Management of nature-related risks, impacts and dependencies could soon become central to asset owners’ sustainable investment strategies.
Alongside its many harrowing and destructive impacts, Russia’s invasion of Ukraine has provided an unintentional boost to the aims of COP26. The rich countries of western Europe no longer want to buy Valdimir Putin’s oil and are scaling up their deployment of renewable energy technologies much quicker than planned, accelerating the transition to a low-carbon world.
But Putin’s war could have the opposite effect on the goals of COP15, the much-delayed UN conference to ratify the Global Biodiversity Framework (GBF) – often referred to as nature’s Paris Agreement – which is currently scheduled for Q3 2022. With Russia blockading Ukraine’s harvest and a fierce heatwave devastating India’s, there is a real risk of severe food price inflation in the global north and starvation in the global south.
At the Munich Security Conference in February, days before Russian tanks rolled across Ukraine’s borders, the Head of the World Food Programme was already predicting famine, on account of climate, conflict and supply chain dislocations caused by the Covid-19 pandemic. With no end in sight to Putin’s war, enthusiasm may ebb for plans to ringfence nature in the hope of replenishing and rejuvenating its over-exploited resources, lest unploughed fields foment hunger and instability.
Ambition needed to finalise GBF
Managing demand is as much a part of food (or, indeed, energy) security as guaranteeing sustainable supply. But the ambition needed to directly address natural resource depletion – and, in particular, the five ‘drivers of biodiversity loss’ as identified by the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES) – could prove hard to find either in Kunming, where COP15 is due to be held, or in the capitals around the world, where its promises need to become policy to have any real impact.
Much of the impetus behind the GBF comes from a 2019 IPBES report, which found that 75% of the land-based and 66% of the marine environment had been significantly altered by human actions, nearly one million species were at risk of extinction from human activities, and that climate change was significantly intensifying biodiversity loss. Alongside the five direct drivers of biodiversity loss – invasive non-native species, pollution, climate change, direct exploitation of organisms and the changing use of land and sea – IPBES also flagged society’s disconnect from and under-valuation of nature as contributing factors.
The GBF is made up of 21 targets and ten ‘milestones’ proposed for 2030 which aim to halt biodiversity and achieve recovery by 2050. The targets currently include ensuring at least 30% of land and sea areas globally are protected through conservation measures, reducing incentives harmful to biodiversity by at least US$500 billion per year, and increasing financial resources to at least US$200 billion per year.
The Kunming conference will be the second part of COP15, the first having been held online last October. The draft GBF was discussed in Geneva in March, but negotiations were so slow delegates agreed to meet again in Nairobi later this month. In Geneva, a youth delegate described the process as “watch[ing] as our hopes for biodiversity were slowly trapped between square brackets” as progress was slowed by the divergent views.
“There are still a lot of open ends in the draft framework. Hopefully the important preparatory work will be finished in Nairobi, but they only have a week,” says Anita de Horde, Coordinator at the Finance for Biodiversity Foundation.
Uncertainty over the final shape of the GBF is bad news for investors in search of clarity and direction. Finalisation of the framework is widely expected to act as a catalyst for legislative and regulatory action in 2023, with governments likely to introduce disclosure requirements covering the nature-related risks of financial institutions and corporates.
These will be accompanied by new laws bringing tougher restrictions and stipulations around interactions with nature that could have far-reaching implications in sectors with high dependencies on natural resources and ecosystem services, such as pollination. For now, wrangling over the GBF’s core objectives and supporting targets – which some argue need strengthening – will inevitably cloud an already hazy understanding for many about how businesses’ nature-related risks can be calculated and mitigated.
“It’s become clear that a lot of companies and financial institutions just don’t have enough visibility on how nature might be sitting in the risk profile of their portfolio or lending book,” says Tony Goldner, Executive Director of the Taskforce on Nature-related Financial Disclosures (TNFD).
From Paris to Kunming
Investors’ experience with climate-related risks are instructive, but only to a degree. The 2015 Paris Agreement set a single goal, of keeping climate change to 2°C above pre-industrial levels, albeit modified in 2018 to 1.5°C and translated into a target of achieving net zero GHG emissions by 2050.
It also included a pledge to align investment with its headline objective. “To accelerate private sector action, we’re looking for the GBF to include language similar to Article 2.1.c of the Paris Agreement on the alignment of public and private sector financial flows, but also to mandate disclosures to reduce negative impacts and risks,” says de Horde.
