While discussions on the ‘environmental’ component of Environmental, Social and Governance (ESG) factors often focus on climate-related disclosures, there is increasing recognition that truly accounting for the environmental impact of business activities and building resilience requires considering not only its impact on climate change, but also on nature and biodiversity.
Both the G20 and G7 have recognised the importance of work on nature-related financial disclosures, with the latter endorsing the recently launched Taskforce on Nature-related Financial Disclosures (TNFD), and calling for the world to become not only net-zero but also nature-positive through its 2030 Nature Compact.
These are welcome moves. The taskforce is well-positioned to produce a financial disclosure framework for companies and financial institutions that can incentivise the financial sector to shift towards nature-positive investments and promote an integrated ecosystems approach to tackling the climate change and biodiversity crises.
Currently, there are limited company disclosures on their impacts and dependencies on nature, which compromises their ability to comprehensively assess investment risk. Establishing a framework and making nature-related disclosures the norm can increase firm accountability and assure investors that the real risks from the degradation of nature have been factored in.
However, the TNFD cannot drive nature-positive investments alone. The impetus for and implementation of change needs to come from both the private and public sectors.
Factoring in nature-related risks
Businesses are exposed to real nature-related risks and allowing for these delivers thorough due diligence for any company. A 2020 World Economic Forum report estimates that more than half of the world’s output (GDP) is either moderately or highly dependent on nature. Its degradation will come at a price and some industries are closer to the line of fire. For example the food industry, given the threat to arable land, and the pharmaceutical industry, given threats to many active ingredients sourced from nature.
Global Canopy and Vivid Economics note three categories of nature-related risks, building on those defined by the Taskforce on Climate-related Financial Disclosures (TCFD):
- Physical risks: operational risks if resources and raw materials increase in price or if supply chains face interruptions.
- Transition risks: changes to consumer preferences (from increased awareness) or regulatory changes, e.g. governments start prioritising the nature-positive agenda.
- Systemic risks: risks that affect multiple facets of the economy, such as Covid-19.
Factoring these in can protect investor interests and adds to the business case for nature-related disclosures. Further, the TNFD’s ‘double materiality’ approach accounts for how nature impacts a company and its operations and how a company’s operations impact nature. In contrast, the TCFD approach only discloses financial risks from climate change impacts on a company or financial institution. While the TNFD is more extensive, it is dependent on data that has not been made public and nature-related metrics that are not yet defined.
Going nature-positive makes business sense
The private sector has every incentive to account for nature, not just climate change, in its business models, given the potential economic benefits of going nature-positive. According to the WEF, nature-positive solutions in green Covid-19 recovery plans could create $10 trillion in business opportunities and 395 million new jobs by 2030. Business gains (per year by 2030) include savings of $130 billion for textiles and $870 billion for the automotive sector from creating a circular economy, benefits of $310 billion with a more diversified food system, and so on.
In financial markets, while the return on sustainable investments has been mixed, such investments have the potential to outperform standard stocks if investors’ tastes become greener. University of Chicago research suggests that the outperformance of funds with high sustainability ratings during the pandemic signals that investors are starting to see sustainability as a necessity, not a luxury.
To caveat, after seeking spectacular rallies in 2020, some clean energy funds have corrected as of this writing. Elsewhere, the tide is also slowly turning. Movements in the commodity markets are being affected by the shift to a low-carbon economy and the expected increase in ‘green capital expenditure’ (e.g., surging prices in copper and other metals used in green technology). Some big oil investors are beginning to consider climate change impacts – Exxon’s appointment of climate-conscious board members, for example, could sway the company’s future in a low-carbon world, while Chevron shareholders have voiced their support for an emissions-reduction proposal.
A joint effort for the public and private sectors
As with net-zero targets, shifting towards nature-positive investments can disrupt the way people do business. Governments should support the private sector through this transition, encouraging nature-positive activities and discouraging those that are not. Governments can use market-based approaches (e.g., subsidies and tax breaks for activities that preserve nature) or approaches that make doing business easier (e.g., less red tape for programmes that benefit nature).
They could require information disclosures to increase firms’ accountability. This is already happening for climate-related disclosures. The UK is set to require climate disclosures of publicly listed firms, and earlier this year New Zealand introduced legislation to require climate-related disclosures from publicly listed companies, insurers and other financial institutions.
Accounting for nature – a work in progress
However, assigning a (monetary) value to nature is easier said than done. Calculating the benefits and risks of nature, biodiversity, and ecosystems is complex. While you can assign direct, indirect, and non-use values to ecosystem services, these cannot easily be distilled into a single, target metric (e.g., below 2 degrees). Moreover, financial institutions will need more detailed information to assess risks down to the asset level to understand the risks to their portfolios. Comparable data across institutions and the ability to forecast and run scenarios are even further away.
To illustrate, the mining industry can impact biodiversity in multiple ways, often indirectly. Yet according to the United Nations Environmental Programme, mining companies currently report on sustainability at the corporate, not site, level. This makes it difficult to assess a firm’s exposure to ESG risks in a sector that is set to grow with increasing demand for renewable energy.
The role of standards and data providers
The TNFD has identified international standard-setting bodies and data providers as key to supporting this new voluntary, global, market-led initiative. The taskforce will seek to align its standards with existing frameworks and definitions where possible. This should help mainstream nature in future investment planning.
The TNFD also aims to build the data infrastructure needed to generate increased demand for the use, interpretation and improvement of existing data and new data through data providers, platforms and downstream data service providers. The effective dissemination of the work plan set by TNFD for the next two years will therefore be crucial.
The UK Financial Conduct Authority’s recent move to publish anti-green washing principles challenges the proliferation of the practice, which leads to poor quality of ESG disclosures by asset managers. The need for such principles reflects just how difficult it will be to improve disclosures not only related to climate risk metrics but also broader sustainability data.
Financial disclosure needs to happen now
In the meantime, as the TNFD develops this framework and set of much-needed guidelines, companies should not wait. Even though the TNFD has not yet developed a normalised metric system, it is relying on existing data from companies to build its database. The WWF suggests how to get a head start and undertake internal monitoring, including tracking the share of a company’s portfolio that aligns with ESG risk mapping or that supports natural ecosystems, or perhaps tracking the company’s nature-related resolutions.
Thus, while the TNFD is well-positioned to create disclosure mechanisms that promote ecosystem-based approaches and incentivise nature-positive investments, its success hinges on everyone doing their part. Financial institutions, governments and financial regulators need to mainstream efforts across their strategies and set specific targets. They must also update international accounting standards and establish the necessary data infrastructure to ensure nature is properly accounted for in different accounting frameworks. In time, the TCFD’s existing efforts will build even further momentum for TNFD uptake.