Biodiversity concerns set to be the next frontier after climate change
With the rise of natural capital initiatives such as the TNFD, systemic risk issues related to ecosystem collapse will soon receive the same amount of attention as climate change
While climate change concerns have so far dominated ESG thinking, awareness of nature risk is catching up fast and already being integrated into sustainability frameworks, according to sources.
The biodiversity-related principal adverse indicators in the Sustainable Finance Disclosure Regulation, the planned update to the EU Taxonomy to incorporate biodiversity risk, the Network for Greening the Financial System's own biodiversity study group, along with the meteoric rise of the Taskforce on Nature-related Financial Disclosures (TNFD), represent well the momentum building behind regulatory attempts to transform nature risk awareness into concrete impact in financial markets.
The World Economic Forum estimates that more than half of the world’s economic output ($44 trillion) is at least moderately or highly dependent on nature, meaning that if natural systems collapse, so will the world’s economic and financial systems.
Due to the sheer scale of the risk – together with scientific studies that show the world has already entered the sixth mass extinction phase – sources say that considerations around nature or biodiversity risk, which have traditionally been excluded from financial decision making, can no longer be relegated to the margins.
“In the finance sector, there’s an increasing realisation that biodiversity loss is as much of a systemic risk as climate change,” said Lucian Peppelenbos, climate strategist director at Robeco.
Biodiversity risk is “no less important, albeit more complex than climate risk”, as both represent a systemic risk with long-term consequences that are “potentially very severe”.
“That’s why we rapidly need to change business as usual to avoid the worst,” he added.
Awareness of biodiversity risk is particularly high among financial firms in the Netherlands thanks at least partly to the Dutch Central Bank’s landmark paper Indebted to Nature. Robeco itself has partnered with WWF-The-Netherlands and has recently published a white paper highlighting its biodiversity strategy.
“We put biodiversity risk on par with climate risk,” Peppelenbos said. “A big question is how investors can address the double materiality: assessing both the risks and opportunities as well the impacts of own investments on nature. This is where we’re building the knowledge, the approaches, and the datasets.”
Peppelenbos thought policy frameworks are still “behind”, but starting to catch up. So far, the EU Taxonomy has been developed to focus on climate change objectives, but work is now underway on biodiversity. Like climate change, biodiversity risk needs clear definitions for it to be mitigated.
“Biodiversity investing is not new – it has, for instance, been one of the categories of the green bond principles since its early days,” said Dr Arthur Krebbers, head of sustainable finance, corporates at NatWest Markets. “It has grown in focus in recent years due to a realisation that a “just transition” for climate should take into account both humans and other species we share the planet with.”
Krebbers said both companies and investors are starting to articulate “a more holistic environmental strategy, incorporating climate mitigation and adaptation alongside other environmental goals”. This is being stimulated by regulatory frameworks, such as the EU Taxonomy, as well as natural capital focused initiatives such as the TNFD.
“I started off as a zoologist hugging trees and orangutans, but now I hug asset managers and bankers, because I realised we can’t save nature by field work alone,” said Andrew Mitchell, founder of global canopy, one of TNFD’s founding partner organisations and vice-chair of TNFD’s stewardship council. “One thing I have witnessed is the staggering car crash in nature happening around the world, the scale and speed of which is generally not understood by financial firms.”
In terms of integrating nature concerns into the financial market infrastructure, Mitchell said more has happened in the last three years, than in the previous 40. “It’s as though people suddenly get it,” he said. “Having taken the first step into the dark room of materiality and nature and climate, they want to carry on.”
According to Mitchell, so far ESG has been more “CSG”, because sustainability conversations have tended to focus on reducing carbon emissions, with little attention paid to water, forests, oceans, landscapes and other nature considerations. However, he also felt confident that the tide is starting to turn.
TNFD was created with the aim of achieving a similar level of guidance for nature risk as Task Force on Climate-Related Financial Disclosures (TCFD) has achieved for climate risk.
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“In recent years we’ve seen the theme of biodiversity starting to be better understood, both by the general populace and financial markets, thanks in large part to a greater awareness around climate change,” said Jacob Michaelsen, head of sustainable finance advisory at Nordea.
Michaelsen described biodiversity as the “next frontier” after climate change as more nuanced and detailed understanding of biodiversity issues take place in sustainability discussions.
“So many people are committed to this and on board in a way they have never been before,” he added. “In such an environment, things can be done pretty quickly, compared to before.”
While it has taken a long time to get climate risk frameworks integrated into financial thinking, the hope is that biodiversity risk will be much quicker.
One of the key changes required to address biodiversity risk effectively is the inclusion of nature impact considerations in investment decisions. The tool created to achieve this is called “double materiality”.
Mitchell explained that financial capital is a subset of natural capital, and not the other way round. Almost all the wealth humans create “derives from free goods from nature, whether it’s living things, like wood, or dead things, like diamonds”. The growth model inherent to consumerism turns “living things into dead things that appear alive”. These processes are then financed by pension funds and banks.
