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July 2023

JULY 2023 Deforestation: getting to the root of the problem The statement “there is no net zero without nature” has become a rallying cry for greater action against deforestation. The 2021 COP 26 pledge to end deforestation, and the 2022 COP 15 1 agreement on a Global Biodiversity Framework, have given greater focus to natural capital. Now, investors need to dig deeper, taking an active role to mitigate the risks of deforestation. KEY TAKEAWAYS Guirec Thouement • Covering 30% of the Earth’s landmass,2 forests are critical to sustaining world biodiversity Sustainability Analyst and protecting local areas, while ensuring their economic viability. • Deforestation and forest degradation reduce biodiversity and damage a vital element in the removal of carbon from the atmosphere. • The monetary contribution of forests to the economies of the developing world has been estimated at USD 250 billion.3 • An average loss of 10 million hectares of forest per year in the last decade4 is prompting a greater recognition of biodiversity impact, resulting in greater inclusion into investment approaches. • Investors can play a role by managing the risks related to deforestation and reducing the biodiversity footprint of investments. Deforestation is de昀椀ned as the conversion of Data shows the scale of this quickening pace of forest to another land use. While the rate of deforestation. Roughly 10,000 years ago there deforestation has accelerated over thousands were approximately 6 billion hectares (ha) of of years, the 20th century was a notable period forest, equal to 60,000,000 km2. By 1900, this had when farmland and urban sprawl encroached reduced to 5 billion ha and by 2018 it had fallen 5 on forests at a rapid pace to provide for booming to 4 billion ha. Forests are critical to sustaining populations. global biodiversity, yet they are currently ALLIANZGI.COM

DEFORESTATION: GETTING TO THE ROOT OF THE PROBLEM disappearing at a rate equivalent to 6 DID YOU KNOW? 27 football 昀椀elds per minute with 10 million ha lost in the last ten years. A昀昀orestation is the conversion from other land uses into forest, or the Forest degradation is a related issue increase of the canopy cover of a particular area of land by more than 10%. 9 which plays a signi昀椀cant role in This includes the conversion of land to forest. reducing biodiversity and preventing Reforestation is the re-establishment of forested areas which have recently carbon removal. It is de昀椀ned as a 10 deterioration in the density or structure dropped below 10% tree coverage. of vegetation cover or its species composition. This can be temporary or 7 permanent. Degraded forests do have Scale of the problem tree coverage, but their environmental contribution to biodiversity and carbon Forests cover almost one-third of The good news is that the rate of sinks is reduced. Fires, disease and pest the Earth’s land. Every continent deforestation seems to have slowed infestation – in part caused by climate excluding Antartica has been since peaking in the middle of the change – are among the factors impacted by deforestation, but 1980s. However, action needs to responsible for such degradation, in this problem has now become be accelerated to avoid signi昀椀cant addition to logging and agricultural concentrated in speci昀椀c regions. biodiversity risks and 昀椀nancial risks. For activities. Between 2001–2015, it is Half of the world’s forest coverage example, land erosion can contribute estimated that around three-quarters is in 昀椀ve countries – Russia, Brazil, to the loss of biodiversity, while a of global forest loss was driven by Canada, the US and China – yet most reduction in crop production can degradation, while the remainder was deforestation is in tropical forests. expose companies in food production from deforestation.8 supply chains to 昀椀nancial risk. Annual change in forest area, 2015 Net change in forest area measures forest expansion (either through afforestation or natural expansion) minus Exhibit 1: Annual net change in forest area, 2015* deforestation Annual change in forest area, 2015 Net change in forest area measures forest expansion (either through afforestation or natural expansion) minus deforestation No data -400,000 ha -200,000 ha -100,000 ha 0 ha 100,000 ha 200,000 ha 400,000 ha No data -400,000 ha -200,000 ha -100,000 ha 0 ha 100,000 ha 200,000 ha 400,000 ha 11 Source: UN Food and Agriculture Organization (FAO). Forest Resources Assessment. Source: Note: The UN FAO publish forest data as the annual average on 10- or 5-year timescales. • CC BY * Source: UN Food and Agriculture Organization (FAO). Forest Resources Assessment. Net change in forest area measures forest expansion (either through afforestation or natural expansion) minus deforestation. Locations with a Note: The UN FAO publish forest data as the annual average on 10- or 5-year timescales. positive change, shown in green, are regrowing forest faster than they are losing it. Locations with a negative change, shown in red, are losing • CC BY more forest than they can restore. 2

