Scientists around the world have highlighted the need to tread more lightly on the planet, halting then reversing the decline of the natural world. But the financial community, including investors, has been slow to respond.
Read this article to understand:
- Why the loss of nature should matter to investors
- About efforts to fast-track environmental concerns
- Whether species loss might threaten earnings in some sectors
In the course of human history, around three-quarters of the land and two-thirds of the marine environment have been significantly altered, impacting the carbon cycle and changing the outlook for many species. As a result, a recent landmark report from the UN’s Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services suggests around one million species of plants and animals are on the brink of extinction.1
So, at what point will society collectively step up and acknowledge the damage being done? What actions are the financial sector taking to address the overuse of resources and devastating pace of species loss? And how soon will the issues start to appear in company accounts and financial markets?
These questions need to be addressed together with climate, not as a secondary consideration, according to John Willis, director of research at Planet Tracker, a non-profit financial think tank.
If the state of the planet is so important, why has it taken the financial community so long to focus on it?
The honest answer is that they have not felt the pressure to do so, because most companies remain focused on shareholder returns. After all, the meetings that take place are shareholders’ meetings (in the UK); they are not stakeholder meetings.
Can I be climate-friendly and nature-friendly and maximise returns?
In many of those, the focus is on return expectations, and the tone of the conversation might conflict with nature and climate change issues. So, one of the very big live questions is: “Can I be climate-friendly and nature-friendly and maximise returns?” That’s a challenge for management teams if the focus is on financial returns, which do not price in nature considerations.
There are those that believe nature targets can only be achieved through abolishing economic growth as a social objective. I am not saying Planet Tracker supports that, as de-growth has numerous implications. It is almost in direct conflict with the idea of maximising shareholder returns and is a difficult message for politicians to sell to their electorates. What is important is to price in these climate and natural capital externalities.
How is the investment sector assessing the issues?
One big issue is definitions. Should we focus on nature? Should we focus on biodiversity – the variety of life on earth? Or should we focus on natural capital; that’s a category that can include non-living things like reserves of gold or oil as well.
Should we focus on nature? Should we focus on biodiversity? Or should we focus on natural capital?
We expect further debate about the most appropriate term, and more discussion about whether biodiversity is the measure the community lands on, because we know we can measure the prevalence of certain species. Should we stick with that because people understand it? Should we look more widely at nature, which could potentially be more complicated? Or should we use a term like natural capital, where people on the street might reasonably ask: “What on earth are you talking about?”, but those in the financial markets will understand.
We are at the point where humanity is drawing down natural capital too fast. How difficult is it to find data on how nature is being impacted and the number of species being lost? What metrics should we be looking at?
The original Earth Summit in Rio de Janeiro in 1992 was all about the environment in the broad sense. It was not all about climate change, but people seem to have forgotten that. For some reason, climate came to the fore, and biodiversity was pushed aside.
One of the more convincing arguments is that those working in financial markets are good at looking at benchmarks. It was fortuitous that people agreed a climate target to limit the increase in global temperature to well below two degrees above the pre-industrial average, and that benchmark effectively became 1.5 degrees.
A benchmark and a performance measure were made available to all
In addition, there was a common currency agreed, where emission calculations could be translated into carbon or an equivalent. That’s fantastic, like converting everything to the US dollar, so when you speak to those in the capital markets, they know exactly what you are talking about. A benchmark and a performance measure were made available to all.
But when you look at the variety of life on Earth, you might be tempted to say: “This is just too complicated.” That is an excuse. There are real practical problems in measuring human impacts, but many financial firms have ESG teams that are simply under-resourced.
At the moment, many of these teams are focused on climate transition. This is not just worrying about the 1.5-degree target, it is about trying to move the entire financial system to be more forward looking. That is the essence of a transition strategy. It means looking at portfolios and determining whether they are aligned with 1.5 degrees and if not, contemplating how they might get there, which is a lot of work.
Then others, like us, have arrived and said: “Are you concentrating on biodiversity loss as well? And what about single-use plastics?” For many in-house sustainable teams, this seems too much. Quite quickly the conversation turns to whether there could be a single measure to capture something complex like biodiversity.
We have areas of the world that are clearly recognised to be rich in biodiversity
I have been in discussions with a number of scientists about this. They already have indicator species (well-known species that can be observed and measured and are known to affect others) they assess. I’m not suggesting a species-led approach is the answer to everything, but it is a fair place to start and what scientists already understand very well. We also have areas of the world that are clearly recognised to be rich in biodiversity, which are closely monitored.
So, if you turn to me and say: “I have not got a measure”, I can turn back to you and say: “You have!” You might say: “Yes, but this is approaching the question at high level, globally,” and I could suggest looking in detail at samples in well-recognised biomes.
It starts to feel as if corporates and financial institutions are running out of excuses. The one that is often left on the table is simply: “I’m busy. I don’t have the time.”
There has been a certain amount of progress made in the climate debate. If we look at the trajectory of that, how far behind is the conversation on biodiversity?
We are not sure. The positive response would be to say climate change has laid down the pathway, the railway tracks, for the debate around nature and biodiversity. There is a compelling argument that says if you have an indicator and you have a benchmark, you might be able to move quite quickly.
