Read this article to understand:
- Why natural capital matters
- Why addressing climate change and biodiversity must go hand in hand
- The risks of nature depletion and the investment opportunities arising from rethinking relationships with the natural world
The arrival of an unexceptional looking frog in a washing machine in the English city of Cambridge recently led to an unexpected discovery: a parasitic worm never seen before. This particular worm had travelled more than 10,000 kilometres inside the frog, concealed inside a suitcase carried by a traveller returning from Mauritius.1 The worm, pseudoacanthocephalus goodmani, became just one of 503 new species officially recognised by the Natural History Museum in London in 2020, adding to the tally of life forms of around 8.7 million species. Other discoveries included a monkey, several snakes, wasps, bees, beetles, barnacles and seaweeds.
These finds illustrate a vitally important ecological point: despite important breakthroughs in science, there are still many mysteries in the natural world. “Our understanding of the natural world is negligible, yet we depend on its systems, interconnectedness and complexity for food, water, climate resilience and the air we breathe,” said Dr Tim Littlewood, director of science at the museum.
Appreciating ecosystem services
We know comparatively little about a world where a single millilitre of sea water – the size of a sugar cube – might contain one million bacteria and ten million viruses (Figure 1).2 But we do know Earth needs diversity to maintain complex equilibria. Notwithstanding the discovery of pseudoacanthocephalus goodmani, species are dying out at an alarming rate,3 undermining millions of years of evolutionary research and development. (More on biodiversity loss here and comments from Elizabeth Maruma Mrema here).
“Data on the Sixth Great Extinction of species is shocking,” says Julie Zhuang, portfolio manager of the Aviva Investors Natural Capital Transition strategy. “According to the World Wide Fund for Nature’s Living Planet Report, there has been an average decline in wildlife populations of 68 per cent since 1970. The decline in freshwater species is particularly troubling: 84 per cent have been lost over the last four decades. These mass extinctions are mostly attributed to the explosion of the human population and intensive use of natural capital – defined as the stock of assets, including living things, geology, soil, water and air – via industrialisation over the last century. Exploiting nature has fuelled global GDP growth, but will lead to damaging economic effects over the longer term.”
Because ecosystems support species containing irreplaceable genetic information, and as each life form is linked to others in a complex web, there may be costs for future generations from the failure to care for living things. “If species are like safe deposit boxes, we are destroying the contents before looking inside,” wrote biologists Andrew Beattie and Paul Ehrlich in their 2001 book, Wild Solutions: How Biodiversity is Money in the Bank.4
Earth needs worms living in frogs. It needs bacteria in the soil to clean water,5 plants to fuel and sequester carbon, pollinating insects to enable fruits to reproduce, birds to disperse seeds and animal predators to control weightings in the food chain. Nature provides another important service as well – psychological relief, soothing in hectic times.
“The man comes out of the wrangle of the shop and office, and sees the sky and the woods, and is a man again,” wrote US philosopher Ralph Emerson more than 200 years ago. “In their eternal calm, he finds himself.”6
Figure 1: Nature’s complexity
Source: Aviva Investors, May 2022. Data from ‘Wild solutions: How biodiversity is money in the bank’, 20017
As well as being a psychological-treatment facility, the natural world produces an abundance of plants with medicinal properties. It operates as larder, energy factory, water tower, air-conditioning unit, fertiliser and pesticide producer, provider of cleaning and recycling services and offers flood control. It supports billions of people directly, living off the land and another three billion or so reliant on wild-caught and farmed seafood as a primary source of protein.8 It is also increasingly being used for design inspiration, in biomimicry, to feed into research projects, when human imagination fails.
But outside traditional societies, these ecosystem services – benefits from the natural world – have been undervalued and underappreciated for years.
Figure 2: What nature provides
Source: Aviva Investors, May 2022
Nature’s role in economics
One contributory factor is the way in which nature has been excluded from conventional economic analysis. “Not so long ago, when the world was very different from what it is now, the economic questions that needed urgent response could be studied most productively by excluding nature,” wrote emeritus professor Partha Dasgupta from the University of Cambridge in his ground-breaking study for the UK Treasury, The Economics of Biodiversity.9 Nature was rarely considered as an asset despite its essential functions, and the cost of using nature’s services – nature depreciation – was ignored.
