The EU regulation on deforestation-free products (EUDR) creates more stringent due diligence requirements, ensuring that companies selling commodities in the EU can prove their products are deforestation-free. The implementation of the mandatory EUDR, which comes into effect in December 2024, marks an important step to tackle this decades-long issue and sets precedent for other jurisdictions to follow suit. However, with less than one year until large companies must comply, data from the ESG Risk Ratings shows that most companies are not yet prepared to meet the new requirements.

By Sydney Krisanda, Sustainalytics.

In this article we offer a deeper understanding of the EUDR, answering five key questions about who the EUDR applies to, how companies are meeting the requirements, and what risks not complying with the EUDR poses to both companies and investors.

Question one: What does the EUDR cover and who is affected? 

The goal of the EUDR is to prevent global deforestation and the release of carbon emissions associated with the consumption and production of forest-risk commodities including cattle, wood, cocoa, soy, oil palm, coffee and rubber. Operators and traders who supply the relevant commodities or products in the EU must prove that products are deforestation and degradation-free, legally produced, and covered by a due diligence statement. 

Question two: Are companies ready for compliance with the EUDR?

Using ESG Risk Ratings data, we analysed the alignment of companies’ deforestation programs to the main EUDR requirements. Across relevant industries, 66% of companies have implemented some level of a deforestation program (see Figure 1). However, comprehensive management efforts are lacking, as only 20% of companies assessed have a strong or very strong program.

Figure 1. Performance of companies’ deforestation program by industry

Source: Morningstar Sustainalytics. For informational purposes only.

Note: The data for this analysis was retrieved on 12 February 2024 from Sustainalytics’ Ratings+ Universe and includes 365 companies from the following industries: household products, retailing, consumer services, consumer durables, food retailing and food products. 

Even more concerning, most deforestation programs lack the proper traceability mechanisms necessary to comply with the EUDR requirements. Increased traceability and access to plot-level information can enable better decision making in supply chains to avoid forest loss. As seen in Figure 2, only 13% of companies have traceability programs in place that cover their own operations as well as direct and third-party suppliers. Moreover, only 17% of these companies have sufficient monitoring of their anti-deforestation programs and only 8% have mechanisms for incident investigation and corrective action.

Figure 2. Percentage of companies meeting select EUDR-aligned criteria within their deforestation program

Compared to 2023, when we reported on the initial EUDR proposal, there has been no change in companies’ performance on these criteria. Based on available disclosure, and with only a few months until its application, companies remain far from prepared for the more stringent requirements the mandatory EUDR brings. Specific improvement areas include: 

Many companies lack full traceability to plantation level

While mill-level traceability is an important intermediary step to achieving full traceability, the EUDR requires that companies trace commodities back to their origin and provide plantation-level GPS information. This also means companies must map their full supply chains, including indirect suppliers which are often difficult to locate. 

Commodity coverage is often insufficient

Many companies, especially those in the food products sector, produce or trade several different forest-risk commodities or products. Often, companies lack comprehensive reporting on all commodities and focus traceability predominantly on one commodity. Companies will need to ensure that they can provide deforestation due diligence across all relevant supply chains. This will create added complexity for companies sourcing several different relevant commodities, as traceability approaches will differ.5

The role of certification schemes

Recognised deforestation prevention certification schemes, such as the Roundtable on Sustainable Palm Oil (RSPO) and Rainforest Alliance, are important mechanisms to facilitate the traceability and transparency of agricultural production processes. However, certifications alone cannot prove compliance with the EUDR. Many of the certifications do not fully align with the EUDR requirements and therefore cannot ensure legal compliance. Instead, certifications can be used to support the data collection process, but companies will need to have internal deforestation traceability and monitoring systems in place to ensure compliance.

Question three: What risks does the EUDR bring to companies and investors? 

Sustainalytics’ Controversy Research database has tracked 1,639 incidents related to deforestation between February 2014 and February 2024, 91% of which occurred at the supply chain level. 

Companies linked to deforestation in their own operations and supply chains face reputational and business risks. One example is packaged food company JBS SA, which is a major supplier of Brazilian beef, among other commodities, to European food retailers. In recent years, the company has faced numerous allegations of deforestation in the Amazon. In December 2023, the New York Times reported on a lawsuit against JBS SA filed by the Brazilian state of Rondônia, over its illegal purchasing of cattle raised in protected areas.

Apart from the legal risk and associated financial losses, JBS has lost buyers over deforestation concerns, whereas related media coverage exacerbates the risk for reputational damage. JBS’s competitor, Marfrig Global Foods SA, which derived 10% of its 2022 revenue from the European market. has faced similar deforestation allegations and associated risks. In 2022 the company lost a USD 200 million loan package from the Inter-American Development Bank Group amid deforestation concerns in the Amazon. In September 2023, Nestle SA announced that it had dropped Marfrig as a supplier due to allegations of illegal land acquisition from Indigenous peoples.

The EUDR is set to impose additional costs and operational consequences. Companies failing to comply with the requirements face possible penalties, including fines up to 4% of the company’s EU revenue, confiscation of revenues gained from the concerned products, and temporary prohibition of placing relevant commodities on the market.Compliance checks will be carried out periodically, with a large focus on companies sourcing relevant commodities from high-risk regions, such as Brazil, Indonesia and Malaysia, where much of the forest loss occurred in 2022.  

Question four: How can companies prepare for implementation of the EUDR?

When the regulation comes into effect, companies should already have the relevant mechanisms in place to satisfy the EUDR requirements. Based on available evidence, Sustainalytics’ ESG Risk Rating data shows that most companies are far off track to meet the mandatory due diligence component of the new law. However, some companies seem to be paving the path for their peers.

Agricultural company IOI Corp. shares in its 2023 sustainability report that it has communicated the EUDR requirements to its suppliers. It is reportedly also working to strengthen its traceability to plantations and ensure assurance for the export of its palm oil products into the EU market. Other companies such as food retailer Schwarz Group and cocoa and chocolate manufacturer Barry Callebaut disclose plans to expand the scope of their deforestation programs to ensure compliance. In turn, Unilever announced in March 2022 that it is piloting a blockchain technology to better track and trace its palm oil supply chain.

Question five: What’s next for EUDR compliance?

In the next months leading up to the implementation of the EUDR, companies and investors should prepare for the potential legal and financial risks that the new regulation could bring. Investors can use a combination of ESG Risk Ratings data and controversies research to engage with companies on their alignment with the requirements and identify potential gaps.

Particular attention should be given to the strength and scope of companies’ traceability and monitoring programs, to ensure that companies can meet the due diligence requirements across all relevant supply chains. 

Sydney Krisanda

ESG Research Analyst, Consumer Goods at Sustainalytics

Visit: https://www.sustainalytics.com