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ESG Explainer: Biodiversity Risks and Impacts

Regulatory guidance for investors and corporates is gaining momentum but still lags climate-focused frameworks.

In the next few months, one of the more overshadowed aspects of investors’ environmental concerns – after climate change – will increase in visibility due to the UN Biodiversity Conference (COP15), which will take place in April and May in China.

2022 will also see the launch of several large frameworks – both compulsory and voluntary – which will impact how investors manage and report on biodiversity risks and impacts. Here, we explain some of the big moves and measures aimed at protecting and restoring natural capital.

Why do investors need to pay more attention to biodiversity risk?

Without biodiversity, nature cannot be productive, resilient, and adaptable. “Just as diversity within a portfolio of financial assets reduces risk and uncertainty, so diversity within a portfolio of natural assets increases nature’s resilience to shocks, reducing the risks to nature’s services,” said the UK government’s ‘The Economics of Biodiversity: The Dasgupta Review’ report.

Whilst progress is being made in better managing humanity’s environmental impact on the planet there is still overuse of its finite resources.

“Biodiversity is just one of the many planetary boundaries in the ecosystems that we rely on,” says Dr Helena Wright, Policy Director at the FAIRR Initiative. “The regulatory environment is strengthening, which means transition risks for investors are increasing.”

However, biodiversity is still an often misunderstood or side-lined issue. To achieve UN Sustainable Development Goals and net zero targets many believe better stewardship of and investment in natural capital is needed.

But investors can only do so much without more detailed guidance on risks and impact.

What can investors do to help?

The quickest way to achieve better biodiversity action would be for investors to stop funding businesses that over-utilise natural resources, investing instead in funds and projects that protect and sustain them. This is harder said than done, due to a current lack of transparency on risks and impacts, as well as the complex relationships and dependencies with ecosystems.

Action on biodiversity is several years further behind climate and frameworks to disclose and report on natural capital risks and impacts are still being developed.

Andrew Mitchell, Vice-Chair of the Taskforce on Nature-related Financial Disclosures (TNFD) Stewardship Council, says investors should look at more ignored areas of biodiversity to do the most amount of good – one example being oceans.

“They have been left out as the poor cousin of the piece because nobody knows how to deal with their problems yet. Oceans are so important, and they suffer from illegal fishing and there is the plastic pollution problem,” he explains. “Apart from a big knee jerk reaction on plastics a few years ago, I’m not sure we are seeing a huge amount of investor action around oceans.”

What recent steps have been taken by policymakers and investors to support biodiversity?

Greater awareness around some of the most obvious biodiversity risks such as deforestation and illegal animal trafficking has gained momentum, leading to legislation and increased scrutiny. Overuse and degradation of the oceans, as Mitchell mentioned, has also started to see attention.

In 2021, biodiversity went up the agenda for policymakers, disclosure bodies and financial institutions, both due to COP26 in November and the first leg UN’s COP15 Biodiversity Conference in October. As a result, new standards, initiatives, and products are being launched to help investors bolster – or at least avoid damaging – biodiversity.

From a policy perspective, Europe and the UK are ahead of the rest of the world, but pressure for change is mounting in many jurisdictions. In 2021, the US Securities Exchange Commission (SEC) proposed climate disclosure guidance, and its request for public comment on its potential rulemaking elicited calls for separate mandatory biodiversity risk disclosures from the likes of US Senator and former presidential candidate Elizabeth Warren.

Here, we cover some existing policy initiatives and those set for implementation soon.

COP26 pledges The voluntary deforestation pledge signed by 141 countries at COP26 in 2021 was intended to stop some of the world’s biggest carbon sinks from being lost and target the causes of deforestation.

The COP26 pledge commits governments to “emphasise the interdependent role of biodiversity and sustainable land use in enabling the world to meet its sustainable development goals”.

The pledge included promises to “ensure systems are in place to accelerate the transition to an economy that advances biodiversity and climate goals”.

Some were not convinced the deforestation pledge would look at the whole picture and that it ignored root causes, including poverty.

Separately at COP26, 45 governments pledged investment to protect nature and shift to more sustainable agriculture and land use, including a Just Rural Transition.

EU Common Agricultural Policy revision – In November 2021, the European Parliament passed revisions to the Common Agricultural Policy (CAP), which included controversial eco-schemes. Much of 2021 saw investors lobbying for changes to the CAP to improve biodiversity provisions. Whilst, overall, its scope is wider, there remain concerns the CAP does not go far enough to protect natural capital.

UK post-Brexit initiatives No longer part of the EU or its CAP, the UK has two forthcoming pieces of legislation that both help to improve the transparency of biodiversity risks and impacts.

The UK Environment Act 2021 is in the final stages of parliamentary approval and includes targets for improving the natural environment. Its wide remit will mandate more reports about environmental protection, nature and biodiversity, and conservation covenants, including along supply chains, from both the state sector and private enterprises. It will also include a 10% biodiversity net gain requirement for infrastructure projects.

The second piece of legislation will introduce the UK’s Sustainability Disclosure Requirements (SDRs), which are intended to create a framework that brings together sustainability-related reporting requirements for corporates and financial institutions. SDRs were designed to broaden UK sustainability reporting, which currently focuses on climate-related risks, to cover a fuller range of issues. The UK has based its climate reporting regime on the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD). However, SDRs also require double materiality and will look at other environmental impacts and risks beyond climate change.

