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Magazine Issues » April 2022

Sponsored feature: Is 2022 the year of nature-related risks?

PatSharmanCACEISAsset managers and fund boards grapple with the impact of climate risks on investments in their funds. However, things move quickly. Alongside awareness of biodiversity loss and the risk it poses, nature is another important risk that must also be considered.

By Pat Sharman, country managing director, Caceis UK

Climate risk is an issue that is quickly confronting asset managers and fund boards, which is amplified by evolving regulation, such as European Union (EU) Taxonomy – an area of regulation that’s about to get more stringent. There is also increased scrutiny by regulators on product offerings that have an emphasis on climate change and Environmental, Social and Governance (ESG) investing.

For example, in July 2021, the Financial Conduct Authority wrote to all asset management CEOs in the UK outlining that “ESG and sustainable investment funds are currently the fastest growing segment of the European funds market” and noting that “we expect clear and accurate ongoing disclosures to consumers where funds make ESG-related claims”. The regulatory focus around the world is very clear – there needs to be clarity and quality on ESG and climate reporting.

Getting prepared: What gets measured gets managed
Assessing risk is a key objective for fund board governance. This especially applies to climate risk. Fund boards need to get their hands on reliable granular data, such as carbon emissions (across scope 1, 2 and 3), so they can begin to monitor which positions in a fund emit the most amount of carbon and what needs more decarbonising. Understanding these financial risks is critical, and the focus on sustainability is about to get more complex. The sooner climate risk is integrated into fund board thinking and decision-making, the better prepared boards will be for future regulations and the next phase of sustainability. This includes additional environmental and nature-related requirements of EU taxonomy and the upcoming Taskforce on Nature-Related Financial Disclosures (TNFD).

Nature – the other environmental emergency
It’s always been well understood that healthy, stable and biodiverse ecosystems help to regulate our climate and control extreme events. They also help provide us with water, food, raw materials and help sustain economic sectors. This makes nature interwoven into the corporate world. And yet, according to the United Nations (UN) 2021 Environmental Programme report, around one-third of the world’s farmland is degraded, about 87% of inland wetlands worldwide have disappeared since 1700, and one-third of commercial fish species are overexploited. Degradation is already affecting the wellbeing of an estimated 3.2 billion people – 40% of the world’s population. Every year, we lose ecosystem services worth more than 10% of our global economic output.1

This damage to our natural environment has an economic impact. Half of the world’s GDP is dependent on nature.2 For example, around $10 trillion in global GDP could be lost by 2050 if ecosystem services continue to decline. Protecting ecosystems has the potential to contribute more than one-third of the total climate mitigation required by 2030.3 These are staggering numbers.

Many of these challenges will be addressed in part two of the UN’s Biodiversity Conference (COP15) to be held in April. The conference could prove an important milestone as the goal is to agree the UN’s Post-2020 Global Diversity Framework, potentially equivalent to the Paris Agreement for nature. It will set out targets for protecting marine and land habitats, reducing pesticides and plastic waste, and increasing financial resources dedicated to biodiversity.

What does this all mean for asset managers, fund board and asset owners?
Biodiversity and nature loss provides risks and opportunities for companies, both now and in the future. Getting to the heart of where these risks lie will be important for asset managers and asset owners. For example, there are dependencies on nature in certain industry supply chains. A study from the World Economic Forum revealed that 163 industry sectors and their supply chains generate $44 trillion of value generation that is ‘moderately’ or ‘highly dependent’ on nature.4 The links between natural resources and agriculture or manufacturing are quite visible, but the interdependency of nature can touch the supply chains of many sectors of the global economy. We’ve always highlighted the importance of understanding the impact of climate risks across a company’s supply chain, and it is no different when considering the impacts of these supply chains to the natural environment.

To help address this, the TNFD aims to give global financial institutions and companies a disclosure framework to report and act on nature-related risks. Scheduled for 2023, TNFD marks an important milestone in ensuring companies address the challenge of nature loss and incorporate it into corporate and financial decision-making. In a nutshell, the framework will help asset managers define a company’s nature dependencies, as well as establishing their impacts are on the environment, alongside the risks that are associated with them.

Nature and the environment also lie at the heart of EU Taxonomy, which seeks to redirect capital flows to more sustainable business activities and companies working towards a low-carbon transition. To align with the Taxonomy, companies must contribute to at least one of six clearly defined environmental objectives, while making sure they do not undermine the others. Although the objectives of ‘climate mitigation’ and ‘climate adaptation’ have been applied first, the remainder – which include ‘sustainable use and protection of water and marine resources’ and ‘protection and restoration of biodiversity’ – will follow from the beginning of 2023. The latter two will help companies avoid reputation risks associated with business activities that undermine environmental objectives.

A new way of thinking
It’s great to see growing recognition within the asset management community of the importance of biodiversity. Launched in 2020, the Finance for Biodiversity Pledge is already backed by 89 signatories representing more than €13 trillion in assets, and is committed to improving and sharing knowledge, as well as engaging with companies on biodiversity.

For fund boards, understanding the impact of climate risk is critical. It’s essential to start getting their hands on good data now so they can begin assessing the impact to funds, because climate risk is a key financial risk. However, boards must also be mindful that a fundamental shift in thinking about the value of nature is beginning to emerge, including accounting for natural capital and the cost of ecosystem degradation. These are also risks that need to be understood in the governance oversight of funds. Finally, oversight of investor disclosures relating to these risks must also be an important consideration for fund boards. This all requires a good level of understanding in the areas of climate and nature-related risks, so that fund boards can provide robust challenge and ensure key risks are being managed.

1https://wedocs.unep.org/bitstream/handle/20.500.11822/36251/ERPNC.pdf

2https://wedocs.unep.org/bitstream/handle/20.500.11822/36251/ERPNC.pdf

3https://wedocs.unep.org/bitstream/handle/20.500.11822/36251/ERPNC.pdf

4https://www3.weforum.org/docs/WEF_New_Nature_Economy_Report_2020.pdf

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