This week saw the release of a landmark new report from the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES), which assesses the state of the world’s ecosystems. The news is not good: massive loss of habitat, more than a million species facing extinction, severe threats to the natural world upon which we all depend. But all is not lost — we still have the ability to ensure a sustainable future for the human race and for our planet, but only through transformative change.
What role for finance?
What role can the finance sector play in this transformative change? Firstly, the sector needs to be aware of the very material implications of this degradation of nature. For example, almost $600 billion of crops each year are at risk from pollination collapse, and this is before the worst effects of climate change begin to be felt.
Increased floods and hurricanes are having greater financial impact due to loss of coastal habitats which previously provided some protection. Disruption to production and transport is increasing, especially in the food and agriculture sector but also in mining, oil & gas, construction and many other sectors.
A recent analysis by the Natural Capital Finance Alliance (NCFA) found that almost three quarters of FTSE All-Share sub-sectors were potentially highly dependent on ecosystem services such as fresh water, climate regulation and nutrients.
Understanding the risks
Secondly, financial institutions need to understand their exposure to nature. Much work has been done to look at impacts of businesses on biodiversity and habitats, for example, but only recently has this focus shifted to include an assessment of the dependencies of business on ecosystem services.
For example, a mining company will be highly dependent on access to water for its operations. Loss of water availability may completely shut down the mine until an alternative source is found, or could lead to the mine being declared a stranded asset, with no future possible production. The providers of loans, investments and insurance to this company will be affected as a consequence.
This risk could be systemic — a collapse of pollination could lead to sector-wide losses for agriculture and food companies; a series of droughts in a particular country could lead to huge financial impacts on a variety of industries (as we have seen recently in Brazil and South Africa); a shortage of production at lithium mines due to lack of water could affect the entire electric vehicle and mobile phone industries worldwide.
Thirdly, the finance sector needs to be able to measure these risks. Fortunately there are a number of tools to help them do this. The NCFA launched its ENCORE tool last year, which enables users to assess dependencies on nature at a sector level.
It also provides guidance on how material those dependencies are to each production process, as well as highlighting the key drivers of change for each natural capital asset — for example, climate change and pollution are profoundly affecting oceans. Financial institutions can therefore understand where risks lie in their portfolios, how material those risks might be and what is likely to exacerbate those risks now and in the future.
A number of banks and investors have already made the ENCORE tool a vital component of their risk management. To address the need for transformative change highlighted by the IPBES report, it is critical for financial institutions to act on environmental dependencies and impacts in their portfolios.
We would therefore encourage all forward-looking financial institutions to try the tool and to feed back to NCFA what additional functionality they would like to see.