Despite carrying a sustainable label, BlackRock’s ESG funds hold companies with a deforestation risk that stretches over 500 hectares, more than any other fund, an innovative tool has found.
Awareness among investors on deforestation risks, including reputational risks, is growing; as well as the possibilities of how to manage them.
“Given the impact of deforestation on climate change, biodiversity and rainfall patterns, both at a local and global scale, there is a clear systemic risk for investors at a portfolio level,” according to a recent report by UK firm Hindsight Consultancy.
Without immediate action to halt deforestation and start replacing lost trees, half of the entire Amazon rainforest could become savannah within 15 years, according to Carlos Afonso Nobre, a Brazilian scientist, who was cited by the World Economic Forum in January this year.
Trase Finance tool
Trase provided analysis to Expert Investor, which was done with an innovative big data tool that is planned to be launched in the next quarter.
The initiative is a partnership between the non-profit organisations Stockholm Environment Institute and the Global Canopy Programme, which seeks to catalyse supply chain sustainability in forest risk commodities.
The tool makes more transparent the ownership structures and financing methods of companies that are driving deforestation through their trade in major forest risk commodities.
While different approaches already exist to assess deforestation risk, the new tool could help to overcome gaps of current methods.
Investors have faced problems in understanding what the deforestation risk of companies are on the ground because of supply chain complexity.
Large traders, such as US agribusiness company Bunge, can have up to 300 subsidiaries, according to James Phare, chief executive of UK software and data consultancy Neural Alpha, which developed the tool.
This has made it very difficult for some asset managers and investors to trace back how much deforestation can be linked to equity investments from a trading company which is exposed to deforestation risk directly and/or through their subsidiaries and supply chains, including relationships with upstream exporters and producers.
Phare explains that the idea of the tool is to help investors understand the indirect pathways of how they are exposed to risk that they might not be aware of.
“So, we have many different examples of this; where we have an asset manager that has equity holdings in a local bank; and then that local bank is very heavily exposed to, for instance, the palm oil sector, through loans that it extends to different companies,” he said.
The big data tool helps estimate deforestation risk in hectares of land by using different data sets; including trading, import, production and satellite data (eg of cleared land around mills).
It proportionally assigns previously deforested area to buyers of the commodity. However, it does not directly attribute responsibility for deforestation to specific companies.
Deforestation risk analysis
The analysis found that, when linking current fund holdings to deforestation risk from 2015 to 2018 (2015 palm oil data, 2015-2017 beef company data, 2015-2018 soy company data), BlackRock, Northern Trust and Credit Suisse Asset Management are the top three financiers of these risks with their ESG funds (see graph below).
A breakdown to ESG fund level, measured in equity investments, revealed a Credit Suisse fund as the top investor in deforestation risk companies, with over $18m (€15.18m), followed by Northern Trust, with $16m (€13.49m) (see graph below).
Vanguard Asset Management and BlackRock’s current equity investments have the largest exposure to beef, palm oil and soy deforestation risk from 2015 to 2018 overall (shares in ESG and non-ESG companies), adding up to almost 40,000 hectares (see table below).
When contacted by Expert Investor, BlackRock and index provider MSCI, which provides many of the ESG indices that the US firm tracks with its funds, did not provide a comment.
In May 2020, however, BlackRock updated its clients that it is “working with index providers to expand and improve the universe of sustainable indices” to deliver sustainable versions.
The firm also has an engagement programme in place for the palm oil sector, and published in January its stewardship approach with agribusiness companies.
A spokesperson at Credit Suisse told Expert Investor: “The fund in question, CSIF (CH) Equity World ex-CH ESG Blue, is an index tracker fund. Portfolio managers have no discretion to overweight or underweight single securities based on research views.”
An NGO report wrote in 2019 that BlackRock owns shares in some of the largest companies responsible for widespread deforestation in the Brazilian Amazon and Cerrado, including soy trader Bunge (8.8 million shares, third largest shareholder).
The report also noted that, in April 2018, Bunge was among a group of agricultural traders fined by the Brazilian Institute of Environment and Renewable Natural Resources (IBAMA) for purchasing 3,000 tons of soy and other grains from farms previously embargoed and for destroying native vegetation in the Cerrado.
Engagement and certificates
Peter van der Werf, engagement specialist at Robeco, which is not named in the analysis, explained to Expert Investor that asset managers have historically focused on the energy transition, climate change and the agriculture exposure of their funds rather than biodiversity.
He says that this “might have led to a situation where that critical view on energy stocks is stronger for these funds than how they are looking at deforestation [risk] from stocks”.
Asset managers have also had difficulties in dealing with complex and opaque supply chains, while there are “a lot of incentives [for farmers] to continue to deforest areas”, he notes.
Robeco has implemented an engagement programme with its investee companies, which is seeking to increase the amount of land that has been certified by the Roundtable on Sustainable Palm Oil (RSPO).
Van der Werf explains that they exclude any company that is below 20% RSPO from its investable universe, as Robeco does not deem these to be sustainable.
Certified land of between 20% and 80% means a company is eligible for enhanced engagement to raise its investability, and it is expected to reach 50% by the end of 2021.
However, Claudia Fox, analyst developer at Neural Alpha, notes that certifications, such as RSPO, do not always guarantee that companies source the commodities more sustainably.
And van der Werf adds that it is difficult to source certified forest risk commodities.
Meanwhile, Robeco has already been successful in using satellite imagery to detect a breach of a commitment from a plantation owner, according to the report by the consultancy.
Trase wrote in its 2020 yearbook that, at least half of all exports are concentrated in the hands of the top five exporters of each of the forest-risk commodities it assessed.
It noted: “This high level of market concentration – in contrast to the much larger number of producers, manufacturers and retailers – means this small group of trading companies is in a strong position to leverage system-wide change in supply chain sustainability.”
“Whilst deforestation risk is pervasive through global commodity supply chains, financial institutions can easily mitigate this risk given this market is dominated by a relatively small number of large global trading houses,” Phare commented.