Finance must wake up to the risks associated with biodiversity loss and the opportunities that arise from nature-friendly solutions, argue Eugenie Mathieu, Julie Zhuang and Jonathan Toub.
Read this article to understand:
- The business risks associated with biodiversity loss
- How investors can engage with policymakers and companies to tackle the destruction of nature
- The investment opportunities that derive from nature-positive activities
COP26 dominated media headlines in November. Political leaders and business chiefs descended on Glasgow to thrash out a new agreement on the climate crisis, while placard-waving activists marched outside the conference halls.
In contrast, another recent COP meeting passed by largely unnoticed. In October, the Chinese city of Kunming hosted part one of COP15, or the UN Biodiversity Conference, where governments convened to discuss humanity’s impact on nature and how to protect the world’s remaining wild places.
COP15’s relative obscurity indicates the lack of attention given to biodiversity loss
COP15’s relative obscurity indicates the lack of attention given to biodiversity loss, even as climate change has risen up the agenda. But there is a growing awareness that the two threats are closely related. Healthy ecosystems trap carbon from the atmosphere more effectively than unhealthy ones, for example.
Like climate change, the erosion of “natural capital” – a phrase that refers to the world’s stock of natural assets, including all living things, but also air, water, geology and soil – presents big financial risks. Estimates suggest 55 per cent of global GDP, around $44 trillion, is dependent on high-functioning biodiversity and ecosystem services. The destruction of nature therefore threatens companies in a range of industries.1
The main impact of the biodiversity decline falls on sectors directly linked to natural resources
The main impact of the biodiversity decline falls on sectors directly linked to natural resources, such as agricultural commodities, food producers, textile producers and pharmaceuticals; other companies may suffer indirect knock-on effects, such as dwindling supplies of fresh water. On a more positive note, some firms are discovering commercial opportunities by proactively greening their operations and devising nature-friendly solutions.
In this Q&A, the team leading Aviva Investors’ Natural Capital Transition strategy, senior impact analyst Eugenie Mathieu (EM), and portfolio managers Julie Zhuang (JZ) and Jonathan Toub (JT), discuss the implications of these trends for investors.
Why has the biodiversity crisis received less attention than climate change?
EM: The destruction of nature has not been seen as an existential crisis in quite the same way as climate change. Secondly, while there is a strong economic incentive to reduce energy usage and therefore emissions, there are fewer economic incentives for companies to curb practices that are harmful to nature. Unfortunately, nature is currently free to exploit. Cutting down trees for new farmland or releasing battery chicken effluent into local rivers is essentially free of charge.
It is much more difficult for policymakers and investors to assess a company’s impact on nature
One reason for the lack of progress is that it is much more difficult for policymakers and investors to assess a company’s impact on nature than its carbon emissions. For example, a major chocolate manufacturer might have 500,000 farmers in its supply chain. How can we measure the impact of every one of those farmers? How many insects were killed by their pesticides? How many trees felled for new plantations? In contrast, it is easier to estimate the carbon footprint of those farmers.
The financial community is beginning to recognise the negative impact humanity is having on nature. Why now?
JZ: Natural disasters have become more frequent over recent decades. Take the Amazon forest fires or the wildfires in California, for instance. These events show the extent to which we have underestimated the erosion of our natural capital and the risks that result. Investors are also starting to appreciate some of the opportunities that come from better management of environmental risks through biodiversity policies.
JT: As investors have integrated climate risk into their portfolios, and looked into potential solutions to climate change, they have become much more aware of the interaction between healthy ecosystems and the climate; you now find some fund managers are able to discuss the carbon-capturing properties of sea kelp or phytoplankton.
Investors have more information on nature loss than ever before
Investors also have more information on nature loss than ever before. We can watch near-live footage of the Amazon being destroyed and use this kind of information to better understand whether corporate and governmental promises to protect nature are being kept.
Has your research uncovered any particular insights to highlight the vast scale of the human impact on nature?
JZ: The data on the Sixth Great Extinction of animal species is shocking. According to the World Wildlife Fund’s Living Planet Report, there has been an average decline in wildlife populations of 68 per cent since 1970.2 The decline in freshwater species, as exposed in the Netflix documentary Seaspiracy, is particularly troubling: 84 per cent have been lost over the last four decades.
Exploiting nature in this way will lead to damaging economic effects over the longer term
These mass extinctions are mostly attributed to the explosion of the human population and intensive use of natural capital via industrialisation over the last century. Exploiting nature in this way has fuelled global GDP growth, but it will lead to damaging economic effects over the longer term as we lose our life-support systems.
Which industries are most accountable for biodiversity loss?
JT: The WWF report shows agriculture is responsible for 70 per cent of terrestrial biodiversity loss. The industry is also responsible for 80 per cent of global deforestation, 29 per cent of the world’s greenhouse-gas (GHG) emissions and up to 70 per cent of global freshwater use.3
We need precision and regenerative agriculture and we also need to reduce food waste
The key question is: how do we balance the need to feed people with the interests of the planet as a whole? Rather than more intensive farming, we need precision and regenerative agriculture, with more efficient use of fertilisers and irrigation, for example. We also need to reduce food waste. The WWF report finds that, while 820 million people on the planet face hunger or food insecurity, one third of the food we produce is lost, either through supply-chain issues or from food simply being thrown away. This illustrates the need to improve the efficiency of agricultural production and supply chains.
