Consequences of not thinking about ESG at the beginning of forest asset evaluation and 7 low-hanging fruits for ESG screening
A forest investment’s sustainability profile is just as important as its technical and financial viability. Let me explain by way of example. There is a pine plantation, grown with the highest quality genetic material, in optimal biological and climatic growing conditions, under experienced management and with the latest technology applied. The harvested wood is sold to a local mill under an offtake agreement with evidence that the terms of this agreement are consistently met. Sounds pretty good right? Maybe… But let’s explore some sustainability scenarios that could turn this investment on its head:
- An endangered species is discovered by a biologist in a riparian area, requiring an expansion of the protected area (and a reduction in your productive pine area),
- Neighboring stakeholders are unhappy with the way the previous owner/manager engaged with them, and they are hostile,
- There is a death of a contracted forest worker, who as it turns out, has not undergone the proper technical or health and safety training,
- …
The proven management regime and financial performance of this asset may be completely undermined by sustainability factors that were not addressed.
Of course, the examples above are extreme cases, and in more developed forest sectors – there are several safeguards in place, both legislated and through evolved best practices to ensure these risks don’t eventuate (or are minimized). However, where the forest sector is less advanced, these lessons have often not been learned yet – and as an investor, you don’t want to fall prey to finding out about an ESG red-flag that may question the technical or financial viability of your investment after it’s too late.
In this article, I will explore why investing in ESG due diligence early on in the investment process is important and why waiting and adding it to the list of things you will address once you’ve acquired the asset is not a good idea. If you want to read more about building a high quality ESG investment process, check out this article.
The Costs of Absent ESG DD
In the introduction to this article, I noted a few likely examples of what could go wrong and the consequences of not finding them early. These risks can either be avoided or adequately planned for if ESG risk is evaluated early in the due diligence process. Below, I expand on more environmental, social or governance factors that could eventuate ant the financial consequences if they do. What’s more – these could be identified before you invest, either altering your investment decision, or allowing you to more accurately underwrite the risk and make a plan to mitigate the risks.
| E, S, or G | ESG Factor to Explore | Consequence of not Discovering Early |
| E | Protection and conservation of biodiversity | If vulnerable or important biodiversity or critical habitat ecosystems are not evaluated at the outset and are included in the plantable/productive area calculation, later removal of these areas (if you find them to be high conservation value or critical habitat) may result in return expectations not being met because the productive area will be lower than expected. |
| S | Land Acquisition and Stakeholder Engagement | You may be satisfied with the legal deeds to the forest property you will own or lease, but if you don’t assess for overlapping land claims (even if customary, informal or illegal) you may upset your local neighbors causing a threat to your plantation – from theft, vandalism, or encroachment with their own land use, or they initiate a harmful media campaign, (land rights in forestry are frequently under the magnifying glass). Poorly managed stakeholder engagement and making assumptions on the legal standing of tenure holdings in the worst case – can result in a full failure of your asset, but more commonly can result in delays in your planting, other forest management, or harvesting activities, which again would challenge your financial assumptions and risk your not meeting return expectations. |
| G | Low Business Integrity | If you don’t fully explore and understand the level of transparency and rigor of corporate governance, you may find yourself in a situation where the manager of the asset is keeping things from you, is participating in unacceptable behaviour (like corruption), or feeding you wrong information. You may find out when it’s too late – perhaps finding the asset in a liquidity crunch, or worse. |
ESG Screening – The First Step
Before you get into a full (and more costly) due diligence, you will likely have a screening process to weed out the assets that either don’t fit your investment strategy or show any significant red flag risks that may make the investment fail or fall far below your return expectations. Some low-hanging fruit for ESG screening to investigate include:
- Certification – Is the forest manager certified under a recognized standard for sustainable forest management. If so, check the audits for major and minor non-conformances. These non-conformances will also shed light on what to investigate in a full DD. Caution, if the manager has a group certification for several managed assets – you will need to understand the particulars of the specific asset you are screening. If you have a preferred standard in mind, and the manager is not yet certified – screen the manager and asset against the standard’s eligibility criteria.
- Wildfire Prevalence and Projections – There are several ways to assess wildfire history. If it is a known concern in the wider area, you might want to invest a bit already at the screening phase to better understand the situation. You might ask the manager if the asset is insured or speak to a forest asset insurer who covers the area in question for an interview and learn about how they see the future for fire risk in the area.
- Biodiversity/Critical Habitat – Though a full biodiversity assessment is not necessary at the screening phase, it would be a good idea to look at the mapping and check the area against known CITES red-listed species, and run your cheques and balances on the land type classification presented by the proponent and the productive area to see if these match up, or if there are any likelihood of you needing to pull area out of the productive landbase, into protected area.
- Workers Rights – Asking the manager to see their health and safety reports will give a good idea of the seriousness in which they take the topic of worker’s rights and won’t take a long time to assess. If they don’t have them – its not necessarily a showstopper but will prompt more digging. Basically, you want to understand if your asset will have access to a willing and skilled workforce and that you won’t be buying into any negative legacy issues.
- Land Tenure – Understand what the tenure and user rights associated with the investment are. It will be good to get a general understanding of the formal and informal tenure arrangements in the area. Also understand if the manager of the asset has been involved in any relocation activities.
- Indigenous Rights – It is critical to understand if there are any Indigenous communities located around your investment, and the extent of their formal and informal rights. You will need to understand past engagement with the affected Indigenous Peoples, and see that there are solid policies and procedures in please for Indigenous engagement.
- Business Integrity – A quick search in the public domain for the company and key management can go a long way in the screening phase. Likewise, the presence of business documentation (policies, procedures, reports) and evidence of the manager following best practices (such as widely recognized accounting and forest evaluation standards) are helpful to understand how the forest business is managed. You will want to go beyond policies and procedures and look into evidence – such as reporting in line with these procedures and any 3rd party audits.
Full ESG Due Diligence
A Full ESG due diligence will be much deeper, and is therefore a topic for another day. For both the screening phase and the due diligence phase, it is recommended to set up a standard checklist or questionnaire that you follow to ensure consistency across your deal evaluation. These checklists should be set up such that they are aligned with your investment strategy (such as address any investment criteria or restrictions) as well as the recognized standards for best practice that you will follow in the execution of your investment strategy and any sustainability targets that you may have. And as I’ve written before, ESG is much more than checklists – in the DD phase, it is recommended to include ESG analysis into your financial underwriting. This will help you understand specific areas of concern that will either be a show-stopper for investment, or will help identify transaction or transition terms with the proponent to ensure that ESG risks can be mitigated once you invest in the asset.
Need help with ESG DD in your forest investment strategy design or deal evaluation?
If you are building a forest investment strategy, or are evaluating forest assets for investment and you need support in either designing or executing your ESG due diligence criteria, reach out, and I will help you make ESG-related forest investment decisions with confidence.
Did you like this article? Sign up now for the ForestLink’s newsletter, where you’ll receive technical advice, reflections, and best-practice guidance to support you with your forest-linked investment strategy or business straight to your inbox.
