Managers hope increasing regulatory pressure will grow investment in timberland

Compliance is essential to all asset classes but, increasingly, timberland managers view rules and government policy as just the starting point for their next investment strategies.

Although evidence suggests that timberland possesses some of the lowest levels of risk among investment asset classes, there is one subset of risk that can never be completely avoided: regulation. But while regulations are often seen as being restrictive, they can also provide impetus. 

“Regulation can be a massive driver for natural capital land use transition and is definitely necessary,” explains Robert Guest, co-lead at natural capital and timberland investor Foresight Sustainable Forestry. “In Europe, the regulatory changes are already happening, and investors respond incredibly positively to incentives, so a combination of these elements is the best way forward.”

For timberland investors, in particular, there appears to be an understanding that the regulatory landscape always remains liable to shift. This is especially pertinent since timberland investments are generally held for extensive periods and harvests are periodic. As such, they are more likely than many other assets to be impacted by changes in regulation. This includes rule changes that stretch beyond their home jurisdiction due to the international nature of timber supply chains.

The uneven scope of environmental regulations across the world is a good example of the complex nature of compliance in the timberland space. However, regulations remain just one part of the picture. For many global LPs, regulations may be shaping their timberland investments, but they are also well aware that guaranteeing long-term returns depends on doing more than the bare minimum dictated by the rules.

Although a stretch of timberland may be based in a single country and subject to a single set of compliance standards, a timberland investment fund is likely to face compliance demands from multiple jurisdictions. Nuveen’s global timberland strategy, for example, comprises more than $2.1 billion of timberland assets and over 873,000 acres under management.

The international flavor of timberland investments mean investors have much to consider. In Europe, the EU Timber Regulation (EUTR) has been in force since 2013 and includes strong due diligence standards while prohibiting the placement of illegally harvested timber and products derived from such timber on the EU market. 

The EU wields significant influence over global industries, accounting for one-sixth of global trade and over $4 billion worth of tropical timber and wood furniture imports, according to the Zoological Society of London. The EU’s new Deforestation Regulation also requires firms trading in forestry and other agricultural products to carry out extensive due diligence on value chains to prevent further deforestation and biodiversity loss. The new legislation sets the tone for other emerging and existing regulations including the UK Environment Act and US FOREST Act.

Similarly, in the US, the recently passed Inflation Reduction Act will create additional incentives for sustainable timberland assets. Some states already prohibit government entities from investing in funds that boycott commercial timber. Differences between how carbon emissions are taxed internationally are also worth considering. All in all, it adds up to a fair deal of regulatory complexity.

If upcoming changes do disrupt some investment strategies, the most prescient investors are likely to have foreseen the direction of travel. ESG standards, in most markets at least, are only strengthening, with the EUTR a case in point. But as the regulatory trajectories in the US and EU demonstrate, although nuances between markets remain, stricter ESG regulations appear inevitable around the world.

Building community trust

Although regulatory focus for timberland investors understandably focuses on environmental matters, social considerations should not be neglected either – whether they emerge from external regulations or internal company values. “The regulatory environment in the UK and Europe is already very robust,” explains Guest. “For us, it is often the social license that affects our decision-making around timberland investments more.”

Many timberland investments simply use regulation as the starting point – as a guide for all their natural capital projects. Manulife Investment Management, for instance, possesses its own carbon toolkit that it applies to its timberland investments. It is also important to recognize that a working forest, far from simply representing timber as a potential construction material, can provide employment, improve the quality of life for rural communities and lower urban migration. These are all factors that improve the long-term value of timberland assets.

“When you carry out afforestation, you need to build up trust as a developer – not just with regulators but also rural communities,” adds Guest. “To help build that trust and maintain our social license – which links to regulations – we adopt lots of initiatives that align with our ESG focus, such as our forestry skills training program where candidates are fully funded with the training and equipment required to pursue a career in forestry.” 

Despite some concern over the challenges regulations could create for investors, more and more managers are enthusiastic about rule changes, and hope that they will drive and direct timberland investment rather than curtail it.

“Target setting is always a positive first step which is why we welcome the new [Taskforce on Nature-related Financial Disclosures (TNFD)] framework this year and [Science Based Targets initiative’s (SBTi)] forest land use and agriculture targeting setting guidance,” says Adam Gibbon, natural capital lead at alternative investment firm AXA IM Alts. “This will help companies with the biggest agricultural footprints understand how upstream supply chains are intertwined with natural capital and set targets which will over time help drive change on the ground.”

The TNFD framework is a global initiative for firms to monitor and disclose nature-related risks and opportunities, while the SBTi is another international program that defines and promotes best practices for companies to reduce their emissions and set net-zero targets. 

New technologies are also aligning with regulatory developments to further timberland demand. In the US, changing building codes have seen height limits for wooden buildings raised from seven stories to 18. This is partly in response to material innovation like the development of cross-laminated timber, which is a market predicted to grow from $1.1 billion in 2021 to $2.5 billion in 2027 – an annual increase of around 15 percent – according to privately owned, multi-boutique manager Pictet Asset Management.

New advances are bound to emerge in the timberland space in the coming years. Investors should be cognizant of the potential technological and regulatory impacts, and, to an extent, this simply represents good financial planning. It also makes sense from an ethical point of view. Timberland assets are hugely important to rural communities and are set to play an increasingly significant role in the carbon emissions of the entire planet. 

Regulations may prove to be pivotal in shaping timberland investments initially but managers seeking high levels of performance over an extended period need to work with other stakeholders – not just regulators. “We prioritize a level of community engagement that goes far beyond what the regulations require,” says Guest. This is a sensible approach if investors want to achieve both returns and compliance.