Nature risks come to the fore: Key takeaways from COP15 | Insight Investment

The UN Biodiversity Conference (COP15)1, which took place in Montreal over 7-19 December 2022, will have a pivotal impact on the shape of future international biodiversity goals. Rescheduled four times since 2020, the conference finalised the post-2020 Global Biodiversity Framework – a series of goals and targets for countries to achieve over the next decade and beyond, with the aim of addressing species and ecosystem collapse and ‘living in harmony with nature’ by 2050

David McNeil Head of Responsible Investment Research and Innovation

Key highlights

• The Kunming-Montreal Global Biodiversity Framework was finalised, and though it is not legally binding, signatory countries will need to detail how they will pursue its key target
• Significant financial commitments and a focus on clear, targeted actions, combined with a lack of broad data, could have implications for specific sectors in the near term
• Private sector disclosures and risk screening regarding biodiversity impacts are set to ramp up, though data scarcity remains a key obstacle
• Insight has conducted an initial research study to illustrate the potential impacts of natural capital risk, and we intend to follow up with additional case studies exploring impacts and dependencies on nature and biodiversity

‘Thirty by 2030’ points to shape of future regulation

The Kunming-Montreal Global Biodiversity Framework (PDF) enshrines a global target of 30% of the world’s land, freshwater and ocean cover to be set aside for nature protection and restoration by 2030, and although not legally binding, the 197 signatory countries to the framework will need to detail national policy measures in contribution to the target – similar to the Nationally Determined Contributions mechanism that emerged from the Paris Agreement and provides a ‘fair share’ peer review mechanism for national progress.

The agreement includes significant financial commitments

This will increase pressure on governments to detail sectoral policies in advance of the target, but the text also recognises that the burden of achieving these goals will fall unevenly on countries – particularly biodiverse emerging markets. Developed countries committed to an annual target of $30bn of biodiversity finance to less developed countries by 2030, but there is a recognition that much larger additional public and private sources of finance will be needed to realise these goals, with the text making specific reference to the role of blended finance (development assistance and private finance).

Restoration of degraded ecosystems will be particularly costly to deliver, with average costs spanning $1,400 to $34,000 per hectare for terrestrial restoration according to analysis by WWF Tanzania (PDF). The Global Biodiversity Framework text focuses heavily on measures to address terrestrial nature loss (in particular, forest ecosystems) but comparatively less on marine ecosystems and biodiversity, despite the severe state of many marine ecosystems. This reflects relative policy progress and alignment of incentives for global governance of terrestrial and marine resources – where reform of fisheries markets and agreement on global management of high seas has been slow in recent years.

The text also makes specific commitments to removal of $500bn of subsidies that are “harmful for biodiversity” annually by 2030, and wide-ranging reform of land-management practices and nutrient use in signatory nations to help deliver on the targets. This is expected to result in significant renewed pressure on agrochemicals producers, at a time when many key emerging markets are embarking on fertiliser subsidy reform.

Greater emphasis on clear, targeted actions – with implications for the private sector

The new framework follows the global 2020 Aichi Biodiversity Targets, all of which were missed by signatory countries. Recognising past policy failures, the 2030 targets are generally more clearly articulated in the form of time-bound commitments and targeted actions to address underlying drivers of biodiversity loss – including a stronger focus on channelling of finance towards solutions (such as forestry or land use-based carbon offsets). Another key expectation is stronger national monitoring and accountability mechanisms to track the impacts and dependencies of countries and industries on nature. Accordingly, there is a much stronger focus on the role of the private sector and investors in delivering on the post-2020 biodiversity agenda, and although mandatory disclosure of nature impacts and dependencies by businesses did not appear in the final text, the framework does require  large and transnational companies and financial institutions to monitor, assess, and transparently disclose their risks, dependencies and impacts on biodiversity through their operations, supply and value chains and portfolios.

