Global impact of the EU’s anti-deforestation law

The European Union’s Regulation on deforestation-free products (EUDR) came into force June 29 and introduces the need for companies to screen global suppliers through mandatory deforestation and forest degradation due diligences. The EUDR covers commodities such as cattle, soy, cocoa and palm oil, with noncompliance penalties of at least 4% of annual turnover to confiscation of goods and a temporary ban from participating on procurement or tenders in the EU. This special report assesses the impact the legislation will have on companies placing products in the EU and key EU sourcing markets in Latin America, Asia-Pacific and sub-Saharan Africa.

The EUDR mandates companies placing commodities on the EU market to screen their global suppliers via the setup of annual due diligence frameworks. These would need to be provided to their respective member states, guaranteeing that the products placed in the EU market have not caused deforestation. The regulation covers cattle, cocoa, coffee, palm oil, rubber, soy and wood (timber) as well as their derivatives produced either within the EU or in third countries. It includes products that have been fed with or have been made with EUDR-related commodities, including beef, charcoal, chocolate, leather and printed paper products. Large companies would have 18 months to comply with the EUDR requirements, and small and medium-sized enterprises would have up to 24 months, setting the dates as Dec. 30, 2024, and June 30, 2025, respectively.

The EUDR’s scope extends beyond deforestation. It also requires due diligence statements to include information attesting that products produced by suppliers have complied with supplying countries’ land-use, labor and human rights laws, including local Indigenous communities’ rights. Besides companies placing EUDR-related products on the EU market, the economies of major palm oil-producing countries in Asia such as Indonesia and Malaysia, the agribusiness industries of countries such as Brazil and Argentina, and EU-bound cocoa exports from countries such as Côte d’Ivoire and Ghana are also likely to be affected.

Companies placing EUDR-related products into the EU market are likely to face increased regulatory scrutiny, including by customs authorities, in the one-year outlook and beyond

Members of the European Parliament (MEPs) as well as the EUDR text itself have pointed to the importance of the regulation for achieving the EU’s European Green Deal and Paris Agreement commitments. Austrian MEP Alexander Bernhuber, for example, mentioned during the EUDR’s April debate that it was important for member states to implement the EUDR via “strict controls and strict sanctions if countries or regions or individual companies do not comply” with its guidelines.

EU member states’ desire to lower deforestation — from an estimated consumption of deforestation-linked products that contributed to 19% of global tropical deforestation between 2008 and 2017 — combined with the nature of the EUDR’s noncompliance penalties indicate that there is high political willingness and commitment for the regulation's enforcement. Penalties for noncompliance, for example, could reach up to 4% of the company’s total annual turnover in the EU. Additional penalties include the confiscation of revenues gained from transactions, public procurement and access to funding exclusion for a period of up to 12 months as well as the inability to obtain grants of concessions, also up to a period of 12 months. The EUDR also says that member states, customs authorities and the European Commission should establish a systematic information and exchange mechanism to ensure the regulation's enforcement. Companies placing products in the EU will need to provide their relevant due diligence statement certifications to customs authorities, who will be able to confiscate noncompliant products.

The EUDR will affect most companies importing EUDR-regulated products into the EU. Levels of preparedness are varied; the 2022 S&P Global Corporate Sustainability Assessment highlights that 34.2% of the largest companies in the S&P Europe 350 index have set targets to reduce, offset or end deforestation in their operations and/or supply chains. The assessment also shows that 35.1% of companies related to food products and 33.3% of those related to paper and forest-related products have set targets to reduce deforestation in their operations or supply chain.

Operational costs related to the EUDR are likely to increase for both European and non-European companies; supplying countries’ resistance is likely

The level of due diligence that companies will need to carry out under the EUDR will depend on the risk level of deforestation and forest degradation assigned to exporting countries by the European Commission, which will in turn classify jurisdictions according to a three-tier system. Countries classified as low risk will have simplified due diligence procedures, while those classified as standard risk or high risk will require suppliers’ due diligences to be supported by satellite images including geolocalization coordinates and/or geospatial polygons. The European Commission’s impact assessment has estimated that as a result, EUDR compliance-related costs for companies are likely to amount between US$170 million and US$2.5 billion per year. The impact of such costs would either need to be “absorbed by a reduction of profit by operators along the value chain and/or eventually passed through to the final consumer” in the EU member states, according to the European Commission.

