Stockholm (NordSIP) – In the first of our series of articles on biodiversity and natural capital, we reminded ourselves of the basic concepts involved and why they are rapidly becoming highly relevant to institutional asset owners. One could argue that altruism should be enough to seek the protection and restoration of natural habitats. Nevertheless, in the context of fiduciary duty it is also important to take a more pragmatic approach and look at the range of economic risks at play. There can be a sense of distance, perhaps exacerbated by the tendency to illustrate articles on biodiversity with pictures of attractive flora or fauna. How are companies in a typical investment portfolio really affected by the crisis in nature?
Taking a bird’s eye view
Before delving into a more precise exposure of companies and sectors to a range of nature-related risks, it can make sense to look at overlaying the geographical locations of portfolio companies’ facilities against a map of global natural capital depletion hotspots. The Cambridge-based collaboration between the United Nations Environment Programme (UNEP) and UK charity the World Conservation Monitoring Centre (WCMC) is a good source of spatial data and maps. The data produced by UNEP-WCMC are used as a source for external providers that feed it into practical tools such as ENCORE (Exploring Natural Capital Opportunities, Risks and Exposure) that can be employed by investors to obtain their biodiversity footprint and other metrics. We will take a closer look at the available metrics in the next article.
Swooping down on the key sectors
The UNEP Finance Initiative’s Beyond Business as Usual report, published in 2020 in collaboration with the Natural Capital Finance Alliance (NCFA) sets out a practical framework for financial institutions to focus in on the areas where they can have the greatest impact. The presence in a portfolio of the following sectors should start to raise some red flags: oil and gas, mining, energy producers and traders, electric utilities, agricultural products, brewers, distribution and luxury goods. While these areas have the biggest direct potential impact on nature, stock values in many other sectors such as tourism and leisure are also exposed to the deterioration of the natural world.
A range of biodiversity related risks
In its 2020 report Mobilizing Private Finance for Nature, the World Bank organised biodiversity risks along five different channels: operations, market, credit, insurance and regulatory/legal. Operational risks include the depletion of key inputs to the production process and the need to develop engineered replacements. Markets can be affected by consumer boycotts and loss of market share to companies that are perceived as more nature-friendly. From a credit perspective, international measures to protect nature could also lead to the downgrade of sovereign debt or losses on bond portfolios once the market prices in biodiversity risk. The insurance sector’s underwriting process has long been conscious of biodiversity and nature-related risks, which could lead to some companies or sectors ultimately becoming uninsurable. Finally, ahead of COP15, governments and regulators have already begun imposing nature-related constraints on companies and markets that can lead to fines or the loss of licenses to operate.
These risks can be broadly categories as systemic, transition-related or physical. However, as consumers and markets become increasingly aware of the significance of the biodiversity crisis, there are additional reputational and litigation risks that can affect companies and their shareholders.
What’s in the toolbox?
Institutional investors have long employed a vast range of financial analytical tools to maintain a healthy risk/return balance in their portfolios. As the climate crisis hit the headlines, this toolbox was expanded to incorporate greenhouse gas (GHG) metrics such as Carbon dioxide equivalent (CO2e) and Implied Temperature Rise (ITR), both of which have been designed for simple, “catch-all” effectiveness at the user level. The biodiversity crisis will also necessitate the adoption of new metrics. Unfortunately, the sheer complexity of the interconnected processes and services of the biosphere cannot be captured in a single metric. In the next article, we will explore the range of nature-focused metrics that are either available now or being developed by academia and non-governmental organisations.
Article produced with the assistance of Angelo Bello, Junior Reporter at NordSIP.