By Paul Wieshammer, Brunello Olivero, Simone Tansini and Prof. Kristjan Jespersen
Recent macroeconomic trends have shown a shift requiring companies, organizations, and investors to be increasingly aware of environmental, social, and governance (ESG) issues such as climate change, biodiversity loss, deforestation, and gender equality (Serafeim, 2014). In addition, the consolidation of stakeholder theory also prompts companies to focus on more sustainable practices (Freeman, 2010). This shift does not only impact firms down the supply chain but also financial institutions. As a result, investors are increasingly focusing on non-financial factors when allocating assets.
For example, the world’s green lung, the Amazon rainforest in Brazil, emits more CO2 than it absorbs (Qin et al., 2021). The primary cause of this issue is clearing land to produce commodities like palm oil, soy, and beef. While protecting rainforests has economic benefits for everyone, it comes at a cost to countries that would have to sacrifice their economic development. This global issue requires efforts from both producing and importing countries.
Institutional investors have started to address this commodity-driven forest risk. They distinguish between reputational, operational, market, and regulatory risks. Many are committing to (net-) zero deforestation to mitigate these risks and are seeking transparency in their supply chain. There are several frameworks and tools in place that can help with this (e.g., Forest 500, Trace). However, there is a lack of information about legal requirements in commodity-producing countries, and when laws do exist, they are often not enforced or ineffective.
When examining the legislative landscape of commodity-producing countries, a notable disparity exists in their approaches to addressing deforestation. This variation is due to the diversity of priorities and political systems across different nations, which is their sovereign prerogative. However, from an investor’s standpoint, this can generate ambiguity and hinder their ability to assess legislation and evaluate deforestation risks comprehensively. Findings from secondary research and interviews show that regulation and country-level problems are not the main drivers behind institutional investors addressing forest risk.
However, when evaluating businesses with commodity risk, adhering to regulations can benefit everyone involved. While it is ideal for companies to go beyond legislative requirements, not all firms are likely to do so. Some may be slower to adopt best practices, while others may lead the way. Nevertheless, regulations can motivate all companies to improve. Additionally, a robust system of legislation encourages ethical conduct and compliance throughout the industry. For example, in 2021, the WWF reported that 94% of deforestation and habitat destruction in Brazil could be illegal. How can investors continue to rely on companies’ reporting when associated illegal deforestation is so widespread?
Therefore, it is necessary to closely examine the risks at the country level that are associated with this issue. The researchers have developed a 3-step solution framework that can be used to interact with companies that are at risk of deforestation:
- Identification of countries with deforestation risk
- Analysis of present regulations associated with land use and deforestation legislation.
- Comparison of local regulations with the current situation and with the ideal scenario of zero deforestation
The third step describes identifying local requirements and their fit gap analysis. Finally, investors must consider the current legislation in a specific country, its shortcomings in achieving net-zero deforestation, and the prevalence of illegal deforestation because legislation will only provide information on what is legal.
By implementing this framework and creating a tool that explains the risks involved in investing in businesses of different countries, investors can more effectively consider country-level risks associated with doing business. Furthermore, it can better identify greenwashing and prevent them from engaging in such practices. In summary, it can provide value through more effective engagement with companies and governments to understand their pain points and promote good practices.
About the authors
Paul Wieshammer is currently pursuing a Master of Science in Management at the University of Mannheim. He is currently focusing his studies on the field of industrial decarbonization. He holds a Minor in ESG from the Copenhagen Business School, and has previously worked as an ESG analyst and a consultant in CSRD and EU Taxonomy related projects.
Brunello Olivero, MiM graduate from IE Business school with a specialization in ESG from Copenhagen Business School. Currently working at Kearney Milan as junior consultant
Simone Tansini, graduate in Business Administration and E-business from Copenhagen Business School. Passionate about the interplay between technology, business, and sustainability.
Prof. Kristjan Jespersen is an Associate Professor in Sustainable Innovation and Entrepreneurship at the Copenhagen Business School (CBS). Kristjan Jespersen is an Associate Professor at the Copenhagen Business School (CBS). As a primary area of focus, he studies the growing development and management of Ecosystem Services in developing countries. Within the field, Kristjan focuses his attention on the institutional legitimacy of such initiatives and the overall compensation tools used to ensure compliance. He has a background in International Relations and Economics.