Other major developments at COP15 include the announcement of the Nature Benchmark by the World Benchmarking Alliance (assessing 400 large companies on progress on nature protection and restoration). Another was the launch of Nature Action 100 by major institutional investors – a global engagement initiative which aims to drive greater corporate action on stemming biodiversity loss and contributing to restoration.

Initial focus will be on sectors with a direct material impact on terrestrial biodiversity

Both benchmarking and engagement on nature and biodiversity issuers look set to be more widely applied, although attribution of impacts (specifically linking downstream biodiversity impacts with upstream company assets or activities) will remain a challenge for investors. Satellite and remote-sensing data will play a key role in measuring impacts and dependencies, but benchmarking and target setting activities are likely to focus initially on sectors with a direct material impact on terrestrial biodiversity (e.g. oil and gas, natural resources, mining and agribusiness).

One common challenge for companies seeking to demonstrate direct positive impacts on nature is the dominance of private and state-owned enterprises within the global agribusiness value chain – which can reduce the influence of public markets in driving specific environmental outcomes. Increasingly, more detailed analysis of company value chains is likely to point to often unexpected areas of nature risk and opportunities for improvement in sectors that may not appear to have significant direct influence on nature.

Private sector disclosures and risk screening to ramp up  

In the absence of global mandatory disclosures, standard setters nonetheless indicated a major push towards wider disclosures of nature impacts and dependencies by companies and financial institutions in 2023. The International Sustainability Standards Board (ISSB) announced revision of its proposed sustainability disclosure frameworks to better incorporate nature impacts, which is likely to heavily influence national disclosure standards.

Risk screening for deforestation risk commodities already looked set to increase sharply, with the UK recently conducting a consultation (PDF) on how to tackle deforestation in supply chains, and the EU passing its own regulation in December 2022. These regulations place the burden on importers of commodities to evidence deforestation risks have been mitigated and appear to indicate a trend towards ‘extraterritorial’ regulation of imported nature loss. A number of major pension funds have adopted similar policies in recent years, which will increase downwards pressure on commodity consumers to source data on downstream nature impacts.

Next year will also see the finalisation of the Taskforce on Nature-related Financial Disclosures (TNFD) framework. This will require companies and financial institutions to integrate ‘nature’ into their decision-making processes and provided detailed performance metrics and forward targets, similar to the Task Force on Climate-Related Financial Disclosures (TCFD) framework, which whilst a voluntary disclosure initiative is increasingly being mandated within national regulations.

Data scarcity remains a key obstacle

A major challenge is the scarcity of data on how nature may impact an organisation’s performance, or the longer-term financial risks that may arise from how the organisation, positively or negatively, impacts nature. The current iteration of the TNFD framework emphasises a bottom-up approach to assessing company nature risks, starting at the asset level. In practice, many first disclosures by companies and investors are likely to rely heavily on top-down assessment of impacts until data mature.

As a member of the TNFD Forum, Insight is closely following the development of the framework. We have also undertaken exploratory work within our corporate bond portfolio of impacts and dependencies on nature in line with the recommendations, as detailed below.

Implications for investors: Nature risks for corporate issuers can be material

Insight explored risks from natural capital depletion for corporate bonds in buy-and-maintain portfolios in a case study published in March 2022. Our analysts explored natural capital risks through a bottom-up assessment of corporate exposures in the breweries sector, where Insight holds a number of long-dated bonds.

Whilst this sector is seen as less vulnerable to long-term structural shifts (such as climate change or technological change) our analysis showed that these issuers can bear significant exposure to natural capital risk.

Figure 1: Final adjusted natural capital risk scores for three brewers analysed in our case study

Source: Insight, as at March 2022.

The study also highlighted the importance of mitigation actions by companies to address their exposures (in this case, water management practices), although it noted the limitations of considering only operational risks and dependencies and not the entire value chain of a company – in 2023 we plan to follow up with additional case studies exploring impacts and dependencies on nature and biodiversity in line with the TNFD recommendations.