Financing and de-risking nature: the next frontier for financial institutions

Financing and de-risking nature: the next frontier for financial institutions

By Laura Canevari

Nature and biodiversity have gained the spotlight this year, becoming the next frontier for financial services. Earlier this year, the Task Force on Nature-related Financial Disclosure (TFND) was launched under the leadership of the Global Canopy, UNDP, UNEP and WWF, aiming to redirect financial flows towards nature-based solutions and nature-adding activities.

The TNFD is informed by a number of recent publications that help to increase our understanding of nature-based risks and record widely the scale of loss that economies globally would experience if we don’t steer towards a future that nurtures nature. In this article, we review the recent findings of these initiatives and their recommendations for financial institutions on how to implement adequate strategies to work with nature.

The economic impacts of global environmental change

The rate of loss of biodiversity and ecosystems degradation is staggering. As noted by IPBES in their Global Assessment Report on Biodiversity and Ecosystem Services, seventy-five percent of the global land surface is significantly altered, 66 percent of the ocean area is experiencing increasing cumulative impacts, and over 85 percent of wetlands (area) has been lost. The average abundance of native species in most major terrestrial biomes has fallen by at least 20 percent. Land use change, climate change, pollution and the increasing material demands exerted by the human population are among the main drivers of nature’s degradation and loss. Yet, without ecosystems services and the biodiversity that sustains it, economic prosperity as a whole is at risk. In fact, according to the World Bank (2020) over half of the world’s GDP is generated in industries that are directly dependent on nature and its services.

The Global Futures Report estimates that the costs to the economy from the loss of nature in a “business-as-usual scenario” could reach US$10Tn by 2050, compared to a potential net gain of +US$490bn under a future scenario guided by the preservation of nature. This is a net drop of 0.67% of GDP per year by 2050. While significatively indicative, these results only reflect the effects that a business-as-usual vs a “global conservation” scenario would have on six major ecosystem services modelled, namely: Pollination; Coastal protection; Water yield; Timber production; Fish production; and Carbon sequestration. Hence, we must recognise that the true impacts of nature loss (and gains secured from protecting it) could in fact be much higher (and in some cases, irreversible).

It therefore should come as no surprise that over the past 5 years the World Economic Forum’s annual Global Risks Report (GRR) ranks biodiversity loss and ecosystem collapse as one of the top five risks in terms of likelihood and impact in the coming 10 years. What’s more, the 5 top risks according to the latest WEF survey are all environmental.

Biodiversity-related financial risks defined

In order to swiftly incorporate nature-related risks within existing ERM (enterprise risk management) and ESG (environmental, social and governance) processes and within investment decision-making, and financial and non-financial reporting, several publications recommend aligning nature-related risks with existing risk categories. In particular, WEF’s “New Nature Economy” Report and the Global Canopy and Vivid Economics report “The Case for a Task Force on Nature-related Financial Disclosures” recommend to align nature risk categories to the the Task-Force for Climate Related Disclosures (TCFD) framework. Accordingly, the classification of biodiversity-related financial risks into financial risk types is best laid out in PwC and WWF´s “Nature is too big to fail[” and is reproduced below in Figure 1.

Fig. 1: Classification of biodiversity-related financial risks into existing financial risk types. Source: PwC and WWF (2020) Nature is too big to fail

Steps to de-risk nature

Financial institutions (FIs) must start to consider the risks and opportunities stemming from the ecological limits of nature. However, and as noted in the WWF and AXA “Into the wild” 2019 report, integrating nature into investment strategies can vary according to the type of strategies followed by financial institutions and the asset classes taken into account. Sustainability indexes (such as Dow Jones Sustainability Index) can prove a useful tool to monitor nature-related issues and for acquiring information on corporate sustainability. However, the market today does not provide a comprehensive list of sustainability trackers to enable a diversified sustainable passive strategy. Some investors following a more active qualitative approach (generally within niche dedicated impact funds) are already integrating environmental considerations, but remain unable to internally calculate their exposure to nature risks.

According to WWF and AXA, the most effective way to integrate nature-related issues into investment decisions would be to quantify them in order to derive natural capital costs from corporate information. This can be done through a three-step approach consisting of:

  1. Formulating a description of corporate activities and environmental impacts on the basis of financial and sustainability reports.
  2. Integrating data from life cycle databases and models extracted from a global environmental-energy-economic model.
  3. Computing natural capital costs in monetary terms based on valuation factors, which determine the monetary costs per environmental impact (i.e. societal costs, solution costs, and potentially avoided costs).

Complementing this information on costs with the likelihood of their occurrence provides then a perspective in terms of risks.

Biodiversity- related target-setting by the finance sector.

Either directly or indirectly, businesses rely on nature and ecosystem services. Yet, dependency on nature can vary considerably between different industries and sectors. Equally, the negative impact of companies on the natural environment differs significantly from sector to sector. The Beyond Business as Usual report, published by UN Environment Programme, UNEP Finance Initiative and Global Canopy earlier this year identified a series of priority sectors that financial sector needs to consider in terms of industries with highest dependencies on the environment and those causing the largest negative impacts, here summarised in Table 1 below.

Table 1. Priority sectors for biodiversity target-setting by financial institutions

The industries in Table 1 all have either potentially high material dependencies and/or potentially high intensity impacts on biodiversity and ecosystem services. This makes them more likely to be material from a financial perspective to institutions, including banks, investors, and insurers, and means that activities—loans, investments, or insurance—expose financial institutions to biodiversity-related risk.

Ways forward

One way for financial institutions to start integrating nature risks in their decision-making is to use the list of priority sectors presented in the previous section to guide the systematic assessment of biodiversity risks and opportunities in their own activities. Moreover, they can start to explore existing tools to assist the evaluation of nature-risks such as ENCORE, the Natural Capital Toolkit, as well as explore metrics from the Global Footprint Network and Trase Finance.

Moreover, financial institutions need to become more familiar with  innovative biodiversity financing tools with high potential to attract capital, such as corporate sustainable timber bonds, corporate green commodity debt funds and ecosystem-based carbon offset bonds. For a full list of innovative investment instruments to finance nature, see the World Bank’s “Mobilizing private finance for nature” recently released report here.

Last but not least, financial institutions should also engage with emerging initiatives such as the Natural Capital Coalition, by signing the Natural Capital Protocol for financial institutions, and with the new Task Force on Nature-related Financial Disclosure.

Cover photo by Crystal Mirallegro on Unsplash.

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