DISCLOSURE INSIGHT ACTION THE NEGLECTED RISK Why deforestation risk should matter to Chinese financial institutions May 2019 CONTENTS 5 Key Findings 39 Asset owners and asset managers 6 Executive Summary 40 Chapter 4. Conclusions and recommendations 8 Chapter 1. Introduction 41 Conclusions 9 Global trends in ESG investment 42 Recommendations 10 An overlooked investment risk 45 Appendix I 12 Why should financial institutions address Research scope and methodology deforestation in their value chains? 45 Research scope 15 Chapter 2. Key findings 45 Company selection methodology 16 The current state of financial institutions’ environment management 46 Financial flow analysis methodology 18 The current state of corporates’ deforestation risk management 48 Methodology of estimating soy-related capital across sector 24 Financial institutions active in the soy sector 50 Research limitations 28 Institutional Investors 51 Appendix II Bond and share underwriters 30 Distribution of capital and exposure to deforestation risks across sectors 52 Appendix III Top 20 investors 32 Chapter 3. International policies, initiatives and good practice 53 Appendix IV Qualitative relationships 33 International policies and initiatives 54 Appendix V 34 Banks CDP responses 38 Institutional Investors Important Notice The contents of this report may be used by anyone providing acknowledgment is given to CDP Worldwide (CDP). 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The securities of the companies mentioned in this document may not be eligible for sale in some states or countries, nor suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates. ‘CDP Worldwide’ and ‘CDP’ refer to CDP Worldwide, a registered charity number 1122330 and a company limited by guarantee, registered in England number 05013650. © 2019 CDP Worldwide. All rights reserved. 2 3 KEY FINDINGS { China has become the largest importer and consumer of soy, with a heavy dependence on foreign sources, especially Latin America. This exposes China’s soy supply chain to deforestation risks. New analysis by CDP found that at least US$2.1 billion of loans made by Chinese financial institutions to Chinese companies in the soy supply chain are exposed to deforestation risks, representing 40.09% of total loans provided to the sector; bond and share issues with value of over US$7.1 billion are exposed, as are US$1.55billion worth of shares. { None of the financial institutions identified has assessed its capital exposure related to deforestation risks, nor have any developed dedicated policies to address deforestation risks. Only 23% (eight out of 35) have a policy in place to integrate general environmental considerations into financial decision- making. { Bank of China, Industrial and Commercial Bank of China and Agricultural Bank of China are the top three banks lending to the soy sector, providing 62% of the total loans. Bosera Asset Management Company, China Southern Asset Management Company and E Fund Asset Management Company are the top three institutional investors funding the sector, representing 25% of the total value of shareholdings in the soy sector. { Five companies (Archer Daniels Midland (ADM), Cargill, Bunge, Louis Dreyfus Company and COFCO1) covered in the sample, which account for 52% of Brazilian soy imports into China, have taken steps to manage deforestation risks within their supply chains. The majority of Chinese companies, however, focus primarily on local pollution control; only a few companies – Muyuan Foodstuff Co., Ltd., Sunner Development Co., Ltd, and Wens Foodstuff Group – have taken action to tackle climate change. { Overall, environmental management by Chinese financial institutions focuses primarily on pollution control. The banking sector demonstrates a better awareness of climate risks than institutional investors, but the awareness of deforestation risks linked to soft commodities remains a work in progress. { Financial institutions with environmental risk management systems in place should take steps to improve their practices. They should first assess the proportion of capital in their portfolio or loan books that is exposed to deforestation risks, before assessing individual exposures to deforestation risks, developing policies to integrate deforestation risk assessment and management, engage and collaborate with portfolio/client companies to eliminate deforestation and mitigate the risks associated with it. 1. Of these, ADM, Cargill, and Bunge responded to the CDP forests questionnaire in 2018 and respectively received scores of C, C and B-. COFCO also responded for the first time but didn’t receive a score. 4 5 EXECUTIVE SUMMARY As the global financial sector increasingly recognizes the risks Step-by-step recommendations posed by environmental challenges, financial institutions have been integrating environmental concerns into their financial To encourage Chinese financial institutions to do so, CDP offers recommendations based on an analysis of current management status and good practice from overseas. The steps set out below decisions. allow institutions seeking an inclusive and sustainable approach to investment to progress according to their own context and goals. Financial institutions are also acknowledging All types of flow are clustered in the feed the crucial role of forests in climate change manufacturing, poultry and pig breeding mitigation, and that deforestation could erode sectors. In particular, pig breeding sector the value of companies participating in the attracts the largest amount of investment, and Financial institutions should first understand their exposure to production, trading and use of the commodities bond and share underwritings. deforestation linked to soy trading and processing. Financial – soy, timber, palm oil and cattle products – most associated with deforestation. Financial { Over the 2013-17 research period, US$2.1 institutions should identify and estimate the volume of financing institutions are therefore increasingly considering billion of loans exposed to deforestation exposed to soy-driven deforestation. deforestation risks in their decision making. risks were made by Chinese financial institutions, accounting for over 40.09% total China is the biggest consumer of forest-risk loans provided to the soy sector. More than Financial institutions should analyse their exposure to deforestation commodities. In particular, China is the largest US$7.1 billion of bond and share issuance Starter level importer and consumer of soy. In 2017, China underwriting, accounting for 54.7% of shares risks by understanding the degree to which portfolio and client imported 63% of the soy traded globally. In and bonds issued by the sector, potentially companies are sensitive to deforestation and exposed to the soy addition, with growing domestic demand for soy faced deforestation risk. As of the end of 2017, value chain. and uncertainties around Sino-US trade relations, about US$1.55 billion of shareholdings were it is foreseeable that Chinese demand for soy estimated to be exposed representing 64.85% from high-deforestation areas, particularly Latin of total shareholdings. America, will continue to rise. This could potentially Financial institutions should develop deforestation risk mangement trigger further and faster deforestation which, in { Only 23% (eight out of 35) of financial policies to guide the integration of deforestation concerns into turn, poses increased regulatory, reputational and institutions active in the soy sector have decision-making processes. For financial institutions with existing operational risks to the soy sector and associated a policy of integrating environmental financial institutions in China. considerations into financial decisions. environmental management frameworks, deforestation risk None of the identified financial institutions management should be integrated. However, these financial institutions are yet to pay has assessed the proportion of their capital attention to the impacts