May 2019 DISCLOSURE INSIGHT ACTION THE NEGLECTED RISK Why deforestation risk should matter to Chinese financial institutions2 3 CONTENTS Important Notice The contents of this report may be used by anyone providing acknowledgment is given to CDP Worldwide CDP. This does not represent a license to repackage or resell any of the data reported to CDP or the contributing authors and presented in this report. If you intend to repackage or resell any of the contents of this report, you need to obtain express permission from CDP before doing so. CDP has prepared the data and analysis in this report based on responses to the CDP ination request. No representation or warranty express or implied is given by CDP as to the accuracy or completeness of the ination and opinions contained in this report. You should not act upon the ination contained in this publication without obtaining specific professional advice. To the extent permitted by law, CDP does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the ination contained in this report or for any decision based on it. All ination and views expressed herein by CDP is based on their judgment at the time of this report and are subject to change without notice due to economic, political, industry and firm-specific factors. Guest commentaries where included in this report reflect the views of their respective authors; their inclusion is not an endorsement of them. CDP, their affiliated member firms or companies, or their respective shareholders, members, partners, principals, directors, officers and/or employees, may have a position in the securities of the companies discussed herein. 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. Key Findings cutive Summary Chapter 1. Introduction Global trends in ESG investment An overlooked investment risk Why should financial institutions address deforestation in their value chains Chapter 2. Key findings The current state of financial institutions’ environment management The current state of corporates’ deforestation risk management Financial institutions active in the soy sector Institutional Investors Distribution of capital and exposure to deforestation risks across sectors Chapter 3. International policies, initiatives and good practice International policies and initiatives Banks Institutional Investors 5 6 8 9 10 12 15 16 18 24 28 30 32 33 34 38 Asset owners and asset managers Chapter 4. Conclusions and recommendations Conclusions Recommendations Appendix I Research scope and ology Research scope Company selection ology Financial flow analysis ology ology of estimating soy-related capital across sector Research limitations Appendix II Bond and share underwriters Appendix III Top 20 investors Appendix IV Qualitative relationships Appendix V CDP responses 39 40 41 42 45 45 45 46 48 50 51 52 53 544 5 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 US2.1 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 US7.1 billion are exposed, as are US1.55billion 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 COFCO 1 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.6 7 Financial institutions should first understand their exposure to deforestation linked to soy trading and processing. Financial institutions should identify and estimate the volume of financing exposed to soy-driven deforestation. Financial institutions should develop deforestation risk mangement policies to guide the integration of deforestation concerns into decision-making processes. For financial institutions with existing environmental management frameworks, deforestation risk management should be integrated. Financial institutions should analyse their exposure to deforestation risks by understanding the degree to which portfolio and client companies are sensitive to deforestation and exposed to the soy value chain. Financial institutions may want to engage with client/portfolio companies to encourage collaborative efforts to tackle deforestation risks, including quality data collection, target-setting, supportive education, etc. Financial institutions may also choose to enter into strategic collaborations to encourage deforestation management in client/portfolio companies. Starter level Advanced level CUTIVE SUMMARY As the global financial sector increasingly recognizes the risks posed by environmental challenges, financial institutions have been integrating environmental concerns into their financial decisions. Financial institutions are also acknowledging the crucial role of forests in climate change mitigation, and that deforestation could erode the value of companies participating in the production, trading and use of the commodities – soy, timber, palm oil and cattle products – most associated with deforestation. Financial institutions are therefore increasingly considering deforestation risks in their decision making.China is the biggest consumer of forest-risk commodities. In particular, China is the largest importer and consumer of soy. In 2017, China imported 63 of the soy traded globally. In addition, with growing domestic demand for soy and uncertainties around Sino-US trade relations, it is foreseeable that Chinese demand for soy from high-deforestation areas, particularly Latin America, will continue to rise. This could potentially trigger further and faster deforestation which, in turn, poses increased regulatory, reputational and operational risks to the soy sector and associated financial institutions in China.However, these financial institutions are yet to pay attention to the impacts of deforestation and risks linked to forest-risk commodities. This research examines one forest-risk commodity – soy – and the deforestation risks associated with it as an example to investigate the connection between such risks and Chinese