Understanding the impact of biodiversity loss
There is a growing focus on nature-related risks by financial market participants and regulators, explains William Attwell, associate director – climate risk, Sustainable Fitch.
While climate change risks are increasingly being priced in by investors, the risks to the global economy and financial systems posed by biodiversity and nature loss are largely underappreciated and often poorly understood. Over half of global gross domestic product is dependent on well-functioning biodiversity and ecosystem services, such as provision of freshwater and raw materials, and pollination of crop plants by insects. The risks associated with the loss of these services are likely to increase and become more urgent amid accelerating degradation of natural systems and species extinction.
The future outlook will depend on whether more effective mitigation measures are adopted following the United Nations Biodiversity Conference (COP15), due to be held in Montreal later this year, and if industry and regulator-driven initiatives to influence capital flows towards nature-positive activities are successful.
There are some positive signs that regulators and financial market participants are developing methodologies to assess and manage the impact of nature and biodiversity-related risks. De Nederlandsche Bank has found that Dutch financial institutions have approximately €510bn in exposure to companies with high or very high dependence on ecosystem services. Meanwhile, the Network for Greening the Financial System, a global grouping of 114 central banks and supervisors, in March 2022 called on its members to develop analytical frameworks to better assess biodiversity-related risks and explore appropriate supervisory expectations.
In addition, 78 financial institutions, including banks, asset managers and insurers – with $10tn in assets under management – have signed the Finance for Biodiversity pledge. This calls for a more ambitious global diversity framework to be adopted at COP15 and supports the scaling up of capital flows to nature-positive outcomes. In this vein, the International Capital Market Association already identifies natural resources and biodiversity conservation as eligible uses of proceeds for the green projects categories in its Green Bond Principles. However, these and similar guidelines are voluntary.
While recognition of the financial risks associated with nature loss is growing, comprehensive assessment and management is plagued by measurement challenges, given the sheer scale, complexity and often localised character of biodiversity and nature risks. The Taskforce on Nature-Related Financial Disclosures has found there are over 3,000 different nature-related metrics currently in use by reporting bodies. And there is currently no biodiversity equivalent of the Greenhouse Gas Protocol used for carbon emissions classification and accounting.
The lack of standardisation makes it difficult for market participants and regulators to pinpoint the financial materiality of specific biodiversity-related risks, or benchmark and compare these risks across sectors, loan books and investment portfolios. Similar data challenges undermine consistent and comparable reporting of entities’ external impacts on nature – through the concept of ‘double materiality’ – as a result of their business activities.
It remains to be seen whether efforts by regulators and industry organisations to address these shortcomings will be effective. Among the European Financial Reporting Advisory Group’s proposed standards for the European Union’s Corporate Sustainability Reporting Directive (effective from 2024) are detailed requirements for disclosures relating to biodiversity and ecosystems, pollution and natural resources. However, concerns have been raised about the complexity of EFRAG’s standards and their interoperability with other standard setters, notably the International Sustainability Standards Board. Unlike the CSRD’s double-materiality approach, the ISSB focuses mainly on financial materiality and enterprise value.
At a global level, the TNFD aims to complement the Task Force on Climate-Related Financial Disclosures framework, which has become the gold standard for climate reporting. In anticipation of the third iteration of the TNFD’s draft reporting framework, the taskforce has launched a special data ‘catalyst’ focused on identifying credible metrics, setting baselines for data relevance and issuing related guidance. Depending on the outcome of this workstream, the final TNFD recommendations (due in September 2023) could play a significant role in influencing future voluntary and mandatory reporting regimes, potentially leading to greater standardisation of nature and biodiversity-related risk metrics.