Dr Rossa Donovan, Technical Director at Nature Positive, outlines why investors must demand a recent biodiversity footprint as part of routine due diligence.
Investment professionals are becoming more practiced in considering their targets’ carbon reporting procedures and results. While this is not yet completely straightforward, guidelines and frameworks have been developed to help with due diligence activities by ensuring carbon performance and governance is consistently reported.
However, investment teams are less practiced in asking whether a recent biodiversity footprint has been carried out, whether there is a biodiversity strategy and action plan in place, whether evidence-based biodiversity targets have been set, and whether the company is already reporting on its progress to becoming nature positive. Some will of course be checking whether the opportunity meets the International Finance Corporation Performance Standard 6 (IFC PS6) and the World Bank Environmental and Social Standard 6 (ESS6). But most will currently not be able to do much more than this.
This is not the fault of investors. Corporate biodiversity governance is not as advanced as that for carbon. The tools and frameworks required to measure and report it – for example the World Benchmarking Alliance’s Nature and Biodiversity Benchmark – are still being developed.
However, a company’s biodiversity footprint has the potential to carry more risk than its carbon footprint. The significance to investors of biodiversity impact will only increase as companies that continue to negatively impact the natural world come under increased scrutiny and pressure to change their practices.
Investment professionals therefore need to understand the relationship which a potential investment opportunity has with nature before taking the plunge. High level screening of impacts to, and dependencies on, biodiversity as part of the due diligence process can quickly rule out sites and activities that are likely to have the greatest negative impact on nature.
Screening can also determine if the potential investment opportunity will meet the standards of IFC PS6 and the World Bank ESS6. After this sifting process, more detailed biodiversity baselining and supply chain risk assessments should take place to provide a more detailed understanding of the risks, and whether they can be controlled or eliminated, and the dependencies that the business model has on nature.
However, companies are not making it easy. Compared with carbon, it is troubling that many CEOs don’t seem to have a comparable grasp on either what their companies’ impact on nature is or what they need to do to reduce that impact by setting appropriate targets. Even where they have set science-based targets (SBTs) to achieve to net zero emissions, many companies do not factor in the importance of achieving this without damaging wider biodiversity and natural capital.
Indeed, we recently reviewed the progress of the UK’s FTSE 100 in tackling biodiversity-related issues, and found that that only 64 made reference to biodiversity in their annual reports. Of these, 12 companies made only a passing reference to biodiversity without any substantive analysis as to how it affected their business. Therefore, almost half of the FTSE 100 companies have yet to interpret how the natural world supports their business. This is likely to also be the case for non-FTSE 100 companies.
Wielding the right tools
The tools and frameworks available for investors to make an assessment of biodiversity targets or strategies are still evolving. The following issues should be considered when trying to understand a company’s relationship with nature.
When carrying out due diligence of a potential investment, it is advisable to carry out a high-level screening of locations and activities to flag any potential risks, and then carry out a risk assessment of the company’s or portfolio’s nature-based impacts to determine whether they align to the IFC PS6 and World Bank ESS6 standards.
The IFC PS6 objectives are intended to protect and conserve biodiversity and habitats, maintain the benefits of ecosystem services and promote sustainable management of living natural resources. The World Bank ESS6 objectives are similar to the IFC PS6 and aim to implement the protection of people and the environment.
Together, these standards represent minimum compliance for lending decisions. IFC PS6 has been adopted by the Equator Principles’ financial institution members when making lending decisions. In addition, under ESS6, bank funds cannot be used to finance projects that involve significant degradation of critical habitat.
For more in-depth analysis, biodiversity baseline assessments and supply chain risk assessments should be considered. A biodiversity baseline assessment will assess a company’s direct operations – those within their direct financial or operational control – and the impact that these have on nature. This involves looking at the locations of sites and known activities and cross-referencing them against biological records within those areas.
A company’s direct impacts on nature are usually better understood and smaller in scale, and most will have strategies and action plans to control or reduce them. However, like carbon emissions, indirect biodiversity impacts – those that sit within a company’s value chain – are likely to be both less understood and much more massive in scale.
Supply chain risk assessments can be used to assess a company’s indirect impacts and dependencies on nature. This involves looking at the whole upstream supply chain: where raw materials are sourced, how they are extracted and processed, where the factories are located, how materials or products are transported, and how the staff are treated. This information should then be cross-referenced with the geographical location and biological records within those areas.
Many raw materials and commodities such as soy, palm-oil, timber, paper, beef, leather and coffee come from areas of high biodiversity, with the environmental protection of their extraction and production varying greatly according to the location and company. Often, a company’s supply chain will be made up of many smaller companies or family businesses that are unlikely to have the same level of environmental and social governance as the company about to be invested in.
This same process can also be applied to a company’s downstream value chain. This will involve assessing the impacts of distribution, packaging, transport and consumer use and disposal. Biodiversity impacts, and any financial risks associated with them, are likely to be greatest in the upstream part of the value chain. However, as we have seen with plastic pollution, they can easily become a problem downstream too. Taken together, this in-depth analysis of the direct, upstream and downstream impacts will provide a picture of the company’s biodiversity footprint and help inform investment decisions.
Following the science
Biodiversity footprints tend to differ by sector.
The food and beverage industry has the greatest potential to impact. It also has the highest dependency on biodiversity, as it relies heavily on large volumes of imported ingredients, often from areas of high biodiversity. However, other sectors such as chemicals, construction, cattle farming and refineries, coke production and nuclear energy all rely heavily on international imports.
In carrying out their due diligence, investors should check whether companies have established their biodiversity footprint already, as this will provide a good indication of whether they are managing their biodiversity risks adequately. Investors should also look for either a separate biodiversity strategy, or for biodiversity to be integrated into the company’s sustainability strategy. Importantly, there should be an action plan and credible targets linked to this strategy and a roadmap of actions and milestones that need to be reached to get there. Targets can be many and varied, but ideally they should be evidence-based and ambitious.
As with carbon, it is now possible to set science-based targets for nature (SBT4N). The advantage of doing so is that this provides a company with evidence-based actions and steps to take to achieve no net biodiversity loss by 2020, biodiversity net gain by 2030 and full ecosystem restoration by 2050. No companies have yet had SBTs for nature formally accepted, but awareness of them is growing fast. Companies considered to be sustainability leaders should be looking to set SBTs in the near future.
Companies that already have a good understanding of their relationship with nature should be seen to be managing their nature-related risks proactively and be reporting on what they are doing in a transparent and meaningful way. While a variety metrics and tools currently exist to measure and monitor corporate performance based on biodiversity impacts, important work is currently being done to provide standardised methods for evaluating risks and dependencies. One such example is the World Benchmarking Alliance’s Nature and Biodiversity Benchmark methodology mentioned above. The first iteration of this is likely to published in November 2022.
Other initiatives are being developed to ensure businesses disclose their biodiversity impacts and dependencies in a standardised way, and to report on internal governance arrangements to oversee the delivery of their strategies and targets. From 6 April, 2022, over 1,300 of the largest UK-registered companies and financial institutions will be required to disclose the financial risks across their portfolios from climate change in line with the Taskforce on Climate-Related Financial Disclosures (TCFD) reporting framework. In a similar way, non-financial companies and financial institutions will likely be required to report and act on evolving nature-related risks in line with the Taskforce on Nature-Related Financial Disclosures (TNFD).
Going forward, investment professionals must make it a routine part of their due diligence activities to ask to see a recent biodiversity footprint. This really is the gold standard in understanding biodiversity-related risks and dependencies, and is a necessary precursor for developing coherent strategies, action plans and credible targets.