Zooming in on Disclosure and Deforestation

Zoomingin on Disclosure and Deforestation

Firms’ impacts on deforestation causea major threat to biodiversity and climate, and hence, ultimately, to human survival. In other words, there is no solution to climate change without a solution to deforestation. 18% of the emissions reductions by 2030 can be achieved by protecting and restoring global forests. Logging, land and agriculture industries are the most critical, as half of their emissions (accounting for 22% of global emissions in 2019) come from deforestation, driven by commodities providing food, fiber, feed and fuel.10 Meanwhile, there is strong evidence that there is a tremendous role for the land sector in combatting climate change, both by reducing emissions from land use practices, but also by sequestering carbon in trees, other vegetation, and soil.11

Deforestation can lead to major financial and investment risks. A significant share of terrestrial biodiversity is harbored by forests, and as these are disappearing, so is the availability of ecosystem services on which many economic activities depend. This is an investment risk: “By financing companies that depend on ecosystem services, financial institutions are exposed to physical risks. The loss of ecosystem services can threaten companies’ production processes12 and this can translate into a deterioration in their financial position. […] Financing companies with a negative impact on biodiversity and ecosystem services also exposes financial institutions to transition and reputational risks”.13

The criticality of deforestation impacts and risks substantiate the need for disclosure standards’ coverage of deforestation. Empirical evidence shows that mandatory sustainability disclosure can turn into positive effects for sustainable development, such as higher mine safety,14 significant improvements in carbon performance15 and lower industrial wastewater and Sulphur Dioxide (SO2) emission levels in cities.16 In the context of deforestation, there are yet no ambitious and international mandatory disclosure regulations, or other effective sustainable finance mechanisms in place. Investors are increasingly mindful of the massive economic importance of nature and ecosystem services, but they need transparency about the impact economic activities, companies and assets have on deforestation. As the Glasgow declaration of 33 investors as well as the very recent declaration in Sharm El-Sheikh by major food companies shows, there is a strong corporate (financial and non-financial) commitment to halting deforestation.17 Investment professionals now critically need access to comparable, reliable and quantifiable information for their decisionmaking.18 Our exemplification of deforestation in light of the three proposals highlights in how far they respond and reflect this gap.

10 Climate Change 2022Mitigation of Climate Change(2022)link 11 IPCC’s 2019 Special Report on Climate Change and Land(2019)link;Nature-based solutions can helpcool the planet -if we act now(2021) link; Griscom et al. (2017)link 12 Examples include agriculture production companies that depend on rain-fed crops, or a regularly replenished aquifer for irrigation, or natural pollinators; trees/perennial crops that depend on a specific microclimate provided by natural habitats. 13 Indebted to nature: Exploring biodiversity risks for the Dutch financial sector (2020)link 14 Christensen et al. (2017) link 15 Bauckloh et al. (2022) link 16 Chen et al. (2018) link 17 Financial Sector Commitment Letter on Eliminating Commodity-Driven Deforestation (2021) link 18 Amel-Zadeh & Serafeim (2018) link

METHODOLOGY

The analysis will review the three proposals 19 along the seven essential ‘building blocks’, which characterise sustainability disclosure regulations and standards (Figure 2).20 We have used these building blocks to map and compare the three different proposals’ (SEC, IFRS S1 and S2, and ESRS) design choices. An overview of these design choices per proposal per building block can be found in Figure 3. The analysis chapter is also structured per building block: first a short definition is provided, followed by the overall recommendation, that identifies the ambition gap between the three proposals concerning the respective building block, and what could be done to close it. Then, one or more design choices are presented, which are the key insights we have derived from our deep engagement with disclosure standards and regulations and are informed by scientific insights on how sustainability disclosure standards and regulations can be implemented in an effective manner. 21 Per design choice, we provided an evaluation of each of the three standards and provided specific recommendations for each to be further developed and adjusted in the upcoming revisions.

Figure 2: the seven building blocks for sustainability disclosure regulation

19 Since their initial publications and first consultation round, EFRAG has published revised drafts of the ESRS standards in November 2022. While our analysis builds predominantly on the former versions (March and April 2022),we took the updated ESRS draftsinto consideration and view our analysis as still applicable 20 State and trends of ESG disclosure policy measures across IPSF jurisdictions, Brazil, and the US (2021) link 21 Among others explained and justified in the ‘Building Blocks’ report: State and trends of ESG disclosure policy measures across IPSF jurisdictions, Brazil, and the US (2021) link

Figure 3: an overview of the three draft standards (versions published in March and April 2022) per building block