Nature was rarely considered as an asset despite its essential functions
“If you study any of the models that treasuries, central banks or international organisations such as the World Bank use, none of the macroeconomic forecasts of the future have ever built a model of the human economy as embedded in nature,” Dasgupta noted.
The error of failing to see human societies as part of the natural world or price the damages arising from human actions is becoming increasingly obvious. “Unfortunately, nature is currently free to exploit,” says Eugenie Mathieu, senior impact analyst and Earth lead on Aviva Investors’ Natural Capital Transition strategy. “Cutting down virgin forest for new farmland or releasing battery chicken effluent into local rivers is essentially free of charge.”
That pricing failure has contributed to a world where humans are using too much resource to build and make (see Figure 3) and are creating mountains of waste – with long-term consequences.
“The size of the global economy is just enormous compared to what it was 50 or 100 years ago,” said conservationist Harvey Locke, chair of Beyond the Aichi Targets Task Force for the IUCN's World Commission on Protected Areas, a body exploring global biodiversity goals.11 “Wow, did that work! But now we're destroying the context for all human life. We're changing the climate, we're destroying the oceans with overfishing, we've over-cleared the land, we’ve begun an extinction crisis and forecasts suggest we could lose up to a million species. That's like throwing all the rivets out of all the aeroplanes and saying: ‘Let's continue to fly’. We just can't continue this way. We’ve got to change.”
“It’s a vicious cycle,” agrees David Craig, founder and former CEO of Refinitiv, one of the world's largest providers of financial market data and co-chair of the Taskforce on Nature-Related Financial Disclosures (TNFD), the group working on a framework for managing and reporting nature-related risks.
“The degradation of nature is creating substantial risk to the global economy because there is very little we do that does not use natural resources. But climate change is also degrading nature and that is impacting the natural resources that will support and absorb carbon, affecting seagrass, ocean reefs, forests, savannas and so on.” (More from Craig, here.)
Breaking the cycle needs a shift in strategy, according to Locke. He recently set out his views in a co-authored paper, A Nature-Positive World,12 which suggested goals for returning the world to health (Figure 4.) The idea was to set out a simple concept everyone could get behind, rather like net zero; the proposal was picked up by the G7 before COP26, the last international climate conference.
“Trudeau, Biden, Merkel, Johnson and Macron all signed [the G7 2030 Nature Compact]13 saying the world must not only be net zero or carbon neutral; it must also be nature positive,” Locke said. “In other words, we have to halt extinctions and reverse biodiversity loss by 2030 and protect at least 30 per cent (of land and oceans) by 2030.”
Figure 4: Ambitious goals for nature restoration and recovery
Note: The trajectory of nature positive by 2030. It recognizes some ongoing loss is unavoidable given current trends and identifies the goal of a net improvement to a nature-positive condition by 2030 (from a 2020 baseline) and full recovery by 2050.
Source: ‘A nature-positive world: the global goal for nature’, April 30, 202114
There is no doubt these targets will be contested and difficult to deliver: the world failed to meet any of the last set of biodiversity targets agreed in Aichi in Japan in 2010.15 But the mood is changing. COVID-19 – a likely nature-based disaster – comes hard on the heels of other dramatic events. Three billion non-human animals were killed or displaced by wildfires in Australia in 2019 and 2020;16 a scale so large it is difficult to comprehend. Human costs were enormous too; recent estimates put insured losses at over $1.4 billion.17
“It’s staggering to see the extremes opening up in human experience, and to ask ourselves: What can we do? What are the most strategic pathways for making an impact?”, said Gretchen Daily, Bing professor of environmental science at Stanford University in a lecture at MIT.18
The first step, she believes, is reframing our thinking. “Rather than an all-you-eat buffet, we need to have a sense of scarcity and we need some table manners. We need to be investing in our life support systems rather than seeing them as a set of one-time, exhaustible resources.”
