Standardisation is required to accurately quantify the environmental and social impacts of land-use investments, says Ivo Mulder, Head of the UN Environment Programme’s Climate Finance Unit.
Standardising environmental and social impacts in land-use investments needs to be a priority for the financial sector. Banks and other financial intuitions (FIs) have the potential to help transition land-use to become ‘nature positive’ in addition to ‘net zero’, by redirecting investment to sustainable land-use projects. To accelerate this transition, UNEP has developed a Land Use Positive Impact Hub to support banks, asset owners and fund managers to determine how to measure the positive environmental and social (E&S) impacts of their land-use investments.
Asset owners, such as pension funds, insurance companies and sovereign wealth funds, are falling short on disclosing nature-related risks and generating positive impacts from their investments. At the same time, there is a lack of clarity across the sector on how to best measure, evaluate and compare different investments against their impacts on ecosystems and local communities.
At the macro level, the European Commission, under the Sustainable Financial Disclosure Regulation (SFDR), has mandated investors to disclose whether investment funds are conventional under Article 6, have elements of sustainability or are ‘light green’ under Article 8 or have sustainability as a core focus, where existing assets in the investment fund can be considered sustainable or ‘dark green’ under Article 9.
Yet, there is growing evidence that funds labeled as ‘sustainable’ do not always deliver what they promise. Research by S&P found that of 12,000 funds researched, representing US$20 trillion assets under management (AUM), only 11% were aligned with the Paris Agreement to keep temperatures below 2C increase. Of the 51 climate-focused funds, representing US$30 billion AUM, only 10% were Paris aligned. Labeling funds as sustainable alone is not an accurate or reliable measure to determine whether the assets under investment will drive down emissions.
Given the rising stakes to halve emissions in the coming eight years by 2030, there is no time for incremental change. Investments in fossil fuels will have to be phased out as soon as possible, but we also need fundamental changes in the way land is managed to produce agricultural commodities for a growing population. Yet, establishing robust E&S frameworks to ensure land-use investments create positive impacts and avoid harms is a complex matter, with the physical scale, often geographically remote nature and novelty of such deals all presenting challenges to corporates, agri lenders and investors.
To best capitalize on sustainable land-use investment opportunities and ensure that the UN Sustainable Development Goals (SDGs) and other global policy commitments are met in a holistic manner, a standardised E&S framework for investors is required to move from business-as-usual towards a more sustainable approach to land-use finance.
Standardising E&S frameworks is critical to developing robust investment strategies and transparent markets as well as minimising reputational, shareholder action and litigation risks. Yet, standardisation can only be achieved if there is a central benchmark against which FIs can monitor, assess and report upon their progress.
Risk assessments and due diligence can be time- and cost-intensive processes, which can hamper the scale of investment required to close the US$4.1 trillion finance for nature gap. A standardised E&S framework would provide greater time and cost certainty across land-use project transactions and provide a more transparent roadmap for the financial sector to achieve positive impacts.
While many FIs have begun to make commitments to reduce their negative E&S impacts, progress is slow. Only a third of FIs have risk-management policies for deforestation covering the most significant commodities. This said, there is a growing recognition that nature-related risks materialise as business and financial risks.
The EU Taxonomy on Sustainable Finance and SFDR are pushing risk disclosure for asset managers and the concept of double materiality is gaining traction across the financial sector, exemplified by the Task Force for Nature-based Disclosures (TNFD) and Exploring Natural Capital Opportunities, Risks and Exposure (ENCORE) tools.
However, it is time for FIs to think beyond risk management and negative impacts and consider how they can incentivise, monitor and report positive E&S impacts generated through their investment portfolios. The implementation of standardised E&S key performance indicators (KPIs) throughout land-use investment cycles can alleviate risks, deliver positive outcomes and contribute to nature positive targets.
Demonstrating positive impacts
Demonstrating positive E&S impacts is key to moving beyond labels and certifications. Clear, verifiable data is critical to ensure investments are reducing emissions, improving ecosystems and supporting rural livelihoods.
