Investors discussed the practical challenges of climate- and nature- positive investing at a recent Paris roundtable hosted by S&P Global Sustainable1 and ESG Investor.
The urgency and relevance of the climate-nature nexus has been clear for all to see at COP28 in Dubai.
Last weekend (9-10 December) saw a host of events dedicated to nature, land use, oceans and food systems, including a high-level plenary discussion on “the importance of action on nature in delivering the goals of the Paris Agreement”.
In recent days, governments have signed up to the ‘UAE Declaration on Sustainable Agriculture, Resilient Food Systems, and Climate Action’, committed to fostering synergies and integration across national determined contributions, national adaptation plans and national biodiversity strategies and action plans, and unveiled various “new and ambitious” initiatives to simultaneously meet climate and biodiversity goals.
These plans and projects stem from a broadening awareness that there is no path to 1.5°C without nature, and that climate change is one of the five main drivers of biodiversity loss.
But this doesn’t make it easy for corporates and investors to reduce their carbon and nature footprints in parallel, nor to identify the investment opportunities that will help to establish a more sustainable relationship with the environment – both growing priorities, with 2030 marking key staging points for the goals of the Paris Agreement and Global Biodiversity Framework (GBF).
Asset managers and owners invited to a roundtable discussion in Paris by ESG Investor and S&P Global Sustainable1 are only too aware of the complexities they face in investing along the climate-nature nexus.
A different magnitude
“There is growing interest in Europe on integrating nature, but it’s still a challenge to approach climate and nature together, which depends partly on identifying the right data to measure both the current and future situation. There is also the question of distilling a diverse and complex topic like nature so it becomes manageable and addressable in portfolios,” said Julie Ansidei, Head of Sustainability and Engagement, EMEA at BlackRock.
The challenge of understanding and managing one’s financed greenhouse gas emissions is an ongoing one for all financial institutions, but getting to grips with risks, impacts and dependencies on nature is recognised as a task of a different magnitude.
Nevertheless, it is what companies and investors will soon be asked to do under Target 15 of the GBF, which encourages governments to set comprehensive reporting requirements, as a key underpinning of its headline goal of protecting and conserving 30% of marine and terrestrial habitats by 2030. In addition, Target 14 requires governments to ensure public and private finance flows are aligned with this objective.
The GBF is less than a year old, meaning investors are still finding their feet, while guidance and regulation are still being developed.
“With climate, we know what the pathways are. But we’re in the early stages of defining what nature positive is – is it just reducing impact or is it financing projects that actually help restore nature?” said Maeva Siga, Analyst at Lombard Odier.
“There are still a lot of questions, and in order to facilitate the comprehension of nature risks and opportunities, it is crucial for investors and companies to take into account the framework provided by the Taskforce on Nature-Related Financial Disclosures (TNFD), and to move forward with nature disclosure by adjusting as we go.”
As Siga suggests, factoring climate change into investment decisions is more of a known quantity, if far from an exact science. The experience of climate-conscious investing can benefit efforts to align with the GBF, including a familiarity with double materiality, which Roslyn Stein, Senior ESG Strategist, AXA IM Prime, regards as crucial.
“Our approach to reconciling and accommodating nature and climate factors, on both the risk and opportunity sides, is to understand the nexus between the two,” she added.
“The Finance for Biodiversity Foundation has put out some useful materials to help investors understand the synergies and trade-offs. It’s important to recognise that these will always exist as we pursue nature and climate objectives.”
Recognising the tensions as well as overlaps of the climate-nature nexus, Stein nevertheless saw “appetite to pursue opportunities” in nature-based solutions (NbS), which can contribute to reducing the impacts of human activity on nature, while generating carbon credits that will contribute to climate mitigation.
NbS projects typically sequester carbon while simultaneously restoring or conserving land by using more regenerative agriculture or forestry techniques, or returning it to nature. But they face similar transparency and accountability issues to voluntary carbon markets (VCMs), where questions have been raised about the extent to which credits or offsets are actually helping to lowering emissions.
Projects that restore land through sustainable agriculture and forestry have the potential to generate biodiversity credits too. But lessons must also be learned, in terms of size, transparency and investor appeal in order to drive more capital to climate- and nature-positive investments.
“Finding investible projects can be a challenge. There is sometimes a lack of projects with the scale and risk/return profile to attract institutional investment,” said Laura Kaliszewski, Global Head of Client Sustainable Investment Solutions, at Natixis Investment Management.
“There is a need for more cross-industry collaboration to offer the right incentives to support the transition to a climate- and nature-positive economy. We also need new solutions to deliver renewable energy capacity to countries with most demand, and greater collaboration to leverage public sector finance to attract more private sector capital.”
Size matters for a number of reasons, according to Gautier Quéru, Investment Director and Land Degradation Neutrality (LDN) Fund Project Manager at Mirova.
