Biodiversity For Financial Institutions: Making the LEAP to Better Decision Making and Stewardship

In our previous article on biodiversity, we identified the current pressures and outlook on incorporating biodiversity into investment, finance, and insurance decision-making processes. We also highlighted the necessity for education and innovation on this growing topic which, given its complexity, should not be looked at through the lens of a single metric. Now that COP15’s Global Biodiversity Framework has been agreed on, we will look at how financial institutions can perform biodiversity assessments to make meaningful decisions, contribute to biodiversity preservation, and be accountable to regulators. 

As mentioned in our previous post, the Taskforce on Nature-related Financial Disclosure’s framework LEAP, suggests a clear and actionable step-by-step guide for biodiversity assessment: 

• Locate your interface with nature;
• Evaluate your dependencies and impacts;
• Assess your risks and opportunities; and
• Prepare to respond to nature-related risks and opportunities and report.¹  

In this article, we’ll discuss how investors can effectively apply the steps set out in the LEAP framework to better inform their biodiversity-related investment decisions. Within the LEAP framework, financial institutions are advised to start directly from the Evaluate step,² so we’ll discuss how this can be done for both financing and investment decisions leveraging readily available information beyond a single metric. We’ll also examine ways investors can assess issuers’ biodiversity risks, measure issuers’ impacts and respond to those findings. In fact, measuring impacts is one of the last steps recommended in the LEAP framework, strongly suggesting that much work needs to be done before financial institutions use metrics to report on their progress. 

How Asset Managers and Owners Can Implement the LEAP Framework

Evaluating Issuers’ Dependencies and Impacts on Biodiversity 

Asset managers and owners can start by assessing which sectors and issuers depend on an ecosystem’s services, and which are having a negative impact on ecosystems. Research on issuers’ products can provide an overview of the activities putting pressure on ecosystems. For example, fossil fuel, pesticides, genetically modified organisms, and palm oil, among others, are all significant contributors to biodiversity loss.

What’s more, product and operational metrics from companies can provide raw data on carbon dioxide (CO2), sulfur oxide (SoX) and nitrogen oxide (NoX) emissions, which can be used to compare negative impacts across sectors. Other operational metrics, such as water withdrawal and consumption, can be used to assess the dependencies of companies active in water-stressed areas.

On the positive impact side, there are several activity involvement tools available that provide insights on companies generating revenues from activities respectful to biodiversity functioning such as sustainable agriculture or aquaculture, sustainable dairy food, sustainable forestry, etc., all of which are dependent on natural resources.

Assessing Issuer Biodiversity Risks and Opportunities 

This step focuses on assessing the risks that biodiversity loss creates for issuers, as well as identifying the mitigation strategies that issuers can implement to overcome these risks. Industry ESG risk ratings and controversies research offer a comprehensive approach to these assessments. Insurers, investors, and banks can focus on companies having a positive impact to identify and maximize portfolio opportunities.

Involvement in environmental controversies is an indication of a company’s biodiversity-related impacts. Using this research can help investors identify companies involved in events that may pose a business or reputational risk due to the potential impact on the environment. 

Assessing a company’s level of ESG risk can also help identify their exposure to material issues such as land use and biodiversity, resource use, and emissions, effluents and waste, among others. This data provides investors with a better sense of how material biodiversity is for these issuers, both within their own operations and within their supply chains. 

Investors can also review how corporate policies and programs on deforestation, water management, green procurement, waste management, GHG emissions etc., are implemented to help identify mitigation and improvement opportunities. For example, a water management program should include water use monitoring and reporting, relate to a policy commitment to reduce use by setting targets and deadlines, and have top management oversight. Moreover, targets should be location and context specific. 

Preparing to Respond and Report on Nature-related Risks and Opportunities 

In this last step of the LEAP framework, financial institutions will have to identify capital allocation solutions to manage biodiversity-related risks as well as set targets, measure progress, and report on all of them. Support from third-party data providers and sustainable revenue metrics can be extremely helpful in identifying companies offering products and services that limit negative impact, and preserve and protect biodiversity such as sustainable agriculture, green buildings, pollution prevention, recycling, sustainable fertilizers, etc.

Overall, there are a variety of data-based insights that support the step-by-step assessment required by LEAP. Together, these data points make a compelling case for financial institutions to properly address the issue.

