- Sustainable finance has been touted as a solution to the palm oil industry’s links with forest destruction and rights abuses.
- The movement’s progress, however, has been hampered by the difficulty of measuring the environmental impact of things like green loans and bonds.
- Mongabay spoke to experts in the field to investigate how much investors and financiers in the palm oil sector care about their clients’ sustainability.
Part one in a five-part series on the attitudes of oil palm financiers towards company sustainability. Read the second, third, fourth and fifth installments.
Within the sustainability sector, finance is increasingly being seen as a powerful lever to help companies “green” their operations. In response to NGO and consumer pressure, a growing number of corporate banks and investors over the past few years have begun using both positive and negative screening methods to improve the sustainability of their portfolios and client companies. Positive screening methods preferentially provide capital to sustainably-run companies, and include socially responsible investment (SRI) funds and green bonds that are dedicated to responsible companies. On the other hand, negative screening methods focus on weeding out unsustainable companies, generally by using environmental, social and governance (ESG) screens that grade companies on a number of metrics, such as carbon footprint and fair labor policy.
Sustainable finance is still regarded as a niche market, but its share of the financial industry continues to grow. According to the Global Sustainable Investment Alliance, from 2012 to 2014, the global sustainable investment market expanded from $13.3 trillion to $21.4 trillion.[1] Reflecting this trend, consortiums such as the UN-backed Principles for Responsible Investment (PRI) are attracting an increasing number of signatories.[2] Much of this demand for sustainable investment is being driven by millennials[3] and institutional clients.[4] Some of these institutional clients, such as the Interfaith Center on Corporate Responsibility (ICCR), may be ethically or religiously obligated to pay attention to such concerns when making investing decisions.[5]
Sustainable finance may be a powerful force for good. Its proponents claim that by placing similar importance on societal impact and financial returns, sustainable investing strategies can help counteract prevailing profit-centric attitudes in the financial industry.[6] However, the sustainable finance movement is now at a crossroads, its momentum stalled by a fundamental problem: the difficulty of measuring the effectiveness of many sustainable financing products.[7]
“Virtually nothing is known about the environmental impact of green loans and bonds,” said Cary Krosinsky, independent sustainability advisor and lead consultant at PRI. There remains no standardized method to evaluate the environmental impact of sustainable financial products, forcing investors to rely on proprietary methodologies that can be confusing and opaque.[8] The 2015 Volkswagen emissions scandal illustrates how easily green funds may be misappropriated. The German automaker had received 4.6 billion euros from the European Investment Bank that was supposedly directed toward low-emissions research, before it was discovered that many of its cars had “defeat devices” installed to ensure their emissions performance would be better when tested in the laboratory than on the road.[9]
Sustainable investment was again thrust into the spotlight in late 2015, as peat fires in Indonesia surged to become the worst ever recorded.[10] The irresponsible land clearing practices of some palm oil and paper companies caused these sectors to be fingered as key culprits.[11] Consequently, the financial institutions that extended these companies large amounts of capital to establish their oil palm and pulpwood plantations also came under close scrutiny for their use of environmental assessments — or lack thereof.
Mongabay spoke to several experts in the field to investigate how much investors and financiers in the palm oil sector care about their clients’ sustainability.
Do financiers account for environmental performance when deciding whether to extend capital to palm oil companies?
Palm oil companies raise capital through two main sources: selling equity to private investors and on the stock exchange, and taking loans from commercial banks.
The majority of equity investors in the palm oil sector do not take environmental performance into account when making investing decisions.[12] Such ESG screens are usually only done by SRI or screened funds with a specific sustainability focus.[13] Rather, for mainstream funds, the initial investment decision is largely made on the basis of a company’s earnings ability.[14]
For a palm oil company, two metrics are commonly used as proxies for earnings ability: the size of its land banks and the age of its plantations.[15] “Evidence suggests that some companies are rewarded for growth-linked key performance Indicators, which often mean conversion of more land banks,” said Iain Henderson, of the UN Environment Program Finance Initiative (UNEP FI).[16] Immature plantations are also preferred to more mature ones, due to their prospects for higher total output over time. Both these metrics create incentives for plantations to expand rapidly and continuously, rather than sustainably.
