According to the Zoological Society of London, ‘biodiversity is declining at a rate faster than ever before in human history, with over a million species currently at risk of extinction. We have reached a crucial tipping point, and it is so important that biodiversity loss is put alongside climate change at the top of the global agenda. 44% of the global economy is dependent on the services nature provides’.
This reliance on nature has led to a degradation of biodiversity and ecosystems. Loss of natural capital – and the material products and services it provides – translates into growing productivity losses and significant impacts for the financial system. It’s so stark that the World Economic Forum ranked biodiversity loss and eco-system collapse as the fourth most severe threat humanity will face in the next ten years.
The next step in sustainability reporting
In recent months, there has been considerable discussion on the evolution of ESG and climate data. The financial services industry has come a long way over the past three years, aided by the availability of data to assess, manage and report on ESG factors and climate risks. Sustainability data is an area that we are highly focused on as we help our clients navigate emerging regulatory reporting and data requirements on ESG and climate risk, alongside education so they can interpret the wide range of data that is available to them.
However, the journey towards sustainability is an evolving one. Earlier this year, the final draft of the Task Force for Nature-related Financial Disclosures (TNFD) framework was published and is expected to be implemented shortly. We believe that the introduction of TNFD will accelerate the focus on nature related risks, which will be another sustainability factor that financial services companies have to consider when assessing the risks that their investment portfolios are exposed to. This is because companies impact the environment from a variety of sources. These include direct pressures, such as land use, or indirect pressures, which can include water extraction.
Data challenges lie ahead
Assessing and managing exposure to nature-related risks through the investments that pension schemes, asset managers and wealth managers own or oversee is going to require data – and lots of it. This is partly because the dependence on nature varies across different sectors. It requires a localised approach by country and by regions within a country. Why? Because no two ecosystems are alike and global target setting, alignment and sharing of best practice will be inherently complex in comparison to carbon disclosures.
Furthermore, certain industries are more prone to biodiversity risks across their supply chains. For example, food production, agriculture and forestry industries usually require intense harvesting of natural resources or rely on a single type of crop or livestock. In fashion, there is a reliance on raw materials and water.
For pension schemes, asset managers and wealth managers, this means making sure that the companies they invest into are focusing on making their supply chains more resilient and adaptive - not only to protect nature, but to limit their exposure to biodiversity risks that could lead to rising business costs, litigation, and re-evaluation of debt servicing capacity.
What does this mean in practice?
One of the key goals of TNFD is to encourage early action by companies and financial institutions to begin reporting nature-related dependencies, impacts, risks and opportunities, given the urgent need to address both nature loss and climate change in an integrated way.
The TNFD framework is built around the LEAP approach – Locate (interface with nature), Evaluate (dependencies and impacts), Assess (material risks and opportunities) and Prepare (respond and report). This drives the data requirements.
The metrics and targets required by financial institutions for TNFD reporting are split into two core areas: Dependencies and impacts - this looks at impact drivers within ecosystems on which a company has an impact or dependency. Here there are 10 core metrics and 14 additional metrics that are sector specific. The second area is risk and opportunity metrics, which looks at nature-related risks and nature-related opportunities across 5 core metrics and 23 additional metrics (sector specific).
Once fully published, the TNFD framework will be a useful and consistent way to direct global financial flows away from nature-negative outcomes, and toward nature-positive outcomes.
How can nature-related risks be evaluated?
They are measured through the proportion of investments in companies with substantial dependencies on ecosystem services at risk (companies with a large share of revenues derived from assets in high-risk areas) or companies that have a high risk to nature (where species richness may be impacted).
The right data and education remain paramount
Through our partnership with Clarity AI, we can now help financial services companies assess nature related risks, opportunities and dependencies across investment portfolios.
A final challenge is making sense of biodiversity and nature risk. What we’ve learnt at CACEIS is that education is the crucial ingredient when new frameworks, such as TNFD, become available. Asset managers, asset owners, fund boards and trustees have spent the last two years familiarising themselves with climate risk and will now have to begin the journey with biodiversity risk. Although TNFD simply provides the framework, the concepts within it need to be understood by those implementing it and interpreting it.
This article was originally published on Informa Connect website