DEFORESTATION: GETTING TO THE ROOT OF THE PROBLEM Agriculture – both commercial and subsistence – remains Exhibit 2: Deforestation in tropical and subtropical the greatest threat to forests as shown in Exhibit 2. forests by cause Commercial agricultural activities include exports of cotton, soy and palm oil, while subsistence agriculture 45% refers to meeting the needs of local communities. This 40% data shows that despite e昀昀orts and improvements on 40% several fronts, forests remain under threat. 35% 33% 30% 25% DID YOU KNOW? 20% Palm oil is one of the main drivers of global 15% deforestation with 85% of this commodity produced 10% 10% 10% in Malaysia and Indonesia, causing a signi昀椀cant 7% 5% and localised issue. Recent research suggested that 0% deforestation due to palm oil had peaked in 2016 and 12 then fallen below 2004 levels. However, this appears Commercial Subsistence Urban Infrastructure Mining to have been driven by weak pricing. The rising in昀氀ation agriculture agriculture expansion of 2022 has renewed interest in expanding the supply of palm oil. Pricing is now half of that year’s peak, but Source: FAO, The State of the World Forest 2020 the focus is now to ensure any new plantations are both environmentally and socially sustainable. Evidence 13 points towards a slow improvement in this situation. Five important roles of forests 3. Ecosystem balance: forests are critical to maintaining the important balance and diversity The role of forests is critical and multi-faceted. This has of ecosystems. Around 60,000 tree species, 68% implications for climate change, biodiversity issues, and the of mammal species, and 75% of bird species 14 support of communities. are living in the world’s forests. Disappearing forests are taking many species to the brink of 1.Water management: the risks associated extinction. The loss would be catastrophic on with the destruction of forests include higher its own, but a decline in biodiversity can have land erosion, reduced soil fertility, and increased material 昀椀nancial impacts. This is especially 昀氀ooding. Land erosion can impact neighbouring true for industry sectors like pharmaceuticals, waterways resulting in marine pollution, further materials, and chemicals where innovation is pressuring local biodiversity and communities. dependent on a diverse mix of animal and plant species. 2. Carbon absorption: healthy forests are natural carbon sinks – they absorb carbon dioxide 4. Social inclusion: many communities depend from the atmosphere through photosynthesis on forests for their livelihood, culture and way which is then captured in the trees and forest of life. Deforestation can risk a community’s soil. In contrast, degraded forests can be a income and health, posing a physical risk from source of carbon emissions. Protecting forests the impact of extreme events such as 昀氀ooding. is critical as 昀椀res or even decaying wood will result in the release of stored carbon back into 5. Disease prevention: the removal of forests the atmosphere. Sustaining forests to allow can lead to closer interactions between wild for their role as net absorbers of carbon is vital animals and humans. This could increase the for achieving decarbonisation targets and risk of viruses and diseases spreading and the 15 supporting the collective global goal of a clean introduction of new epidemics. energy transition. 3

