ESG challenges and opportunities in Brazil

Leading Brazilian corporates are embracing the transition and transforming commitments into real actions.

ESG assets may represent one third of global assets under management by 2025.1 Yet, recent events, including the war in Ukraine, the energy availability crisis, inflation and rising rates as well as continued growth in GHG emission, extreme climate events and loss in biodiversity, have led to urgent and genuine questions about sustainable finance.

UBS BB recently organized the Brazil ESG Conference, discussing the progress and challenges of corporates in a country that is central to the global ESG discussion.

Overall, we left the event with the certainty that leading Brazilian corporates are well aware of the challenges, embracing the transition and transforming commitments into real actions. 20 companies shared thoughts about how they are investing in low-carbon technologies and adjusting their processes, with innovative solutions in agribusiness, waste management, mining, biodiesel, financial services or retail. There are challenges to overcome, both on the environmental and social sides. While corporates do not have the exclusive solution to those challenges, they no doubt have a great role to play.

This is a global discussion. Brazil has unique assets to become a leader in sustainability.

We thank the following companies and leaders for their participation: 瑞银集团 , UBS BB , Banco do Brasil , Robeco, Verra, BNDES, Orizon, CBA, 3Tentos, Caramuru, SLC Agricola, Sylvia B. Coutinho, Daniel Bassan, Frederic de Mariz, Fernando Vita , Joao Auler , Stuart Harper , Andrew Lee , Peter van der Werf, Angelo Sartori, Lourenco Tigre, Milton Pilao, Ricardo Carvalho, Mauricio Hasson, Marcus Thieme, Alvaro Dilli, Daniel Maria, Denis Minev, Guilherme Grunthal

We came away with some takeaways

• Investors are looking for a real impact and spending meaningful resources to integrate ESG considerations. The purpose is not just to improve ESG scores but to reach real-world outcomes. According to Sylvia Brasil Coutinho , UBS Brazil CEO and head of Wealth Management Latin America, investors ought not to “focus only on companies most advanced with ESG targets but on the transition stories, where tough discussions need to happen, and where engagement can create the most impact.”
• Corporates are urged to transform commitments into actions. Disclosure is an essential first step, and data need to be standardized and actionable for investors and regulators. Data is a challenge, well-structured for large companies around some topics (climate), patchy in other topics (biodiversity, social metrics). “Corporate executives are eager to engage in those discussions, they want to do what is right, disclose it, and monetize their ESG assets”, according to Daniel Bassan , CEO of UBS BB, a leader in green debt issuance and ESG advisory in Brazil.
• Carbon markets are promising. There is still a challenge to scale up both the supply and the demand side for carbon credits, despite the huge interest and momentum on this theme. ”Brazil has a natural role to play as a provider of credits globally, especially in nature-based solutions”, according to Frederic de Mariz , head of ESG Advisory at UBS. Carbon markets are still marked by incomplete international agreements, lack of pricing transparency and reputational concerns, while clearer categories of projects are emerging. “It is not just the carbon, co-benefits are essential, especially when it comes to biodiversity and social metrics”, according to de Mariz. ESG is not just about climate.
• Does ESG pay off? Financial returns of ESG investments are expected to be as good or better than traditional investments in the long run. ESG returns are not concessionary. Bias towards growth stories and tech is impacting negatively the ESG portfolios in 2022. Meanwhile investors are not always willing to pay a higher price to those companies that invest in the transition. Price advantage for low-carbon producers and good ESG companies is not present in all industries (meaningful for certified soy producers, unclear for low-carbon aluminum), yet consensus is that companies that do not have a sustainability strategy will be out-of-business in the medium term.
• Agribusiness. Brazil feeds 10% of the world’s population2, using 30% of its territory for agribusiness3 (vs. 39% in Europe? and 52% in the US?). Yet, 66% of the territory is protected.? Brazil could double food production without cutting a single tree, by leveraging existing pastureland for agriculture. Illegal activities need to be punished and enforcement is a bottleneck. Moreover, we need to recognize that around 25 million people live in the Amazon region, many in poverty, so finding ways to develop a sustainable bioeconomy to create green jobs in this region is crucial for the maintenance of the forest and its biodiversity. This must be a public/private partnership, also supported by the international community, according to Sylvia B. Coutinho.

