by James Hulse
Our natural world is under growing threat — from plastics in the ocean to the Australian bush fires. These threats often seem removed from the global economy — a world away from banking and finance. But three emerging initiatives in 2020 look set to bridge that gap, bringing nature into the spotlight for the financial world.
Why is nature important to investors?
All economic activity depends on natural assets — such as water, forests and clean air. Manufacturers must have access to water to build cars; the agriculture sector needs bees and other pollinators to grow crops without excessive costs.
These natural assets are increasingly being degraded by pressures such as pollution, deforestation and climate change. Financial institutions are in turn exposed to natural capital risks that affect the businesses that they invest in, lend to, or insure.
In 2020, for the first time, the World Economic Forum’s top five global risks were all environmental, including major biodiversity loss and ecosystem collapse.
Key developments in 2020
Firstly, in the Netherlands, the Dutch National Bank is working on a report, due to be published in the Spring, which will assess how the Dutch banking sector may be at risk from its dependency on biodiversity. Having completed this analysis already for climate change, raw materials and water, the Bank has joined forces with the Dutch Environment Agency to develop a methodology for measuring and assessing biodiversity, using the Natural Capital Finance Alliance’s Encore tool.
The Bank’s report is likely to bring clarity on the finance sector’s economic dependence on the natural world and the systemic risks which are emerging from a combination of climate change and other environmental degradation.
Secondly, moves are afoot to establish a Task Force on Natural Capital, with discussions taking place at the World Economic Forum in Davos last week. The idea has the backing of major governments and will build on the success of the Task Force on Climate-related Financial Disclosures (TCFD) which set out the risks from climate change, together with the suggested responses from companies and financial institutions. It is clear that natural capital more broadly presents a related systemic risk and this initiative will increase the focus on natural capital risks to the finance sector and potential risk management solutions
Finally, in October 2020 the Convention on Biological Diversity (CBD) is due to hold its annual conference in China, bringing governments together to discuss action to protect nature. There are hopes that this year’s conference could provide a ‘Paris moment’ for biodiversity and nature, with potential new commitments from major governments. This would send a signal to the private sector that nature is high up the priority list for global legislators and will need to be protected from over-use by stronger regulation.
How should financial institutions respond?
Many financial institutions are already looking at their material impacts and dependencies on nature, through their investment, lending and insurance portfolios. For example, lending to the agriculture sector relies on access to water, and droughts can cause material financial losses, while investing in the palm oil sector may increase the risk of financing deforestation and biodiversity loss.
The Natural Capital Finance Alliance provides advice to the finance sector through its website, including guides on how to understand and assess their exposure to natural capital risks. They also produce the Encore tool, which enables financial institutions to identify which sectors are most dependent on nature and which of those dependencies are most material.
This year could be a wake-up moment for the finance sector — and an opportunity for financial institutions to better understand how the businesses that they finance depend on nature and where risks might lie.
It is also an opportunity for the finance sector to prepare itself for inevitable increasing regulations in this space, and understanding the risks is an important first step.
James Hulse is a consultant on climate change, natural capital and responsible investing, with 17 years experience as a trader and fund manager.