“The problem is that the money is blind,” said Mitchell. “When you make an investment decision, until recently, you didn’t have any idea about the impact on nature or climate. These things were called non-material.”
He continued: “You can trash a rainforest with a palm oil company, but the costs of doing that don’t show up in the share price of the company, because the company doesn’t pay for it. As these externalities are external to our economy, they create a massive imbalance, which only now is becoming visible.”
Double materiality means looking at the impact of an investment not only on the portfolio but also on the environment. While TNFD will follow the same set of pillars as the TCFD in its framework, it differs from the TCFD by, for example, looking at nature impact considerations. TNFD takes both an “outside-in” look at the portfolio and an “inside-out” look on the impact of nature.
“We want to see nature impact considerations being incorporated into the net-zero transition and climate disclosure frameworks,” said Karen Ellis, senior economist at WWF. “We need to integrate nature thinking into the metrics so nature can be used to help achieve net zero goals, as a synergy rather than a trade-off, and to deliver the wider nature restoration goals needed to prevent ecosystem collapse and the enormous economic and social consequences that will create.”
Ideally it would be a “net zero nature positive transition plan” that is required of financial institutions. Ellis pointed to the upcoming COP15 conference as an important a lifting off point for biodiversity frameworks, where hopefully a global Nature Positive Goal can be agreed, to sit alongside the Net Zero Goals that came out of the Paris agreement, and to deliver on the commitment made last year in the G7’s Nature Compact to halt and reverse biodiversity loss by 2030.
Without the integration of biodiversity concerns into climate risk frameworks, net-zero transition plans could have unintended consequences on nature.
“Biomass is a clear example of where risks for nature have been created because of a narrow focus on carbon emission reduction,” said Peppelenbos.
While biomass is relatively safer for the environment than fossil fuels, it can have negative impacts on everything from soil to water resources, forests, the atmosphere and climate.
“It’s important to look at climate change beyond carbon and understand it is about the integrity of our biosphere, which includes the atmosphere,” Peppelenbos added. “We should also be aware that in fighting climate change, nature is our biggest asset.”
Historically, 60% of all emissions have been absorbed by land or oceans, according to Peppelenbos. “Nature is the biggest carbon sink. In the soil there’s five times more carbon embedded than in the atmosphere. It’s a huge asset, and we must treasure it, and use it.”
Data and standardisation challenges
One of the biggest challenges facing market participants who engage with biodiversity issues is fragmented data and a lack of harmonised standards.
“To measure climate change, you just need to measure the amount of greenhouse gases in the air, but biodiversity is more complex,” said Michaelsen. For example, biodiversity concerns are vastly different for an arboreal forest than a tropical or temperate forest or even wetlands.
Then there’s the nuance around how to recognise the connection between biodiversity, climate, and other areas. “We already know that biodiversity and climate are interlinked, but what are the links between biodiversity and say water discussion? It starts to become complicated when you think about this from a ‘do-no-significant-harm’ perspective. We have some interesting years ahead of us.”
“The challenge, in practical terms, for the KPI, biodiversity and other areas, is we’re often forced to look at input metrics rather than output metrics,” Michaelsen said. An input metric could be the number of surveys a firm does on relevant areas or how many experts it engages with. But firms also need to tackle output metrics and assess the true impact on nature of the economic activity.
“There is plenty of data but it is currently in so-called alternative datasets,” said Mitchell. That data is split between governments, firms, academics and civil society organisations. In order to be able to assess an impact on nature, those data sets need to be integrated and their formats and standards harmonised.
One key data point missing from financial institutions is the location of the assets of the investee firm. “You might give a $50 million loan to the headquarters of a major company but you don’t know where that money is being deployed,” said Mitchell. “With nature, unlike climate, the impact is very spatially specific. You need to know whether your industrial plant is in a delta or a desert, because the natural capital situation is very different in those environments, whereas for emissions, it doesn’t matter.”
According to Mitchell, what financial markets needs is a global translator that can scoop the data and turn it into decision-grade information. “That’s what TNFD is looking at,” he added. “It’s a huge challenge, and no-one has ever done it before, but it’s coming.”
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TNFD will be releasing a beta version of its framework in March 2022. Following a so-called open innovation approach, TNFD’s 34 taskforce member and technical team will continue to work on the framework while inviting financial institutions and corporates to give feedback and test the beta version. This is to ensure that its end-product, the final version of the framework due to be delivered in Q3 2023, is really by the market for the market.
Mitchell noted the speed with which service providers are buying up specialist data providers. For example, S&P Global recently bought True Cost, and MSCI bought Beyond Ratings. That demonstrates a “realisation” that the market is coming and a “need” to buy the relevant expertise in.
Mitchell also spoke of a “language barrier” that often hinders the inclusion of nature risk in investment decisions. “You have to change the dialogue and make financial firms think of nature in terms of an infrastructure that keeps the earth safe,” he said. “Their systems are better equipped to process that kind of language. It’s not just about how many butterflies or bees you can see in your garden.”