Climate Advisers recently came out with strong support for efforts by the Commodity Futures Trading Commission (CFTC) to expand its “capacities to define, identify, measure, monitor, assess, and report on climate-related financial risks and their effects on financial stability,” as recommended by the 2021 Financial Stability Oversight Council report. This is particularly important in commodity sectors because the sourcing and financing of agricultural commodities produced in tropical regions, such as soy, palm, cocoa, pulp & paper, and cattle represent the largest cause of deforestation and forest degradation, which produces roughly the same amount of climate pollution as the global transportation sector.
Since deforestation both generates greenhouse gas emissions in the current year and reduces carbon storage capacity in future years, sectors with high deforestation risk have an outsized impact on climate change. Furthermore, the vast majority of tropical commodity greenhouse gas emissions are generated abroad in regions at high risk of deforestation, so derivatives in the forest, food, and land sector expose US investors potentially to funding related activities linked to illegality, environmental damage, climate change impacts, human rights abuses, and more. In fact, the US imported $618 billion in tropical commodities in 2020 alone ($76 billion in tropical agricultural commodities), and 40% of US GDP is exposed to climate-related risks from the land use sector.
In response to the Commission’s request for “public feedback on all aspects of climate-related financial risk as it may pertain to the derivatives markets, underlying commodities markets, registered entities, registrants, and other related market participants,” Climate Advisers submitted our comment intended to provide background on the climate-related financial risks in tropical commodity sectors and to advise on the questions posed by the Commission. In particular, Climate Advisers emphasized the following recommendations for the CFTC to adopt:
- Incorporate Climate-Related Financial Risks from Deforestation into Risk Management Processes: To reduce future volatility and ensure the longevity of functioning commodities markets, the Commission should endeavor to capture climate-related financial risks from deforestation through stress testing, scenario analysis, and risk management guidance for counterparties. Both physical climate risks and climate transition risks related to deforestation are highly likely to impact the prices of tropical commodity derivatives and the ability of counterparties to fulfill contracts, which may necessitate higher margins to cover potential defaults. Furthermore, these risks are highly geographically concentrated in countries with high deforestation exposure, so the Commission should seek to understand the potential impacts of regional physical climate risks (for example, changes to regional water availability) on volatility within that commodity market. Similarly, as governments announce updated Nationally Determined Contributions and conservation policies that impact countries with high tropical commodity output, the Commission should be prepared to consider how resulting supply changes will impact commodity markets.
- Require Disclosures from Registrants: The Commission should consider requiring mandatory disclosures from all registrants to better protect investors and decrease information asymmetry in the market. Climate Advisers would like to highlight the following essential disclosures:
- Firstly, the Commission should require that all registrants disclose Scope 1, Scope 2, and Scope 3 emissions and emissions intensity using the Greenhouse Gas Protocol and best available data and methodologies. As climate risks are materializing and the cost of carbon emissions is increasingly internalized on financial statements, understanding the emissions and emissions intensity of a registrant is a necessary part of making an informed investment decision. For the forest, food, and land sector, Scope 3 emissions disclosures are particularly valuable. Scope 3 emissions in the downstream companies dependent on tropical commodities typically comprise upward of 80 percent of total emissions, and Mars Inc. estimated that 29 percent of the company’s total Scope 1, 2, and 3 emissions are generated from deforestation driven by tropical commodities. Given that internationally agreed-upon climate change targets are predicated on halting deforestation, these supply chain deforestation practices are unsustainable as governments implement climate policies, and present regulatory and transition risks for investors across the economy.
- Secondly, specialized metrics should also apply to registrants that trade tropical commodity derivatives due to their outsized role in climate change through producing emissions in the current year and reducing future capacity to store carbon. Recommended qualitative and quantitative metrics for counterparties in commodity markets with high exposure to deforestation are outlined in our letter and include disclosures on whether the commodity was produced on recently deforested land and any land disputes with Indigenous Peoples and traditional communities.
- Regulate Voluntary Carbon Markets: The Commission should consider taking a larger role in the regulation and enforcement of voluntary carbon markets through combating fraud and market manipulation, just as it does in other spot commodity markets. Carbon credits are an important instrument for allocating capital to nature-based solutions, placing a monetary value on cost-effective carbon sequestration and storage, and providing a pathway for local communities to realize sufficient economic benefit from standing forests to prevent deforestation. However, evidence of double counting, lack of additionality, and uncertainty around the duration of carbon storage have reduced investors’ credibility in these markets. Increased rigor around enforcing contract commitments and accountability in cases of fraud would improve both the integrity of supply and the credibility of company claims. Strict listing standards should also be enforced in the case of derivative carbon markets, but Climate Advisers would advise against forming a derivatives market around carbon credits until prices become less volatile and fraudulent counterparties are thoroughly investigated.
- Certify Deforestation-Free Derivatives: In commodity markets with high exposure to deforestation, investors face heightened risks around the sustainability of supply and escalating regional and global climate-related financial risk. Typically, commodity markets are based on the premise that the underlying products are identical, highly price elastic, and undifferentiated. In this case, emissions-intensive commodity producers and those that rely on deforestation for expansion are more exposed to climate-related risks than their counterparts, which introduces an element of differentiation for investors. The Commission should explore methods of building that differentiation into commodity markets through deforestation free or ‘No Deforestation, No Peat, No Exploitation’ certifications.
- Certify Derivatives that have Free, Prior, and Informed Consent (FPIC): Any efforts to incorporate climate-related risk analysis further into the Commission’s work should have a social justice component, including in the forest and land use sector. Receding tropical forests driven by tropical commodity deforestation have led to frequent land disputes between commodity producers and Indigenous Peoples or traditional communities. Impacts on marginalized groups, labor violations, and illegal activity are often obscured by complex commodity supply chains and opaque derivatives markets, leaving investors unable to reliably assess exposure or alignment to personal/institutional values. Land insecurities, along with illegal encroachments into indigenous territories, have also heightened violence against environmental defenders. Investors should be aware of these impacts and should have the option to enter contracts that certify FPIC and that they are not linked to land insecurity issues.
Additional detail on these recommendations and more context around the significance of climate-related risks from commodity-driven deforestation can be found in our full comment letter.
The financial risks from climate change and deforestation are growing more pronounced. It is time for the CFTC and other federal agencies to ensure the financial sector is able to accurately assess and respond to these risks. Adopting the recommendations above will ensure investors can develop informed investment strategies, and protect the integrity and resilience of U.S. markets through sound regulation.