How Banks Can Integrate Biodiversity Into Their Decision Making

Banks can act by reviewing their sector policies and setting financing objectives for activities contributing to biodiversity conservation, such as sustainable forestry or renewable energy. According to our recent benchmarking analysis,³ today’s most ambitious European banks have a separate policy dedicated to biodiversity issues. Other financial institutions include specific requirements in their sector policies, where biodiversity can be addressed in three different ways:  

1. Exclusion: The bank denies financing to certain activities harmful to biodiversity.  
2. Introduction of minimum requirements: These can be external certifications or the introduction of coherent policies and programs that serve as a prerequisite to receiving financing or a different banking service. Such requirements can be sector or location specific.
3. Set precise expectations: In this approach, the bank stipulates a path for development, where today’s aspirations could appear in tomorrow’s minimum requirements. Thus, banks are preparing their clients for potentially more stringent policies in the future. 

Let’s look at an example. Of all the pressures on biodiversity, land use change is the most impactful. At the same time, this topic is the easiest to address through banking policies. According to the World Wildlife Fund (WWF), agriculture is the leading cause of deforestation because of the conversion of forests into growing and grazing areas. Hence, by introducing strict deforestation policies banks can act against biodiversity loss, and simultaneously prepare themselves for recently adopted European Commission Deforestation-free product regulation. The legislation aims to ban the import of six commodities: beef, wood, palm oil, soya, coffee, and cocoa – and some of their derived products such as leather, chocolate or furniture – if produced on land deforested or degraded after 31 December 2020, putting significant pressure on banks.

As financers of companies’ activities and developments, banks will have a key role in contributing to both biodiversity impact mitigation and preservation, but will also be closely scrutinized by regulators and NGOs. Banks will therefore need enhanced policies and robust data to ensure compliance and demonstrate credibility.

Leveraging Investment Stewardship to Drive Positive Impact on Biodiversity 

With recent European regulations such as the Sustainable Finance Disclosure Regulation (SFDR) and Markets in Financial Instruments Directive (MiFID II) mandating investor reporting on “sustainable investments,” investors will have to engage with companies, making stewardship a key element of responsible investment strategies. In this context, engaging with companies on biodiversity is a powerful tool to both learn from companies’ good practices and incentivize laggards to tackle the issue, especially when it is material.  

For investors interested in addressing biodiversity issues within their portfolio, there are a few key actions they can take: attend annual general meetings, participate in collective engagement initiatives, vote for resolutions pushing companies to reinforce disclosure, go through the LEAP framework to reduce their negative impacts on nature, etc. Since 2020, we’ve seen a significant increase in votes and resolutions on themes like plastic waste, pesticide use, water stewardship, and deforestation. In some cases, the resolutions were withdrawn because the company committed to address the issue — partially thanks to engagement pressure from investors.

When engaging with issuers, an easy way to start the conversation is to acknowledge the importance of the topic, then move to the impacts of their activities. When talking about dependencies, engagement can also help bring to the table companies relying on the same resource. For example, companies depending on water from a catchment area would value the sustainable management of the resource to maintain their operations, but outside of the engagement framework there would be less chances for them to enter in the dialogue. 

To address the complex and interlinking elements of biodiversity loss and climate change, investors can take a comprehensive approach, using several tools to assess double materiality, protect and promote long-term value, and capitalize on opportunities and generate systemic impact throughout value chains. 

As new learnings and regulations arise, investors' needs and requirements will also change. From identifying material biodiversity-related issues among portfolio companies to engaging issuers to make positive change, discover how Morningstar Sustainalytics Stewardship Services can help.  

To learn more about Sustainalytics’ Biodiversity and Natural Capital Impact thematic engagement program or to discuss how we can help assess the companies in your portfolio, contact us. 

References

^{1 Taskforce on Nature-related Financial Disclosures. 2022. The LEAP Nature Risk Assessment Approach. (website). https://framework.tnfd.global/the-leap-nature-risk-assessment-process/.}

^{2 Ibid.}

^{3 Benchmarking analysis conducted in Q1 2022 of 15 major European banks and leveraging information from ShareAction’s 2021 report “Countdown to COP26: An analysis of climate and biodiversity practices of Europe’s largest banks.” https://shareaction.org/reports/countdown-to-cop26-an-analysis-of-the-climate-and-biodiversity-practices-of-europes-largest-banks.}