How could investors start exploring the risks and impacts associated with biodiversity loss?

Biodiversity loss has quickly manifested itself as a prominent theme for the financial system. Tangible approaches for examining risks and impacts, however, remain at nascent stage still. This blog post explores two potential approaches.

The Dasgupta Review, published in February, clearly laid out how our economic system is embedded in nature and emphasised the role of the global financial system in bringing about change to halt biodiversity loss. Nevertheless, investors, asset managers, banks and other financial institutions lack tangible tools for evaluating biodiversity risks and impacts in their portfolios.

What exactly is biodiversity?
Life on earth started some 4 billion years ago and has since evolved to form complex ecosystems on our planet. Biodiversity is this diversity we can observe today, and it cannot be chemically manufactured.

It is far more difficult to monitor biodiversity loss compared to climate change. With global warming we can measure the concentration of greenhouse gases in the atmosphere, or measure how many tons of CO2-equivalents a company emits annually. There are no similar indicators for biodiversity loss, yet.

Biodiversity enables nature to flourish, and nature in turn allows our economies and societies to prosper. Nature’s invaluable ecosystem services are the bedrock for our economy – according to the World Economic Forum, more than 50% of the global GDP is dependent on nature.

An avenue for evaluating physical risks
Like climate risks, it is possible to examine the physical risks caused by biodiversity loss. That is, how dependent are businesses on nature’s ecosystem services? The agricultural sector, for example, is dependent on pollination, and the brewing industry is dependent on the availability of fresh water.

The ENCORE dataset allows one to examine, which ecosystem services underpin different economic activities. It includes 86 different business processes covered for 21 different ecosystem services, with a materiality rating for each linkage.

De Nederlandsche Bank utilised the ENCORE dataset in its seminal report ”Indebted to Nature”, which found that the Dutch financial institutions worldwide have €510 billion of exposure to companies with high or very high dependency on ecosystem services.

An avenue for evaluating transition risks
Transition risks entail risks that follow the societal and economic shifts towards minimising negative impacts on nature. Consider climate change – as we pursue decarbonisation, companies that delay actions to reduce emissions are exposed to transition risks. An example to this is the pricing of CO2 emissions in Europe.

The transition risks of biodiversity loss could be examined through its five key drivers. These are climate change, changes in land and sea use, natural resource use and exploitation, pollution, and invasive species.

It is likely that public policy makers or market participants will seek to regulate more stringently the activities that damage nature. Changes in consumption preferences could also exert pressures for businesses to reduce their negative impacts on nature.

If these drivers for biodiversity loss are priced or regulated in the future, this could result in significant financial losses for companies and investors. Companies, whose own activities are having an impact on these five drivers, could be subject to transition risks.

Conclusion
This blog post sought to shed some light to the “double materiality” of biodiversity. That is, biodiversity loss has an impact on companies, but simultaneously, companies have an impact on biodiversity.

The two proposed avenues here are by no means exhaustive. They are meant illustrate how investors could navigate the first steps in exploring risks and impacts from biodiversity loss. The TNFD is developing a comprehensive framework for nature-related risk management, due to be finalised in late 2023.

Sitra, the Finnish Innovation Fund, has an ongoing study relating to investors and biodiversity, due to be published in summer 2022.

Miika Korja
Specialist, Climate and Nature Solutions
Sitra, The Finnish Innovation Fund