How are investors integrating ESG into their allocation?

Representatives from Robeco and different groups at UBS discussed how ESG touches all financial products. The purpose is “not just to improves ESG scores vis a vis a benchmark”, but to achieve “real world outcomes”. Robeco explained that ESG integration no doubt is leading to different investment decisions than they would have made 10 years ago. Robeco defines a system of “traffic lights” (green, orange, red) to track the evolution of corporates on ESG topics. The asset manager also defines standards by sectors (palm oil, P&P, soy). In sectors where there is a lack of good quality data, the approach is to measure a minimum performance and exclude investment below that. When there is a lack of data, portfolio managers start with engagement. Climate already has good data and is well integrated. On the other hand, biodiversity is in the early days, with only patchy data. Data intelligence is attracting a lot of resource and portfolio managers do not want to rely on external ESG scores only. Data need to be clean and “fit for purpose”, meaningful.

Asset managers do not only focus on the companies most advanced in transitioning to a lower carbon economy, but on transition stories, where the difficult discussions need to happen, and where you can have more impact. Investors want to understand which solutions are driving those real-world outcomes. Information is essential for investors to better manage risk and reach the outcomes they want?(engagement, transition etc). Funds want to “find companies where ESG can create value“. 10% of global debt issuance is green?, at UBS BB, this is close to 20%. UBS BB is structuring more than 50% of the ESG debt in Brazil in 2022.?

What is the opportunity of carbon markets?

There are various methodologies to certify and register credits, with Verra and Gold Standards being leaders. Nature based solutions is the most common approach in Brazil to reach carbon neutrality. Its not just the carbon, co-benefits are essential, especially linked to social impact in rural communities and biodiversity. There is a challenge to scale up voluntary carbon markets, both for the demand and supply sides. The actual demand for credits may not be as strong as it looks.

BNDES did a public tender for US$2mn in March 2022 and will launch another one in the second semester for US$10-20mn. the first tender attracted 15 projects, of which 5 were selected. Explicit goals were to crowd in private investors, with a match-funding initiative and to spread knowledge around carbon. Brazil has the potential to monetize nature-based solutions. Scope 1-2 at BNDES (for banks in general) are not material, and BNDES is also including its supply chain in scope 3 decarbonization efforts (loan portfolio not yet a focus). UBS neutralized its own emissions since 2000 (scope 1-2), with a bulk purchase of 4.2 million of credits, spread across geographies and technologies (80% in renewable energy)

UBS retire credits immediately after purchase and are expensed. BNDES keeps them on balance sheet as intangible assets, and they can be traded in the future. Accounting considerations and capital treatment for BIS III purposes are a discussion topic.

Pricing is complex. There is no benchmark or transparent reliable market data. Should it trade similar to a commodity? For regulatory purposes in Brazil, it is not commodity and not a security, it is defined as a financial asset.

The principle of additionality is also a topic for debate, considering unpredictable future prices and perverse incentives for regulators. Producers that bear a cost to protect their legal reserve can use carbon to monetize this asset, under strict conditions if they prove additionality. In fact, even if there is an ambitious Forest Code, enforcement is uneven.

How is the industry adjusting to a path to zero?

Orizon is one of the largest waste management companies in Latin America and produces 2 million carbon credits every year in renewable energy (waste-to-energy). The company is also investing in waste-to-gas, and its projects have a meaningful positive social impact.

CBA is a leader producer of aluminum and produces 5 times less CO2 than the world average for aluminum production. This is mostly due to its reliance on hydropower (will add wind supply in 2023) and energy efficiency initiatives. The company targets 40% reduction in carbon emissions until 2030. The company noted a price premium for low-carbon aluminum production is not a reality yet. 23% of production globally is low carbon. Despite the absence today of a price advantage, CBAM and other international carbon mechanisms globally will benefit CBA, while high-carbon producers “won’t have a business in the future”. Transition is a cost but also creates opportunities to adjust processes and unlock new revenues.

How is agribusiness growing while meeting environmental concerns?

