Pressure Mounts on EU to Delay Deforestation Rules
The EUDR has become a “bureaucratic monster” and must be re-written, says prominent centre-right MEP Peter Liese.
The European Commission is under increasing pressure to delay stringent new anti-deforestation rules, as businesses, lawmakers and foreign governments warn that the requirements would be impossible to comply with.
The EU Regulation on Deforestation-free Products (EUDR) would ban the import of certain commodities that have contributed to deforestation anywhere in the world. It aims to end the bloc’s contribution to global forest destruction.
The rules cover products such as cattle, wood, cocoa, soy, palm oil, coffee and rubber, as well as derived products such as leather, chocolate, tyres, and furniture. They would require companies to access detailed data reaching across national borders and deep into their supply chain.
The law passed all the stages of EU regulatory approval in 2022 and is set to come into force in December.
But last week, Peter Liese, a Member of European Parliament (MEP) and environmental spokesman for the dominant centre-right European People’s Party (EPP), called on the Commission to delay implementation and use the interim period to “reduce bureaucracy in the text”.
“The regulation has been turned into a bureaucratic monster by a majority of greens, social democrats, leftists and French liberals,” Liese said in a statement, just over a fortnight after the European elections saw a marked swing to the right. The centre-right EPP remained the dominant party and increased its numbers, while far-right parties won seats off the liberals and greens.
Liese said he supported rules to halt deforestation, but insisted the EUDR went too far, too fast.
“Many small farmers around the world, and even small forest owners in the European Union, cannot work with the text,” he said. “Even the preparatory work that the commission should have carried out has not been done.”
Third countries, including ones that are pursuing the common goal of stopping deforestation, are “complaining massively” about the legislation, he added.
In May, US President Joe Biden wrote to the European Commission calling for the EUDR to be delayed. This followed a letter from 27 US Senators urging the US government to put more pressure on the EU. The senators argued the rules would harm US paper and pulp industry, complaining in particular about the requirement to trace a shipment all the way back to the specific plot of land it came from.
“The EUDR traceability requirement will be nearly impossible for a significant segment of the US paper and pulp industry to comply with,” the senators wrote.
The Australian government also called on the commission to delay the rollout in May. Companies have made similar moves, complaining about a rushed rulemaking, unrealistic expectations and lack of clarity over the rules.
“It’s an impossibility”
Michael Littendberg, Partner at US law firm Ropes & Gray, where he advises a large number of companies that will be affected by the rules, said many of his clients were worried about their ability to comply the EUDR.
“In many supply chains, there isn’t sufficient traceability all the way back to a plot of land where the particular commodities originated,” he told ESG Investor.
“That’s more than just a difficulty in compliance: it’s an impossibility in compliance because the data doesn’t exist,” he said. “You have to have information flow from every step in the supply chain. In some supply chains, that’s 10, 11, 12 or even more steps [upstream].”
Although there is a legitimate concern that regulation is too proscriptive, the European election results mean the pendulum may swing in the other direction, Littendberg said.
“With EU-level institutions as well as national institutions moving to the right, we are now seeing economic realities starting to clash with some of the bolder aspiration of the EU Green Deal,” he added. “I think we are going to see some things pushed back, and some amended over time. There is a better-than-even chance that [the EUDR] will get delayed.”
Sophie Tuson, Senior Associate with law firm RPC, said while the law does not come into effect until December, it will apply to products that are being made now.
“[That means] for products with long lead times, like footwear and apparel, businesses should be collecting the evidence to prove they are deforestation-free now to avoid penalties once the regulation kicks into force at the end of this year,” Tuson said.
Along with the challenges of geolocation, a key obstacle to compliance is being able to prove that products have been produced in line with the relevant laws of the producing country. The European Commission has provided little guidance on how companies should demonstrate this, she said.
“This all adds to the general feeling of an increasing ESG compliance burden for businesses with many trying to do the right thing but concerned they will struggle to comply with the new rules in time,” Tuson said.
The risk of non-compliance is considerable. Fines under the EUDR could be an “eyewatering” 4% of a company’s EU turnover, Tuson said, and non-compliance could result in confiscation of products and exclusion from public funding and contracts.
Material cost
A recent study by the Anthropocene Fixed Income Institute of US-based agricultural commodity trader Cargill’s soy business found the company was unlikely to be fully compliant with the EUDR, and that this would have a material impact on its credit rating.
While Cargill estimates that 96% of its soy products are deforestation-free, the authors of the report found this was based on proxies and estimates that could downplay the company’s true deforestation footprint.
The study modelled scenarios in which Cargill had either full, partial or low compliance with the EUDR. Each would impose major costs on the company’s earnings before interest, tax, depreciation and amortisation (EBITDA), the authors found.
The initial cost of full compliance would be 43% of EBITDA, the cost of partial compliance would be 73%, and the cost of low compliance would by 86%, the authors estimated. In a year where EBITDA was US$11.28 billion, the initial costs would range from US$4.85 billion to US$9.46 billion in the first year. In other words, whatever happens, Cargill is likely to take a big hit to earnings thanks to the EUDR.
The result would be a reduction in the company’s credit ratings, a serious consideration as the company has more than US$2 billion of fixed income securities outstanding.
“Overall, investors may be exposed to increasing supply chain-driven risk which is not yet fully reflected in bond spreads,” the report found. “Holders of Cargill bonds may benefit from asking further questions of the company around its sourcing, certification scheme and readiness to comply with the EUDR legislation.”
Co-author Patricia Hutchinson said these were only estimates, as transparency was poor. “This highlights the need for increased transparency in this space,” she said, arguing that other companies were likely in a similar position to Cargill.
“The EUDR is likely to have broader impacts across the industry,” she added. “Whether it’s a greater or lesser impact depends on the company, and where they export or import.”
For holders of Cargil’s securities, there is a 6-month window to 30 December 2024 for engagement, Hutchinson said.
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