Private finance

Posted: 27 May 2007 in


Given all the problems associated with the pulp sector, we might think that investors and financial institutions would be wary of financing pulp and paper projects or associated companies or at least, that they would conduct extremely careful due diligence before doing so. Far from it, according to a report by the Centre for International Forestry Research (CIFOR) released in 2006. The report, “Financing Pulp Mills: An Appraisal of Risk Assessment and Safeguard Procedures”, analyses 67 pulp mill projects financed between 1995 and 2004. The report’s author, Masya Spek concludes that inadequate research into proposed pulp projects “may lead to a new wave of ill-advised projects, setting up investors, forest-dependent communities and the environment for a precipitous fall.” CIFOR’s Chris Barr describes the problem as “the low-fact financing of pulp mills”.

The lack of due diligence in pulp mill financing is particularly glaring regarding the supply of raw materials. CIFOR compares financing of the pulp industry to financing of the oil industry. Oil companies are valued according to their proven oil reserves. It is one of the first things that potential financiers look at. For pulp companies, however, banks seem unconcerned about their access to raw materials. They simply assume that there are ample supplies of raw materials for this sector. Availability, cost and even the legality of the wood are often not considered.

Pulp mills are extremely capital intensive. As such, private financiers of pulp mills play an important part in deciding which mills get built and where. The record so far is not impressive. CIFOR’s 2006 report notes that when banks look into financing pulp mills, “In many cases critical risk factors are not addressed.” According to CIFOR, financiers have failed to weed out the bad projects from the good. However, given the structural problems (including overproduction, overconsumption and a reliance of subsidies) inherent in today’s globalised pulp industry the implication that there are any good pulp projects is extremely dubious.

CIFOR is particularly concerned about the lack of attention paid to the source of raw material to feed the mills. For example, when the Indonesian pulp and paper company APRIL carried out its initial public offering in 1995, the prospectus stated that the successful operation of the Riau Andalan pulp mill was a key risk factor. But details of wood supply to the pulp mill was “non-reviewed information”.

APP and APRIL built their enormous pulp mills in Sumatra before establishing tree plantations. They did so with funding from a wide range of commercial banks and financial institutions, including ABN Amro, Barclays, Credit Suisse First Boston, Deutsche Bank, Dresdner Bank, HypoVereinsbank and Commerzbank. None of these banks appeared concerned that the pulp mills did not have an adequate source of raw material. The result has been a massive increase in the rate of deforestation, illegal logging and land conflicts in Sumatra.

Determining whether a company has an adequate supply of legally obtained raw material should be an obvious part of the due diligence process and of the credit risk assessment. But, as CIFOR notes, “The risk assessment and due diligence practices of banks are not in themselves sufficient to identify poorly performing or unsustainable pulp producers.” Part of the problem lies in the superficiality of the credit risk assessment process. Lenders and investors rely on information from credit risk agencies and securities analysts and carry out little research when information is not given, for example about fibre supply. When problems arise, the damage has already been done. Even if a company receives a credit downgrade, this is “reactive rather than predictive”, writes CIFOR.

Analysts’ reports of pulp companies rarely pay sufficient attention to the issue of fibre supply to pulp mills. Reports tend to use company statistics rather than drawing up a framework of information that is needed and critically analysing companies’ data.

Banks also often rely on assessments by consulting firms for valuation reports, feasibility studies or industry overviews. According to CIFOR, however, financiers often fail to read the actual reports and use the mere existence of the report to prove that the project is acceptable. In addition, many of the consultant firms utilised are biased towards the industry and pay little heed to environmental and social risk factors.

Once a company has launched its Initial Public Offering and goes back to the market for debt or equity, the due diligence process is repeated but the process is simpler as the company already has a track record in the market. Thus, the quality of the due diligence process sinks even further and key risks are often overlooked.

Urgewald is therefore recommending that private banks develop forest policies with a specific sector standard for pulp.


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