Last week when we released our first issue brief, Social & Environmental Due Diligence: From the Business Case to the Impact Case, we simultaneously released the scorecards used by our loan officers to evaluate clients’ social and environmental practices. To ensure the quality of the data we gather and the consistent application of due diligence standards by our loan officers, the scorecards alone are not enough, training is also required. In the case of our environmental scorecard, this has meant collaborating with the Rainforest Alliance to design and deliver three-day, field-based trainings in Costa Rica, Peru, and Kenya (next up is Ghana). Led by Rainforest Alliance agronomists, loan officers visited certified and non-certified farms in order to deepen their first-hand knowledge of sustainable agriculture.
Earlier this week, we sat down with Jesse Last, Root Capital’s Value Chain Relations Manager and Elizabeth Teague, our Senior Associate for Environmental Performance, to discuss how these trainings strengthen our environmental due diligence.
We talk a lot about sustainable agriculture at Root Capital. Why is it an important part of our mission to grow rural prosperity? What does it look like?
Elizabeth: Rural livelihoods depend upon healthy ecosystems, so supporting businesses that serve as environmental stewards has always been an important part of our mission. Particularly in the long-term, agricultural businesses and the farmers they source from can’t prosper if they don’t care for the natural resource base that supports them.
Jesse: Sustainable agriculture looks different depending on the context, but there are a number of best practices that are hallmarks of sustainable agriculture: protecting soil with cover crops, using compost or other fertilizers to build soil fertility, interspersing crops with trees that capture carbon and provide a variety of ecosystem services. Sustainable agriculture reflects the interaction between crop, landscape and culture – it’s both the challenge and the opportunity.
Both of you have been responsible for implementing sustainable agricultural trainings for our staff—particularly our loan officers—in Latin America and in Africa. Why are these trainings important?
Jesse: Last year, we rolled out a new environmental scorecard for our loan officers to use when conducting due diligence on potential clients. One of the best pieces of feedback we received from our loan officers was that it was hard for them to evaluate agricultural businesses’ environmental performance without seeing concrete examples and best practices first-hand. So the idea behind the training was to get loan officers out to the field to talk about it, touch it, feel it—really get engaged.
Elizabeth: We also launched these trainings in the context of increasing portfolio diversification. Loan officers are now being asked to evaluate the environmental performance of businesses working in very different industries with very different environmental risk profiles, ranging from agroforestry coffee to mango to sorghum. So one of the goals of the training was to give loan officers a better sense of the fundamental principles behind sustainable agriculture and what those principles look like across different industries. We want to make sure that every loan officer understands what to look for when doing environmental due diligence, especially when entering new or less familiar industries.
On that note, can you talk about how Root Capital approaches environmental due diligence for businesses working in industries that are generally considered higher-risk, from an environmental perspective?
Elizabeth: We’ve done a lot of thinking about this as we diversify our portfolio. As we explore agro-processing, aquaculture, palm oil, and other industries that typically have larger environmental footprints than our core industry, agroforestry coffee, we know we need to be cautious to ensure that only businesses using sustainable practices enter our portfolio. As a result, we’ve revised our lending policies to require a deeper level of environmental due diligence (e.g., a third-party expert review) for businesses in these high-risk industries. We choose to implement this requirement rather than simply exclude these businesses so that we don’t overlook best-in-class businesses working in these more problematic industries.
Jesse: Broadly speaking, we think we can have a greater impact by engaging with a business or an industry rather than slamming the door shut. If we refuse to engage, the benefits that can come from access to finance —higher and more stable incomes, improved livelihoods, etc.— are lost. In fact, a lack of resources is often a driving force behind environmental degradation. While we of course would decline to finance businesses engaging in activities such the degradation of high conservation value areas, there are other instances in which we might write a loan covenant stipulating that continued financing is contingent on improving specific practices over time, with concrete milestones along the way.
For example, if we find that a prospective business is supplying its farmers with a hazardous pesticide, we would work with that business to phase out the pesticide through the promotion of alternative products and producer education. We would condition disbursements on improved practices in that area.
We just released our first issue brief that explores the business case of social and environmental due diligence. How do you see environmental due diligence positively contributing to Root Capital’s financial results?
Jesse: In the issue brief, we lay out five areas where we find the alignment between environmental, social, and financial interests to be strongest—one of which is identifying and mitigating risk. An example of an environmental risk with immediate financial implications is the application of pesticides. If a business doesn’t have sufficient oversight over its suppliers’ agrochemical use, it places its product at risk of buyer rejection. Other things, like poor soil management practices among a business’ suppliers, will likely reduce productivity, and thus production volumes, in the medium- to long-term. These issues all inform credit risk. Moreover, the alignment we have with our clients on our environmental mission represents a competitive advantage and, in some cases, helps us attract or retain business.
Elizabeth: We see these loan officer trainings as an important part of making sure environmental due diligence contributes to our bottom line. They equip our loan officers with tools and strategies to identify best-in-class environmental practices and evaluate related risks. These trainings help our loan officers perform more effective due diligence, particularly in the context of portfolio diversification and environmental challenges such as climate change and increasing resource scarcity.