How to build deforestation-free supply chains: lessons from Indonesia

As pressure steadily rachets up on companies to cut their greenhouse gas emissions, addressing forest risk in supply chains is proving a hard nut to crack.

More than 1,000 companies have set targets to reduce emissions from their operations and energy use. But many overlook their supply chains, where the largest share of emissions is often hiding. Commercial agriculture is responsible for a staggering 70% of tropical forest destruction – a significant source of emissions.

The biggest culprits are cattle, soy, palm, and timber/pulp: products that end up in virtually every consumer good on the shelf. At least $941 billion in annual corporate revenue depends on these forest-risk commodities.

Yet companies risk serious reputational and material consequences if they do not act against deforestation. Financial institutions are also worried. In September 2019, asset managers and institutional investors representing $17.2 trillion in assets signed an open letter calling on companies to move faster on deforestation, threatening loss of access to markets. Norway’s $1 trillion sovereign wealth fund is showing the way; it has divested from 33 firms on the basis of deforestation risk from palm oil.

Eliminating deforestation from supply chains has proven to be much harder than expected. But after years of some of the highest deforestation rates in the world, linked to palm oil production, Indonesia may be beginning to make headway against the forces of forest destruction. The Indonesia story offers useful lessons for companies and financial institutions.

We have seen an unexpected drop in deforestation in Indonesia in recent years. That may be in part thanks to the Indonesian government’s moratorium on clearing primary forests and peatlands, though environmentalists have pointed out numerous loopholes in the moratorium.

Credit for this decrease must be given to numerous global brands and upstream companies that control a large portion of the palm oil market in Indonesia, who have voluntarily committed to a “no deforestation, no peatland, no exploitation” approach in their sourcing in order to achieve Roundtable on Sustainable Palm Oil (RSPO) certification.

To be clear, many companies operating and/or sourcing forest-risk commodities from Indonesia have not yet made any of these leadership commitments - and progress is mixed among those who have. But a new evaluation report offers useful lessons for the world on how the private sector can mitigate forest risks:

Smallholder support: a secret ingredient for success

Smallholders can make up a significant share of companies' supply sheds. In Indonesia, smallholders control 40% of the land used for oil palm production. But qualifying for sustainability standards, including certification, is a significant financial obstacle, even if the benefits ultimately outweigh the costs.

In response, companies are pledging to support Indonesian smallholders as they shift to sustainable production models. This includes financial assistance through loans, premiums paid, and payments for ecosystem services. Some companies also provide technical support and community development support (including education facilities, health facilities and banking services).

Trust, but verify

Commitments to reduce commodity-driven deforestation vary in their scope and degree of monitoring from company to company. This can make it difficult to evaluate which company actions are actually protecting forests within and around company supply chains.

That’s changing. More companies are mapping their full supply chains to locate sourcing locations and are relying on satellite monitoring of land-use change within their supply chains. Unilever, Cargill, Mondelez and Walmart use Global Forest Watch Pro, while Nestlé is relying on Earthworm’s Starling system.

Walk the walk on non-compliance

Having identified suppliers associated with deforestation, a minority of trailblazing companies are sending clear signals on how they will deal with non-compliant suppliers – whether suspending, excluding or engaging them to reform. A few companies such as Kelloggs, Apical and Bunge have catalogued the number, names and status of engagement for non-compliant suppliers. Monitoring by outside groups such as Mighty Earth’s Rapid Response tool can alert companies to problems within their own supply chains.

How financial institutions can mitigate deforestation risks in their portfolios

Financial institutions increasingly recognize that deforestation is a risk to their lending and investment practices. As a first step, financiers need to address their deforestation exposure in their portfolios (see the Accountability Framework Initiative for detailed guidance). But they can also go further, finding and financing credible paths of supply chain development.

Send clear signals to portfolio companies

Financial institutions can set exclusionary criteria in their policies that prohibit certain transactions in their lending practices. In Indonesia, the companies Ahold Delhaize, E. Leclerc and Eagle High Plantations all require suppliers to set policies barring sourcing from protected areas - thus protecting their investors from this risk. It’s a clear standard that, if widely copied, could have a significant and positive impact.

Offer investment products that support the transition to sustainability

Opportunities to reallocate capital from unsustainable to sustainable commodities include scaling up and consolidation of land-use finance credit facilities; defining areas and ecosystems for additional investment; and harnessing the power of multi-stakeholder initiatives working to reduce deforestation and enable sustainable development, such as the Good Growth Partnership.

Join forces

Financial institutions are recognizing the need to level the playing field both in the market and among financial institutions by taking collective action on these issues. The RSPO has a dedicated finance sector working group; in Brazil, the Cerrado Working Group also includes finance sector actors.

Getting ahead of regulation

The European Union is considering applying import restrictions to commodities associated with deforestation. This will reward companies who are already going beyond legal requirements. In the future, legal standards around the environment and traceability for high-value export markets will only be strengthened – which will fence out those companies that have not already controlled for deforestation. Similarly, the day is coming when financial institutions will need to disclose the climate impacts of their portfolio against the Paris target of keeping global warming below 1.5°C. Companies, and the financial institutions they work with, need to act quickly to weed out the bad business and support the good.