When I went to school, I learnt to look at forest systems as ‘How many baseball bats can we make out of the ash trees?’ It was a very particular way of looking. Now when I look, I see the most amazing solar panel array that you could imagine made from ubiquitous local materials. I see millions of chemical reactions going on silently, non-toxically, in water. I see miracle materials being made, the answer to how to clean. A circular economy – that’s what I see
Source: Speaking on ‘The future of nature’, WGBH Forum Network, 201719
“It does seem that in some cases we have developed an isolated a view of the market,” says Dr Paul Pritchard from sustainability consultancy Iken Associates. “It’s been all about making money, buying things and selling things without necessarily thinking back along the value chain to where all the raw materials come from, and how sustainable those processes might be.
“Until recently, I don't think biodiversity loss was considered in a strategic way within the majority of businesses,” he adds. “There were specific issues addressed, but it’s only recently we have started to look at this as a global issue and how it connects to climate. That's where we are starting to join the dots. Agreement on a future global biodiversity framework emerging from the Kunming COP 15 conference in April-May 2022 could be a major step forward in that regard.”
Searching for metrics: Local issues, global problem
The process is becoming increasingly urgent, because “people have begun to appreciate the quantum of risk,” Craig says. He flags the stress tests carried out by central banks in Brazil, the Netherlands and France, which threw up some startling numbers.
Agreeing standardised metrics to capture the state of the planet has not been achieved
“The French study found 40 to 50 per cent of bank loan books are exposed to nature,” he says. “That’s considerable, particularly if you marry it with the scale of environmental degradation, where we are losing around a football pitch of primary rainforest every six seconds. It’s an extraordinary number. If you look at this bluntly and start putting the factors together, it means switching from “‘Let's care for pandas” to a serious assessment of economic risk and reality.”
But agreeing standardised metrics to capture the state of the planet, with the aim of managing better outcomes for all, has not been achieved.
“The factors are contextually sensitive to location and industry; it matters where you are,” says Craig. “There is no single number to capture this complexity, although there may be a set of numbers that achieves it. Water use is measurable, as is land use, then there is STAR (Species Threat Abatement and Restoration) for biodiversity, and other metrics are surfacing as well. We will get to a set of numbers, but it will never be as simple as climate.”
“It is much harder for policymakers and investors to assess a company’s impact on nature than its carbon emissions,” agrees Mathieu. “For example, a major chocolate manufacturer might have 500,000 farmers in its supply chain. How can we measure the impact of each? How many trees were felled for new plantations? How many insects were killed by their pesticides? The difficulty is that biodiversity impacts are entirely local. It relates to how many trees are cut down, how you pollute the waterways and manage waste. It is unlike the carbon emitted into the atmosphere, where we have a common metric (carbon dioxide equivalent), and you can estimate the carbon footprint pretty accurately from readily available data, like how much fuel was used to get a product to market and how many tonnes of fertiliser were applied.” (See more on biodiversity).
Figure 5: Eyes wide open - assessing risks from climate and ecosystem vulnerability
Source: Aviva Investors 2022. Data from CDP, September 2021
Some companies, like cement producer Holcim, have begun targeting ‘nature positive’ outcomes, setting targets to improve biodiversity in its quarries and reducing water consumption, for example.20 But it’s early days, with CDP research suggesting few of the 9,700-plus companies it polled recently are giving nature risk the attention it deserves (see Figure 5).21 It remains to be seen how many companies will adopt the goal of being ‘nature positive’ when it is so hard to measure and therefore prove.
Figure 6: Nature-based risk considerations
Source: Aviva Investors, 2022. Data from ‘Integrating biodiversity into natural capital assessments’, March 202122
Companies are increasingly experimenting with how to quantify biodiversity impacts. Luxury goods manufacturer Kering, for example, has been a pioneer in the field of biodiversity accounting. It published its first environmental profit and loss (eP&L) account in 2011, measuring the monetary impact of its business activities on the environment. Its current target is to reduce its eP&L footprint by 40 per cent across the supply chain by 2025 and relative to growth, using a 2015 baseline. Its 2020 biodiversity strategy includes a target to restore and regenerate one million hectares of its supply chain and protect one million hectares of critical habitat by 2025.
