Dr Anthony Kirby, Head of Regulation and Risk for Asset Management and Capital Markets in Europe at EY, considers the challenges of nature-related reporting for UK asset managers.
There is general agreement that the human species relies on natural ecosystems and biodiversity for everything – from daily essentials such as food, clean water, medicines, energy and raw materials, to culture and well-being. The World Economic Forum estimated its monetary value in 2018 to be equivalent to an estimated US$125 trillion worth of economic, natural and social capital.
What is the TNFD?
The arrival of the Taskforce on Nature-related Financial Disclosures (TNFD) was announced as early as July 2020. The purpose was to address the catastrophic loss of nature and biodiversity, acting as a source of systemic risk and instability for markets and the financial system, and thence impacting countries, corporations and financial institutions.
The TNFD was officially launched in June 2021 with an overarching aim to align corporate reporting and financial spending to alleviate nature-related risks. It was supported by an informal technical expert group, and a founding partner group consisting of Global Canopy, UNDP, UNEP FI, and WWF, to develop recommendations for more effective nature-related disclosures in order to promote more informed investment decision-making. Two years later, 19 September 2023 marked an important milestone – the publication of a final version (version 1.0) featuring standards, covering the voluntary reporting of nature-related risks and opportunities for businesses globally.
The final version was set up to address the information gap between various firms’ interactions with biodiversity in nature and the impacts on financial performance and longer-term financial risks. Its significance in that regard is obvious and as such has been widely endorsed by corporates, financial institutions, governments, regulators and civil society. It is not expected that the rules should apply to overseas firms accessing the UK by way of the temporary permissions regime.
What are the TNFD recommendations?
The 14 TNFD recommendations are designed to be consistent with the four critical pillars of the Task Force on Climate-related Financial Disclosures (TCFD), the International Sustainability Standards Board (ISSB) and Global Reporting Initiative (GRI) standards, and are set to accommodate the different approaches to materiality taken by, for example, the ISSB’s first two IFRS sustainability disclosure standards, the climate reporting platform CDP and GRI standards.
To that end, there are important commonalities with the TCFD recommendations which are already regarded as mandatory in the UK, Switzerland, Hong Kong, Singapore and New Zealand/Aotearoa.
- Governance e.g. The board’s oversight of nature-related dependencies, impacts, risks and opportunities; and the management’s role in assessing and managing the same.
- Strategy e.g. The identification of short-, medium- and long-term dependencies, impacts, risks and opportunities; The effect of nature-related issues on the firm’s business model, value chain, strategy and financial planning; and the resilience of the firm’s strategy to nature-based risks.
- Risk and Impact Management e.g. How a firm identifies, assesses and prioritizes nature-related issues in its direct operations? How it does the same in both its upstream and downstream value chains? And the processes for managing nature-related dependencies, impacts, risks and opportunities.
- Metrics and Targets e.g. The metrics used to assess and manage nature-related risks and opportunities and Metrics used for dependencies and impacts. The TNFD is seeking feedback on the metrics for financial institutions at the time of writing.
There are three additional components which feature recommendations which go over and above those required under the current version of TCFD as follows:
- Governance (additional beyond TCFD) – Human rights policies and engagement on human rights from the board with respect to indigenous people and local communities;
- Strategy (additional beyond TCFD) – Sensitive locations of assets or activities in direct operations, as well as in upstream and downstream value chains; and
- Risk & Impact Management (additional beyond TCFD) – How nature-related processes are integrated into the overall risk management process.
What type of reports are in scope?
The TNFD rules are likely to apply at an entity-level, as a first step, and if the TCFD is a future guide, we could see prudential regulators looking to track comparative progress with the former, leaving conduct regulators to focus on areas such as managing conflicts of interest and competition in future product reports.
TCFD precedents at an entity-level suggest that the corresponding TNFD reports could take the form of annual reports, taking into account nature-related risks and opportunities in managing and administering investments on behalf of clients. The format of such reports are likely to become standardized according to the formats described above over time, featuring management accountabilities and clarifications as to why a firm:
- has not met its targets and/or
- if a firm has not set any targets if falling within the scope of the TNFD measures.
Regulators and end investors will expect reports to be published in an easily comprehensible manner on a prominent place on the firm’s website, covering all assets managed by the firm including those assets delegated to third-parties such as vendors or third-party managers. The appetite for regulators such as the Financial Conduct Authority (FCA) to press asset managers to provide details of product level reporting in the same manner as the TCFD will need to be assessed in due course.
