April 26, 2018
Climate Advisers’ Gabriel Thoumi is delighted to be a guest contributor for this month’s Supply Change newsletter.
Global commodity-driven deforestation continues to rise in 2018, even as environmental advocacy groups have dialed up pressure on companies (and increasingly investors) to demonstrate progress through shareholder and marketing campaigns. These campaigns have typically encouraged corporate adherence to certification standards, investor policies, environmental regulations, and/or voluntary company commitments. Yet, these campaigns often miss a key seemingly unrelated risk: corporate governance.
Strong corporate governance encompasses company systems, rules, practices, and processes which effectively manage staff and shareholder interests while adhering to government regulations, creditors’ covenants, and contractual obligations.
Climate Advisers and Auriga recently analyzed the links between deforestation risk and corporate governance risk to better understand how corporate governance might influence a company’s ability to achieve their deforestation commitments. Their results, summarized below, could be important for companies struggling to meet their 2020 deadline to reduce or eliminate commodity-driven deforestation in their supply chains.
Corporate governance matters. It sets the tone, determines the rules, and establishes the strategic direction for the company. Also, shareholders and their capital depend on corporate governance processes to steer the company in a direction that efficiently maximizes shareholder value while minimizing material risks.
Corporate governance drives trust. When a corporation has effective and transparent governance systems in place, it can respond to and stay ahead of business risks. Also, it can have a greater ability to obtain financing, including better access to credit and ability to raise capital via equity and debt issuance.
Corporate governance matters for deforestation. Industry experts (paywall) recognize corporate governance as a “major operational risk to companies and their investors,” that should be considered when addressing deforestation risk. The Chain Reaction Research coalition of Aidenvironment, Climate Advisers, and Profundo’s previous research finds that palm oil growers in Indonesia may have over 6 million hectares of stranded assets (assets with unanticipated or premature write-downs, devaluations, or conversion to liabilities). These stranded assets are partially the result from poor corporate governance.
Without properly functioning governance systems in place to manage risk, companies may inefficiently spend shareholder money on deforestation related practices that buyers are uncomfortable with. For example, last June the palm oil producer, Sawit Sumbermas Sarana, saw its share price decrease by 15 percent and lost its client Unilever (responsible for 8 percent of its revenue in Q1 2017), after violating its No Deforestation, No Peat, No Exploitation policy.
That’s why we teamed up with a fellow research and policy group, Auriga, to investigate corporate governance risks within palm oil production in Indonesia. We targeted this industry and region because of well-known and documented corporate governance concerns regarding land-use tenure and labor rights violations. In March 2018, we reviewed all 19 publicly-traded agriculture companies – many of which are palm oil producers – operating in Indonesia that trade on the Indonesian Stock Exchange. We conducted this research because, as public companies, they were obligated to disclose consistent and accurate information on governance.
We found that two of the 19 publicly-traded Indonesian companies – Salim Ivomas Pratama and London Sumatra – have corporate governance trends that run afoul of the law, with 33 cases of allegedly breaking Indonesia’s 1999 Anti-Monopoly Law.
These legal issues occur when an executive, director, or board member simultaneously holds a similar position at a competitor, buyer, or supplier. As a result of these duplicative roles, this person has access to non-public, insider information on business strategies and pricing. This means they have both conflicts of interest and competing interests. These executives, directors, and board members must work for the shareholders of two different companies that are competing with each other while simultaneously develop concrete strategies to address material deforestation risks.
Why do deforestation risks matter? The corporate parent of the aforementioned companies, Indofood Agri Resources, recently lost part of its financial relationship with Citigroup. Other banks may follow Citigroup out of concern for deforestation risks, which many ofthe world’s central bankers in the Financial Stability Board Task Force on Climate-Related Financial Disclosures recently agreed is a key financial risk that global financial institutions and corporations must address. Together, these corporate governance and deforestation risks can scare away capital.
In sum, corporate governance is a risk multiplier for deforestation risk. Insider information and complex corporate structure can enable companies to cover up poor performance and relevant violations – making it difficult for buyers, investors, and campaigners to manage risk and ensure accountability.
Looking ahead, campaigns may seize the opportunity to target corporate governance risk as a point of leverage for ensuring compliance with the growing number of 2020 zero-deforestation commitments tracked on Supply-Change.org.
Gabriel Thoumi, CFA, FRM, Director Capital Markets
Climate Advisers is a mission-driven policy, capital markets and politics shop working to deliver a strong low-carbon economy. In the United States and around the world, we create and implement large-scale, cost-effective strategies to strengthen climate action and improve lives.
More stories about changing supply chains are summarized below, so keep reading!
- The Supply Change team