The Neglected G in ESG 

Apr 15, 2024 | News

An Analysis of International Best Practice Standards for ESG Alignment in Forest Investment, with a focus on Governance 

ESG, though not the trendiest acronym at present, holds significant importance in today’s investment landscape. With certain US states prohibiting investments in ESG-themed ventures, some companies are reevaluating their approach to ESG, as exemplified in Larry Fink’s recent letter to investors at BlackRock. Nonetheless, ESG remains a crucial framework for evaluating and managing forest investments, particularly concerning environmental (E) considerations, given the intrinsic environmental value of forests. Similarly, the social (S) aspect highlights forests as a vital public good, yet the governance (G) dimension, essential for every business, often receives less attention. 

I delve into ESG extensively in my blog, particularly in relation to forestry. What I’ve observed is that while ESG serves as a broad framework encompassing environmental and social concerns, governance issues frequently take a backseat. In this article, I aim to dissect the governance component of ESG in the context of forest investment, providing valuable resources to ensure robust governance in your forest investment strategy. 

International ESG Standards for Best Practice in Forest Investment 

There is a rabbit hole of opportunity to go down when considering how to design your forest investment ESG Policy and management system, below I have identified a few, and what elements they are strong in. 

FSC Forest management principles and criteria and
PEFC Benchmark Standard for Sustainable Forest Management
Forestry specific sustainable forest management guidance – specifically strong for economic, environmental, and social elements. I prefer these as a guide to designing an ESG policy and management system because they are quite detailed. SFI is also a good Standard, but is US-centric. 
IFC Environmental and Social Performance Standards When operating in emerging markets, I would argue that this is the gold standard for responsible environmental and social elements. As it is industry agnostic, it can be difficult to interpret and some elements are either irrelevant or too light of coverage for forestry. However, it is an excellent resource and categorically, if you use IFC E&S, you will be sure to have your environmental and social standards covered. 
OECD Guidelines for Multinational Businesses If you are aligning your investment strategy to an EU SFDR, Article 8 or 9 Fund – you are also required to align to the OECD Guidelines for Multinational Enterprises (EU, 2023). I find this standard especially useful for assessing governance issues, where it addresses issues like corporate governance (see the OECD Principles for Corporate Governance OECD, 2023). It also addresses environmental and social issues – though not as in depth as IFC E&S. 
UN Guiding Principles for Business and Human Rights As the name suggests, this is the gold standard for ensuring human rights issues are well addressed across your investments, and alignment is also a requirement for SFDR. Note that SFDR also refers to alignment with The International Bill of Human Rights, and the ILO’s fundamental principles and rights at work (ibid). 
ISSB Being under the IFRS Accounting Standards umbrella, the ISSB sustainability disclosure standards follow a similar framework. The S1 standard is for general sustainability disclosures, while S2 focuses on climate. 
TCFD (now under IFRS), TNFD, SBTi (FLAG) / GHG Protocol These are various disclosure standards relevant for the forest sector. Increasingly, investors are requiring their forest funds and assets to disclose according to these standards and methodologies. These are mostly related to climate and nature. 
Verra’s VCS, Gold Standard, Climate Action Reserve, American Carbon Registry, Plan Vivo These are some of the main carbon certification standards relevant for the forest sector. If forest assets include the selling of carbon credits in their revenue model, in most cases the entity issuing the credits will need to have the entity certified. There are still some examples, where a buyer of a claim pays for the emission removal or avoidance activity in forest landscapes without certification, but these are not regulated in any way. 

OECD Guidelines for Multinational Enterprises on Responsible Business Conduct 

In forest investment, ESG is often applied through the lens of ESG investing, that is an approach that seeks to incorporate environmental, social and governance factors into asset allocation and risk decisions, so as to generate sustainable, long-term financial returns. (OECD, 2020). 

OECD breaks down ESG themes under the following criteria: 

Environmental Factors Social Factors Governance Factors 
– Natural resource use 
– Carbon emissions 
– Energy efficiency 
– Pollution/waste 
– Environmental opportunities 
– Workforce
– Human rights
– Diversity
– Supply Chain
– Board independence
– Board diversity
– Shareholder rights
– Management compensation
– Corporate ethics

Other ESG index providers (Thomson Reuters, MSCI, Bloomberg) distinguish governance criteria as: management, shareholders, CSR strategy, corporate governance, corporate behaviour, cumulative voting, executive compensation, shareholders’ rights, takeover defence, staggered boards, and independent directors.  

For the sake of this article, I amalgamate these various governance factors under the umbrella of corporate governance and refer to OECD for guidance on the topic in forest investment.  