Article 2.1.c led to companies and investors being required by law to report on their alignment with Paris, typically with reference to the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).
For some, the impending requirement to manage and report on nature-related risks is a concomitant of the fight against climate change. “It’s a necessity if we’re going to achieve climate targets to extend our focus to biodiversity. I think that is very much on the investor’s radar,” says Max Boucher, Senior Manager, Research & Engagements at the FAIRR Initiative.
According to 2021 World Economic Forum report, around a third of the CO2 reductions needed by 2030 to keep the world on track for 1.5°C of global warming could come from ‘natural carbon solutions’, specifically reducing deforestation and peatland impact, peatland restoration, reforestation and cover crops.
But the timeline for mandatory reporting of nature-related risks will be much less leisurely than the seven years from the signing of the Paris Agreement to the introduction of TCFD-based rules for London-listed firms in April. With the UK’s Financial Conduct Authority designing Sustainability Disclosure Requirements, including the reporting of nature-related risks, and the European Commission planning to release this year the Environmental Taxonomy’s delegated acts around biodiversity, water and pollution, investors will need to get to grips with some unfamiliar and complex concepts pretty quickly.
As well as having less time to act, investors will have more to measure. Although the finite carbon budget offers a compellingly clear focus for climate action, accurate measurement CO2 emissions across supply chains remains elusive. The GBF covers a wider range of challenges than the Paris Agreement, including biodiversity loss, soil degradation, ocean pollution, forest depletion and more. It may in time be possible to concentrate nature-related risks into a few key indicators, or even a single metric. For now, however, many investors are in the earliest stages of understanding the nature-related risks, impacts and dependencies in their portfolios.
To this end, the market-led, UN-backed TNFD released in March the beta version of its voluntary disclosure framework, complete with a set of definitions and concepts around commercial interaction with natural resources, and its LEAP (locate, evaluate, assess, prepare) framework, designed to give practical guidance to make the concepts more tangible.
Launched in June 2021, the TNFD has been formally endorsed by both G7 finance ministers and the G20 Sustainable Finance Roadmap. Following seven principles – market usability, science-based, nature-related risks, purpose-driven, integrated and adaptive, climate-nature nexus and globally inclusive – it aims to deliver a risk management and disclosure framework for organisations to report and act on evolving nature-related risks, ultimately shifting global financial flows to nature positive outcomes. The framework will tackle the lack of information on the immediate impacts and longer-term risks nature has on organisations and the positive or negative effect they have on nature. TNFD’s 18-month consultation and development process will culminate in a final version being released in Q3 2023.
Not starting from scratch
Boucher says GBF will spark a significant shift, raising the profile of nature-related risks across the private sector.
“A lot of investors are at the starting line. Having a formal global agreement could be the pistol shot that really gets them investing in assessing biodiversity and trying to measure and address it in their portfolios. A lot of people are feeling their way around the issue and waiting for that starting shot,” he says.
While we might be on the cusp of a more comprehensive and holistic appraisal of nature-related risks, many elements are already in place, across the public and private sectors. Not only is 2022 the 50th anniversary of the first UN conference on the environment, but also the half-centenary of the Clean Water Act, which established the structure for regulating the health of US waterways.
Companies and their investors have needed to be cognisant of environmental regulation for many years. In certain sectors, they have been aware of the risks to enterprise value arising from their ongoing dependence on natural resources and ecosystem services. In others, regulation has long required detailed disclosures on environmental impacts.
“Sectors such as real estate, which heavily impact biodiversity and natural resources, currently face reporting requirements through industry-specific regulation, rather than ESG disclosure rules. Before building, they already have to consider proximity to bodies of water, for example, and other nature-related impacts. But this is information is not necessarily translated into information about biodiversity risks to investors,” says Sara Razmpa, Portfolio Manager and Head of Responsible Investment at Swiss asset manager Unigestion.
Over the past decade, both the private and public sectors have focused on reducing deforestation, but limited progress underlines the need for further action. More than 140 countries pledged to reverse deforestation by 2030 at COP26, but evidence suggest an increase rather than a decline.