66% of the Brazilian territory is protected by law. Importantly, 25% of the total territory is protected land that is in private hands. The role of agribusiness (not just public entities) is material. Farmers only use 50% of their land for productive activities, on average, the rest is preserved. Crop production was multiplied by 6 in Brazil over the past 50 years, but cultivated area grew only by a factor of 2, stressing the role of productivity increase and in particular crop protection inputs. There is large focus today to develop nature-based solutions for crops.?

Soy is not a leading factor explaining deforestation in Brazil. SLC is a leading soy producer. The company employs 500 firefighters in 22 properties. The company committed to a zero-deforestation policy (legal or illegal, no land conversion) with a cutoff date of August 2021. The company noted that the cost of certification of soy is not meaningful, while certification is positive for reputation. In addition, there is a premium for certified soy of approximately $2 per ton.

Caramuru is a leading company in the agribusiness sector, transforming soybeans into added-value product, including food and biodiesel. Selling to European markets meant the company required certification early on. The company noted that certification also helps with lenders and clients. The company created its own “Sustentar” Program, with an ambitious list of items verified with its thousands of soybean suppliers including environmental (some of it via satellite monitoring) and social metrics. The company follows a 2008 cut-off date for zero deforestation (legal and illegal) in the Amazon biome, similar to the other signatories of the Amazon Moratorium. For all other biomes, the company is 100% deforestation free, with a 2020 cut-off date.

What social metrics should companies integrate in their impact strategies?

The most common topics include education, financial inclusion, access to essential services, healthcare, water and sanitation and micro and small enterprises financing. Renewable energy, when it has to do with first-time access can also have a social impact (for off-grid population for example).

Banco do Brasil was the first Latin America bank to issue a social bond in USD, with use of proceeds targeting low-income mortgage access, covid-relief bonds, loans to small farmers. 33% of total loan portfolio of the bank is ESG aligned, of which 44% has a social component, which represents approximately US$25bn or 1.5 million transactions. Banco do Brasil is committed to a target of “well below 1.5C” and noted the goal to use technology to reduce the cost of compliance verification. In addition, the company created a list of exclusions and develop lines of credit to finance transition. The banks sees sustainable finance as a unique opportunity to generate businesses and jobs.

Bemol is the largest retailer in the western Amazon, where logistics represent a tremendous challenge. Bemol offers credit and operates retail points and pharmacies. Western amazon is home to 8 million people and the region present the worst HDI in the country. ?Bemol also finances internet access (which is crucial for distance learning, telemedicine, and other essential services). The company operates the largest solar plant in northern Brazil. Bemol has projects to include indigenous people and refugees with access to employment. Access to credit is essential for inclusion and helps create a credit history. Improving social conditions and creating economic alternatives is essential to tackle the environmental challenge. According to Sustainalytics, green projects are easier to identify than social projects. There are widely accepted taxonomies and science-based data for climate, not yet for social metrics.

Overall, Brazil counts leading examples of sound ESG practices across sectors. Challenges remain so that those practices are shared more widely by all companies and their suppliers, while consumers and investors have access to the information they need to make educated choices.

Sources:

1https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/

2Reuters with Embrapa data, https://www.reuters.com/article/brazil-grains/brazil-feeds-some-10-of-worlds-population-research-finds-idUSL2N2L23F6

3Embrapa, https://www.embrapa.br/en/car/sintese

?European Environment Agency, https://www.eea.europa.eu/themes/agriculture/intro#:~:text=Agriculture%20data%20service&text=Grassland%20and%20cropland%20together%20make,environment%20(OECD%2C%202017)

?USDA, https://www.ers.usda.gov/topics/farm-economy/land-use-land-value-tenure/major-land-uses/#:~:text=About%2052%20percent%20of%20the,%2C%20and%20farmsteads%2Ffarm%20roads.&text=Land%2Duse%20change%20occurs%20for%20a%20variety%20of%20reasons

?Embrapa, Ibid.

?https://www.environmental-finance.com/content/the-green-bond-hub/sustainable-bonds-to-exceed-the-trillion-dollar-barrier-in-2022-for-second-consecutive-year.html

?UBS data and Nint.

?Embrapa, Ibid.