Other than avoiding industries that harm nature, like intensive farming, how else can investors ensure portfolios are resilient to the risks associated with biodiversity loss?
JZ: Investors can 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 risks – and engage with them to move even further and faster. Companies doing the right thing now should outperform in the long run, as measured both by financial returns and their impact on nature.
Investors can seek out innovative companies that directly protect nature
Investors can also seek out innovative companies providing products or services that directly protect nature or lessen the harmful impact of human activity. Companies involved in precision agriculture, sustainable animal nutrition, wastewater management, meat alternatives, the circular economy, plastic reduction or biodegradable materials could represent potential investment opportunities.
JT: Investors also have a role to play in engaging with policymakers on macro-level policy initiatives, as there are problems the market cannot solve independently. High-level intergovernmental discussions will shape the playing fields on which all companies operate, and we are working to advocate for improved standards on nature protection.
What kind of policy changes are needed to ensure nature is protected?
EM: Companies are too often incentivised to damage the natural world. Fossil fuel producers and the agriculture sector still receive substantial subsidies. We also need tougher legislation to address the ridiculous impunity companies have to pollute the environment: consider the furore over water companies repeatedly and knowingly dumping raw sewage into Britain’s rivers. Southern Water’s recent £90 million fine for dumping sewage in rivers and coastal waters was a good step in the right direction.4
Policymakers could look much more closely at taxation
Policymakers could also look much more closely at taxation. For instance, taxes on meat or fish consumption, or on nature-destructive activities like cruise ships, would help shift consumer behaviour and force positive change among companies. Everyone who is making their money directly from exploiting nature should be paying for it.
Could you cite examples of companies that are leading the way in improving their impact on nature?
JZ: As an apparel retailer, Adidas is classified as having a high impact on biodiversity, but it is an industry leader on sustainability, using a high percentage of sustainably sourced materials in its products. The company scored extremely highly in the 2020 Fashion Transparency Index, which tracks environmental components of the circular economy, sustainable materials and sustainable management of natural resources.5
DSM is working on innovative solutions and has committed to phase out all harmful chemical production by 2025
Chemicals company DSM is another example: it is working on innovative solutions, including a type of animal feed that reduces methane emissions from cattle by more than 30 per cent. DSM was also ranked first in a recent benchmark of 35 chemicals companies’ management of hazardous chemicals6 and has committed to phase out all harmful chemical production by 2025. The company’s executives are appropriately incentivised with compensation linked to the development of eco-friendly products, improved energy efficiency and reduced GHG emissions.
As investors pay more attention to ESG, are nature-friendly companies attracting a “green premium”?
JZ: There is a green premium attached to some early-stage technology companies working on nature-positive solutions. But over a long-term investment horizon, the opportunities related to, say, biodegradable plastics or meat substitutes could be greater than is currently reflected in share prices.
Opportunities in biodegradable plastics or meat substitutes could be greater than currently reflected in share prices
In many cases, companies’ improving management of biodiversity and environmental risks is currently underappreciated by the market. 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.
Could you say a little more about the challenges involved in collecting and analysing data on natural capital?
JZ: It can be difficult to measure a company’s impact on its natural environment, as there is no single metric – as with carbon emissions – that will give you all the information you need.
Comparisons across companies are also challenging
Comparisons across companies are also challenging. A single GHG 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 key impacts on nature have to do with its packaging, sourcing of ingredients like coffee or cocoa, and water use; a bank’s will be associated with its policies on lending to high-impact industries. It is currently not possible or meaningful to compare a bank with a beverage company using a similar set of metrics.
Investors therefore need to gain a picture of relevant risks on a sectoral basis, collecting data from a variety of sources. Independent or non-profit groups, such as the World Benchmarking Alliance, the Climate Disclosure Project, 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 carried out excellent research into sector-specific biodiversity impacts.
We have a proprietary transition risk model that draws on different datasets
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. We have a proprietary transition risk model that draws on these datasets, as well as others.
EM: We are seeing progress on industry-wide initiatives to improve and standardise the data available. For example, the Task Force on Nature-related Financial Disclosures is developing a framework, similar to that of the Task Force on Climate-related Financial Disclosures, to provide a more accurate picture of companies’ impact on nature and inform better risk management. This is a positive step.
One of the points made in the 2021 Dasgupta Review, The Economics of Biodiversity, is that we must serve as “judge and jury for our own actions”.7 To some extent, asset managers will be the judge for savers and pension holders. Do you see your role in those terms?
JT: It’s exciting that biodiversity is now being recognised in our industry. But there are many nuances to be aware of. I agree our role is to help clients invest sustainably by identifying companies we believe to be leading on reducing their and their customers’ impacts on nature, but to do that we really need to understand the intricacies involved; that’s why good data is so crucial.
Investors in natural capital need to focus on their dual mandate
JZ: To protect their credibility and integrity, investors in natural capital need to focus on their dual mandate: to deliver a positive outcome for nature as well as driving investment returns. If investee companies make promises but don’t deliver on them, for instance, it is important to look at engagement or time-bound divestment.