Disclosure challenges and the LEAP framework
The ability to satisfy both qualitative and especially quantitative elements of TNFD reporting will depend on the availability of trustworthy core data e.g. featuring targets and goals set in relation to nature. To date, we estimate roughly one in five data vendor companies carry biodiversity data, yet only a subset – perhaps one in eight – carry elements which immediately map to TNFD requirements, a significant shortfall.
The FCA has already clarified it will likely not require firms to disclose information if data gaps cannot be addressed as an industry level, but the regulator could expect that asset managers explain where and why they have not disclosed particular data, plus the steps those firms are taking to address any gaps. It remains to be seen whether the FCA insists that firms link gaps with the requirements to prevent harm under this year’s consumer duty measures, and require firms to provide adequate evidence to indicate proper due diligence in avoiding intentional greenwashing.
The good news is that TNFD has also developed a framework called LEAP – A nature-based opportunity and risk assessment framework developed for financial services firms, the latter based on the methodology:
Locate, Evaluate, Assess, Prepare (for TNFD)
- Locate the interfaces with nature;
- Evaluate the nature-related dependencies and impacts;
- Assess material nature-related risks and opportunities;
- Prepare to respond and report on nature-related risks and opportunities.
Where to next?
Some market participants such as pension funds, sovereign wealth funds and insurers are hopeful that TNFD could mark a pivot point that sees companies and investors start to consider the impact of their actions on nature – referred in some European quarters as giving consideration to impact materiality.
Governance, policies and procedures for data collection and nature governance structures will be enhanced, in preparation for alignment with TCFD and ISSB/European Sustainability Reporting Standards reporting as well as the myriad of other mandatory ESG reporting requirements coming through into law over the next three to five years. Asset manager firms should be able to take a more standardised and rigorous approach to risk assessment provided that there is interoperability between system providers and data vendors.
And there’s the rub. Many firms could become reliant on TNFD-aligned products derived from investors who are not taking liability, from companies which are missing vital datasets or from firms who cannot present the data in a useable format. Mapping assets and identifying opportunities and risks across environmental biomes is one thing – extracting specific and relevant biodiversity data such as remote sensing metrics (RSM), mean species abundance/loss (MSA/L), potential disappeared fraction (PDF), product biodiversity footprint (PBF) or Species Threat Abatement and Restoration (STAR) in a consistent manner across priority nature-risk locations which span different countries with varying regulatory regimes is quite another.
Further, this quarter could be an especially busy one in the FCA’s calendar. Firstly, the FCA welcomed the ISSB launch of its first sustainability-related reporting standards, the General Requirements for Disclosure of Sustainability-related financial information (IFRS S1), and the requirements for Climate-related Disclosures (IFRS S2) on 26 June 2023. According to the FCA, these standards answer the clear market demand for complete, consistent, comparable and reliable corporate sustainability disclosures.
Secondly, the UK’s Transition Plan Taskforce (TPT) and its dedicated nature working group has been working on its disclosure framework to assist firms in preparing transition plans, which are expected to become mandatory in due course. The final form of the transition plan disclosure framework is expected to feature interpretative guidance on the framework together with a technical annex mapping the disclosure framework to TCFD, the ISSB exposure drafts listed above as well as the new TNFD framework. A status update was published on 27 July 2023 stating that the final version of the disclosure framework could become available as early as October 2023.
Finally, it is expected that the FCA will issue a policy statement document for its Sustainable Disclosure Regime (SDR) following on from earlier publications of DP21/04 and CP22/20. The document is expected to feature references to a sustainable-improver category with reference to the TPT framework above, as well as references to stewardship plus further detail on the UK’s anti-greenwashing rule. It is currently unclear whether the SDR will make detailed reference to the UK’s green taxonomy prepared based on advice from the UK’s Green Technical Advisory Group (GTAG), but the definitive word on the future of the latter, including references to interoperability with the world’s other 30-odd taxonomies, is expected before the end of the year.
To close, the final TNFD recommendations and the FCA’s reaction to them will be a pivot point on the precise detailed requirements and expectations on management and reporting of nature and biodiversity risks and opportunities in the UK. End-investors, corporates and activists will be interested in the direction of travel, as well as the appetite for effective enforcement. Over time, the publication of the TNFD could well catalyse a debate on the efficient allocation of capital to cover sustainable or green investments – an interesting direction of travel which some EU prudential regulators are likely to press for over the next couple of years.
Dr Anthony Kirby is writing in a personal capacity and his views on this subject do not reflect those of EY.