Post-COP15 Outlook: Evolving Investor Responsibilities in Biodiversity

Following COP15’s Global Biodiversity Framework negotiation outcomes, financial market participants could face new regulatory pressure sooner than expected to integrate biodiversity assessment into their investment, finance, and insurance decision-making processes. All economic activities are dependent to a certain extent on biodiversity, with agriculture, aquaculture and fishery, food and beverages, and forestry among those with the highest dependencies. With continuous biodiversity erosion, the aforementioned industries face the highest risk, and all other economic activities are not possible if we cannot feed the world’s population.¹ Increasing awareness around nature-related risks is leading financial institutions to better understand how their investments may contribute to biodiversity loss.

The investment community is learning more about what's on the horizon for potential nature-related regulation and understanding the associated risks to identify the first steps in addressing global biodiversity decline.

Europe as a pioneer in establishing ESG regulations

Several pieces of regulation introduced in the European Union directly address the financial industry’s role in funding environmentally and socially sustainable activities. Among these initiatives, the EU Taxonomy Regulation is the most notable and advanced regulatory framework, as it uses comprehensive science-backed criteria and numerous thresholds. As announced, all four remaining objectives of the EU Taxonomy that will likely enter into effect in 2023 with a link to biodiversity:²

• The sustainable use and protection of water and marine resources
• The transition to a circular economy
• Pollution prevention and control
• The protection and restoration of biodiversity and ecosystems

In addition to the EU Taxonomy regulation aiming to reorient capital flows to more sustainable activities, the EU’s Sustainable Finance Disclosure Regulation (SFDR) was introduced to improve transparency in the market for investment products. The SFDR requires investors to report on one biodiversity-specific Principle Adverse Impact* (PAI): activities negatively affecting biodiversity-sensitive areas. The regulation also includes three biodiversity-related voluntary indicators:³

• Share of investments in companies whose operations affect threatened species,
• Share of investment in companies without a biodiversity protection policy covering operational sites owned, leased, managed in, or adjacent to, a protected area or an area of high biodiversity value outside protected areas, and,
• In companies’ activities that cause land degradation, desertification, or soil sealing.

Among mandatory PAIs, we also see a wide range assessing non-linear biodiversity impacts: from carbon footprint and exposure to companies active in the fossil fuel sector to energy consumption intensity per high climate impact sector.

Investors in France are also subject to local regulation; for example, Article 29 of the French Energy-Climate Law adds a biodiversity erosion and preservation layer on top of an advanced climate reporting requirement. Thus, asset managers and owners must set a biodiversity alignment strategy with key objectives for 2030 and every five years afterwards. This will require investors to assess the pressure investee companies have on ecosystems and how such negative impacts can be mitigated. The regulator also highlights the need to identify the nature dependencies of portfolio companies and enterprises contributing to preserving and protecting ecosystems.

Additionally, the comply or explain rule introduced by Article 29 is pushed further as investors are required to publish an improvement plan with corrective actions in case asset managers are not able to provide the requested information. With this measure, the French regulator is looking to identify good practices on biodiversity integration in the investment and stewardship processes from market participants before setting more stringent rules. We expect such pioneering regulation to prompt similar standards from other European countries, especially once the remaining biodiversity-related EU Taxonomy remaining objectives are published.

On the banking side, with the introduction of Pillar 3 disclosures on ESG risks regulation by the European Banking Authority, institutions must report the Green Asset Ratio (the percentage of assets in the loan book aligned with EU Taxonomy), an exercise that may be challenging as it includes the entire lending portfolio.⁴

Biodiversity impacts are complex and interconnected

Biodiversity will likely become a strategic environmental consideration for companies and financial institutions to successfully transition to a sustainable global economy. Even though addressing biodiversity loss is tricky, it has been largely identified that human activities put particular pressure on the land and freshwater ecosystems. These pressures are defined by the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES)⁵ as:

• Changes in land and sea use
• Direct exploitation (wood, water, minerals etc.)
• Climate change
• Pollution
• Invasive alien species
  

Such prolonged stresses on ecosystems harm natural resources and put all services reliant on the environment at risk. Moreover, biodiversity interconnects with climate change; thus, increasing global average temperature risks the very survival of many species. At the same time, the loss of biodiversity is a vector of climate change acceleration. For example, environments diversified in species of plants are more efficient for carbon sequestration.

Measuring biodiversity impact requires multiple metrics

It is unlikely to reach a scientific consensus on a single metric, and the world can’t afford to wait for industry agreement on absolute measurement. Multiple inputs need to be considered to effectively measure biodiversity impacts for companies and investors. Currently, we can identify pressures on nature as identified by IPBES and the LEAP (Locate, Evaluate, Assess, Prepare) framework presented below to assess the impacts and dependencies to make meaningful financial decisions.

In recent years, we saw the emergence of impact measurement metrics such as Mean Species Abundance (MSA), Potentially Disappeared Fraction (PDF), and even monetization. Unlike carbon tracking, where tones of CO2 equivalent (tCO2e) is a quantifiable metric for disclosure, measurements like MSA and PDF only provide a partial view when analyzing a company, a loan book, or an investment portfolio.

Compared to climate risk, biodiversity loss continues to be more difficult to measure. However, market participants are exploring new methods to measure portfolio impacts. For example, in the recently published beta version of the Task Force on Nature-related Financial Disclosure (TNFD) framework,⁶ the concept of LEAP has been utilized as an effective assessment approach:

• 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
  

A version of LEAP for financial institutions (LEAP-FI) provides additional guidance to investors, banks, and insurers to leverage a similar framework. Companies themselves would ideally address the “locate” step; therefore, financial institutions are advised to start with dependency and impact evaluation. In this phase, it is proposed to scope the potential nature-related risks and opportunities by sector and geographies in which the capital is allocated.⁷

Monitoring for education and innovation on biodiversity assessment

The financial industry is learning more about the complexity of impacts related to biodiversity loss and how they could be affected by new legislation, investor interests, and environmental outlooks. Hosting several client roundtables on biodiversity this past year, the Sustainalytics Advisory and Research teams continue to gather insights to support understanding of the issues as well as effective integration of biodiversity. Our aim is to cultivate meaningful opportunities for the early adoption of nature-related impact measurement.  

The outcomes from COP15 could produce an ambitious post-2020 global biodiversity framework, with specific and measurable targets, to help drive the transformative changes needed to halt and reverse the loss of biodiversity and decline of ecosystem services. With the increasing demand for disclosures on companies’ impacts on natural resources, there are strong catalysts for investment in biodiversity conservation and restoration. More and more companies are taking action to mitigate the risks associated with ecosystem degradation. Innovative solutions and education are needed to address the biodiversity loss challenge, which also underpins new growth drivers for the global economy.

Discover Morningstar Sustainalytics' Biodiversity & Natural Capital Impact engagement program to address biodiversity loss as it applies to their portfolio companies. Leveraging the power of collaborative engagement, investors can engage directly with corporations and other stakeholders that can positively and materially address biodiversity loss and nature degradation.

* Under the SFDR, Principle Adverse Indicator is defined as “Negative, material or likely to be material effects on sustainability factors that are caused, compounded by or directly linked to investment decisions and advice performed by the legal entity.”