On 13 June 2023 the UK House of Lords voted in favour of an amendment to the Financial Services and Markets Bill (FSMA) now making its way through Parliament, which would require financial institutions to carry out due diligence on illegal deforestation in their customer's supply chains.

The amendment was narrowly voted through by 212 votes to 203, with frontbench support from the Labour, Liberal Democrat and Green parties as well as several unaffiliated peers. The measure also has the backing of the Global Resource Initiative (GRI) (a cross-sector taskforce set up by Government to recommend action to reduce the UK's deforestation footprint, and which includes some financial institutions amongst its members). 

The Lords amendment would prevent entities regulated under FSMA 2000 from carrying on any regulated activity in the UK  that may directly or indirectly support a commercial activity in relation to a 'forest risk commodity' or a product derived from one, unless relevant local laws have been complied within the source country. They would need to have a due diligence system in place within 2 years of the Act being passed and then implement it in practice. The list of forest risk commodities is yet to be determined.

The Government would have to set out minimum requirements for the required due diligence systems within a year following the Act being adopted. These would cover:

(a) identifying and obtaining information about the commercial activities of any beneficiary of the regulated activity and of their group regarding the use of a forest risk commodity;

(b) assessing the risk that relevant local laws were not complied with, or that free, prior and informed consent was not obtained from local communities, or from indigenous people in accordance with their rights under international law, in relation to that commodity; and

(c) mitigating that risk.

This is similar to the requirement in Schedule 17 of the Environment Act 2021 to be imposed on businesses proposing to use forest risk commodities in their commercial activities, which the Government is currently considering how to implement. One difference is, however, that businesses won't need to show that prior informed consent has been obtained, just that local laws with regard to land use have been complied with. 

The GRI's final report in May 2022 recommend that financial institutions should be made subject to similar requirements to those in Schedule 17.  As former Barclays chair, Sir Ian Cheshire, pointed out in an open letter from the GRI to the Government in January 2023, that recommendation was based on the GRI's conclusion that disclosure mechanisms such as the Taskforce on Nature-related Financial Disclosure and voluntary net zero pledges are insufficient to stop lending and investment contributing to deforestation.

However, opposing the proposed amendment during debate on 6 June, Baroness Penn (on behalf of the Government) said:

“In practice, this would amount to UK banks being required to check most of the world’s major companies and their supply chains for links to illegal deforestation, and stopping any finance to them until those companies can provide the data needed to do so. This is while the rest of the world’s banks carry on financing this activity with no global standard on deforestation in place.

Global due diligence is not something that can be legislated for by Parliament and the UK financial sector alone. In fact, trying to do so may make this problem harder to solve. Imposing this data requirement on UK financial firms alone where such data is lacking globally could lead to one of two things: firms trying to satisfy the requirement but failing due to a lack of data, leading to misreporting and misallocations of capital; or keeping that business outside the UK, with no chance of securing the type of environmental change we want and that is the aim of the amendment."

The next stage of the Bill is its third reading in the Lords on 19 June 2023 before it passes back to the Commons for consideration of the Lords amendments. Given the Government's majority in the Commons, this is amendment is probably unlikely to survive unless individual Conservative party politicians rebel against the Government's position. Similar debates are being had in the EU with regard to the inclusion of financial institutions in the draft Corporate Sustainability Due Diligence Directive.