By George Scott
Banking on sustainable timber: what role do banks play?
- Without financing, large-scale forest exploitation projects would not be commercially feasible.
- In this article, author George Scott examined how the UN-REDD Lower Mekong Initiative engages with financial actors involved in forest based industries in order to tackle illegal deforestation and unsustainable forestry activities.
- The article finds that it is necessary to build the capacity for banks to collaborate with local and regional partners in order to understand better the nature and extent of illegal logging and to remove it from their lending and investment portfolios.
Without financing, large-scale forest exploitation projects would not be commercially feasible. Forest- based projects require capital not only to buy equipment and machinery, but also to pay the costs of harvesting the timber, processing it, and transporting the finished products to the markets.
How are banks and investors involved in deforestation and unsustainable forest use?
Banks serve as important players in the trade of products produced by forest-based industries. They provide, among other things, credit for trade, letters of credit to guarantee payment of trade, facilities for discounted trade credit and other short-term financing instruments. Without bank financing, forest-based industries could not work their way into the equity and bond markets that allow them access to long-term financing.
One approach to reducing illegal deforestation and unsustainable forestry activities is to target the financial actors involved.
A review of data on issuances of securities (debt and equity) to companies in Southeast Asia between 2013 and 2021 found that the forest and pulp/paper sectors in China and Japan dominated financing activities.
During that time, the proportion of financing originating in China has decreased, while the proportion of financing originating in Japan and the United States has increased. Additionally, finance of domestic companies accounts for nearly 10% of total finance extended, implying that while the level of involvement in forest related finance by domestic banks may be relatively low, it is still material and represents a route for intervention.
Why is this a risk for banks?
Banks involved in financing forest-based industries may face legal risks resulting from banking regulations and the anti-money laundering laws. Banking regulations require that banks know their customers, manage risk, and avoid financing projects harmful to the environment. Failure to adhere to these regulations can result in banks losing their licences and facing administrative sanctions and even criminal charges.
Given the extent of illegal logging and illegal conversion of forest land across the Lower Mekong Region is unknown, it is difficult for financial institutions to quantify the level of their exposure and its potential impact.
Much of the timber logged illegally is used as a primary input, feeding global supply chains of pulp and paper and wood products, including, plywood and wood panelling, flooring, mouldings, joinery as well as furniture. Exposure to companies that operate within these supply chains is an additional risk for banks and investors as the underlying companies face potential operational risks from disruption to to supply and price changes.
These companies represent an increased and unquantified credit or reputational risk, in the event that regulations are tightened or legal action is taken against them. Finally, banks themselves face a significant reputational risk in a global market where customers value the integrity of their banks.
To reduce the financing of illegal logging or unsustainable forest activities, it is necessary to build the capacity for banks to collaborate with local and regional partners to better understand the nature and extent of illegal logging and land conversion and to remove it from their lending and investment portfolios. That capacity would also support the development of prudent banking policies on forest-based projects.
Why is now a critical time for the global banking sector?
2021 was a critical time accountability in global financial sector, which will have a significant impact on how banks conduct business in the coming years:
In the EU the European Parliament called for a new deforestation due diligence law to apply to finance houses as well as agribusiness supply chains.
In China, the revision of laws governing commercial banks is an important opportunity to institute stronger forest safeguards.
In the UK, parliamentarians from across the political spectrum supported calls for similar regulation of supply chains to cover financiers, echoing recommendations by the government-appointed Global Resource Initiative taskforce.
In the US, the proposed Targeting Environmental and Climate Recklessness Act (TECRA) in the US, a marker bill intended to stimulate debate, would restrict access to the US financial system for environmental culprits in the same way that currently applies to firms accused of cybercrime, human rights abuses, corruption, and wildlife trafficking.
In the Asia Pacific region, seven of ten countries have now developed sustainable finance regulations or voluntary guidelines. Notably, Malaysia’s work developing a ‘green taxonomy’, a list of activities that are defined as environmentally sustainable, is a first for the region. However, there is a risk that financial institutions of lower capacity facing less regulatory scrutiny will continue to finance unsustainable activities.
Towards a regional engagement and collaboration platform for banks involved in the forest sector
A platform for collaboration and capacity building between regional lenders can provide a place to showcase efforts of banks and help raise awareness of illegal logging and forest conversion within the Lower-Mekong capital providers. It will:
- support efforts to increase capacity to identify forest crime and exploitative or destructive activities and support financial institutions in the development and harmonization of prudent policies for lending and investment to sustainable forest projects and activities;
- create a level playing field for banks, and send clear signal to corporate clients, thus increasing the expectation to demonstrate legal and certified sourcing; and
- help promote legal and sustainable timber value chains that can be cascaded down to producers and plantation level.
Box 1: Examples of Standard Chartered policy and guidelines on forest lending
Position Statement on Forestry
Standard Chartered will not finance clients who:
- develop new timber plantations by converting or degrading HCV or HCS forests, legally protected areas, or peatlands;
- use fire in forestry or plantation operations including in the clearance and preparation of land for planting; and
- are involved in illegal logging or trading activities.
Standard Chartered will only finance clients who
- have Forest Stewardship Council (FSC) or Programme for the Endorsement of Forest Certification (PEFC) certification for their production sites; or have an agreed timebound plan to achieve certification – applicable to producers;
- follow an appropriate chain of custody scheme (FSC, PEFC or equivalent scheme) for timber, pulp or paper products originating from high-risk countries, to demonstrate the legal origin of the timber, including certification for those species regulated under the Convention of International Trade of Endangered Species (CITES) – applicable to processors, manufacturers and traders; and
- have restrictions on product from high-risk countries
Chain of custody and supply chains
Standard Chartered encourage their clients to ensure that their policies on key sustainability issues such as having deforestation-free supply chains are cascaded down the supply chain to producers and that they are working towards full visibility of supplier actions to a plantation level.
- Their clients are expected to demonstrate legal and certified sourcing.
- Their clients are expected to follow an appropriate chain of custody scheme, FSC, PEFC, or equivalent
Position Statements on cross-sector themes
In addition to their sector statement on Forestry, Standard Chartered unilaterally apply our Positions on Human Rights and Climate Change.
- Forced labor and modern slavery
- Land-use change and degradation
- Climate Change and Climate Transition
Ultimately, supporting the development of a more enabling banking system that is better positioned to support companies and SMEs to develop Sustainable and legal timber value chains.
This article is part of the 8-story mini series featuring key highlights, lessons learnt and insights in the first phase of the UN-REDD Lower Mekong Initiative. Click on the link below to read the rest of the articles.