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Counting the business cost of deforestation

The risk of brand damage and consumer boycotts from poor environmental corporate practice has never been higher. Some companies are changing their ways, others could do more.

The cost of raw materials grown in rain forests can be priced in dollars, but until recently, the impact of deforestation and loss of wildlife was not accounted for. The global reaction to the ongoing Amazon fires starkly shows that ignorance of the other side of the transaction is untenable for businesses.

The preservation of rain forests is essential to the chances of the world meeting its target of neutral carbon emissions by 2050. And, in a mood of heightened anxiety over the world’s ability to limit global warming to 1.5˚c, there has been a swift naming of global companies whose supply chains involve businesses in the Amazon region. This includes supermarkets and fast food chains that source beef from land that has been cleared of forests. It includes clothes companies that source leather from the same land and from banks that finance such businesses.

The result can be reputational damage and consumer boycotts for the companies identified. More broadly it can impact whole industries as consumers adopt lifestyle changes to stop buying, or to buy less of, a generic food, service or product that is linked to unsustainable practices.

The heightened public militancy about the Amazon has closely followed horror at deforestation in Indonesia to meet growing global demand for palm oil. A touchstone for both crises has been the threat to endangered species. Here the accounting analogy is just as true, as the public have never been better informed at the numbers of orangutans and tigers that live in rain forests of Southeast Asia, how their numbers have dwindled and how close to extinction they are at current rates of deforestation. Images of orphaned orangutans or those left homeless by deforestation have become emblematic of those that seek to preserve the rain forests.

"At the heart of the issue is an increasing expectation from the public and regulators that companies will manage their impact around climate change, human rights and biodiversity. Companies that turn a blind eye and refuse to manage these long-term risks will undoubtedly suffer over the longer term."

Investors too, will need to explain their policies.

Sleeping tiger - the natural rubber supply chain

In this context, it can be viewed as fortunate that manufacturers of tyres, gloves, shoes, condoms, sealants and shock absorbers have escaped significant public scrutiny of their supply chains. All rely on natural rubber grown in the world’s rain forests.

Almost 85% of natural rubber is produced by approximately 6 million smallholder farmers1, most of them in the equatorial regions of Southeast Asia.

The region’s warm and wet climate is the natural habitat of trees that produce a sap known as latex. This is obtained in a process known as tapping, where the bark of a tree is cut to allow the latex to pour into a cup. The farmers dry the latex to create rubber and then sell this to aggregators who sell it to distributors who pass it on to manufacturers such as Michelin, the world’s largest buyer of natural rubber2.

The precarious living conditions of some of those who grow and harvest natural rubber makes a sharp contrast to the corporate identity of large manufacturers that rely on rubber as a raw material. Notably, the price farmers receive for rubber has shifted several hundred percent over the past decade. There was a price spike in 2011 caused by growing demand from China when many smallholder farmers cleared land to plant rubber producing trees, but prices fell back to a decade long low in 2018, caused by a combination of lower demand and oversupply. When prices reach such depths it can mean that many farmers struggle to pay rubber tappers a living wage. Studies have also revealed inadequate safety standards, discrimination, long working hours and, in some cases, the use of child labour in the harvesting of natural rubber3.

Another issue in the supply chain is the land clearances that have taken place to meet global demand for natural rubber. While not on the scale caused by the palm oil industry it has reduced the size of rain forests which are known to be one of the world’s biggest carbon sinks. Such forests, which contain eight out of 10 species found on land, are also home to many endangered species such as tigers, orangutans and elephants.

Deforestation-free rubber

The elevation of reputational risk around the natural rubber value chain has led many of the largest end users of the raw material to self-regulate. This has largely been driven by tyre manufacturers who as an industry consume over 70 per cent of all natural rubber in the world.

The process started in June 2016 when Michelin made a commitment to responsible natural rubber sourcing after an examination of its supply chain in conjunction with the WWF. The partnership is notable in that the WWF believes rubber can and should be produced without clearing natural forests.

In 2018 a group of the world’s leading tyre manufacturers (including Michelin), vehicle manufacturers (BMW and Ford), pressure groups such as the WWF and the Rainforest Alliance, rubber traders and processors created the Global Platform for Sustainable Natural Rubber (GPSNR). This organisation’s stated mission is “to lead improvements in the socioeconomic and environmental performance of the natural rubber value chain”4. More explicitly it is seeking to harmonise standards to improve respect for human rights, prevent land-grabbing, protect biodiversity and water resources, improve yields, and increase supply chain transparency and traceability.

Hermes expects certification to follow from the GPSNR initiative, mirroring the progress made by manufacturers in the palm oil supply chain.

In the expectation of these higher standards, Hermes is using the insights gleaned through engagement with companies such as Michelin to help smaller companies meet higher standards of sustainability.

One such company is Swedish engineering company Trelleborg which Hermes became a shareholder of in 2018. The company is a world leader in engineered rubber and polymer products for use a wide range of uses in transport and general industry. The company has a presence globally, factories principally in the Czech Republic, USA and China and natural rubber makes up around 10% of its raw material needs for usage in its large tires in particular.

Trelleborg has developed a Code of Conduct and aims to only work with suppliers who adhere to the relevant sections of this Code. To this end, suppliers are reviewed through a questionnaire assessment and their most “at-risk suppliers “ are typically audited via a site visit.

In recognition of the complexity of the natural rubber supply chain we have been encouraging the company to develop a stand-alone sustainable natural rubber sourcing policy. Development of such a policy and subsequent liaising with direct and importantly indirect suppliers in southeast Asia and Africa could help with supporting and raising standards at the small farms and plantations. In our view, a dedicated policy would shine a spotlight on ensuring wages are adequate throughout the value chain, ensuring the chain itself is economically sustainable. It would also make a commitment to achieving zero deforestation - for which greater recycling of rubber end-products is also part of the solution. Such actions on addressing the environmental and social and sustainability risks associated with this raw material could enhance the business in terms of its risk profile and ultimately its returns profile over time.

Hermes’ ongoing engagement with Trelleborg is focused on the following United Nations Sustainable Development Goals (SDGs).

SDG 1: End poverty in all its forms everywhere.

SDG 2: End hunger, achieve food security and improved nutrition and promote sustainable agriculture.SDG 12: Ensure sustainable consumption and production patterns.

SDG 15: Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, halt and reverse land degradation and halt biodiversity loss.

Conclusion

Companies that source raw materials or do business in the world’s rain forests increasingly will have to explain their impact on deforestation, human rights and biodiversity. There is a clear and pressing need for responsible investors to engage with companies to help them improve their performance on sustainability, while still delivering robust financial returns.

Risk profile
  • Past performance is not a reliable indicator of future results.
  • 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.
  • The performance of the Fund may have some dependence on the economic environment of emerging markets, which may negatively affect the value of the fund.
  • It should be noted that any investments overseas may be affected by currency exchange rates.
  • This information does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.
  1. 1https://www.worldwildlife.org/projects/transforming-the-global-rubber-market
  2. 2“A small-scale farmer leads the way for big changes to rubber farming in Myanmar,” published by the World Wildlife Fund in March 2018
  3. 3Lower prices drive natural rubber producers into poverty,” published by Aidenvironment in October 2016
  4. 4https://www.gpsnr.org/about-us

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