Four ways to properly integrate nature-related risk in financial decision-making
Nicolas Poolen, Advisor Green Finance, WWF Netherlands
Last month, nearly 200 governments signed the Kunming-Montreal Global Biodiversity Framework, a historic agreement in which governments committed to halt and reverse nature loss by 2030. More specifically, Target 14 instructs governments to align all relevant public and private activities, fiscal and financial flows with the goals of preserving and protecting nature and its services; and Target 15 to ensure that large companies and financial institutions assess and disclose their impacts and dependencies on nature, and reduce biodiversity-related risks.
Some leading central banks are already taking nature-related risks seriously.¹ In 2019, the Dutch Central Bank (DNB) published its first study on nature-related risks facing the Dutch financial sector², and more recently, draft guidance for managing climate and environmental risks.³ These are crucial first steps for embedding these risks in supervisory tasks.
Increased efforts by the financial sector to assess and act on nature-related risks, as well as recognition of them by governments, are very encouraging. Despite this progress, the draft DNB guidance illustrates how approaches to nature-related risk assessment and response often neglect or omit four critical aspects that render approaches less effective and, on occasion, cause more harm than good.
To properly integrate nature-related risk in financial decision-making, financial regulators and other financial institutions must engage in systemic risks, stewardship, site-specific approaches, and transition plans.
1. Systemic Risks
Nature-related risks are often categorized as physical risks or transition risks. However, and perhaps understandably, less attention is given to larger, more complex systemic risks which manifest themselves beyond individual assets, and beyond individual financial institutions. Systemic risks reflect the nature of complex environmental systems, and can be difficult to predict, identify, and respond to given interrelationships between many different factors. Yet ignoring systemic risks and delaying mitigating action might give financial institutions a false sense of security. They face ongoing exposure to systemic risks, for instance, when the impacts of companies within a portfolio create risk for other companies within the same portfolio (an example of which appears in our recent report on water risks for institutional investors⁴). Similarly, the impacts of current borrowers may compromise ecosystems thereby limiting seemingly unrelated future lending opportunities long past loan maturities. Systemic risks transcend asset class and payback periods, exposing diversified investors to risk today and in the future. While this may seem daunting, responsible investors must assess and act on risks beyond individual assets.
2. Stewardship and Collaboration
Systemic risks affect a broader set of linked stakeholders, and can only be fully addressed by acting as a collective, not through individual action. Individual actions by multiple stakeholders are far less effective than coordinated and integrated interventions. And unfortunately, many efforts⁵ to manage individual operational impacts and risk through efficiency gains actually drive increased cumulative resource use by stakeholders, thereby increasing risk (also referred to as ‘rebound effect’). The Global Biodiversity Framework describes the need for ‘whole-of-society’ approaches that engage government, civil society, business, and finance. Stewardship is one such approach that safeguards nature within and beyond direct value chains, and within a larger spatial and temporal scope, by engaging with local communities, companies, financial institutions and governments linked to the landscapes in which they operate. There are already clear examples of companies acting as stewards of nature and contributing to mitigation of risks beyond their own assets (and also operations or supply chains of other potential investees) that need to be scaled and replicated. These include WWF’s work on water stewardship with companies such as AB InBev⁶ and H&M⁷, and collective actions programmes such as WWF-UK’s Basket project.⁸
3. Site-Specific Approaches
The Taskforce on Nature-Related Financial Disclosures (TNFD) first beta-framework, released in March last year, emphasized that nature-related risks are highly site-specific. Unlike risks related to greenhouse gas emissions, other nature-related risks (and the impacts and dependencies that may cause these) are largely defined by the geographic context in which they take place. This context includes factors such as the vulnerability of species and ecosystems, the timing of impacts or dependencies, the extent to which local ecosystem thresholds have been transgressed, and impacts of other stakeholders on the same ecosystem. For instance, impacts on nature and associated financial risks related to water use within Chile can vary widely depending on whether they take place in Chile’s Patagonia wetlands or the Atacama Desert. Time plays a similar role, and nature-related risks may differ during wet or dry seasons, or during water-related events. Any assessment of nature-related risks that lacks consideration of location-specific factors may provide some high-level insights for corrective action but may also lead to misinterpretation and even counter-effective risk management. A recent WWF publication shows that many approaches do exist for location-specific approaches to assessing ESG-risk.⁹
4. Transition Plans
Target 14 of the Global Biodiversity Framework instructs governments to align financial flows with the goals of the agreement. Both public and private financial flows need to be tested and adjusted by governments so that they support delivery on the agreement’s milestones guiding action on nature through 2030. This strengthens global momentum for societal transition that will affect markets, legal systems, regulation, consumers, and innovation over the next ten years. The transition risks associated with these changing systems cannot be managed by financial institutions simply integrating nature in day-to-day or even yearly risk management and strategy cycles. To effectively manage risks and capture opportunities, strategic, science-based transition plans should be developed and aligned with transitions for 2030 and 2050, and include intermediate targets for 2025. And though not tailored specifically for financial institutions, the recently released Science Based Targets Network draft methodology provides key building blocks for setting targets.
Despite the significant progress that has been made in recent years, and the immediate steps that can be taken to integrate risks today, there is still much to be done before nature-related risks and opportunities can be fully addressed.
Understanding systemic and site-specific nature-related risks, identifying appropriate stewardship opportunities, and designing long-term transition plans are all critical steps that financial institutions must take to properly integrate nature-related risks in their decision-making. And improving asset-level data, facilitating supply chain traceability, and developing sector-wide transition scenarios, will accelerate their pursuit. Taken together, these steps will help shift financial flows towards nature-positive outcomes and avoid increasing price and financial instability.
WWF and partners are working to bridge the gaps, so stay tuned, and please reach out for more information on our work and opportunities to collaborate.
Thanks to Avital van Meijeren Karp for her contributions to this article.
Footnotes
[1] WWF’s Sustainable Regulation (SUSREG) tracker assesses and compares measures put in place by central banks, financial regulators and supervisors to foster a sustainable financial system in key coutnries worldwide. See individual screenings here: https://www.susreg.org/assessments
[2] De Nederlandse Bank & Planbureau voor de Leefomgeving (2019) Indepted to Nature: Exploring biodiversity risks for the Dutch financial sector, available here
[3] De Nederlandse Bank (2022), Gids voor beheersing van klimaat- en milieu-risico’s, available (in Dutch) here
[4] See “Cascading Risks” (p. 12) in WWF, Deltares, Achmea IM (2022) Bridging the Gaps in ESG and Water Data to Create Opportunities, available here
[5] See this paper in Frontiers in Environmental Science on the effects of improved irrigation efficiency discussed by Conor Linstead, WWF-UK Freshwater Specialist.
[6] For more information on WWF’s work with AB Inbev, see here.
[7] For more information on WWF’s work with H&M, see here.
[8] For more information on WWF-UK’s Basket Program, see here.
[9] WWF, World Bank Group & Global Canopy (2022) Geospatial ESG, available here.