These frameworks will impose legal requirements, but it could be several years before they see legislative approval and feedback from stakeholders could see changes made.

Will investors get more guidance on biodiversity risks and impacts in 2022?

As more guiding principles are brought in, a key facet will be whether they are voluntary or compulsory, which could impact their effectiveness as biodiversity protection.

TNFD’s Mitchell says upcoming initiatives are giving brand new information to institutions. Starting with voluntary guidance works well, he says, as it gives those affected a chance to get ready for compulsory measures. “We have to make it not so complicated that it’s impossible to use, not make it so easy that it is meaningless. That takes time in the voluntary phase to figure out, with testing.”

Voluntary disclosure bodies are developing reporting standards for biodiversity risks, which should also help identify hazards.

Global Biodiversity Framework – In October 2021, the first leg of the UN Biodiversity Conference (COP15) took place virtually, where a draft Global Biodiversity Framework (GBF) was finalised, ahead of formal adoption when delegates meet in Kunming in Q2 2022.

The Kunming Declaration – the confirming agreement on the GBF – has been compared with the Paris Agreement due to the scope of its ambition. Its 21 targets and 10 milestones hope to spur regulation and investor action, notably Target 15, which requires businesses to report on their dependencies and impacts on biodiversity.

Currently, there are several working groups finalising and adding details to the draft, including plans for how it will be furthered.

At the Kunming conference, the post-2020 group said it will unveil an agenda to push governments on goals for nature over the next decade.

“This will be a framework that will have targets in it and ways in which biodiversity impact can be measured, and essentially saying no net harm to nature by 2030; 30% of the world protected by 2030, and half the world protected fully by 2050,” says Mitchell.

Taskforce on Nature-related Financial Disclosures (TNFD) – One of the largest biodiversity reporting measures unveiled this year will come from the TNFD. It will release its draft framework for reporting risks in Q1 2022. This aims to bolster the availability and quality of data needed by organisations complying with its reporting framework.

TNFD released two reports in 2021, ‘Nature in Scope’ and ‘Proposed Technical Scope’, which outlined the proposed scope of its framework and its timeline for further developments and research between 2021-2023. The TNFD will borrow from the existing Task Force on Climate-related Financial Disclosures (TCFD) framework, but unlike TCFD it will be designed for corporates and investors to report on impact as well as risk.

TNFD was designed to give more thought to nature, instead of environmental efforts being centred around climate, Mitchell says.

International Sustainability Standards Board (ISSB) – In 2021, the IFRS Foundation announced the formation of the International Sustainability Standards Board (ISSB), with the aim of providing a baseline standard for sustainability reporting that can be adopted by companies globally, with an initial focus on climate disclosures.

The ISSB is taking a climate-first approach, with its first standard expected to be finalised by Q2 2022, As it was formed partly by the subsummation of the Climate Disclosure Standards Board (CDSB), the CDSB’s recent consultation on a biodiversity standard could be adopted by the ISSB.

EU regulations – The EU has several proposed pieces of legislation with the potential to protect biodiversity but has had stilted progress on the topic to date, partly due to differing agendas between members states. Investors also warned that unsustainable agricultural practices could be added to Europe’s green taxonomy, via a complementary delegated act similar to the one unveiled in December. This means investors could potentially find themselves allocating capital to funds that might not be classed as sustainable under other definitions.

EU supply chain due diligence The European Commission has proposed several measures with the potential to increase transparency along supply chains which could help investors to understand the biodiversity risks and impacts in their portfolios.

A legislative initiative on sustainable corporate governance was intended to impose requirements on company directors to take greater responsibility for human rights and environmental impacts along their supply chains. However, the proposal has met with strong opposition from business and has been delayed several times.

Separately, the Commission has proposed initiatives introducing mandatory due diligence rules for importers of specific commodities associated with deforestation and forest degradation. Importers of products including soy, beef, palm oil, wood, cocoa and coffee and some derived products, would be required to collect the geographic coordinates of the land where the commodities were produced.

Corporate Sustainability Reporting Directive (CSRD) – This proposed reporting framework is due to replace the Non-Financial Reporting Directive (NFRD) as the key European legislation covering sustainability reporting by corporates. The European Financial Reporting Advisory Group (EFRAG) and the Global Reporting Initiative (GRI) are collaborating on the development of supporting standards. The updated directive will require over 50,000 firms to provide a non-financial statement on a series of ESG-related factors and, through the Article 8 Delegated Act of the Taxonomy Regulation, disclose their alignment with the taxonomy’s environmental technical screening criteria.

EFRAG aims to submit a draft EU standard to the European Commission by June 2022. Separately, the GRI aims to publish an updated GRI Biodiversity Standard in the second half of 2022.

Are we on the right path?

Although many jurisdictions are expected to bring forward measures this year to manage and protect biodiversity, it is likely the Global Biodiversity Framework will be the game-changer.

Mitchell says the legislation is ambitious, thorough and will encourage investors and regulators to think about the infrastructure needed to place a value on natural capital. “If you don’t look after 50% of the infrastructure, it won’t be good enough to keep the other half running. However, I don’t think the world is mature enough yet [for it].”

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