EU deforestation law presents material risk for soy traders

A NEW European Union law, which aims to ensure that products sold in the EU are deforestation-free, was adopted in April 2023.

The regulation requires companies selling products to Europe that include commodities such as soy, palm oil, beef, or timber, to prove that they do not contribute to legal or illegal deforestation globally.

The Anthropocene Fixed Income Institute (AFII) reports that “Europe ranks among the largest importers of soy products, with at least half sourced from Brazil. Soy traders will either need to incur costs to improve the sustainability of their supply chains or risk falling short of the regulation, which may limit their access to European markets or result in lofty fines. These consequences could potentially result in a deterioration of their credit quality.”

The AFII has examined how bondholders exposed to leading soy traders can assess financial risk arising from the regulation and consider whether the market is already pricing in such concerns.

The AFII says that there are three main takeaways:

  • The EU regulation on deforestation is a material risk for soy producers’ investors. Furthermore, the EU may extend the regulation from deforestation to other ecosystems. Credit deterioration and higher borrowing costs could be significant for investors.
  • These heightened risks do not appear to be reflected in current credit spread levels. It would be strategic for investors to review investments before the regulation is enforced, which could drive a pricing adjustment.
  • Amongst large investment grade issuers, American agribusiness Bunge, with $2.9 bn bonds outstanding, appears the most exposed to a potential spread repricing.

AFII says, “From a bondholder’s perspective, the EU regulation represents a very material financial risk. Hefty penalties in case of non-compliance, loss of access to a major soy market and reputational risk may significantly impede soy traders’ revenues.

“Three key factors emerge as primary drivers of financial risk for investors: the role of soy in the company’s revenue structure, the degree of exposure to ecosystem conversion, and the effectiveness of the company’s mitigation strategy. When comparing companies’ risks, it’s important to note that even if two companies share similar absolute levels of ecosystem conversion exposure, their risk levels may differ significantly based on factors such as the size and diversification of their operations.”

They says that “Bunge and Amaggi stand out for having the greatest conversion risk compared to their revenue, making these companies more susceptible to the financial repercussions of non-compliance with EU regulatory requirements. Despite Amaggi having the highest Forest 500 score in the ranking, both companies are still poorly scored.

Although Cargill and Archer-Daniels-Midland carry the second and third-highest conversion exposure respectively, they appear considerably less risky than Bunge in relative terms. When comparing the two companies, which are similar in size and operations, Archer-Daniels-Midland appears to carry a higher level of risk compared to Cargill.

The AFII concludes that “Financial institutions have not yet proactively addressed deforestation (and more broadly ecosystem conversion) in their investment policies. However, the EU deforestation regulation, and other increasing regulatory pressures require the agricultural industry to act, and this should be reflected in asset prices.

If financial institutions increasingly adopt more stringent ecosystem conversion policies, borrowing costs could become substantially higher for agricultural companies that poorly manage their supply chains, anticipating costs to comply with regulation, or fines for non-compliance.”

More about the Anthropocene Fixed Income Institute here
Read their full report here


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