financial institutions. By analyzing financial flows to 30 companies active in China’s soy supply chain, including soy importing, crushing, animal feed manufacturing, and poultry, pig and cattle breeding companies, this research provides an overview of the financing landscape in the sector and highlights the estimated value and distribution of capital exposed to deforestation risks. CDP’s research found that {Financial flows exposed to deforestation risk are unevenly distributed across sectors. All types of flow are clustered in the feed manufacturing, poultry and pig breeding sectors. In particular, pig breeding sector attracts the largest amount of investment, and bond and share underwritings. {Over the 2013-17 research period, US2.1 billion of loans exposed to deforestation risks were made by Chinese financial institutions, accounting for over 40.09 total loans provided to the soy sector. More than US7.1 billion of bond and share issuance underwriting, accounting for 54.7 of shares and bonds issued by the sector, potentially faced deforestation risk. As of the end of 2017, about US1.55 billion of shareholdings were estimated to be exposed representing 64.85 of total shareholdings. {Only 23 eight out of 35 of financial institutions active in the soy sector have a policy of integrating environmental considerations into financial decisions. None of the identified financial institutions has assessed the proportion of their capital that is exposed to deforestation risks, nor has acquired the data and tools to quantify deforestation risks. Chinese financial institutions have not demonstrated sufficient awareness of deforestation issues linked to forest-risk commodities. Some Chinese asset managers have acknowledged the long-term value of tackling climate change and lowering the carbon footprints of their portfolios. However, they have not yet extended their focus to deforestation and the potential risks associated with it. Deforestation is an overlooked yet critical source of risks posed to Chinese financial institutions. The risks involved should be considered in financial decision-making. Step-by-step recommendations 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 allow institutions seeking an inclusive and sustainable approach to investment to progress according to their own context and goals. 8 9 2. Climate Bonds Initiative and China Central Depository People’s Bank of China; Ministry of Finance; National Development and Re Com- mission; Ministry of Environmental Protection; China Banking Regulatory Commission; China Securities Regulatory Commission; and China Insurance Regulatory Commission. See “Seven state ministries jointly issue ‘Guidelines for Establishing the Green Financial System’”, Deloitte China. Facing multiple sustainability challenges, investors are attempting to better understand how ESG issues impact their lending and investments. This growing concern is evidenced in the growth of the UN-backed Principles for Responsible investment PRI which, since its launch in 2006, has attracted more than 2,300 signatories, representing around US90 trillion in assets as of 2018. They commit to integrating ESG considerations in their investment. Between 2002 and 2019, the number of investors requesting climate change, water security and forest stewardship ination through CDP rose from 35 to 525. In 2019, these investors represent US96 trillion in assets. In addition, ‘green investment’, focusing on generating a positive environmental impact, has increased dramatically. The issuance of green bonds has surged from US10 billion in 2013 to over US170 billion in 2017 2 . China has become the second largest player within the green bond market, accounting for 21.8 of total issuance in 2017. In China, the significant growth of green bonds over the past two years has been largely attributed to a range of regulatory changes and political encouragement for the development of the green GLOBAL TRENDS IN ESG INVESTMENT bond market as a tool to finance sustainable infrastructure. 3In 2016, the Guidelines for Establishing the Green Financial System was jointly issued by seven authorities, setting out a comprehensive green finance policy framework. 4China has not only became a major player in the green bond market, but is also playing a leading role in developing green finance and investment. Many financial institutions in China have recognized the significance of facilitating the transition towards a sustainable economy, and the potential benefits such a transition offers beyond financial returns. However, there is an overlooked exposure that poses multidimensional risks to financial institutions – deforestation risk, channeled through companies involved in the production and trade of the commodities that contribute to deforestation. Chapter 1 Introduction10 11 2008 120 100 80 60 40 20 0 2009 Million of Tons ProductionsI mportationC onsumption 2010 2011 2012 2013 2014 2015 2016 2017 Source PRI Newswire, 2018. China Soybean Industry Report 2018 Brazil was the Largest Source of Imported Soybeans to China. Available at https// Source reproduced from http// Source https//trase.earth/ Figure 3 Linkage between China’s soy imports and deforestation risks in Brazil 12 https//trase.earth/ 5. CDP, 2017, From risk to revenue The investment opportunity in addressing deforestation 6. J. Eliasch, 2008, Climate Change Financing Global Forests-The Eliasch Review, accessed 12 April 2018. 7. “China Soybean Industry Report 2018 Brazil was the Largest Source of Imported Soybeans to China”, PRNewswire, 31 May 2018. 8. China Industry Ination Network, “Analysis of China’s soybean imports and import sources in 2018”, accessed 11 April 2018 9. See, for example “Deforestation and Climate Change”, Lauren Bennett, 18 April 2017, Climate