Brazil, one of the signatories of the COP26 agreement, has failed to act, meaning April 2022 saw the worst month of deforestation in the Amazon on record, almost doubling the area of forest cleared compared to the previous April. According to the World Resources Institute, over 11 million hectares of forest were lost in the tropics in 2021, resulting in 2.5 gigatonnes (Gt) of CO2 emissions, equivalent to the annual fossil fuel emissions of India.
Laws prohibiting deforestation include the EU Timber Regulation, which bans imports of illegally harvested timber and derived products, the US Lacey Act and the Australian Illegal Logging Prohibition Act. Although many current commitments are voluntary and targets are typically missed, new laws are being introduced requiring firms to conduct greater due diligence across their supply chains to prevent environmental harms.
Despite increasing regulation and disclosure levels, the impact has been insufficient, not only in halting deforestation but in minimising financial risks. A recent analysis of submissions by 675 large companies to environmental disclosure platform CDP found that 211 businesses faced forest-related risks of US$79.2 billion across their operations and supply chains. Further, only 36% of firms had public company-wide no-deforestation policies.
The willingness of governments to take stronger policy action appears to be increasing, from the passing of a UN Environment Assembly resolution in March to introduce a legally binding instrument to end plastic pollution to last week’s announcement of the US’s first Action Plan on Global Water Security.
Mobilising the private sector
Just as the GBF is not ground zero for public policy action to protect nature, rather a recognition of the need to build on measures to date, so TNFD does not represent the start of the response by investors and managers.
Alongside the ‘climate-nature’ nexus and environmental protection legislation, the UN’s Sustainable Development Goals (SDGs) have also alerted the private sector to the increasing need to support and protect nature. Formally adopted in 2015, the 17 SDGs aim to promote sustainability for people and planet by reaching 169 targets by 2030, many addressing nature-related risks and impacts directly or indirectly. SDGs on hunger, water quality, and land use, for example, are widely used to guide impact and thematic investments. In response, a range of private sector initiatives have explored how to assess and integrate nature-related risks into their business models and strategic assumptions.
The Finance for Biodiversity Foundation recently published an overview of frameworks aimed at guiding and building consensus across corporates and financial institutions, segmenting them by sector and activity focus, e.g. measurement, target-setting, disclosure, policy advocacy and engagement. The foundation also offers a guide to measurement approaches for financial institutions, categorising six tools by business application, asset class, coverage, scope, metrics and data. Typically, the result of public-private collaborations, these include ENCORE (Exploring Natural Capital Opportunities, Risks and Exposures), partly developed by the UN Environment Programme.
These frameworks aim to break down the challenges for investors and other financial institutions, helping to identify the major nature-related risks, impacts and dependencies that can make the biggest differences, both to returns and regeneration.
TNFD’s Goldner admits we don’t yet have the data and tools to do this consistently and comprehensively. But he emphasises the importance of location and dependency, pointing out that the funding of facilities or projects in one site can carry very different nature-related risks and impacts to those elsewhere.
“Companies and financial institutions need to think very carefully about the impacts they’re having on nature in particular locations, their dependencies on nature in those locations and the interaction of impacts and dependencies in terms of long-term risks – to nature on one side and to business processes, cash flow and enterprise value on the other,” he says.
Notwithstanding the urgency with which data is required by investors on nature-related risks, TNFD is taking an iterative, consultative approach to its disclosure framework, aware of the many current gaps in understanding and information.
Having digested feedback to its March beta release, which Goldner describes as its “skeletal core”, TNFD’s July release will unveil its “metrics architecture”, outlining its overall guidance and approach to measurement of nature-related dependencies, impacts, risks and opportunities, with proposals for more precise metrics to follow, which may borrow or build on the existing work of standard setters and disclosure platforms.
As well as consulting with new and existing users and developers of sustainability standards, TNFD is walking in step with national and regional regulators, so its recommendations can be integrated easily into forthcoming regulations. This includes the US Securities and Exchange Commission, even though the US regulator is still consulting on its TCFD-based draft rules for climate disclosures.
Many European asset managers are already getting stuck into the minutiae of nature-related risks as they prepare Principle Adverse Impact (PAI) statements for their funds, required under the EU’s Sustainable Finance Disclosures Regulation (SFDR).
“Asset managers already have to report on biodiversity as part of SFDR which requires us to take it into account in our PAIs, or via ‘do no significant harm’ assessments,” says Unigestion’s Razmpa.
