EU Due Diligence Update: Deforestation Enters Regulatory Crosshairs

By Sean Donnelly

Inevitably, perhaps, the outcome of November’s COP26 summit has polarized public opinion. While policymakers point to progress on issues such as the operation of the ratchet mechanism and the regulation of global carbon markets as evidence of a successful outcome, critics assert that the Glasgow conference failed in its principal aim of maintaining as viable the target of limiting global warming to 1.5°C above pre-industrial levels.

Ultimately, only time will tell if the commitments ratified in Glasgow are sufficient to “keep 1.5°C alive”. But despite the prevailing atmosphere of uncertainty and ambivalence that punctuated the resolution of the conference, optimism can be derived from the fact that tangible progress was achieved on tackling at least one major climate driver – deforestation.

COP26 Commitment to End Deforestation

According to the World Resources Institute (WRI), if tropical deforestation were a country, it would be the third largest emitter of carbon dioxide on Earth. Additionally, on balance, the world’s forests are carbon sinks, removing approximately 7.6 billion tons of carbon—roughly 20% of global emissions—from the atmosphere each year. In this context, the announcement on November 2, 2021, of a multinational commitment to end deforestation by 2030 seems, on the face of it, an unambiguous cause for celebration.

Of course, in responding to this, it is important to retain a healthy degree of skepticism. Indeed, the BBC notes that global rates of deforestation have increased since a similar pledge was launched in 2014. Nevertheless, the publication on November 17, 2021, of a European Commission “Proposal for a regulation on deforestation-free products” suggests that EU regulators are serious about translating the pledge into practical policy action, with potentially far-reaching economic and legal consequences for companies trading on the EU market.

This blog summarizes the content of the Commission’s draft regulation and outlines the immediate steps your company can take to build a due diligence capacity in line with forthcoming EU regulation on deforestation.

Graduated Levels of Risk-Determined Due Diligence

The proposed regulation sets out mandatory due diligence rules for companies trading in the EU market with regard to commodities that are associated with deforestation and forest degradation (“Relevant Products”) – notably soy, beef, palm oil, wood, cocoa and coffee – and some derived products, such as leather, chocolate and furniture. Its purpose is to ensure that only deforestation-free and legal products (according to the laws of the country of origin) are allowed to be traded on the EU market.

The contents of the draft regulation make clear that, if enacted, the new due diligence provisions will have a profound impact on international trade. Crucially, they will create obligations both for those businesses that initially make deforestation-linked commodities available on the EU market (“Operator''), as well as for those companies that subsequently trade in such commodities (“Trader”). In other words, whether you are importing Relevant Products into the EU, or if you are buying and selling such products once they have been made available on the EU market, you need to have systems and processes in place to ensure they do not derive from deforested land.

Prior to commercializing the Relevant Products on the EU market, both Operators and Traders will have to comply with the following procedure:

• Exercise due diligence to ensure that the products comply with Article 3 of the draft regulation; and
• Make available to the competent authorities a due diligence statement asserting such compliance and assuming responsibility for the legality of the Relevant Product.

The due diligence statement will have to include in depth information on the place of production and producer, documents and data to demonstrate compliance with the regulation, and information regarding risk assessment and risk mitigation measures when applicable. Therefore, Operators and Traders will have to structure and implement a thorough compliance program comprising policies to control and procedures to mitigate and manage risks of non-compliance that can, if needed, be audited by independent monitors.

A benchmarking system, operated by the Commission, will identify countries as presenting a low, standard or high risk of producing commodities or products that are not deforestation-free or in accordance with the legislation of the producer country. Obligations for Operators and Traders will depend on the level of risk of the country or region of production, with simplified due diligence duties for products coming from low-risk areas and enhanced scrutiny for high-risk areas.

How Your Business Can Start Preparing

While the ultimate shape of the forthcoming EU regulation on deforestation remains to be determined, the contents of the Commission’s draft regulation provides companies with a strong basis from which they can begin planning to increase their due diligence capacity in preparation for the imposition of mandatory obligations.

Perhaps the most practical step businesses can take in the short-term is to undertake a comprehensive review of their value chains in a bid to identify suppliers operating in countries that the Commission is likely to designate “high risk” in regard to deforestation. Gladly, Article 27 of the draft legislation gives businesses a steer in how they may go about approaching this task by laying out the kinds of factors the Commission will consider in designating a country’s risk level:

• Rate of deforestation and degradation;
• Rate of expansion of agriculture land;
• Production trends;
• Whether the nationally determined contribution (NDC) to the Paris Agreement takes into account emissions from deforestation in its commitments;
• Agreements concluded with the EU addressing deforestation and that facilitate compliance with the regulation; and
• Whether the country has national laws to avoid and sanction deforestation with sufficient severity.

Indeed, one of the major innovations in the draft legislation – distinguishing it, for instance, from the extent of the due diligence provisions laid out in the European Union Timber Regulation (EUTR) – is that Operators would be required to collect the geographic coordinates of the land where the commodities they place on the market were produced. This strict traceability provision, reflecting the fact that deforestation is intrinsically linked to land-use change, is intended to ensure that only deforestation-free products enter the EU market, and that enforcement authorities in Member States have the necessary means to control that this is the case.

Transparency and Relationship Building

But, of course, knowing the "red flags" to look for is one thing; the practical task of identifying and monitoring critical risk factors throughout the value chain is significantly more complex. This is particularly the case in a circumstance when many companies do not have a centralized database encompassing all their suppliers and lack visibility into the business practices of the upper tiers of their value chain. It is imperative, therefore, that businesses invest the resources required to create a comprehensive database of country and category risk profiles, incorporating appropriate category tags and spend amounts, in order to effectively map the kinds of risk factors identified in the draft legislation against their supply chains.

Supplier relationship building, too, will be critical in preparing your company for a variety of due diligence elements, be it risk analysis, stakeholder engagement, or reporting channels. Practitioners can start by trying to better understand the parties involved in their supply chain, and what their respective social and environmental risks are. Companies also want to lay the foundations for robust reporting practices, including processes to collect information from their suppliers. Supplier relationships can take years to establish and are key to obtaining reporting data. Through early action, companies can prepare their trading partners for the data provision needed once new due diligence requirements are legally binding or existing legislation expands.

EcoVadis: A Scalable Ratings Solution

EcoVadis’s industry-leading ratings solution can support executives and procurement leaders in this process of gaining transparency into the upper tiers of their supply chains. Providing critical insight into environmental, social and ethical risks across 200 purchasing categories and 160 countries, EcoVadis is unrivaled in the industrial breadth and scale of its monitoring solution.

Utilizing a uniquely holistic assessment methodology, distinct in its capacity to account for the correlationality of adverse social and environmental impacts, EcoVadis evaluates sustainability performance across four themes – 1) Environment, 2) Labor and Human Rights 3) Ethics; and 4) Sustainable Procurement – and provides an overall rating that is weighted according to the specificities of a company’s size, location and industry.

In addition to providing the purchasing company with unrivaled transparency into supplier capability, this holistic approach also, critically, spares suppliers the undue burden of completing multiple, generic self-assessment surveys and provides them instead with detailed feedback, as well as a means of benchmarking performance against industry peers.

Get in touch or find out more about how EcoVadis can help your company to keep ahead of the regulators and proactively build sustainability and resilience throughout your organization and supply chain.