Investors worried about EU deforestation law

London — As a new EU zero-tolerance deforestation law looms, several major investors told Reuters they are concerned about their exposure to the issue, with some saying they could quit consumer goods makers with “risky” supply chains.

The EU agreed in December a new rule to prevent companies from selling into its market coffee, beef, soya, rubber, palm oil and other commodities linked to deforestation. Companies must prove their supply chains are not contributing to the destruction of forests or be fined up to 4% of their turnover in an EU member state.

Germany’s Union Investment, a top-20 investor in Unilever and Reckitt, in 2022 wrote to 56 consumer goods companies to find out more about deforestation in their supply chains.

“The fines can be a risk for the performance of these companies in the stock market,” said Henrik Pontzen, head of ESG at Union Investment, which has about €424bn ($467bn) in assets under management and stakes in Nestle, PepsiCo, Danone, Beyond Meat and L’Oreal.

An internal Union Investment document seen by Reuters shows that the firm received just 30 responses to its outreach. Of those, only 14 companies said they had zero-deforestation goals.

“As a major investor, this is very atypical,” Pontzen said. “Typically, we receive an answer from any company we write to. Maybe the reason for not answering is they don’t have anything to say.”

Union “will exclude companies when all our escalation options have been exhausted,” Pontzen said.

He is not alone in his frustration over the companies’ lack of engagement.

Eight major institutional shareholders — Schroders, Janus Henderson, NBIM, Union Investment, KLP, Aviva, Fidelity International and Ninety One — told Reuters they were talking to consumer goods makers about this issue, three of whom said they will identify stocks they may exit.

The legislation is expected by legislators to be implemented by the end of 2024 for “big operators”. Though consumer goods manufacturers are particularly exposed, other sectors that import goods associated with deforestation, including commodities houses and industrials companies, will also face scrutiny.

“The companies have to be cleaner than clean, given the fact that there’s such a high penalty,” said Jonathan Toub, a portfolio manager at Aviva, which invests more than £223bn and has stakes in Tide maker P&G, Unilever, Nestle and Reckitt.

Norway’s sovereign wealth fund, NBIM, one of the world’s largest investors with more than $1.3-trillion in assets under management, said the rules will affect firms that have not prepared for it.

“It can influence market access, potentially lead to noncompliance penalties, or impose increased due diligence costs,” said Snorre Gjerde, NBIM’s investment stewardship manager.

'Significant ramifications'

The UN Food and Agriculture Organisation estimates that 420-million hectares of forest — an area larger than the EU — were lost to deforestation between 1990 and 2020. EU consumption represents about 10% of global deforestation, according to the European Parliament. Palm oil and soya account for more than two-thirds of this.

The new rule will require companies to produce electronic due-diligence forms to customs officers showing their supply chains are not contributing to the destruction of forests.

Consumer goods makers are counting on technology such as satellites and artificial intelligence to help eradicate deforestation from their supply chains. But the efforts may not be enough to comply with the rules, said EU legislator Christophe Hansen.

“They, of course, want to slow down the process or be less ambitious,” he said.

Several large consumer goods companies say they are close to meeting their ambitious zero-deforestation goals.

Nestle, the world’s biggest food company, is aiming to be entirely deforestation-free for cocoa and coffee only by 2025.

Unilever, maker of Dove soap and Ben & Jerry's ice cream, is aiming for a deforestation-free supply chain in palm oil, paper and board, tea, soya and cocoa by the end of 2023.

’Maybe’ a little ambitious

Companies will need to show when and where commodities were produced and “verifiable” information that they were not grown on land deforested after 2020.

Magdi Batato, head of operations at Nescafe and KitKat owner Nestlé, the world’s biggest food maker, thinks the rules are “maybe” a little ambitious.

“There is still work to be done [in the industry],” he said.

Artificial intelligence (AI) may speed up the process.

“AI is definitely part of that solution,” David Croft, Reckitt’s global head of sustainability, told Reuters.

Reckitt, which has not yet publicly disclosed that it is considering using AI to reduce deforestation, buys several commodities whose farming damages forests including rubber for Durex condoms.

Unilever said in late 2022 that it, too, was “applying artificial intelligence to satellite imaging to detect changes in tree cover and provide deforestation alerts.”

But these actions are not putting all investors at ease.

“If things don’t change, we can exclude companies,” said Arild Skedsmo, a senior analyst at Norway’s largest pension fund KLP. “The EU rules make deforestation a financial risk as well as an environmental risk.”

Reuters