Moving towards a common nature-risk framework
Meanwhile, the TNFD – co-led by Elizabeth Maruma Mrema, executive secretary of the UN Convention on Biological Diversity, and Craig – is attempting to fast-track an agreement on a framework for nature-risk accounting, so companies can incorporate a natural-asset view into their published accounts. The hope is that this will encourage consistency, helping organisations focus on how changing conditions in the natural world might impact their financial performance and what might happen in future scenarios, with the goal of channelling investment to more sustainable outcomes.
We are looking at how to identify the natural assets that revenue is dependent on or assumed in the cost base
“In our risk management framework, we are looking at how to identify the natural assets that revenue is dependent on or assumed in the cost base,” Craig says. “A few companies have a tiny line that accounts for, say, water used. But if that water source disappeared, it is likely to cost a lot more to replace it. We will have to start identifying the natural assets we rely on and where risk controls should be focused.”
Early work by the members of the TNFD is based around the four pillars (governance, strategy, risk management, metrics and targets) already established by the Task Force on Climate-Related Financial Disclosures (TCFD). The TNFD released its initial proposals in March 2022, which will be refined in 2022 and 2023.
“Asset managers and insurers are taking this seriously because they have regulatory, financial and fiduciary responsibilities to factor in such externalities,” says Craig. “They are thinking: We need to focus on this, and fast.”
Why investors need to better understand ecosystem vulnerabilities
This is far from a conceptual exercise; nature risk is relevant and elevated, now. (See World Economic Forum 2021 Global Risks Report).23 In Japanese fisheries, for example, catches have been drifting down for more than 15 years.24 (This should not be a great surprise, perhaps; humans have a history of eating species into extinction, as Leonore Newman, Canada research chair in food security and environment, points out in her book Lost Feast.25 Even populations numbering billions, like North American passenger pigeons, alleged to taste like a combination of duck and steak, have been eaten into oblivion.) The tendency has implications for investors if stock depletion is masked.
“Often there will be actions taken by management that delay how soon the warning signs start to show up in a company’s financials,” says John Willis, director of research at Planet Tracker, a non-profit financial think tank. “We have seen this in Japan, which has a number of listed fishing companies. The catches started to fall, but management started cost-cutting and embarking on acquisitions to try to get around the problem. But you still eventually reach a position where you have played every financial card and are out of options. That is exactly what is happening now.” (More from Willis, here.)
Outside fisheries and agriculture, many other companies are exposed to dwindling supplies of water, as the percentage of the planet affected by drought has more than doubled in the past 40 years.26 Recent analysis suggests certain agri-businesses and consumer products companies could be subject to significant earnings hits (40 per cent plus of pre-tax earnings) from water scarcity.27 Other earnings effects might come for companies using waterways for transport; think of how low water levels in the Rhine forced chemicals producer BASF to close some operations in 2018 when it was unable to obtain the raw materials it needed.28
If water scarcity becomes more of an issue, it is reasonable to expect that polluters will face greater scrutiny, leaving themselves open to fines and litigation.
Litigation has enormous power to signal what society is happy to tolerate
“Litigation has enormous power to signal what society is happy to tolerate,” says Tom Tayler, senior manager at Aviva Investors’ Sustainable Finance Centre for Excellence. “Sometimes the threat can be as important as the litigation itself. If companies and governments believe they are going to face sanctions if they do not fulfil their responsibilities, that is a powerful incentive to do the right thing.”
He highlights the trend in sustainability policy to explicitly link the climate and biodiversity crises, which is likely to aid those wanting to build on climate litigation to bring cases related to species loss or erosion of natural capital. (Consideration of legal risk is already set out within TCFD guidelines; TNFD guidance is pending.)
The more positive side of the coin is the opportunities for companies developing circular economy ideas, developing technologies to use resources more sparingly, devising nature-friendly solutions and targeting sustainable development. These are all growth areas being explored by researchers, entrepreneurs and investors.