If you have an indicator and you have a benchmark, you might be able to move quite quickly
We are going through discussions on this now with the Taskforce on Nature-related Financial Disclosures (TNFD) and other platforms such as the Nature 100. After the work done by the Taskforce on Climate-related Financial Disclosures and Climate Action 100+, they might be able to motor.
But the reality seems more complex, perhaps because there is potentially a lot of capital available related to discussions around natural capital and this area is under-resourced. There is a lot at stake. We need to get this right, fast.
What was achieved at the first of two meetings of the Conference of the Parties to the Convention on Biological Diversity (COP15), which took place in Kunming in China? Was the outcome an opportunity missed or a promising first step towards global political agreement on biodiversity?
The positive conclusion is that the conversation is underway. The parties are starting to define their terms and there were some high-level principles agreed. But if you look closely, there were very few announcements from companies. Compare that with all the company climate commitments made at COP26, which often crowded out announcements from governments.
There is much greater wealth accumulation in private hands
I see something promising there, because perhaps one of the biggest outcomes from COP26, which would then impact COP15 Part II, is whether the private sector in its broadest sense is the group to watch.
Having been through the COVID-19 pandemic, many governments are quite stretched and don’t have a lot of money to hand out. There is much greater wealth accumulation in private hands. Going back to COP15, will that mean more companies make commitments to monitor their environmental impacts? I hope so.
What is limiting progress? A lack of data or a lack of will?
A lack of capacity. Financial institutions are feeling bruised on climate and starting to make a lot of promises, so adding more on biodiversity is probably not where they would like to be.
Those that do not wish to move forward suggest data is the problem
One issue I would like to raise is the way those that do not wish to move forward on climate or biodiversity suggest data is the problem as scientists keep changing the rules. This is an absurd argument. Wouldn’t it be remarkable if science did not move on? It would be like saying to a technologist: “You presented me with this phone 20 years ago, and now you are presenting me with one that is slimmer and does everything a computer does. You have changed the rules!”
Could you easily compare the commitments being made by two companies in the same sector from the information available now?
It might be difficult. There are a handful of companies leading the way but there are two considerations to bear in mind. The first is that you will rarely get full transparency from companies forced to reveal information. They will give you the minimum requirement.
Some companies have already realised their dependency on natural capital
The second is that some companies have already realised their dependency on natural capital. For instance, if earnings are agriculture-based, it’s worth thinking about whether the land they rely on is still going to be there to cultivate in the future. For these companies, the land is effectively their factory for future output. They are likely to worry more about climate change and maintaining biodiversity than someone who appears to be less affected, like a technology company for example. That is why some are already pushing hard on biodiversity and some are not.
We are starting to see the cost of capital increase for climate change laggards. Do you expect to see the same for companies exposed to biodiversity loss?
I do, and it may happen more quickly than many expect. Take a steel producer and climate change. They may feel somewhat insulated from the problems caused by emitting carbon as climate change impacts everyone. But if we take one of the largest ocean fishing companies in the world, which is finding it harder and harder to catch fish, the impact is much more personal and significant. The same is true for a forestry company with no suitable land to grow trees on, which will have to rely on the price of the timber rising to compensate for lower volumes. The relationships can be more direct.
One of the things that surprised me at COP26 was how much nature was part of the discussion. It’s fantastic, but the wish is that people recognise how one affects the other. We are getting there!
We cannot view climate change over here, and land use and biodiversity over there. The issues are interrelated
If you look at land use, for example, we recently covered a Brazilian biofuels company that was heading for a listing. The energy people liked it because the company was producing biofuels. The non-energy people did not, because they looked at the water being used on the land and the fact that the resource could be used to grow other crops.
Ultimately, we cannot view climate change over here, and land use and biodiversity over there, because the issues are interrelated.
The one caveat is that we also need to be realistic. For example, say I am running a fishing company. An observer might say: “The oceans are depleted. You are finished,” but there often will be actions that can be taken by management that might delay how soon the warning signs start to show up in the company’s financials.
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 you are out of options. That is exactly what is happening now.
You have gone on the record saying that demand for sustainable investment products is a challenge for index providers. How is that market evolving?
Indexation is a complex area and one to watch over the next six months. We have seen it evolve, but there is a problem as the analysis becomes more complex.
The issues are not always clear for non-professionals
Sophisticated investors can look at index strategies and ask questions like: “Why do you own Exxon in a low-carbon fund?,” and the investment manager can turn around and say: “Yes, we own it, but it is underweighted, and the portfolio has a number of zero-carbon assets.” But these issues are not always clear for non-professionals, and the Securities and Exchange Commission and the European Securities and Markets Authority are examining claims around these strategies.
Generally, index providers say: “As long as we can measure the relevant variables, we can set the rules, and we can warn about unintended consequences.”
An important question is what happens next to performance. For example, in a low-carbon investment strategy, you are likely to be underweight oil and gas, but oil and gas companies have been performing well recently, while green technologies, which are likely to be overweights, are doing less well. What happens when the overall performance of the strategy is affected by these weightings and it underperforms funds measured against well-known indices?
An important question is what happens next to performance
Of course, the significance of these oil and gas companies has shrunk as part of the S&P 500 but, as they recover, they will come to form a larger part of the wider index – the part the low-carbon strategy won’t be owning. Will it all become a bit too uncomfortable if it results in lower investment returns?
There are also players working on biodiversity, and their work is fascinating. But they must be sure about measurement, and that is complex, as we have discussed.