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Forest river in summer
FORWARD THINKING | – 3 Min

Climate is one thing – but how can the finance sector address biodiversity risk?

By ROBERT-ALEXANDRE POUJADE 12.11.2020

In this article:

    How do you calculate the value of a tree, or the microbes supporting it, or the more complex organisms that live in or depend on it? How do you value the system interlinking and supporting these entities, and everything around them?

    The idea of assigning a value to ecosystems, and the services they provide to help regulate our environment, is not new. Over the years, various approaches have been used to value nature as part of cost-benefit analyses and similar exercises.

    One of the best known estimates of environmental damage is the social cost of carbon – that is, the net present value of the social and environmental impact of an additional tonne of CO2 being emitted into the atmosphere. Estimates of this number vary, and ultimately the real figure could be extremely large, but many firms use some form of an internal shadow price for carbon to help them make investment decisions.

    The Task Force on Climate-related Financial Disclosures (TCFD) is one initiative to help companies properly account for climate risk and the cost of CO2 emissions in portfolios.

    Alongside climate change, however, the loss of biodiversity is an often-neglected, slow-motion environmental threat. It could also grow to have significant implications for financial markets.

    Material risks

    At current deforestation rates, a football field of forest is lost every second. Of this, a significant amount is biodiversity-rich, primary rainforest. Deforestation and other factors could cause the Amazon to turn from a carbon sink to a carbon source. Rainforests provide other significant ecosystem services such as water-cycle regulation and the prevention of soil erosion and desertification.

    Turning to the oceans, warming and acidification are having significant detrimental effects on delicate ecosystems such as coral reefs. With 2°C of warming above pre-industrial levels, virtually all reefs will be lost due to coral bleaching. Even limiting warming to 1.5°C, the preferred aim of the Paris Agreement, would result in 70% to 90% of reefs disappearing.

    Leaving aside philosophical arguments on the inherent value of nature, the loss of natural capital has real and material consequences. Touching on recent events, it is thought further encroachment on the natural world will result in additional – and potentially more deadly – pandemics as humans come into contact with more novel viruses. Losing biodiversity also means losing the potential to discover new medicines, while perhaps impacting the supply of existing ones.

    The loss of ecosystems means losing the wider valuable benefits these provide. Globally, it has been estimated ecosystem services, including water purification, crop pollination, flood protection and carbon sequestration are worth USD 125 trillion to USD 140 trillion per year – that is around 1.5 times global gross domestic product.

    The financial sector is exposed to the loss of natural capital. DNB and PBL, for example, highlighted in June the physical risks to financiers from biodiversity loss, with 36% of Dutch financial institutions’ portfolios worldwide having exposure to companies with ‘high’ or ‘very high’ dependency on one or more ecosystem services. DNB estimates the global financial sector has a EUR 28 billion exposure to products that depend on pollination alone.

    A new task force emerges

    As is the case with many aspects of sustainability, data remains an issue when it comes to identifying biodiversity risk.

    It is timely, therefore, that the UN has launched an initiative to create a framework mirroring the TCFD, the Task Force on Nature-related Financial Disclosures (TNFD), which aims to tackle this issue. The initiative, which has the support of the UK and Swiss governments and banks including BNP Paribas, aims to make organisations better equipped to make and act on natural capital-related disclosures, through developing frameworks for reporting nature-related financial information. Following initial discussions this year, TNFD will be developed in 2021 to be launched worldwide in 2022.

    While deforestation is one of the metrics financial institutions have been pushing consumer organisations for information on, often by taking a climate change tack, a TNFD would help businesses more holistically address nature-related impacts in their supply chains.

    Other action areas

    Given the interlinkages between climate change and biodiversity loss, and the possibility of positive feedbacks in these areas accelerating change, immediate action is paramount.

    While TNFD is being set up to provide guidance on nature-positive investment methodologies, financial institutions and the wider business landscape can start by thinking about the dependencies and impacts of their operations on the natural world, through tools such as NCFA’s ENCORE, which BNPP AM has recently piloted.[1]

    More broadly, the integration of sustainability into all business decisions and investments is key, as is openness, transparency and engagement on these cross-cutting issues. Knowing which companies are the most involved in substantial deforestation is a key step forward to reducing biodiversity risks, as can choosing low-carbon energy sources that also have wider environmental benefits.

    Finally, as most biodiversity-rich areas are in developing countries, economic assessments should also take into account local perspectives of their worth and importance, and the needs of local populations should be factored into any investment decisions.

    Acting in an inclusive and equitable manner will preserve the wide-reaching benefits of biodiversity for not just local populations, but also the wider global community.

    Read more about sustainable investing

    ______________________________________________________________________________

    [1] UNEP-WCMC, UNEP Finance Initiative and Global Canopy Webinar, Connecting Financial Flows with Biodiversity Targets,  June 30, 2020,  https://www.brighttalk.com/webcast/17290/418965

    ______________________________________________________________________________

    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
    • Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
    • Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.
    • Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
    Investments are subject to market fluctuations and the risks inherent in investments in securities. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay, the strategies described being in risk of capital loss. There is no guarantee that the performance objective will be achieved.
    Copyright © 2022 Morningstar, Inc. All Rights Reserved. The overall star rating for each fund is based on a weighted average of the number of stars assigned to it in the three-, five-, and 10-year rating periods. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
    Past performance or achievement is not indicative of current or future performance.
    The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
    Source: BNP Paribas Asset Management, as of 30/06/2022, unless otherwise stated.

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