CDP's Morgan Gillespy argues that Chinese banks, which have otherwise made strong progress on green finance, have a blindspot over deforestation risk. Amid uncertainties over US-China trade war, the risks related to soy are set to deepen
Once seen as a fringe concern, the question of how to analyze the environmental impact resulting from lending and investments has risen to the top of the global financial policy agenda over the last 20 years. At CDP, we have seen this process first-hand, with the number of investors requesting environmental data from companies through CDP’s platform rising from 35 to over 525 between 2002 and 2019.
The past 20 years has also seen China continue its rise to the status of global economic superpower. In what the World Bank has called “the fastest sustained expansion by a major economy in history”, China has become the world’s most populous country and largest on a purchasing-power parity basis. It is also the world’s largest emitter of greenhouse gases, emitting 28.3% of global carbon dioxide in 2017.
Fortunately, the two trends have not happened in isolation. China’s political leaders have embraced green finance as an important tool for achieving the vision of “ecological civilisation”, which was adopted as a key policy goal around 2012.
China's progress on green investment is encouraging, but the issue deforestation reveals a gaping hole
Since then, China has taken a number of steps to position itself as a world leader on green finance, including the 2016 publication of Guidelines for Establishing the Green Financial System, a comprehensive policy framework for to support green investment, by seven Chinese authorities, including the People’s Bank of China. Meanwhile, regulatory changes and political support have enabled China to become a major player in the green bond market over the last two years, accounting for 21.8% of global issuances in 2017.
However, while China’s progress on green investment is encouraging, the issue of deforestation reveals a gaping hole in how Chinese financial institutions have so far understood the relationship between environmental issues and lending and investments.
In CDP’s new report The Neglected Risk: Why deforestation should matter to Chinese Financial Institutions , we look at the Chinese financial system’s vulnerability to deforestation risk through the lens of one forest risk commodity: soy.
According to CDP’s 2017 Global Forests Report, based on 201 company responses to CDP’s Forests Questionnaire, up to $941bn of turnover globally is dependent on commodities linked to deforestation, including timber, palm oil, cattle products and soy.
Companies producing soy and other forest-risk commodities are exposed to legal and regulatory efforts to reduce deforestation, reputational impacts as public concern over the issue grows, as well as physical impacts from climate change. Their customers are also exposed to reputational issues, as well as potential supply disruptions. Financial institutions, which provide financial services to growers, traders, processors, and retailers are therefore linked to these same deforestation risks.
Brazilian soy exported to China accounts for half of Brazil's land-conversion risk from soy
China is the world’s largest consumer of soy, importing nearly 96 million tons of soybean (around two-thirds of globally traded soy) in 2017. This demand, driven by China’s rapidly growing meat consumption, is primarily answered by soy from deforestation-risk areas, particularly Latin America, which provides 60% of China’s imported soy.
This means that clear links between China’s demand for soy and deforestation in Latin America can be drawn: data from Trase shows that in 2017, Brazilian soy exported to China was associated with more than 49,000 hectares of land conversion risk, accounting for 50% of the land conversion risk associated with Brazil’s soy exports. With growing domestic demand for soy, alongside uncertainty around Chinese-US trade relations, it is likely that China’s reliance on soy from high deforestation areas will continue to rise.
These links have substantive implications for Chinese financial institutions with interests in the soy sector, including banks, asset managers and underwriters.
Over the 2013-17 period examined in the report, CDP uncovered $2.1bn of loans exposed to deforestation risks made by Chinese financial institutions, accounting for more than 40% of total loans provided to the soy sector. Bond and share issues with a value of over $7.1bn are exposed; as are $1.55bn worth of shares.
In fact, while there was a high degree of concern around potential regulatory risks from forest-risk commodities, none of the financial institutions interviewed by CDP mentioned the operational risks posed by forest-risk commodities, and only five out of the 30 mentioned reputational risks.
Chinese financial institutions reported widely varying levels of environmental management; the banking sector, for example, demonstrated a relatively better awareness of environmental challenges, including climate issues, and a wider range of practices, such as GHG accounting and internal low-carbon policies, while underwriters’ disclosures show lower levels of awareness and fewer activities.
China's demand for soy threatens to overwhelm the forests of soy-producing countries in Latin America
This is clearly not good enough. But if the links between Chinese financial institutions and deforestation in Latin America demonstrate the vulnerability of investments and loans to deforestation-related risks, they also demonstrate the power that these same financial institutions have to bring in measures that can significantly mitigate this exposure and spur meaningful action throughout China’s soy supply chains.
Our report contains four levels of actionable recommendations for banks, underwriters, and shareholders to understand and mitigate deforestation risk.
China’s appetite for soy, as well as other deforestation risk commodities, forms part of a much wider story about China’s economic development and its turn towards the outside world and towards global trade.
It is a story of progress. It is also a story increasingly fraught with danger, as China’s demand for soy threatens to overwhelm the forests of soy producing countries in Latin America. But, most importantly, it is a story whose ending remains undecided. As our report shows, the time is now for Chinese financial institutions to author a secure, sustainable future for China’s soy trade.
Morgan Gillespy is director of forests at CDP.