“The number of hectares put under conservation or restoration is important, given that the goal of the GBF is to increase this area globally by 2030,” he said.
“The key is to ensure that there are solid practices on the ground that are truly reliable and governed by standards, not false solutions subject to controversy. A very intensive monoculture, for example, can be good for climate, but will not be for biodiversity.”
Quéru argued the case for market participants coming together to ensure high standards of transparency and accountability are maintained.
“We know there is debate around VCMs but these are improving in terms of integrity and governance; biodiversity credits need to take account of these issues from the beginning. Commodity certifications can be useful, but in the end it’s really about improving the reliability of standards set by third-party service providers.”
Stein said that investors needed to apply the same levels of due diligence “as any other acquisition”, but acknowledged the steep challenges set by the nature of NbS investments, which can involve multiple stakeholders, impacts and links in the transaction chain, not to mention extended time horizons.
This can require time on the ground and having the networks to be able to understand what’s happening in more remote projects, as well as having the tools to track impact, roundtable participants noted.
“Third-party providers can provide a level of comfort. Initiatives that can improve transparency – not just for investors but other stakeholders – are also important. I’d also emphasise the importance of transparency and methodologies used to assess and certify projects,” added Stein.
Dealing with uncertainty
With certain NbS schemes, investors can help turn brown into green almost literally, but investments in other types of transition – which require established firms to manage climate and nature risks by reorientating their business models or supply chains – can be no less data-intensive.
Investors are keen to fund the transition to net zero, but somewhat less so to take a leap in the dark. Understanding investee firms’ next steps is a priority.
“Investors want to see credible [net zero] transition plans. Rather than long-term targets, they want to know what will be happening one year from now and into the mid-term. They also want help in challenging the data and understanding what is and isn’t critical,” said Kaliszewski at Natixis.
Transition plans are currently hard to analyse and compare, partly because they are still a relatively new obligation, with guidelines and the prospect of regulation expected to increase consistency and transparency over time. Equally, the perspectives and requirements of institutional investors are far from uniform.
“We regularly discuss with asset owner clients their needs around metrics and analytics, which can differ according to the current status of their decarbonation journey, the frameworks and targets they’re using, and how they want to implement targets at portfolio level,” explained BlackRock’s Ansidei.
While it’s important to have a view of how the transition will unfold in order to advise clients trying to understand the net zero pathways of various industries, asset managers need to be alive the need to adjust to circumstances.
“We all have to acknowledge the uncertainty we’re dealing with, knowing that we will have to adapt our view of the transition according to factors such as policy intervention, technology innovation and consumer preferences,” said Ansidei, nevertheless adding:
“We see interest among certain asset owners regarding how they can contribute to the climate challenge beyond portfolio decarbonisation, for example through increased investments to support the transition in private markets or emerging economies.”
The data challenge
French investors have had to weigh nature considerations alongside climate-related risks sooner than most, largely due to Article 29 of France’s Energy-Climate Law, which requires reporting of climate and biodiversity risks and impacts by large corporates and financial institutions. While this first-mover position may have its upsides in the long term, it has left asset managers and owners with obligations before they necessarily have all the tools to do the job.
“Understanding and managing the biodiversity footprint of one’s investment portfolio is an important issue in France. Lots of providers are offering metrics, but this is very ‘high level’ at the moment, highly modelled and not really linked to reality,” said Alina Maria Moldovan, ESG Analyst at Kepler Cheuvreux.
Measures of biodiversity ‘intactness’ such as mean species abundance and potentially disappeared fraction have grown in use, but are treated with caution by some due to concerns over the assumptions underlying their methodologies. Elsewhere, progress is more promising.
“At a more granular level, investors are bringing together data on the five core contributors to biodiversity loss and modelling that into company assessments. The data does exist; it’s not perfect, but it is possible to develop models with which to build a biodiversity score,” said Moldovan.
The challenges of sourcing nature data are near universal across the finance sector. In September, the central banks and securities regulators of the Network for Greening the Finance System (NGFS) acknowledged that their initial analysis of physical and transition nature risks was limited by “uncertainties and data restraints”. Nevertheless, the NGFS is pushing ahead with its efforts to support members’ understanding of the “material macroeconomic, macroprudential, and microprudential consequences” of nature degradation.
“There is so much nature data out there that accessing it, bringing it together and turning it into investment-relevant data is a real challenge,” said Lauren Smart, Chief Commercial Officer, S&P Global Sustainable1.
“There needs to be more financial analysis done on nature-related data sets, and more examples of practical applications of using data. Learning while doing is absolutely vital, because we can’t afford to wait, given the time horizons we’re dealing with.”
Even with imperfect data, today’s analyses are enabling investors to understand the risks, impacts and dependencies of larger firms in their portfolios and partnering with them accordingly.