“Currently, managers are relying on biodiversity scores for companies from external data providers, which inevitably involve a level of estimation or judgement from analysts. This has merit, of course, but the finance sector will be better placed to control these risks when we have a better grasp of what we’re measuring and the underlying units of measurement.”
Goldner sympathises with these frustrations, but notes that the work being conducted in the finance sector to understand the materiality of nature-related risks is being augmented by diverse technological advances generating data that offers unprecedented levels of breadth and granularity.
“It’s become really apparent just how fast these new technologies, tools and capabilities are being developed. We’re confident that in a year or two’s time, there’ll be a quite a few things possible that only recently would have seemed incredibly difficult to imagine being part of a framework like ours. We’re encouraged by the speed of technology innovation,” he says.
Responding to risk
While new data sources come on stream and the TNFD develops its universal framework, investors can utilise the patchwork of information already available on specific areas of nature-related risks and performance, e.g. on water usage.
FAIRR Initiative’s Boucher believes it may be possible over time to derive a meaningful single rating or score for companies’ nature-related risks in the future. It would be a “hugely complicated” task, he concedes, taking in climate, water, land use change, waste and pollution, use of inputs like fertiliser and pesticides as well as natural resources, accounting also for the fact that every ecosystem will react differently to a change in the balance of those factors.
“It’s quite desirable for the market to have a single measurable figure like CO2 equivalent emissions that would reflect biodiversity as an investment factor, suitable to drive portfolio construction, reporting, target setting, and so on,” he says.
“From the investors’ point of view, it makes sense to have a single figure that can be used in similar ways to an ESG score. But at the same time, investors need to be able to understand and track those drivers of biodiversity loss. That would allow companies and investors to respond to biodiversity risk in a way that they think is appropriate.”
TNFD’s Goldner agrees with the need for simplicity, even if not to the fullest extent. “If you’re sitting on top of a trillion-dollar pension fund, it’s not that helpful having reams of data on the specific condition of one particular ecosystem that’s in some way relevant to your portfolio,” he says. “But we also don’t think that this can all be rolled up into a single number.”
These challenges are not preventing asset owners and managers from engaging with investee firms on nature-related risks. Alongside ‘Say on Climate’ votes, this year’s AGM season saw a large number of shareholder resolutions on topics relating to nature-related risks, including water use and plastic pollution.
Bilateral engagement efforts will be augmented by collaborative action, which has already been seen on climate and a range of other systemic themes. Asset owners and managers are due to launch Nature Action 100 this summer, promising “robust” dialogue as they look to scale engagement with companies and policymakers aimed at reversing biodiversity loss.
According to de Horde, detailed engagement between investors and large corporates on nature and biodiversity will be inevitable if not necessarily confrontational. “If you’re highly dependent on nature and exposed to certain sectors of the economy, such as agriculture, it doesn’t make you a bad company, but it does mean you can have more of an impact,” she says.
Handling the headwinds
There are many clouds over the negotiators as they head to Kunming for COP15, not least the risk of further delays, delegate restrictions or even a change of venue, due to China’s ongoing struggles to enforce a zero-Covid policy.
The irony is not lost on Goldner. “Covid wasn’t just a public health risk but a nature-related risk and a wake-up call to say we can’t go back to business as usual,” he says, noting the need to take coordinated action to prevent new outbreaks of zoonotic diseases.
But the bigger risk to the GBF is that discussions will be buffeted by concerns over food security, which could lead politicians to push back on targets that demand structural change. As FAIRR’s Boucher notes, the need to balance short- and long-term objectives is nothing new, but he insists that the unfolding food crisis underlines the unfitness of the current global food system. He also argues that already available solutions can bring benefits in the short term while also reducing the damage being done to nature, helping to restore the planet’s resources while also delivering to its people.
“Moving to greater use of alternative protein, which involves diverting resources from feeds for livestock, would alleviate the short- and long-term issues,” he says, additionally calling for greater use of legumes in crop rotation, and government support for manure-based fertiliser cycles, rather than subsidising fertiliser purchases.
TNFD’s Goldner agrees that the headwinds facing governments – specifically the food security crisis and the pressure on global supply chains – are “inextricably linked” to the broader crisis around our relationship with nature and the way in which we’re drawing on those resources.
“While there’s a strong tendency to go back to business as usual and try to solve these problems in familiar ways, we’re at a moment when relying on the same toolkit is going to exacerbate the risks in the longer term.”
Additional research by Jack Grogan-Fenn.