Testing the application of the EU Taxonomy to core banking products: High level recommendations – Nordea Case Study Case Study: Nordea - Application of the EU Taxonomy on forestry sector lending to small and medium-sized corporates in the Nordic region

Introduction

This case concerns the application of the EU Sustainability Taxonomy on small and medium-sized enterprises (SMEs) in the forestry sector in the Nordic region. It highlights open questions related to the acceptance of joint sustainable forest management certifications for multiple estates, challenges meeting both economic forest use and continued estate level carbon sequestration, and data and monitoring issues for financiers. It also suggests that SMEs may need tailored guidance on the application of the Taxonomy.

Case description

The case of an SME investing in a forest estate falls under the Taxonomy for climate mitigation (Existing Forest Management; NACE Level: A - Agriculture, forestry and fishing; Code: A2). Sustainable forest management (SFM) is: “use of forests and forest land in a way, and at a rate, that maintains their biodiversity, productivity, regeneration capacity, vitality and their potential to fulfil, now and in the future, relevant ecological, economic and social functions, at local, national, and global levels, and that does not cause damage to other ecosystems”. The Taxonomy requires, among others, compliance with the SFM requirements, regularly updated forest management plans, the establishment of a verified baseline GHG balance and demonstration of maintained or increased forest carbon sequestration. Operations that are FSC or PEFC certified are likely to meet the SFM and DNSH criteria of the Taxonomy.

Financing was provided as a general-purpose loan. The forest estate is located in the Nordic region and more specifically in a Swedish context. Purchase of a forest estate is a capital expenditure, whereas ongoing forest management expenses would be operational expenditures.

EU Taxonomy requirements

Fulfilling sustainable forest management criteria

The size of a forest estate varies broadly in Sweden, but the average forest estate is below 50 hectares. Single small forest estates face challenges in combining the use of forests for economic purposes and fulfilment of the Taxonomy criteria for continued, maintained or increased carbon sequestration. Swedish forests are generally covered by a forest management plan, which is updated every 10 years. The forest management plan details spatial and forest-specific information, planned forest management actions over the next 10 years (e.g. thinning, harvesting), and identifies areas for conservation. Such information can be used to assess the above ground carbon stock, but carbon sequestration measuring could also benefit from inventories on a regional level to reduce the burden on small forest owners and enable carbon sequestration measurements on aggregate level. Forest management plans may not detail that the land has not been converted from high carbon stock land since January 2008. To be certified by FSC/PEFC, a forest management plan established by a certified planner is mandatory, considering the FSC/PEFC requirements. Sustainable forest management should further be conducted in accordance with local regulation. Such regulation with additional controls increases the financier’s certainty around the forest estate adhering to sustainable forest management practices. However, it may lead to a certain preference for lending to only larger forest estates above a certain size if there are regulatory-driven estate size- related control thresholds. Testing the application of the EU Taxonomy to core banking products: High level recommendations – Nordea Case Study

Fulfilling the Do No Significant Harm (DNSH) criteria and minimum safeguards

According to the Taxonomy, applying an FSC/PEFC certification of the area will likely be sufficient to cover SFM and Do No Significant Harm (DNSH) criteria. Minimum safeguards as stated in the Taxonomy would generally not be met by an SME (e.g. reference to OECD guidelines for multinational enterprises), instead would have to rely on national legislation and company-specific adherence to prudent practices of social safeguards. It remained unresolved if any part of minimum safeguards would be covered by FSC/PEFC certification. In providing a Taxonomy compliant forest loan to an SME, a bank would want to receive and store evidence of a FSC/PEFC certification at loan inception and also prove a continued certification compliance throughout the loan tenure at certain intervals. Privately owned forests in the countries observed are commonly certified; either via an FSC certificate or a PEFC certificate, or both. To reduce the administrative burden, smaller private forest owners are commonly covered by an umbrella FSC/PEFC group certificate. It is not clear whether the Taxonomy accepts such joint certifications.

Methodology and data used

The analysis relied on data in real loan cases, existing forest management plans and FSC and/or PEFC certification requirement related data. Interviews were undertaken with sector experts within the bank and external forest practitioners and forest industry specialists. The analysis was performed by persons involved in managing the bank’s Green Bond Framework, providing banking services to the agriculture and forestry sectors, and working with sustainable finance.

Challenges

The analysis supports identification of possible solutions to increase availability of financing solutions for Taxonomy-compliant forest activities. The case spurred further discussion amongst the stakeholders, which contributed to an open dialogue around potential solutions. The likelihood for finding solutions has increased. However, certain challenges remain:

 receiving confirmation that the land has not been converted from high carbon stock land since January 2008;  measuring and receiving information on carbon sequestration and identification of the body eligible to undertake the verification and the party to cover related costs;  application of Taxonomy to single smaller forest estates facing challenges using the forest for economic purposes while satisfying carbon sequestration requirements;  acceptability of FSC/PEFC umbrella certificates under the Taxonomy.

Recommendations

Regulators

 The acceptance of umbrella FSC/PEFC certificates within the Taxonomy would particularly benefit forest-related financing of SMEs. SMEs may also need tailored guidance on the Taxonomy.  The question of accepted verification body should be solved, and stakeholders, generally, will benefit from single sources of data, such as certifications including carbon sequestration data.  Creating incentives could be considered when applying the Taxonomy for the first time.

Testing the application of the EU Taxonomy to core banking products: High level recommendations – Nordea Case Study

Peers

 It is recommended that an internal green/sustainability framework on use of proceeds should include the Taxonomy, and define data needs and how evidence is collected, stored and monitored throughout the loan tenure.  Sector-specific competence is also beneficial.  Granting of a Taxonomy-compliant forest loan may require specific stipulations in loan contracts.  Tracking the use of proceeds may pose challenges and the same applies for general- purpose loans, where the allocation of proceeds could benefit from the possibility to use average assumptions.