Non-European companies and local producers and traders from EUDR-regulated countries are likely to record increased EU-bound export-related costs

Suppliers based in countries that export to the EU will need to provide documents and certificates of traceability to European partners, with a higher threshold in certain areas in the Amazon, Indonesia and Africa. This has prompted some of the producing countries to express concerns regarding the EUDR increasing the costs of exporting to the EU, potentially putting at risk small and medium-sized companies. Countries that have raised such concerns include Colombia, Indonesia and Malaysia. The latter two have, for example, said that the EUDR contradicts the nondiscriminatory principles of the World Trade Organization and that small and medium-sized companies are likely to struggle adapting to the EUDR’s certification and traceability procedures as they would require new technologies, processes and administrative costs for compliance. However, both countries have agreed to form a technical joint task force with the EU to study the effects of the EUDR.

The EU is likely to cooperate and provide financial assistance to countries demonstrating willingness to combat deforestation

This is ingrained in the EUDR, which says member states should provide technical and financial assistance to "least developed countries," but is also part of the EU’s Paris accord and EU Green Deal commitments. During the 26th UN Climate Change Conference of the Parties (COP26) held in 2021, European Commission President Ursula von der Leyen pledged a €1 billion contribution to the Global Forest Finance Pledge, to be disbursed over five years.

MEPs have said the EU also attempts to work with and provide financial and technical assistance to some of the supplying countries, but most of the world’s producing countries are unlikely to enact new legislation to combat deforestation in the one-year outlook. They are instead likely to focus on enforcing existent deforestation commitments.

Countries such as Côte d’Ivoire are viewing the EUDR as an opportunity, opting to lobby the EU for increased financial support to bring down deforestation via such a pledge. Côte d’Ivoire, in anticipation of the EUDR, introduced its own GPS tracking system to improve data on where cocoa beans originate and has been distributing electronic tracking cards to farmers — necessary to trade — since February. Other affected countries such as Ghana have also introduced a national mandatory traceability system to meet EUDR requirements. Weak enforcement capabilities, limited international funding and a negative track record in countries like Brazil, which has nonetheless pledged to eradicate deforestation by 2023, increase the probability of producing countries not being able to meet their deforestation targets and/or the deforestation expectations of the European Commission, a situation that would increase the number of countries being labeled as high risk by the EU. Global deforestation has been steadily increasing over the past years, rising 10% in 2022 year over year to 4.1 million hectares, according to the World Resources Institute.

EUDR enforcement is likely to delay the advancement of trade negotiations, particularly those between Brazil and Indonesia and the EU

The probability of the EU and Brazil not reaching an agreement over the EU-MERCOSUR (Southern Common Market) trade agreement ratification had been rising even prior to the EUDR entering into force. Its passing, however, will likely prompt Brazilian President Luiz Inácio Lula da Silva to further delay ratification. On June 12, Lula expressed concern about the passing of EU legislation with extraterritorial effects. His statement was consistent with Brazil’s policy of opposing environmentally motivated barriers to trade. Lula has expressed his commitment to halting illegal deforestation in Brazil by 2030 but has also said extraterritorial legislation would potentially restrict Brazilian agribusiness exports while introducing new items on the agreement already negotiated between MERCOSUR and the EU. Lula has said it is impossible for Brazil to agree to the EU’s existing demands; ratification is unlikely in the one-year outlook. In June, Lula said he wanted Brazil to be classified by the European Commission as a low-risk EUDR deforestation jurisdiction.

Indonesia and Malaysia have taken similar approaches through the Council of Palm Oil Producing Countries, urging the EU to label them as jurisdictions of low deforestation risk. On May 31, they said the EUDR’s impact on small holders would affect the progress of the countries' separate free trade agreement negotiations with the EU. Indonesian Coordinating Minister for Economic Affairs Airlangga Hartarto said in June that the EUDR amounted to a “new trade barrier.” The EU negotiations with Indonesia have lasted seven years, and although the country is willing to reach an agreement, Hartarto has also said the country is willing to wait another seven years.

Compliance costs of operating in high deforestation-risk countries will likely increase incentives for companies placing affected products in the EU to switch to low-risk jurisdictions

The impact of the EUDR is likely to reconfigure trade and supply chains across the affected commodities over the next decade. Even if source-export countries adapt, the difficulties associated with tracing complex supply chains, as well as its associated costs, will increase the incentives for companies to seek alternative sourcing options from locations designated by the European Commission as high risk. For example, the European Commission’s impact assessment, referencing soy imports from Argentina, Brazil and Paraguay, has stated that relocation to low-risk jurisdictions would potentially favor imports from the US and incentivize production within the EU.