DEFORESTATION: GETTING TO THE ROOT OF THE PROBLEM Deforestation as a political topic The EU is also in the process of adopting regulation which addresses deforestation in supply chains. This will require Political momentum to end deforestation was evident companies selling products in the common market to ensure 16 at the COP 27 climate conference and later at its that goods or their components/ingredients are not the biodiversity equivalent COP 15, which included an result of deforestation. They will also need to consider their 20 agreement to protect at least 30% of the world’s oceans supply chain’s contribution to deforestation. This regulation by 2030.17 Such high-level e昀昀orts are already having an is an important step forward for two reasons. First, it impact on awareness of deforestation and are driving formally recognises the indirect impact that developed positive action. One example is opposition from several economies have on deforestation. Although these countries European Union (EU) member states to the free trade may no longer have deforestation in their own region, 18 agreement with the Mercosur South American trade bloc, their demand for consumer imports can have signi昀椀cant due to the impact on deforestation. A sustainability impact negative impact. It is estimated that European consumption study for the EU Commission raised concerns that increased contributes to around 10% of global deforestation.21 Second, demand for soy and beef, resulting from this agreement, it directly connects all activities in the entire supply chain would cause a detrimental impact on the Amazon with their respective impacts on deforestation. Exhibit 3 19 rainforest. shows that some companies are still directly exposed to deforestation through the location of some production sites. Exhibit 3: Companies with production sites exposed to However, many 昀椀rms may be exposed to deforestation deforestation through geographical presence* through their supply chain activity. 15% 13% What action can investors take against 11% deforestation? We expect deforestation to remain a high priority for 10% investors in the coming years. It is a material risk for industries that rely on deforested areas for production. 3% However, only a minority of companies are directly exposed in this way – see Exhibit 4. It’s likely that many 0% businesses are exposed through their supply chains, although there is a lack of data to con昀椀rm this. Investors Companies Companies Both will want to identify those companies that are exposed to active in healthy active in increased deforestation. EU legislation can support this, forested areas deforested areas prompting fuller disclosures and a greater availability Source: MSCI and Allianz Global Investors research as at 1 April 2023. of data for investors, which is likely to further raise * Based on constituents of the MSCI ACWI. awareness and drive investor action. Exhibit 4: Industry exposure to deforestation via company production sites in deforested areas* 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Industrials Information Financials Materials Consumer Consumer Real Health Energy Utilities Communications technology discretionary staples estate care services No direct exposure to deforestation Direct exposure to deforestation Source: MSCI and Allianz Global Investors research as at 1 April 2023. * Based on constituents of the MSCI ACWI. 4

DEFORESTATION: GETTING TO THE ROOT OF THE PROBLEM We have identi昀椀ed three ways for investors to address Exhibit 5: Number of companies with a deforestation deforestation in their investment approaches: policy* 1. Identifying deforestation risk materiality 3000 For investors, it will be important to identify companies that are exposed to deforestation – whether directly or 2500 2432 indirectly – alongside how much risk exists in the sector they are operating within. Di昀昀erent approaches to 2000 identifying risks include: 1500 • Screening for direct exposure through the location of production sites, as shown in Exhibit 3. 1000 • Understanding the supply chains used by companies 500 or sectors, as well as deforestation policies and 74 practices. This is important as the products impacting 0 deforestation are often further upstream in the supply chain. Yes Not disclosed • Engaging with companies is a critical tool in ensuring their awareness of the topic in the absence of Source: MSCI ACWI and Allianz Global Investors research as at 1 April 2023. appropriate disclosures. Engagement also enables *Based on constituents of the MSCI ACWI. identi昀椀cation of possible risks and the likely strategic initiatives required for companies to become resilient in this area. 2. Regulatory screening Reforestation projects can also be financed. Many such 22 The evolution of regulations including MiFID II led EU projects are currently more philanthropic in nature. regulators to introduce formal Principal Adverse Impact However, reforestation can help drive innovative financial 23 24 (PAI) or Do No Signi昀椀cant Harm, screens in 2022. Three solutions, to