EU's Deforestation Regulation poses risks for companies and investors

4 min read
Americas, EMEA, Asia
Tessa Walsh

The EU’s Deforestation Regulation is set to impose new burdens on companies that import some commodities and products made from them and will also have significant implications for investors, according to research by Jefferies.

EUDR came into force on June 29 and all EU member states have new legal obligations to implement it and start preparing to enforce it when it starts to apply to the private sector on December 30 2024.

The regulation will ban the entry of forest-risk commodities – palm oil, beef, coffee, cocoa, soya, wood and rubber – into the EU if their production has driven deforestation or forest degradation since December 31 2020.

European companies are getting ready for the regulation, which will require extensive reporting requirements, risk assessments and risk mitigation that could change trade flows as compliance will be enforced with checks and potentially fines.

Large and medium-sized organisations have 18 months to comply with the measures and smaller companies have two years. The cost for companies to set up due diligence is estimated at €5,000 to €90,000, depending on the complexity of their supply chains, the report said.

The regulation could also reshape ESG-labelled debt issuance as companies incorporate new targets to highlight compliance as data availability increases on deforestation risks in global supply chains.

The Global Forests Report 2023 published by non-profit CDP, formerly the Carbon Disclosure Project, included reporting from more than 1,000 companies on their management of deforestation risk in 2022. It shows that while more than 60% of companies disclosed some risk caused by deforestation, 90% were not prepared, despite the incoming regulation.

Companies in four industries with the highest potential impact on forests – materials; food, beverage and agriculture; manufacturing; and retail – represent 87% of reporting companies.

Exposure to deforestation risk also represents considerable financial, regulatory and reputational risks for investors. Understanding this will require investors to map out supply chains for forest-risk commodities, compare geospatial data on where deforestation is occurring using satellite imagery and assess company disclosures to analyse governance of deforestation risks, Jefferies said.

"Deforestation will be the ‘new coal’ in financial institutions’ portfolios," CDP said.

Slowing deforestation

The EU is a major importer of commodities linked to tropical deforestation, such as Indonesian palm oil and Brazilian beef. It has calculated that without intervention, deforestation would increase by 9% in 2020–30 as a result of its trade.

The Deforestation Regulation was adopted by the European Parliament in April to increase due diligence requirements on companies exposed to forest-risk commodities and derived products including leather, chocolate, furniture, charcoal and paper, which add up to €85bn of trade. EUDR covers about 60% of all EU agricultural imports of around €120bn.

Introducing the regulation could increase diplomatic tension and the price of imports of forest-risk commodities and disrupt global trade flows, particularly in palm oil production, according to Jefferies.

The EU is the world’s largest importer of palm oil, with a 20% share of global imports, and looks set to categorise Indonesia, Malaysia and Columbia as “high-risk” deforestation countries. The three countries produce 83% of global supply.

The world’s largest palm oil traders and companies include Wilmar International, Sime Darby Plantation, Cargill, Bunge, Archer Daniels Midland, Olam International, and Viterra, among others, according to CDP.

Ivory Coast may also be significantly affected as the country supplies 44% of the EU's cocoa, which contributes 6% to its GDP and is a major driver of deforestation. Ghana is also a major cocoa producer.

Higher compliance costs for operators could be passed to consumers and cause supply disruption through changing trade patterns and delays as alternative suppliers are found. EU operators switching to "low-risk" origins could favour soya exports from the US, to the detriment of exporters in Argentina, Brazil and Paraguay, for example.

Other markets, including the US and UK, could follow suit in implementing similar regulation.