Impact funds such as &Green, RSCF and AGRI3 have defined the E&S objectives for the positive impacts they seek to achieve, in addition to putting in place robust risk management frameworks. Other financial institutions have joined forces in networks and coalitions such as GFFN and IFACC to adopt KPIs to demonstrate that their investments are generating the desired positive impacts. These KPIs set out a framework to monitor project impact performance, aggregate reporting across their portfolio and publicly disclose this information.
In addition to impact funds, there are a growing variety of debt funds, specialised green bonds and listed equity funds that aim to apply E&S frameworks to generate positive impacts. Early movers, such as Robeco and BNP Paribas that deploy E&S frameworks on thematic funds, can directly impact a company’s future strategy. The approach is shifting when engaging the board, attracting new talent, reporting on impacts and showing value for customers. Standardisation of these frameworks would further support diverse options for private capital to be directed towards sustainable land-use practices.
As well as providing a central benchmark, standardisation would help to create a comparable track record of successful deals. This degree of market transparency would encourage greater liquidity across the sector and support the creation of a new sustainable land use asset class.
The fund management industry is in its infancy regarding the assessment and demonstration of E&S impacts. This has raised challenges for aggregating impact results at the fund level and makes it difficult for financiers to identify where to invest capital to achieve their desired impacts.
In lieu of harmonised standards, there are a number of common challenges in establishing and implementing frameworks and indicators for monitoring E&S impacts. These include:
- the resources and costs required to undertake accurate measurements on an individual project basis, particularly for investments covering large areas where datasets are often highly fragmented or where measuring improvements in livelihoods do not easily lend themselves to cost-saving technical solutions, such as remote sensing;
- the difficulties in translating data into quantitative KPIs; and
- the lack of alignment between the realisation of investments impacts or project interventions, particularly on biodiversity, and the life of a typical investment.
In addition, many funds and asset managers remain driven by short term return expectations, which do not allow for the full extent of positive nature impacts be realised.
Ultimately regional and national regulations are required to implement and enforce standardized E&S frameworks, as demonstrated by the EU Taxonomy and SFDR, however insufficient and inconsistently enforced regulations in emerging market jurisdictions remains an ongoing challenge. UNEP is working with national institutions and FIs to strengthen domestic regulatory frameworks in order to address this challenge.
As sustainable land-use financing matures, there is an opportunity for mainstream asset owners and asset managers to capitalize on the pioneering work of impact investors and look to integrate positive E&S benefits into the way they think about the return on their investments.
It is the role of governments to mainstream E&S frameworks across the sustainable land-use sector, however established FIs also have a role to play in helping to foster wider standardisation of positive E&S impact metrics when setting KPIs and monitoring methods that will to help to make sustainable land-use an attractive asset class. By adopting a standardised approach to positive impact reporting, governments and established FIs can also begin to quantify their contribution to global commitments, such as the SDGs.
This is a unique opportunity for FIs to become positive contributors at a time of increasing pressure on the financial sector and address the joint biodiversity, climate and global health crises.
Harmonisation and standardisation
Encouragingly, progress on free, open-source E&S impact frameworks has been made this year. Through the Land Use Positive Impact Hub, UNEP, together with a group of investors and practitioners, have been working towards the standardisation of E&S KPIs and have developed a directory in the five priority impact areas of biodiversity conservation, climate adaptation, climate mitigation, forest protection and sustainable livelihoods.
These tools provide sample frameworks, however in order to be effective, a standardised E&S framework must be agreed upon and championed by the financial sector.
One of the greatest challenges to standardisation will be measuring the interdependent nature of E&S impacts. For this, FIs need to think holistically at the landscape level, to better understand the interlinkages between all activity sectors and move a risk-led approach to an opportunity approach.
A standardisation process must remain flexible to new developments in technology to address these challenges and ensure that monitoring integrity and assessment rigor is maintained across interconnected KPIs. It is equally critical that a standardisation regime is supported by robust legislation to ensure E&S impacts uphold the highest available standards of transparency and credibility.
With the increasing impacts of climate change, investment choices will also need to account for future climate scenarios, ensuring the resilience of the very ecosystems they depend on. With little information available, at the granularity required, for locally focused investments, FIs need to come together to consider climate risks and opportunities at a landscape level.
This article was co-authored by Raphaele Deau, Environment and Social Lead, Climate Finance Unit, UN Environment Programme (UNEP).