How a financial institution made deforestation due diligence work in practice

Publication / 2 Jul 2024

A new report documents an in-depth, real-life example of how a pension fund carried out due diligence on its deforestation-related risks and impacts.

Using Deforestation Free Finance guidance developed by Global Canopy, Neural Alpha and the Stockholm Environment Institute, Climate & Company (C&C) worked with Swedish Pension fund Andra AP-fonden (AP2). The result is a new report detailing a step-by-step methodology designed to support other financial institutions as they move forward on deforestation due diligence.

Deforestation poses a systemic risk to ecosystems, people and the global economy – and the finance sector is key to the production and trade of commodities that drive nature loss. By engaging the companies that they finance or provide with services, financial institutions can shift businesses toward becoming deforestation-free. There is no deforestation-free finance without deforestation-free value chains.

While financial institutions are currently exempt from UK and EU due diligence laws, this could be changing. The EUDR mandates a review within two years (likely by mid-2025) to see if financial institutions should be included. In the UK, the Financial Services and Markets Act has tasked the Treasury with a review to ‘assess the extent to which regulation of the UK financial system is adequate for the purpose of eliminating the financing of the use of prohibited forest risk commodities’. To avoid being left behind, financial institutions need to act now.

The good news is that advanced guidance and data are available to support action. Global Canopy, Neural Alpha and Stockholm Environment Institute released the ‘how-to’ guide, ‘Due diligence towards Deforestation-Free Finance’, in 2023. This sets out a recommended approach for financial institutions to conduct due diligence to identify, prevent and mitigate risks and impacts of deforestation, conversion and associated human rights abuses. Drawing on this guidance, Swedish pension fund AP2 partnered with C&C (with support from Global Canopy) to conduct due diligence across their entire equity portfolio, so as to meet their commitment to a portfolio free from commodity-driven deforestation by 2025.

First, C&C assessed the deforestation exposure of every company in AP2’s equity portfolio. This identified a focus list of 155 companies with high to very high risk. C&C and AP2 then evaluated these companies’ deforestation risk management policy strength and implementation, using Forest 500 data and internal assessments. AP2 now pledges to actively engage with 100% of the companies with ‘very high’ exposure to deforestation in their equity portfolio by 2025, reserving divestment as a last resort for companies that continue to poorly manage risks.

This approach is set out in a new report, Making deforestation due diligence work in practice. This documents each step taken by C&C and AP2 to implement the due diligence guidance, including how the partners combined existing data sources (including Forest 500 and Trase) and systematised the assessment as much as possible. It also explains the solutions used to address technical challenges, so that these can be readily adopted by other financial institutions and analysts conducting due diligence.

This methodology, together with the online code repository, forms a prioritisation and management tool to help practitioners assess deforestation-related dependencies and impacts throughout their entire portfolio.

Financial institutions have the power to shift the flow of finance towards more sustainable business practices – for people, economies and nature. The approaches detailed in this report can be applied to a broad range of financial institutions with large and diverse portfolios, but are particularly suited to global equity and corporate bond portfolios. Financial institutions now have even more practical guidance to support their nature-related assessments and engagement process.

Get started today. Read the report, ‘Making deforestation due diligence work in practice’.

A recording of the Due Diligence guidance launch is available to watch here.

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