By Deepshikha Singh y Guy Wilkinson, La Française Sustainable Investment Research
As with climate-related financial analysis, Biodiversity-related risks to corporates and financial institutions’ portfolios can be distinguished between physical and transition risks.
Physical sources of risk include, for example, the decline of ecosystem services on which economic actors depend. These risks can be chronic (i.e., gradual decline in numbers and species diversity of pollinators resulting in reduced crop yields, or increasing costs of manual pollination) or acute (i.e., pests wiping out significant parts of a harvest because of the disappearance of natural predators, or disease spreading as a consequence of reduced natural resistance, potentially leading to pandemics), or both (i.e., disruption to micro-climates and the hydrological cycle caused by deforestation).
As per the IPBES report, losing critical ecosystems such as the Amazon could lead to tipping points that would cascade the planet into existential risk. Services provided by ecosystems are worth roughly $125-$140 trillion per year (more than 1.5x global GDP). Between 1997 and 2011, the world lost an estimated $4-$20 trillion per year in ecosystem services owing to land-use change and a further $6-$11 trillion per year from land degradation.
Transition risks result from a misalignment between financial institutions’ portfolio allocations and strategies and developments aimed at reducing or reversing the damage to Biodiversity and ecosystems, such as government measures, technological breakthroughs, litigation and changing consumer preferences. These measures and developments are likely to target the five direct drivers of Biodiversity loss listed above, which could affect a great variety of economic agents and sectors. For example, expansion of protected areas via the Global Biodiversity Framework or Natural Capital solutions will limit businesses’ ability to expand into or exploit natural resources.
Currently, many economic activities have a negative impact on Biodiversity. Harmful government subsidies alone amount to around US$500 billion annually (OECD, 2020), and will likely have profound impacts on sectors and companies when redirected and eliminated. A study found that the Dutch financial sector had €15 billion in exposure to companies that are active in already protected areas, rising to €28 billion in a scenario where protected areas are increased to 30% of land and inland waters by 2030. Scenario analysis and stress testing will be instrumental to the assessment of transition risk.
Physical and transition risks can interact and affect economic agents through various channels, before materialising into traditional sources of financial risks (i.e., credit or market risks).
Risks and Opportunities from a Net Nature Positive goal
The Taskforce for Nature-related Financial Disclosure (TNFD) describes a third form of nature-related risk – ‘systemic risk’ – a rare, but overlapping and compounding, impact of physical and transition risks that can result in the breakdown of the entire system, rather than the failure of individual parts.
However, there are also significant opportunities that are arising for us as investors from addressing Biodiversity loss. Changes in global regulations and social behaviour towards protection, preservation and restoration of nature will create numerous opportunities in many sectors. Technological innovations will be needed as companies and governments grapple with monitoring and reducing their risks related to nature. In Brazil, for example, a state-of-the-art satellite-based deforestation monitoring system in the Amazon biome, run by the National Institute for Space Research, has enabled the government to monitor and enforce actions against deforestation. In Mexico, a national automated mapping system allows the evaluation of national subsidies/incentives through spatial analysis tools.
There will also be an added opportunity with companies that have better Biodiversity risk management, and that can help achieve the GBF goal for a nature-positive future. According to the WEF, sustainable supply chain investment has the potential to decrease operational costs by up to 16%, and can increase revenue by up to 20%. We see some of the largest chemical, agricultural and technological companies in the world, actively working on solutions to answer positive Biodiversity targets. The World Economic Forum recently concluded that ‘nature-positive’ solutions can create almost 400 million jobs and over $10 trillion in business opportunities by 2030.
