Federated Hermes Global Emerging Markets
At a glance: The power of investors in the fight for sustainable palm oil
- Extensive monocropping for the production of palm oil is one of the main causes of deforestation.
- However, environmentalists argue that boycotting palm oil may have adverse environmental, social and economic repercussions.
- Responsible investors take the same view and prefer engagement over the exclusion of palm oil from investment portfolios, unless the production fails to meet strict sustainability criteria.
- Engagement and advocacy are needed to eradicate deforestation and exploitation.
- Actors along the value chain and responsible investor can encourage the adoption of globally recognised certification standards. They can also support smallholders with capital and expertise to increase their yields.
- While we have no exposure to growers and distributors in our portfolios, we have positions in food or cosmetic companies, local banks and supermarkets selling products that contain palm oil in various emerging markets.
- We are encouraged by the progress that our current holdings have made and we will continue to engage on material cases.
If emissions from tropical deforestation were a country, it would rival the United States1
It is hard to overstate the importance of forests, both environmentally and otherwise.
Covering over 30% of the world’s land mass2, forests supply food, medicine, building materials and fuel for more than a billion people. Worldwide, they provide more than 86m green jobs and support the livelihoods of many more. In terms of biodiversity, forests are home to an estimated 80% of the world’s plant and animal life3, including endangered species such as the orangutan, Borneo pygmy elephant and Sumatran rhino.
According to the UN Food and Agriculture Organization (FAO), the rate of global deforestation has been decelerating over the past three decades4. Nevertheless, it continues to endanger local communities, contribute to global warming and result in the loss of biodiversity:
- Today, most deforestation is happening in the tropics where, thanks to newly constructed roads, previously inaccessible areas of forestland are now reachable. This is a concern, not only because tropical forests are one of the greatest biodiversity reservoirs on Earth, but because the World Economic Forum and Swiss Re estimate the value of biodiversity to exceed $40tn, more than half of the world’s GDP5. The 15th meeting of the Conference of the Parties (COP 15) to the Convention on Biological Diversity (CBD) ─ which is scheduled to take place this year in China ─ is expected to further emphasise the value of biodiversity and ‘natural capital’.
- Fewer trees also mean a loss of cooling power and carbon capture, which has alarming consequences for global warming. If tropical deforestation were a country, its annual impact would be comparable to the greenhouse gas emissions (GHG) of the United States, the world’s second largest emitter.
Figure 1. Tropical deforestation ranks third in CO2e emissions
- Put differently, the loss of tropical trees is causing more emissions every year than 85m cars would over their entire lifetime.6
- In addition to the environmental damages, the loss of tropical forests has dramatic social implications, depriving local communities of their homes and income. The process often goes hand-in-hand with worker exploitation, child labour and/or corruption.
So, if palm oil causes deforestation, why can't we just stop using it?
At the heart of palm oil’s success is its versatility. Palm oil is used in 70% of cosmetic products, yet most of us don’t think about its origins when going about our morning routine with soap bars, toothpaste and face creams.
And it’s not just cosmetics; palm oil is in around half of all supermarket products. It is a key ingredient in staple foods such as bread and margarine, as well as delicious treats like chocolate, ice cream, peanut butter, instant noodles, chocolate spreads and biscuits, where it is praised for its texture and taste. It can also be used in the production of biodiesel and biofuel for cars and power plants.
Second, palm oil’s high yield makes it the cheapest vegetable oil on the market. The fact that palm oil is an ingredient in so many affordable foods is key here, particularly given our ever-increasing global population size and appetite.
Figure 2. Comparison of global oil yields by crop plant in tonnes per hectare (t/ha)
The winds of change: advocating to increase palm oil yields, sustainably
With the above data on yields, affordability and job creation, ESG advocates within the investment industry support sustainably produced palm oil.
Indeed, the Investor Working Group on Sustainable Palm Oil, which is coordinated by the United Nations Principles for Responsible Investment (UN PRI), is backed by over 60 global investment organisations, representing approximately $7.9tn in assets under management. Signatories endorse the UN PRI’s statement regarding the expectations of companies operating across the palm oil value chain – including producers, refiners, traders, consumer goods manufacturers, retailers and banks – and advocate that these companies adopt and implement the UN’s publicly available, “No Deforestation, No Peat and No Exploitation” (NDPE) policy13.
Currently ill-equipped and undercapitalised smallholders ─ which represent approximately 34% of Indonesian palm oil production – may hold the answer. These smallholders typically produce half the yield achieved by large scale producers; with better resourcing, this could change. If Indonesian smallholders catch up to their large scale counterparts, then the industry could deliver an additional 26m tonnes of palm oil, all without further deforestation16.
The certification jungle: reforming standards and encouraging widespread adoption
Then, there is the issue of credibility. In obtaining certification, it is not unheard of for producers to cut corners and pay bribes. Rather than providing assurance, some certificates may not be worth the paper they are written on.
To this end, we have been working with the UN PRI to strengthen certification standards, especially as they relate to the ISPO, where very little protection is currently afforded to human rights and community livelihoods.