Eric Wakker, head of the Asia division of sustainability consultancy Aidenvironment, told Mongabay that while some major mainstream funds do incorporate ESG risk assessment, this usually “lags behind the investment decision.” The Norwegian Government’s pension fund is one major fund that follows such a post-investment screening approach. The fund appoints a ethics council that periodically reviews the fund and provides advice as to whether certain companies should be excluded from its portfolio.[17] In August 2015, for example, the fund announced it would exclude four of Asia’s largest conglomerates (Daewoo International, Posco, Genting and IJM) “based on an assessment of the risk of severe environmental damage” associated with the firms’ Indonesian oil palm holdings.[18]
In the absence of more rigorous and widely accepted metrics, many investors follow the actions taken by funds seen as leaders in the ESG field. The Norwegian pension fund’s list of excluded companies is particularly influential on many funds’ investment and divestment decisions.[19] Investors taking a positive screening approach may invest preferentially in the companies whose sustainability policies are regarded as “best-in-class” in a particular sector. These companies’ partners in the supply chain may also be regarded as “good” investment choices, thanks to their association with the sustainable company.[20]
Other investors use metrics that are less specific. Some have developed formulas that measure a company’s ESG risk by monitoring its media coverage, tracking key words that signal possible environmental concerns.[21] Other investors do not use screens for individual companies; instead, they identify and evaluate the most material ESG risks on the sector level only, with the aim of avoiding any investment in a sector deemed problematic.[22]
On the bottom end of the scale, some investors may only exclude securities that are regarded as “worst-in-class” within a particular sector. “This is often just a way to hedge reputational issues,” the UNEP’s Henderson noted.[23] Finally, some investors may not implement ESG methods to any significant extent. A 2012 report by the Worldwide Fund for Nature, an NGO, found that in general, few institutional investors quantified or even tracked the exposure of their portfolios to palm oil.[24]
Compared to equity investors, commercial banks, which extend loans to palm oil companies to finance land expansion, have taken a more proactive approach to incorporating sustainability. Most large Western and international banks consider environmental risk as part of their risk assessments;[25] many of these banks are members of the Equator Principles, a widely-used framework that helps banks evaluate and manage their environmental and social risk.[26] Besides their corporate banking operations, many high-profile banks have also been expanding their ESG operations and products. For example, Goldman Sachs’ asset management wing has recently created a new Head of Global ESG position,[27] and Morgan Stanley has created both an Institute for Sustainable Investing and an Investing with Impact Platform for wealth management clients conscientious about the sustainability impact of their investments.[28] [29]
In the palm oil industry, both equity investors and banks regard membership in the Roundtable on Sustainable Palm Oil (RSPO), the industry’s largest eco-certification body, as the de facto standard for sustainability best practices and good management.[30] At the same time, many investors also recognize the flaws in the RSPO’s methodology – for example, the RSPO does not ban all deforestation or peatland conversion, and has been accused of weak enforcement of its own standards. As a result, these investors are looking to other ways to quantify and measure the sustainability of palm oil companies.[31]
While current trends are promising, there remains room for improvement across the financial sector, as the extent to which banks implement ESG principles in practice varies greatly.[32] Even banks with sustainability departments often still evaluate investment decisions only after they have been made.[33] In its annual survey, the 2013 Global Investor Survey on Climate Change found that about half of the asset owners and managers contacted used a framework to quantify material climate change risk, but only about a quarter had actually changed an investment or decision-making process as a result of this analysis.[34] Most worryingly, many regional and local banks, especially the Southeast Asian banks that conduct large amounts of business with oil palm companies, do not consider ESG risk at all.[35] Until these issues are addressed, financiers will continue putting their money into unsustainable palm oil, whether they are aware of it or not.
Citations
[1] 2014 Review, Global Sustainable Investment Alliance, 2014, p3.
http://www.gsi-alliance.org/wp-content/uploads/2015/02/GSIA_Review_download.pdf
[2] Report on Progress 2014, Principles for Responsible Investment, 2014, p30.
http://2xjmlj8428u1a2k5o34l1m71.wpengine.netdna-cdn.com/wp-content/uploads/2014_report_on_progress.pdf
[3] Cary Krosinsky (personal communication, July 30, 2015).
