improved producer practices from monitoring by the buyers themselves. However, there are also indications of “cattle laundering“, through practices such as registering in the CAR only a portion of the farm free from irregular deforestation or transporting livestock from irregular farm to regular farm before sale to the slaughterhouses, among others.
One of the big challenges is to monitor the whole chain, which involves a complex plot. Before the gateway, there are producers of inputs related to nutrition, reproduction, animal health, fuels, agricultural inputs and maintenance. Livestock production, within the gate, also involves more than one reality, with farms of rearing, rearing and fattening. And behind the door is the manufacturing industry, the retail chains, and the end consumers. According to data from the last IBGE Census of Agriculture, 2006, 33% of the herd is in the breeding and rearing phases, which tend to be less supervised by the monitoring controls of slaughterhouses, wholesalers and retailers.
In general, monitoring focuses on the manufacturing industry, which generally looks only at its direct suppliers, a gap that can provide a loophole for “laundering” livestock and “leaking” practices. The problem may be with the vendor vendor, who passes without tracing the supply chain. Like refrigerators, most wholesalers and retailers only monitor direct suppliers. With the cheapness of technology, it has become less complicated to monitor in several stages of production and links in the chain, but there is still a lot to evolve (more here).
Of the total soybeans produced in Brazil, 41.5% are for domestic consumption and 58.5% are exported, making Brazil the largest grain exporter in the world and the second largest producer, behind only the United States. Soybean production in the country is concentrated mainly in the Cerrado, which is home to 47% of the crop, followed by 35% in the Atlantic Forest, 12% in the Amazon and 6% in the Pampa. In the Cerrado, soybeans are a major driver of deforestation, especially in the new agricultural frontier in the biome, the region known as Matopiba (which includes the states of Maranhão, Tocantins, Piauí and Bahia) where production expansion occurred mainly on native vegetation.
Like the livestock chain, soya production also involves many links: suppliers of agricultural inputs, producers, originators (traders, warehouses and cooperatives), the crushing industry, the vegetable oil industries and the distributors. Great traders generally have systems for evaluating direct suppliers, but most have no way of monitoring indirect suppliers. These suppliers are generally small and medium-sized producers who market soybeans through cooperatives or intermediary storage companies. As they are not monitored, it may be that soybeans produced by indirect suppliers in an area of illegal deforestation come under a check, even if monitoring passes through instruments such as the Soy Moratorium. Some of the traders are already developing remote monitoring systems or partnering with existing tools. Another strategy for acquiring soy free from illegal deforestation is to encourage certification.
Between wholesalers and retailers, the bottleneck is also in tracking indirect suppliers. One of the strategies to combat deforestation is the purchase of certified soybeans or support to producers to certify themselves.
Chain of forest products
Popularly known in Brazil as oil palm, the oil palm is produced mostly in the state of Pará, which concentrates 90% of production. Ninth largest producer, producing around 300 thousand tons per year, the country is not yet self-sufficient in this commodity, a deficit of about 200 thousand tons. Palm oil is used as a base in products like margarine, creams, ice cream, biscuits, chocolates, fillings, cocoa butter substitutes and cooking oil.
The risk of involvement of companies in the palm oil sector with deforestation in Brazil is low, compared to livestock and soybean chains. Palm production occurs in accordance with the Agroecological Zoning (ZAE), an instrument of territorial planning used by the Federal Government to expand the oil palm cultivation on a sustainable basis and free from deforestation. The ZAE was coordinated by the Brazilian Agricultural Research Corporation (Embrapa), obtained from the crossing of the climatic aptitude with the aptitude of the lands for the palm.
The gap in this chain is the fact that there is no 100% monitoring of traders and manufacturers of oil products, but the tracking rate is high. In addition, a recurring practice is to evaluate and support rural producers to raise production quality according to socio-environmental criteria. Monitoring practices by palm oil-consuming companies have been enhanced by the adoption of non-deforestation commitments, strongly driven by actions of non-governmental organizations, especially Greenpeace, on a global level. The biggest pressure has been on Indonesia, the world’s top producer, where cultivation expands over tropical forests.
Source: Analysis signed by Cíntya Feitosa for the P22On – electronic product Revista Page22, journalistic communication channel, which integrates the Center for Sustainability Studies (GVces) of the School of Business Administration of the Getulio Vargas Foundation (FGV EAESP): https://bit.ly/2Eb6dG3