the extent that it is possible to put a financial of the 14 PAIs on sustainability factors that are applicable value on the natural capital derived from forests. to corporate issuers are aligned to biodiversity factors, with one speci昀椀cally addressing biodiversity sensitive areas, Deforestation is a far-reaching challenge, both including forests. These advances in regulation will provide geographically and across our three pivotal sustainability additional pressure for improved corporate disclosures and themes: climate change, planetary boundaries (including we expect further evolution of the regulatory landscape to biodiversity), and inclusive capitalism (including many social drive greater nature-based disclosures. sustainability issues). The recent progress on globally coordinated policy alongside a regional focus is pushing 3. Impact investing deforestation into the mainstream for industry sectors and Investors can have a positive impact through the 昀椀nancing companies. This will not only prompt improved disclosures, of sustainably managed forests and alternatives to wood but we anticipate it will also more formally embed this as a raw material (providing that the alternatives to wood important sustainability issue into investment approaches. do not have detrimental impacts on sustainability). In addition, new 昀椀nancial products are being developed which may contribute towards reduced deforestation, for example: • Carbon credits from sustainable forests. Re昀椀nement is needed on the scope, structure and governance of these instruments, alongside the long-term protection of these assets.25 26 • Forest bonds and other speci昀椀c instruments. As above, consensus on principles and approaches will be needed to accelerate adoption. 5

DEFORESTATION: GETTING TO THE ROOT OF THE PROBLEM 1. UNEP, December 2022, COP 15 ends with landmark biodiversity agreement 2. BCG, June 2020, The Staggering Value of Forests - and How to Save Them 3. United Nations Forum on Forests, April 2013, Economic Contributions of Forests 4. FAO, 2020, The State of the World’s Forests 5. WEF, April 2022, Here’s How the Earth’s Forests Have Changed Since the Last Ice Age 6. International Forest Industries, January 2020, 27 football 昀椀elds of forest lost every minute due to deforestation 7. FAO, March 2007, Manual on deforestation, degradation and fragmentation using remote sensing and GIS 8. Our World in Data, 2015, Deforestation and Forest Loss 9. WEF, April 2022, Here’s How the Earth’s Forests Have Changed Since the Last Ice Age 10. WEF, April 2022, Here’s How the Earth’s Forests Have Changed Since the Last Ice Age 11. Our World in Data, 2015, Deforestation and Forest Loss 12. CIFOR, 2021, Slowing deforestation in Indonesia follows declining oil palm expansion and lower oil prices 13. CIFOR, 2021, Slowing deforestation in Indonesia follows declining oil palm expansion and lower oil prices 14. UNEP, May 2020, Earth’s biodiversity depends on the world’s forests 15. IISD: SDG Knowledge Hub, July 2021, Preventing future pandemics starts with protecting our forests 16. COP 27 refers to the 2022 United Nations Climate Change Conference held in Sharm el-Sheikh, Egypt. 17. COP 15 refers to the 2022 United Nations Biodiversity Conference of the Parties to the UN Convention on Biological Diversity held in Montreal, Canada. 18. European Commission, June 2019, EU and Mercosur reach agreement on trade 19. CIRCABC, August 2022, 20. European Commission, December 2022, Green Deal: EU agrees law to 昀椀ght global deforestation and forest degradation driven by EU production and consumption 21. European Commission, April 2023, Parliament adopts new law to 昀椀ght global deforestation 22. European Securities and Markets Authority, May 2014, MiFID II 23. Under the EU Sustainable Finance Disclosure Regulations, Principal Adverse Impacts are any impact of investment decisions or advice that results in a negative e昀昀ect on sustainability factors. 24. D o No Signi昀椀cant Harm (DNSH) refers to products or services which do not harm any of the six environmental objectives in Article 9 of the EU Taxonomy. 25., August 2021, US forest 昀椀res threaten carbon o昀昀sets as company-linked tress burn 26. International Finance Corporation, October 2016, Slide 1 ( and Climate Bonds Initiative, Forest Bonds | Climate Bonds Initiative Investing involves risk. The value of an investment and the income from it will 昀氀uctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. 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