In this Simply Said series on biodiversity, we have sought to identify the scale and significance of the problem, understand nature-related risks in investors’ portfolios, and examine the tools available to keep track of it all. With roughly half the world’s GDP dependent on natural resources that are under serious threat, responsible investors must at the very least take steps to manage the related transitional and physical risks to their portfolios. There are many good reasons for institutional investors to take positive steps towards redressing the situation, for instance the inherent link between the natural environment and climate change mitigation and resilience. There may also be growing pressure from stakeholders and regulators, as well as the more positive motivation of new, attractive investment opportunities in nature-based solutions (NbS). With nature firmly on the agenda, what can investors do to take the plunge in this new direction? Is the asset management industry product offering up-to-scratch, and what market initiatives are out there to help investors join the fast track towards nature positivity?
First step: measure and engage
A sensible and logical first move is to look at your current portfolio through a natural capital lens to get a snapshot of its exposure to nature-related risks. Speaking at the Climate Action Sustainable Investment Forum on May 4, 2022, Carine Smith Ihenacho, Chief Governance and Compliance Officer at Norges Bank Investment Management (NBIM) describes how they ran their portfolio through the ENCORE tool to reveal that roughly one third of their EUR 1.1 trillion holdings was exposed to nature-related risk. As she explained “we are a large globally diversified investor, and we have spread our investments across 9,000 companies in more than 70 countries. Of course, if half of global GDP depends on natural capital ecosystem services, then so does the value creation of many of our portfolio companies, so it is a huge concern for us.” This initial analysis can be used by any investor as the basis for engaging with portfolio companies, and where appropriate demanding further nature-focused disclosures into their value chains. Smith Ihenacho revealed that NBIM divested from seven companies last year due to their high natural capital risk exposure.
Second step: positive action
Many investors are exploring ways to make their portfolios nature positive. Speaking at the Sustainable Investment Forum 2022, Marion Maloney, Head of Responsible Investment & Governance at the UK’s Environment Agency Pension Fund (EAPF), is keen to point out that their principal aim remains achieving healthy financial returns for their members. Nevertheless, they have established a process to seek demonstrable net biodiversity gains at the same time. Maloney stresses the need for baseline monitoring, making it an upfront requirement early on in any investment discussions to ensure the subsequent accurate measurement of impact. EAPF will also aim to incorporate nature-related clauses into contracts, for instance requiring forestry investments to be made permanent, thus locking in carbon sequestration benefits. Maloney believes that all natural capital investments should include climate resilience elements, and that investors should also make sure they examine the social impact of these projects. These can include access to land, fair acquisition procedures and local job creation. Given the complexity of all the factors at play, Maloney advises asset owners to pay particular attention to their choice of partners and providers: “I want asset managers that know their stuff, and as part of this we have often used third party providers to come in and check that what is being provided is right because I don’t want any sort of reputational risk to the fund.” She highlights a point made by many investors in natural capital: the opportunities are out there, and there is enough data to work with, but it is labour intensive. There is no catch-all metric and there are multiple strategies to consider. This is why collaboration across academia, policymakers, non-profits, NGOs and end-investors is crucial for success.
What does the market offer nature-minded investors?
While many ESG investment strategies will seek to “do no significant harm” to the natural world or may include some biodiversity elements within a broader environmental focus, there are still relatively few dedicated natural capital strategies that can seamlessly slot into the “core” bucket of an institutional portfolio. This is changing, as new funds are launched based on the premise that innovative companies that generate demonstrable benefits to nature will increase in value as governments takes steps towards a nature positive global economy. With their focus on nature-based innovation as an alpha driver, these strategies may have a small to mid-cap equity bias, which along with short track records can hinder their scalability for large institutional investors. Typical portfolio companies might include alternative protein producers, smart agriculture firms or circular economy innovators. Investors in these funds should make sure that managers’ upfront claims are backed up by accurate, independently verified impact measurement. Beyond listed equity markets, there are dedicated biodiversity impact funds within private markets, and a fast-growing green bond market to explore.
Investors do not need to go alone down the road to nature positivity. There are many ongoing market initiatives to join or track, for instance the Task Force for Nature-related Financial Disclosures (TNFD), the Natural Capital Finance Alliance (NCFA) or the Natural Capital Investment Alliance (NCIA). The latter was founded by three asset management firms in 2021 with the aim of mobilising a minimum of USD 10 billion worth of investment. Elsewhere, 89 financial institutions managing a total of EUR 13 trillion have signed the Finance for Biodiversity pledge since its establishment in September 2020. The related foundation oversees several working groups involving market practitioners and academics looking at engagement practices, impact assessment, public policy, and other nature-focused investment activities. It would be an excellent first port of call for institutional investors that are beginning to address biodiversity risks in their portfolios.
While the industry moves ahead, progress at supranational level has been slow. The Fifteenth meeting of the Conference of the Parties to the Convention on Biological Diversity (COP15) has been delayed multiple times. It is now tentatively scheduled for the third quarter of this year. Meanwhile, the preparatory Fourth meeting of the Open-ended Working Group on the Post-2020 Global Biodiversity Framework will take place in Nairobi, Kenya between June 21 and 26. Many in the investment industry have been expecting a nature-related consensus to come out of COP15 that would mirror that of the 2015 Paris Climate Agreement. The biodiversity can must not be kicked further down the road, so that a framework can be swiftly set up that unblocks the trillions worth of capital needed to reverse the serious threat of nature loss.