OECD, Corporate Governance and Forest Investments 

First of all, I am not a lawyer, nor do I play one on TV. What I have observed from my work, however, is that corporate governance in relation to the management of forest assets can get sloppy. Sure, everything is in order at acquisition, but over time – governance tends to be the ESG factor that gets relegated to least important. Small forest businesses or operators charged with managing assets likely don’t have the capacity in-house to be strong in the governance department. The responsibility then lies with the investment managers and boards to ensure that corporate governance is sufficiently robust (depth will be dependent on the size and scope of the operator/operation). 

To dig further into corporate governance, below I explore the 6 OECD Principles for Corporate Governance, and have interpreted their meanings, as they relate to forest assets. For detailed understanding of the principles (which are much deeper than I have explained below), please refer to the publication (OECD, 2023).  

  1. Ensuring the basis for an effective corporate governance framework 

Forest companies, or 3rd party forest managers responsible for executing forest operations need a management framework that is consistent with legal requirements, and considers overall economic performance, financial sustainability, resilience, and market integrity. There needs to be a division of corporate governance requirements that is clearly articulated. This may rely on outsourcing certain legal or tax accounting functions. There should be vested bodies that are operationally independent and accountable to execute various supervisory, regulatory and enforcement activities (such as independent boards or councils).    

  1. The rights and equitable treatment of shareholders and key ownership functions, and, 
  1. Institutional investors, stock markets, and other intermediaries 

There needs to be equal treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights at a reasonable cost and without excessive delay. In the case of forest funds, with participating institutional investors – having an LPA with clear terms and conditions, an advisory board made up of LPs, regular reporting frameworks, annual investor conferences and regular site visits (especially important for foreign investments), and a means for raising concerns – all support these principles and allow institutional investors to engage with their assets. For forest assets, investors need full transparency in relation to other shareholders, debt providers, etc. Investors also need to be involved in regular shareholder meetings, receive regular reporting (financial, ESG, operational, etc.) and be able to participate in decision-making as per the agreed terms and conditions. 

A strong governance policy framework at the intermediary level (fund or asset manager) is necessary to state the rules of engagement to support the legal, consistent, and transparent execution of investment activities and investor relations with the investee.  

  1. Disclosure and transparency 

The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the forest business, including the financial situation (3rd party audited accounts), performance (based on the results of agreed financial, ESG and operational KPIs), sustainability (based on agreed sustainability KPIs), ownership, and governance of the company. If the entity responsible for executing forest management over the asset is not owned by the investor – detailed ownership information is not required. However, there need to be safeguards in place to ensure the 3rd party operator is maintaining predefined corporate governance requirements. Where the asset includes the operator, material corporate governance disclosures need to be put in place – dictating things like major share ownership and voting rights, remuneration policy for board members and key executives, and related-party transactions. As per Principles 2 and 3, intermediaries (funds/asset managers) also require the corporate governance framework to include a mechanism for this consistent flow of information to the asset owners.   

  1. The responsibilities of the board 

The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders. In the simplest forest investment ownership structures – there may be a single owner with a 3rd party operator. As such a traditional board may not exist. There still needs to be clear definition in the corporate governance framework, the responsibilities for strategic and investment decision making. It needs to clearly define if 3rd party experts are brought in, and how their expert advise will/will not be taken on. More complex ownership structures require a more diverse board, with various shareholder’s having a role as well as the inclusion of outside parties. This is especially important to bring neutrality and perhaps outside expertise to the table, where other board members may be lacking. An example of this would be where asset owners are inexperienced in forest operations and need guidance, or where a traditional timberland investors are shareholders in a company with strategic impact objectives – and they need to bring on an ecologist, carbon scientist, or other.  

  1. Sustainability and resilience 

The corporate governance framework should provide incentives for companies and their investors to make decisions and manage their risks, in a way that contributes to the sustainability and resilience of the corporation. In the rapidly evolving financial regulatory environment – keeping on top of sustainability disclosure requirements, including impacts on issues such as climate, biodiversity, equality and other human rights, pollution, and so on, is straining investors, investment managers, and the forest businesses or 3rd party operators. Getting clear through your corporate governance framework, which standards will be followed and having a supporting procedural framework to support implementation will help. As mentioned, this is a rapidly evolving space, so designing procedures and considering it done and dusted for your 10-year holding period is not enough. You will need to regularly review your sustainability disclosure policies and procedures to ensure they are aligned to the standards of the day. Incentive structures that reward sustainability performance is a sure way to ensure that the topic is a priority for management. 

Help me with the G! 

Establishing the appropriate corporate governance framework begins with your investment strategy, and builds as you further develop your investment framework. You then put it to work as you start evaluating, negotiating, transacting, and implementing your strategy. It can be difficult to understand the level of ‘robustness’ needed in the corporate governance framework of your investment strategy. If you need support in establishing your corporate governance framework as part of a wider ESG framework, please reach out.     

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