It’s estimated that the world’s forests are home to around 80% of terrestrial animal, plant and insect species. Forests absorb atmospheric carbon dioxide – a key cause of global warming; they’re also an important source of genetic material that keeps drug companies in business.

But in 2021, even in the middle of a global pandemic, the world lost some 11.1 million hectares of tropical rainforest. That’s around 30 football pitches every minute. From 2001 to 2015, about a quarter of global tree-cover loss can be attributed to the production of just seven commodities.

Ahead of this year’s abrdn’s Sustainability Summit held in six cities across Asia, we take a timely look at how this issue affects the world, the Asia-Pacific region in particular, and explain why investors should care. This article draws on research from our recent paper – Deforestation – why it matters to investors.

Read the paper

 

What’s the problem?

While attention is often on deforestation, we’ve focused on forest loss where possible. This is the combination of deforestation – the permanent conversion of forest to another land use – and forest degradation – changes within a forest that negatively affect the structure or function of the location .

It’s happening primarily in the tropical regions of Latin America and Asia Pacific, driven by growing global demand for ‘forest risk commodities’ (FRCs) including cattle, palm oil, soy, plantation rubber, cocoa, coffee and plantation wood fibre (see Chart 1).

Forest loss reduces nature’s ability to store carbon and damages the long-term health and stability of our planet. Forests provide a wide range of ‘ecosystem services’ – water supply, a source of genetic material, regulating soil quality and even cooling the planet – which are undervalued despite the economic benefits.

 

Focus: Indonesia on the right track

This Southeast Asian country is home to the world’s third-largest tropical forest, but agricultural products are a key component of the economy.

Recently Indonesia has managed to maintain FRC production growth while reducing the rate of deforestation. In 2014-2015 the country lost 1.09 million hectares of forest. But by 2019-2020, the loss was down to 115,500 hectares – a drop of almost 90%.

This can be attributed to policies including a permanent ban on new permits to clear primary forests and peatlands. A moratorium on new palm oil plantation licenses also helped, although high rainfall over this period, which reduced fire risk, also played a role.

However, this lower rate of deforestation was tested when the policy landscape changed (the moratorium on new plantation licences ended and policies to support biofuel production were put in place) and commodity prices recovered.

Despite this, in 2022, Indonesia experienced its second-lowest rate of annual deforestation caused by industrial palm oil production, following a record 22-year low in 2021.

Why should investors care?

In the past, the financial risks linked to forest loss have tended to focus on reputational damage to brands and retailers.

But this is changing for two main reasons. New regulations, such as the EU Deforestation-free Regulation (EUDR), increase transition risks and the cost of complying with new rules to limit forest loss. At the same time, physical risks due to the damage to ecosystems caused by forest loss are beginning to materialise.

Trase Earth's Supply Chains Data Explorer can help investors better understand the environmental indicators associated with commodity-supply chains.

Where are the opportunities?

We’ve identified four opportunities as new industries develop amid greater regulatory scrutiny:

• Traceability – Opportunities in areas such as radio-frequency identification (RFID) and blockchain technology to track where commodities have come from. There has also been interest in using satellite and drone technology for monitoring activities.
• Restoration – New investment funds have emerged to funnel capital into ecosystem restoration. There are real-asset opportunities for landowners around nature-based solutions. These offer another potential growth area, with carbon markets offering alternative income streams.
• Alternatives – The race to develop viable alternatives to FRCs, such as plant-based ‘meat’ and vegan ‘leather’. There’s research into soy alternatives, such as micro-algae and insects.
• Auditors – Companies that provide compliance due diligence, monitoring and auditing services.

Focus: How Asia ‘imports’ forest loss

Growing wealth in the region has led to dietary changes including a rise in meat consumption. A preference for chicken and pork, has led to dependency on imported soy which is used as animal feed.

China is the region’s largest importer of soy, with around 85% of its soy consumption reliant upon imports mainly from Brazil, Argentina and the United States.

China and India, the world’s most populous countries, can claim net forest gains at a domestic level. But they have also increased ‘imported’ forest loss – of which tropical forests are the most threatened habitat.

But it’s not just an Asian issue. For example, consumption patterns for the Group of Seven (G7) countries – Canada, France, Germany, Italy, Japan, the UK and US – lead to an average loss of 3.9 trees per person, per year, in tropical forests elsewhere.

Final thoughts

Many companies will be forced to change the way they source and supply FRCs as rule changes take effect around the world. This creates risks and opportunities for investors.

The new European Union deforestation rules stand out not only in terms of the commodities they cover, but also in their coverage of legally produced FRCs.

Countries that are heavily dependent on the export of FRCs to the 27-country EU may see a reduction in export revenues (e.g., Indonesia, Brazil and Malaysia). That said, these exports could be diverted elsewhere, for example, to China or the US.

However, beyond Europe, producers may simply segregate supply chains—separate out FRC supply chains destined for the EU market, while still producing deforestation-linked commodities for other, less discriminating, markets.

That’s why, for regulation to be truly effective, more Asian markets would need to follow the example set by the EU and other jurisdictions.