EUDR and Commodity contracts

Contracts are the ball bearings upon which the international trade train keeps rolling. They are an essential yet often under-appreciated component that keeps everything moving smoothly.

A conversation I had with a trader two years ago about the European Union Deforestation Regulation (#EUDR) illustrates this perfectly: "Why should I, as a trader, worry about ensuring sustainability? We have contracts. If I need sustainability because a customer in the EU requires it, I pay $140 for certification on my contract."

What a difference two years make!

Today, the reality and liability associated with the EUDR have become crystal clear. Due diligence requirements for compliance are now foundational.

Trade contracts determine the quality and standards of goods being traded. Therefore, due diligence requirements, especially traceability, should be a core part of securing compliance and market entry. However, the industry body, FCC, still does not have definitive answers for trading companies on the clauses and language needed for cocoa contracts entering the EU market as of December. With cocoa needing to ship in the next couple of months, this issue is urgent.

Key Issues:

Penalties: Under the EUDR rules, non-compliant goods can be seized 100%. Unlike other quality defects where buyers can use undamaged goods and claim insurance on damaged ones, non-compliance with EUDR due diligence results in a total loss. Additionally, the EU can issue fines up to 4% of the annual revenue of the company operating in the EU. These penalties can be enforced retroactively for up to five years!

Scope: Existing penalties for contraventions in cocoa trade were related to default, delay, quality, or weight loss. The new regulation requires sophisticated documentary due diligence evidence for compliance, which is challenging due to unsettled technical details. For instance, the EUDR requires polygons for cocoa harvested from plots over 4 hectares, while smaller plots need only a GPS point from the center. However, the standard for these measurements is not well-defined, leading to significant uncertainty.

Enforcement: There is no standard for auditing documentary proof for the most critical data point in due diligence submissions. A clause like “Delivery of good fermented, main crop cocoa that is EUDR compliant” is not sufficient due to the evidentiary burden on importers to warrant the quality of exporters' data, which covers land use rights, environmental protection, forest regulations, labor rights, and human rights.

Unintended consequences: There is a significant risk of false positives resulting from agroforestry practices. We have yet to find a land use monitoring system that can accurately tell the difference between pruning in agroforestry systems and deforestation/change of land use. This will unduly penalise the most sustainable forms of cocoa production.

Cost and supply crunch: Under these conditions it is very likely that the market will quickly split into EUDR compliant and non-EUDR compliant cocoa. As the EU is the largest consumer of cocoa an expected price premium for EUDR compliant cocoa is to be expected. What is not to be expected is that this will be passed on to the producers as the difference is purely driven by documentary evidence and not substantial quality differences.

Liability: Importers face risks of claims up to five years in the future on any part of any bean that has entered the EU, even if first shipped to a non-EU country for processing. The responsibility to implement the regulation is delegated to individual national bodies, which means data may be evaluated differently across EU countries. The same batch of cocoa landing in Hamburg may be judged differently from a batch in Rotterdam.

The nuance: Compliance vs. Due Diligence

It might be worthwhile discussing the difference between compliance and due diligence in the total scope of the EUDR for perspective.

Both compliance and due diligence are essential for adhering to the EUDR. Compliance ensures that companies meet legal standards, while due diligence involves a proactive approach to managing risks and promoting sustainable practices. Together, they help companies align with the EUDR's goals of preventing deforestation and promoting sustainable supply chains.

Key distinctions:

• Scope: Compliance meets specific regulatory requirements; due diligence involves broader risk management.
• Focus: Compliance ensures legal obligations are met; due diligence identifies, assesses, and mitigates risks to prevent non-compliance.
• Documentation: Compliance provides documentation of adherence; due diligence maintains detailed risk assessment records.
• Responsibility: Compliance ensures meeting legal standards; due diligence actively manages supply chain risks.
• Nature: Compliance is reactive; due diligence is proactive.

This last point is crucial and show the limits of trying to manage the EUDR through commodity contracts. Due diligence requires ongoing and pro-active management of a process.

In a world where each ton of cocoa is traded 44 times on the futures market before it lands, the traders world of dealing in contracts is facing massive upheaval!

Commodity contracts are good at setting standards for meeting compliance, but they are not particularly good at due diligence that requires a pro-active engagement.

Call to Action:

Given the profound impact of the EUDR on supply chain management and contract roles, it’s clear that due diligence requires ongoing, proactive management.

We need a competent, independent third-party data authority to vet and provide seamless data services. Robin Dand , Secretary General and Company Secretary at the The Federation of Cocoa Commerce Limited , suggests the International Commodities Exchange Commodity Traceability (ICE CoT).

This is similar to the concept that SAP has been promoting in the automotive supply chain with the introduction of a “digital twin.” If each cocoa bean has a digital twin companies can track its transformation and EUDR compliance as it moves through the supply chain. A cocoa digital twin could help in managing the full lifecycle and complete ESG reporting.

This is not something that can be achieved through traditional certification systems are their foundational data is problematic as has been shown by the recent suspensions of Fair Trade and parts of Rainforest Alliance in C?te d’Ivoire.

We support the need for an independent data authority that can ensure the quality of original data, and EUDR legislation that requires stringent data capture standards and protocols.

Setting standards on data nomenclature is not enough. We need standards on the quality of data capture and specific data capture protocols. Self-reported data and self-drawn polygons should not be the standard.

In summary:

• Urgency of EUDR Compliance: The looming deadline and lack of clarity has sounded alarm bells across multiple industries and from multiple governments. Cocoa being bought right now has to be shipped with unclear risks and evaluation standards. This needs urgent attention.
• Challenges in Implementation: There are unresolved technical details and inconsistencies in the enforcement of EUDR, such as the lack of standardized methods for tracing land use and ensuring documentary proof. This creates uncertainty and risks for importers, as data may be interpreted differently across EU countries.
• Proactive Due Diligence and Industry Collaboration: The shift from reactive compliance to proactive due diligence is crucial. This includes implementing robust traceability systems, engaging with independent third-party data authorities, and enhancing data capture standards. Poor data standards at source risk undermining all the technology and effort put into downstream traceability systems.

At the World Cocoa Conference in Brussels this year, there was much discussion about the decommodification of cocoa. The EUDR's due diligence requirements are changing cocoa from a faceless, interchangeable commodity to a unique, origin-bound product.

Data and context of production now matter substantially. This is why we at COOKO believe the future lies in hybrid cocoa: a blend of bits and beans. By capturing origin data at the point of harvest, Source Fermented Cacao? is augmented with embedded data.

If you start right, you've won half the challenge!