Companies doing the right thing now should outperform in the long run
“Investors can also allocate capital to transition leaders in their respective industries – companies that are moving in the right direction in terms of their management of natural capital and environmental risk - and engage with them to move further and faster,” Zhuang says. “Companies doing the right thing now should outperform in the long run, as measured both by financial returns and their impact on nature.”
There are specific opportunities in agri-food production, one of the areas most responsible for carbon and methane emissions, biodiversity loss, soil depletion and heavy water use. “The key question is: how do we balance the need to feed people with the interests of the planet as a whole?” says Jonathan Toub, portfolio manager of the Aviva Investors Natural Capital Transition strategy.
“At the moment we have around one third of the entire surface of the earth used for cropping or animal husbandry, but those activities use around three quarters of all available freshwater. In many areas the land is gradually being degraded, greenhouse gas emissions are contributing to warming and biodiversity is being diminished. These impacts really need to be addressed,” he says. “Rather than more intensive farming, we need precision and regenerative agriculture, with more efficient use of fertilisers and irrigation, for example.”
We need to improve the efficiency of agricultural production and supply chains urgently
Reducing food waste is another priority, according to Toub. “One third of the food produced for human consumption, around 1.3 billion tonnes, is lost through supply-chain issues or from food simply being thrown away,” he says. “This is enormously costly given the drain on the land as well as the fuel, water, seeds, fertiliser and man hours that have gone into producing the food. We need to improve the efficiency of agricultural production and supply chains urgently.”
With more eyes on ecosystem monitoring, there may be positive earnings impacts for companies improving the management of biodiversity and environmental risks. “Companies involved in testing, inspection and certification of natural capital tend to get overlooked, for example, despite facilitating better standards in biodiversity risk management globally,” Zhuang adds.
Looking through a nature lens
We are losing our suicidal war against nature
There are multiple uncertainties in an environment where nature and climate appear to be locked in a vicious cycle. “We are losing our suicidal war against nature,” warned UN Secretary General António Guterres at the United Nations Biodiversity Conference, in Kunming, China in 2021. “Our two-century-long experiment with burning fossil fuels, destroying forests, wilderness and oceans and degrading the land has caused a biosphere catastrophe.”
But if there is one positive takeaway from this alarming situation, it must surely be that the penny has finally dropped: wider swathes of society seem to be waking up to the fact it is not possible to keep clearing, burning, building, consuming, and dumping waste without being more mindful about the consequences. Ehrlich describes actions that decimate the richness of the natural world as “intensely stupid”, like chopping off a limb. It’s time to confront them.
Measuring and comparing nature-risk: A portfolio manager’s perspective
“Comparing the actions taken by different companies is challenging. A single greenhouse gas emissions figure can show meaningful differences between companies in different sectors, but with biodiversity, every sector has very different impacts that are not easily measurable or comparable.
For example, a beverage company’s main impacts on nature relate to its packaging, the sourcing of ingredients like coffee or cocoa, and water use, while a bank’s will be associated with its policies on lending to high-impact industries like fossil fuels and palm oil and soy plantations. It is currently not possible or meaningful to compare a bank’s impacts on nature with a beverage company’s using a similar set of metrics.
Investors therefore need to gain a picture of the risks that are relevant on a sectoral basis, using data from a variety of sources. Independent or non-profit groups, such as the World Benchmarking Alliance, CDP, Forest 500, the Zoological Society of London’s Sustainability Policy Transparency Toolkit, the Farm Animal Investment Risk and Return Initiative and the Fashion Transparency Index, have all carried out research into sector-specific biodiversity impacts.
Another useful tool is ENCORE (Exploring Natural Capital Opportunities, Risks and Exposure), developed by the Natural Capital Finance Alliance in partnership with the UN Environment Programme, which assesses the impact of 177 sectors on 11 aspects of nature, including soil and water pollution, ecosystem disturbance and GHG emissions. Our proprietary transition risk model draws on these datasets, as well as others.”
Portfolio Manager, Aviva Investors Natural Capital Transition strategy