Equally, we are pushing to improve the process by which certification is granted and remove the risk of malpractice. Here, modern technology ─ from satellite monitoring to geolocation tracking and blockchain ─ could be used to enforce certification standards. Investigations on the ground might also complement a company’s self-disclosure on ESG matters, as could third-party verification checks by the like of Aidenvironment, RSPO and others.
How are the companies we invest in contributing to the sustainable palm oil transition?
It is abundantly clear that the production of palm oil has far-reaching implications.
Unilever Indonesia, our consumer stock in the country, benefits from Unilever’s group-wide approach to palm oil. The group is one of the largest users of palm oil globally and aims to use only RSPO-certified palm oil.20 It implements procurement and supply chain management initiatives to improve traceability and enforcement, such as blockchain technology, geolocation data and satellite imagery. It also maintains a public database of suspended suppliers, as it believes transparency to be key in making the industry more trustworthy. The company has set an ambitious target to achieve a deforestation-free supply chain by 2023. Furthermore, it helps independent smallholder farmers to obtain the certification and/or improve their yield and it supports regenerative agriculture overall.
92% of the palm oil used by China Mengniu Dairy, our food company in China, is RSPO certified. All materials used in the company’s packaging has also received Forest Stewardship Council (FSC) certification. We will continue to engage with the dairy company to strengthen its commitment and disclosures regarding sustainable palm oil.
We covered PT Bank Rakyat Indonesia (BRI) in a previous issue of ESG Materiality. Loans related to palm oil are not material – accounting for only about 3% of BRI’s loan book, as of December 201925. Still, BRI’s Sustainable Finance Action Plan and sustainability report cover this segment in detail. As a condition for new loan approval, the bank requires clients to follow international labour laws, have RSPO or ISPO certification and complete an environmental impact assessment. We are encouraged by the progress made, and our engagement efforts now look to bolster certification coverage to 100%, with preference for RSPO26.
Sustainable palm oil: a commitment beyond the financial
Palm oil can be grown sustainably. To realise this goal, we will need to engage extensively with companies involved in the palm oil supply chain, but our outlook remains positive. With rates of deforestation declining globally, significant progress being made by leading companies, and mounting pressure from investors and other stakeholders alike, it would seem an end to deforestation may come sooner rather than later.
This document does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments. The value of investments and income from them may go down as well as up, and you may not get back the original amount invested. Past performance is not a reliable indicator of future results and targets are not guaranteed. Investments in emerging markets tend to be more volatile than those in mature markets and the value of an investment can move sharply down or up.
2 According to the UN Food and Agriculture Organization (FAO) report, State of the World’s Forests 2020 (July 2020), forests cover 31% of the global land area.
3 As above.
4 Between 2015 and 2020, the rate of deforestation was estimated at 10m hectares p.a., down from 16m hectares per year in the 1990s (regional differences apply; see the rate of deforestation in the Amazon rainforest has increased recently, after a long downward trend).
5 Research from the World Economic Forum in collaboration with PwC “shows that $44tn of economic value […] is moderately or highly dependent on nature and its services and is therefore exposed to nature loss” (Jan 2020). According to Swiss Re, 55% of 2018 global GDP (or US$41.7 trillion) depends on high-functioning Biodiversity and Ecosystem Services (BES) including such necessities as food provision, water security and regulation of air quality that are vital to maintaining the health and stability of communities and economies.
11 For example, many Indonesians who did not have employment opportunities before are now able to send their children to university. The flip side of this is that while the global palm oil market creates opportunities, reports of displaced communities and illegal land grabs are not uncommon. Growers also drain peatland to create new palm oil plantations, with this land becoming highly flammable. Thousands of people in Indonesia have suffered acute respiratory infections due to the smoke haze and air pollution. See UNICEF, as cited in France24 and Reuters, Areas Burned in 2019 Forest Fires in Indonesia.
20 In 2019, it achieved 95% sustainably sourced palm oil and palm kernel oil for its core volumes (see Unilever, Transforming the Palm Oil Industry).
23 LG H&H’s business sites of Ulsan and Onsan in fact became the first to receive RSPO Segregation Certification in 2014 for the entire production process, from raw material storage to shipment. See the company’s CSR report, 2019.
26 At the end of 2019, 80% of the bank’s total loan book for palm oil had certification (up from 65% in Dec 2018). Certification for the remaining 20% was ongoing. The Bank also considers the protection of surrounding communities and conservation areas when reviewing the mapping of plantation areas.
28 At the end of 2019, 90% of the bank’s total loan book for palm oil had certification, an impressive improvement considering this number stood at 57% in December 2018. See BCA’s sustainability report, 2019, for more information.
30 See OECD, Agricultural policy monitoring and evaluation, 2019 (as quoted in FOA, The State of the World’s Forests, 2020, p.147).
31 See Coady, D., Parry, I., Le, N.-P. & Shang, B, Global fossil fuel subsidies remain large: an update based on country-level estimates, 2019 (as quoted in FOA, The State of the World’s Forests, 2020, p.147).
32 “Ground-truthing” is defined by the FFP as, “The use of information about the actual situation on the ground, gathered from primary or secondary sources that are independent of companies in the supply chain, as opposed to paper-based compliance indicators and company self-reporting”. See FFP, Ground-truthing to improve due diligence on human rights in deforestation-risk.