[4] Palm Oil Investor Review: Investor Guidance on Palm Oil, WWF and EnviroMarket, 2012, p23.
[5] Interfaith Center on Corporate Responsibility, “The Connection Between Faith & Investing,” accessed November 22 2015. http://www.iccr.org/our-approach/connection-between-faith-investing
[6] The Impact of Sustainable and Responsible Investment, US SIF Foundation, 2013, p2.
http://www.ussif.org/files/publications/ussif_impactofsri_aug2013_final.pdf
[7] Todd Cort and Cary Krosinsky, “Green Finance Environmental Impact Hard to Measure,” Financial Times, November 4 2015.
http://www.ft.com/intl/cms/s/0/abeb036c-78a8-11e5-a95a-27d368e1ddf7.html
[8] Ibid.
[9] Russell Hotten, “Volkswagen: The Scandal Explained,” BBC News, November 4 2015. http://www.bbc.com/news/business-34324772
[10] “Indonesia’s Forest-Fire Haze,” The Economist, November 6 2015. http://www.economist.com/blogs/graphicdetail/2015/11/daily-chart-3
[11] “Indonesia’s Forest Fires: Everything You Need to Know,” The Guardian, November 11 2015.
http://www.theguardian.com/sustainable-business/2015/nov/11/indonesia-forest-fires-explained-haze-palm-oil-timber-burning
[12] Eric Wakker (personal communication, November 7 2015).
[13] Palm Oil Investor Review, p25.
[14] Ibid.
[15] Eric Wakker (personal communication, November 7 2015).
[16] Iain Henderson (personal communication, October 29 2015).
[17] Annual Report 2014, Council on Ethics for the Government Pension Fund Global, 2014, p6.
http://etikkradet.no/files/2015/01/Council-on-Ethics-2014-Annual-Report.pdf
[18] Richard Milne, “Norway Fund Excludes Four Asian Groups Over Palm Oil Links,” Financial Times, August 17 2015.
http://www.ft.com/intl/cms/s/0/b8305bbe-44c7-11e5-b3b2-1672f710807b.html
[19] Palm Oil Investor Review, p22.
[20] Iain Henderson (personal communication, October 29 2015).
[21] Eric Wakker (personal communication, November 7 2015).
[22] Ibid.
[23] Iain Henderson (personal communication, October 29 2015).
[24] Palm Oil Investor Review, p21.
[25] Eric Wakker (personal communication, November 7 2015).
[26] Equator Principles, “Members & Reporting,” accessed November 22 2015, http://www.equator-principles.com/index.php/members-reporting.
[27] James Comtois, “Goldman Sachs Asset Management Names ESG Leader,” Pensions & Investments, June 9 2015.
http://www.pionline.com/article/20150609/ONLINE/150609847/goldman-sachs-asset-management-names-esg-leader
[28] Morgan Stanley, “Institute for Sustainable Investing,” accessed November 22 2015,
http://www.morganstanley.com/what-we-do/institute-for-sustainable-investing
[29] Investing with Impact: Creating Financial, Social and Environmental Value, Morgan Stanley, 2014.
http://www.morganstanley.com/globalcitizen/pdf/investing-with-impact.pdf
[30] Palm Oil Investor Review, p25.
[31] Ibid.
[32] Benjamin McCarron (personal communication, October 23 2015).
[33] Eric Wakker (personal communication, November 7 2015).
[34] 3rd Annual Report on Actions and Progress, Global Investor Survey on Climate Change, 2013, p6.
https://www.ceres.org/resources/reports/global-investor-survey-on-climate-change-2013/at_download/file
[35] Sustainable Finance in Singapore, Indonesia and Malaysia, World Wide Fund for Nature, 2015, pp. 47-67.
http://d2ouvy59p0dg6k.cloudfront.net/downloads/wwf_frc_forest_risk_commodities_report_2015_online_1.pdf