“We’re working with corporates in sectors like food, and beauty and fashion, which rely heavily on natural capital, to reduce their carbon and nature footprint, by providing financing within their supply chains to produce better and more with less, for instance, via regenerative agriculture,” said Quéru at Mirova.
Kepler Cheuvreux’s Moldovan said a growing range of upsides were presenting themselves.
“We’re beginning to look at nature-positive opportunities in public equities. Agri-food, for example, is the sector with the largest impact on biodiversity. We know we need to transition towards more efficient agriculture and improved traceability. These are leverage points,” she observed.
“We’re also looking top-down to see who is providing solutions, such as geolocalisation or drip irrigation tools and services, also factoring in the extent to which these solutions are strategically important to the providers. It will take time to model accurately, but in the meantime, we can look at those actors that are pushing the right levers.”
Sticks and carrots
But at this early stage the overall picture is mixed, with firms in many sectors slow to invest in the capabilities necessary to understand their nature footprint more fully, in the absence of the stick of regulation or the carrot of higher profits. According to Geoffroy Dufay, Head of Nature Products and Analytics at AXA Climate, many corporates do not yet consider nature-related risks and impacts as material and as such are cautious about prioritising expenditure and action at the strategic, rather than the operational, level.
“Corporates understand that financial institutions want data points that can be compared with other companies or different sectors. But corporates also ask how these data could be useful internally, for instance to work on their strategy and operations, or even using data points to concretely deal with their sourcing strategy or the environment around their sites,” he said.
There can be a big gap between the underlying data – e.g. water consumption to inform usage reduction plans – and estimations of that data at the portfolio level to inform risk management strategies.”
For Hans Moussavou, Head of ESG Research and Reporting at Amiral Gestion, the biggest challenge – and possibly also the biggest opportunity – lies further along the value chain.
“Mid and small caps are aware that there is an opportunity for them in the next few years, but quantification is a big challenge due to issues around data quality and collection,” he said.
“For climate, we have some existing models and experience to critique and to challenge the data, but it will be different for biodiversity. We will still need data providers, but the companies themselves will have a deep and important role to play, perhaps in an enhanced multi-tier collaboration model that remains to be further defined.”
Dufay agreed that nature and biodiversity risks present new challenges with potentially high costs to report and manage. While the final recommendations of the TNFD offer a valuable framework, the corporates and investors needed to prioritise their analyses, he said, rather than attempt a comprehensive assessment at the outset; a point made by the taskforce itself.
Even so, identifying the most material nature-related risks can be a complex and multi-faceted task, not least in a policy environment that is currently far from aligned with the targets of the GBF.
“The definition of nature scenarios to perform risk and opportunity analyses needs to be very specific – maybe more than for climate – to consider the specificities of the sectors and the geographies,” said Dufay.
“The perfume industry, for example, is heavily exposed to water scarcity in theory. But until now, many exemptions were granted to enable supply in periods of water stress. When we build a scenario, a key question is: when will the situation change and transform the risk profile of these companies?”
The pace of change in the regulatory landscape is beginning to accelerate. Alongside France’s Article 29 is a raft of European regulation, including – but not limited to – the EU Deforestation Regulation, Nature Protection Law and the Corporate Sustainability Due Diligence Directive, all of which have potential implications for our use of nature’s riches.
Unforeseen events may drive regulatory change further and faster than currently anticipated, suggested Frederic Samama, Head of Strategic Development at S&P Global Sustainable1.
“There was a time when the power was with the car makers rather than regulators. Then an NGO in California triggered the VW scandal and regulators rapidly took action in a number of jurisdictions to enforce and enhance the rules. That’s a case study of the impact of unforeseen event on regulation. There’s no way to put that into a model,” he said.
In terms of the climate-nature nexus, the pace of change is already quickening. On Finance Day at COP28, governments and NGOs issued a joint call for countries’ future nationally determined contributions to the Paris Agreement to include nature. They also proposed that the outcome of the Global Stocktake should support “combating land degradation, reversal of biodiversity loss, restoration of ecosystems, avoidance of the worst impacts of climate change and fostering climate-resilient development” through enhanced international cooperation.
Unveiled last weekend, the UN Food and Agriculture Organization’s Global Roadmap outlines plans to meet food security and nutrition goals within the context of the objectives of the Paris Agreement and the GBF.
As we have seen increasingly over the past decade, developments at the policy level will soon have far-reaching implications for financial institutions, for their decision-making processes, their offerings to beneficiaries and clients, and for their resources and partnerships.
“Above all, we need to improve the internal expertise of fund managers and asset owners,” said Quéru. “Institutions need to hire agronomy and biodiversity experts, just like they’ve been hiring energy specialists for the past 15 years.”