The implementation of the EUDR is unlikely to reduce nongovernmental lobbying for companies to relocate from countries deemed as medium- and high-risk jurisdictions

Even if companies are compliant with the EUDR but operate in countries regarded by the European Commission as high risk, such as Brazil, nongovernmental organizations are likely to continue to call for deforestation-linked boycotts (see Brazil: March 2, 2022: Fresh concerns about mining and agribusiness in Brazil’s Amazon raise risks of boycotts and withdrawal of investment ). NGO scrutiny toward companies associated with deforestation is also likely to increase as additional compliance data is made available. In June, several supermarkets in Europe initiated an investigation after a report by NGO Mighty Earth, which welcomed the EUDR but said it had dangerous gaps, allegedly revealed that a soy supplier had been linked to deforested lands in Brazil’s Cerrado biome. The Mighty Earth report highlighted that the EUDR is estimated to affect only 26% of the Cerrado biome as it did not include “and other wooded land” as part of the scope, which would have increased the impact on the Cerrado to up to 82%.

The classification of countries as medium- or high-risk jurisdictions is also likely to accelerate the pattern, at least in Latin America, of financial institutions opting to lower their risk exposure via withdrawing financing to agribusiness projects

The latest of such actions took place in May when 21 Brazilian banks agreed to self-regulate by agreeing to deny credit to beef producers connected with deforestation (see Latin America: Dec. 7, 2022: ESG and exclusionary policies affecting Latin America ). Similarly, over the past number of years, litigations against agribusiness companies linked to deforestation have also been on the rise. Producing countries unable or unwilling to comply are likely to start exploring alternative export markets. In the case of Brazil, if it is unable to place parts of its products in the EU market, government efforts to improve market access to mainland China will likely continue to accelerate. Indonesia's chief investment affairs minister, Luhut Binsar Pandjaitan, has openly said palm oil exports could progressively be diverted to Africa.

The mandatory screening of suppliers beyond deforestation and the EUDR is likely over the three-year outlook

The European Commission is scheduled to review the legislation by June 2025, potentially expanding its reach, with biodiesel and maize likely to be included based on initial proposals, and expanding other ecosystems such as savannahs and wetlands. If ecosystems are expanded, the EUDR is likely to affect further the soy-producing area of the Cerrado biome in Brazil, significant parts of which were left out under the current scope of the regulation. The inclusion of biodiesel and maize would likely have the biggest impact for producers in Brazil and Argentina, some of the main exporters to the EU market. Other initiatives similar to the EUDR are in discussion in the US, namely the Fostering Overseas Rule of Law and Environmentally Sound Trade (FOREST) Act, which in its current proposal includes deforestation-free products such as palm oil, soy, cocoa, rubber, meat and wood.

Expansion of due diligence requirements to other economic sectors is also likely as several Europeans initiatives are under discussion or were recently approved. Negotiations are ongoing at the EU Parliament for a Corporate Sustainability Due Diligence Directive (CS3D) that, if approved, is likely to expand due diligence requirements to the whole supply chain for large EU companies and non-EU companies that are active in the EU, with an increased focus on sustainability-related compliance including human rights and environmental concerns. This would be likely to increase compliance risks for all sectors, putting a particular emphasis on extractive, agriculture and textiles industries and financial institutions that provide support to companies, especially if the latter is included as part of the CS3D proposal. This comes as member states have also approved their own legislation, such as Germany’s Supply Chain Due Diligence Act (SCDDA), approved in January, which follows similar requirements as the CS3D, and the Netherlands, where updated human rights due diligence legislation has been submitted. The SCDDA applies to German and international companies with significant German operations and to suppliers to companies, even if they do not have a presence in Germany. Noncompliance with the SCDDA will expose companies to fines of up to €8 million or 2% of annual revenue and will bar companies from public tenders in Germany.

Source: S&P Global Market Intelligence © 2023 S&P Global

This research was prepared by and reflects the views of S&P Global Market Intelligence, which is separate and independent from other businesses/divisions of S&P Global, including S&P Global Ratings.