Biodiversity: the Crisis Hiding in Your Portfolio

    Stockholm (NordSIP) – 2022 is expected to be the year investment in nature finally hits the headlines.  Biodiversity loss is a key priority at supranational level as the scale of the crisis and its potential effects become apparent.  There is also a growing realisation that natural environments will play a crucial role in meeting previously agreed climate change mitigation and resilience targets.  In this series of articles to be published by NordSIP in the run-up to the 15th Conference of the Parties (COP15) to the UN Convention on Biological Diversity (CBD), we examine the practical implications for institutional asset owners:

    • A reminder of the key issues and factors at play and how they relate to portfolio investments.
    • An understanding of the portfolio-level risks and opportunities presented by investments in nature.
    • The challenge of developing the necessary information flows and metrics to support nature-based investments on an institutional scale.
    • Industry initiatives and first steps for institutional asset owners to consider.
    • An overview of the investment industry’s current and potential nature and biodiversity-focused offering.

    NordSIP will also aim to summarise the key outcomes of COP15 once the event has concluded.

    How does biodiversity relate to investment portfolios?

    With the looming prospect of nature-related legislation being imposed on investors not too far down the line, it is worth taking a step back to understand the basic reasons biodiversity is moving up the agenda.  Simply put, the natural world is rapidly deteriorating, leading to an existential threat to our global economy and established way of life.

    Nature is an asset, in the same way that human capital and produced capital are.  Natural capital includes abiotic components such as mineral and fossil deposits, clean air and water alongside the living biodiversity of flora and fauna and the benefits that these all convey.  These benefits include so-called ecosystem services such as pollination, air filtration and protection from the climate crisis and disease.  Many industries rely heavily on natural resources and ecosystem services.  The food and pharmaceutical industries are perhaps the first that come to mind.  A 2020 World Economic Forum (WEF) study of 163 industry sectors and their supply chains found that $44 trillion worth of economic value generation is moderately or highly dependent on nature and its services.  This translates to more than half of the world’s total economic output being potentially under threat from biodiversity loss.

    The links between natural resources and agriculture or manufacturing may seem fairly obvious, but the extent of this interdependency throughout all sectors of the economy is quite revealing.  The WEF report highlights indirect, hidden dependencies in certain industry supply chains.  The natural world affects values in real estate, the travel and tourism industries, and leisure and lifestyle goods.  One final measure of nature’s worth, albeit harder to quantify, is the maintenance of human capital though mental health benefits – particularly evident during Covid-19 pandemic lockdowns.

    Biodiversity is a fundamental component of the world’s natural capital.  Just as judicious investors will diversify their assets to create a robust portfolio, nature incorporates a multitude of complex interdependencies that support its continued existence.  This domino effect is what makes the biodiversity crisis such a potent threat.

    What is the extent and cause of the problem?

    As Professor Sir Partha Dasgupta puts it in his final report on the Economics of Biodiversity: “We are all asset managers.”  The comprehensive review, commissioned by the UK government and published in 2021, clearly shows how badly we have been managing natural capital as an asset.  Dasgupta estimates that “between 1992 and 2014, produced capital per person doubled, and human capital per person increased by about 13% globally; but the stock of natural capital per person declined by nearly 40%.”

    Well managed companies will take careful stock of their assets and make sure they have the means to continue operating efficiently.  This discipline has not been replicated in our global management of natural resources, with numerous indicators showing evidence of a drastic decline across the board.  In 2015, the Stockholm Centre for Resilience published its work on the evolution of seven key planetary boundaries from 1950 to the present.  Among the worst problem areas was genetic diversity, where the extinction rate had already pushed beyond the boundary into the high-risk zone.

    There is no shortage of statistics to quantify the biodiversity crisis, but what are the underlying causes?  If we return to Dasgupta’s asset management analogy, markets have neglected to price in the value of the goods and services that nature provides.  Nor has there been a proper assignment of the cost of negative externalities to those that cause them.  These externalities are direct or indirect effects on nature of a company’s production process, which are rarely charged back to the firm.  This has translated into perverse incentives to invest in and maintain linear “take/make/waste” production cycles, with ecosystem services and other benefits of nature being considered “open to all at no monetary charge.”  Essential natural resources and services are rapidly disappearing into this accounting black hole.  Ecosystem services are so diverse that many pass under the radar.  For instance, the enormous value of insect pollination to agriculture is beginning to enter the public consciousness, but equally important aspects such as soil health are relatively ignored.

    The degradation of the natural world is compounded by many other negative factors including badly directed government subsidies, pesticide use, habitat destruction through changes in land use, human population growth and urbanisation.

    The finance and investment industry must be part of the solution

    In its 2021 report on the State of Finance for Nature, the United Nations (UN) is calling for an increase of at least 140% in annual nature-based-solutions (NbS) investments to fill a USD 4.1 trillion financing gap by 2050.  Much of this will have to come from the private sector.

    It is hoped that the CBD’s COP15 in Kunming, China will produce a nature-focused international consensus similar to that of the climate-focused Paris Agreement at the United Nations Framework Convention on Climate Change (UNFCCC) COP21.  While investment opportunities already exist, much work will need to be done to create the economic framework to support institutional nature-based investment at sufficient scale to effectively address the problem.

    In the next instalments of this series, we will break down the risks that biodiversity degradation presents for investment portfolios.  Conversely, we will highlight some of the opportunities presented by investments in nature-based solutions.  Reliable data are essential to the investment industry, so we will also explore the available and forthcoming metrics that focus on the natural world.

    Article produced with the assistance of Angelo Bello, Junior Reporter at NordSIP. 

    Image courtesy of Ria Sopala from Pixabay
    Richard Tyszkiewicz
    Richard Tyszkiewicz
    Richard has over 30 years’ experience in the international investment industry. He has worked closely with major Nordic investors on consultancy projects, focusing on the evaluation of external asset managers. While doing so, Richard built up a strong practical understanding of the challenges faced by institutional investors seeking to integrate ESG into their portfolios. Richard has an MA degree in Management and Spanish from St Andrews University, and sustainability qualifications from Cambridge University, PRI and the CFA Institute.

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