The relationship between biodiversity and financial services

The role of financial services in driving climate change action is increasingly well established. There is regular mainstream media coverage of fossil fuel divestment and environmental, social and governance (ESG) investing is now commonplace.

However, biodiversity is another major environmental risk and increasing focus for ESG investing – and there is a clear role for financial services to help tackle the biodiversity challenge and the loss of natural ecosystems. A Green Finance Institute report recently concluded that a minimum of £44 billion to £97 billion in investment above current public sector commitments is required for the UK alone to meet nature-related outcomes in the next 10 years. 

Can financial services play a similar role in helping to reverse biodiversity loss as they do in mitigating climate change? 

ESG and the power of financial services

It was in 2005 that the term "ESG" was first used in a report setting out how embedding these factors in capital markets makes good business sense and could lead to more sustainable markets and better outcomes for societies. Since then, the term has become widely used at all levels of business. The uptake has been driven in a large part by the adoption of ESG investing principles by the financial services industry. It has also been aided by data which shows a link between highly sustainable companies and improved financial performance.

Financial services firms can help to drive the corporate agenda. The investment principles they adopt have an impact at all levels of business: initially because of the requirements that may be imposed on companies seeking a loan, which, in turn, need to flow down the business' supply chain. Where the financial market goes, the corporate market follows.

Now, there is a growing focus in ESG investing on biodiversity – simply put, the variety of life on Earth in all its forms and interactions – as the role it can play in tackling the climate crisis becomes clearer. A first step in tackling biodiversity loss would be to start to put a financial value on nature – to consider the "economics of biodiversity" – which would help incentivise companies to take into account the short- and long-term impact of their operations on the natural world. 

Economics of biodiversity

In February 2021, Professor Sir Partha Dasgupta's review of the economics of biodiversity was published following a 2019 HM Treasury call for evidence. The review proposes a new framework to account for nature in economics and decision-making to reverse biodiversity loss. It notes that nature's worth to society is not reflected in market prices because much of it is open to everyone at no monetary charge.

One of the core recommendations of the Dasgupta Review is to change the primary measure of economic success and the economic health of nations away from gross domestic product to "inclusive wealth" and to introduce natural capital into national accounting systems. The government's response, published in June 2021, agrees with the Dasgupta Review's central conclusion and states that the government is committed to delivering a "nature positive" future, ensuring that economic and financial decision-making improves the environment.

The Dasgupta Review emphasises the key role the financial services industry can play in the fight against biodiversity loss. The government's response demonstrates its awareness of the importance of economic considerations in this area and may indicate that there will be increased legislation to ensure that the impact of investments on biodiversity is accounted for.

Nature-related reporting requirements

A key measure used in driving climate change commitments is increased reporting requirements. Mandatory reporting in line with the Task Force on Climate-related Financial Disclosures (TCFD) is already in place for all premium-listed UK companies, and the requirement is expected to be widened to capture other UK companies in the coming years. 

Nature-related financial disclosures may well also be on the horizon, with the development of a reporting framework by the Task Force on Nature-related Financial Disclosures (TNFD), which consists of an informal working group including the UN Development Programme, the UN Environment Programme's Finance Initiative, the UK, Switzerland and several major financial institutions. The aim is for the framework to redirect flows of finance to allow nature and people to flourish and to steer finance towards outcomes that are nature positive. The framework is currently still in development and is due to be tested in 2022 before being made available worldwide.

If a similar approach is adopted to TCFD reporting, then the TNFD framework will be designed to make companies think about the impact of nature on their business, as well as the potential impact on their business of biodiversity loss. Companies are likely to have to evidence a clear understanding of nature-related risks and opportunities and, critically, to show how these might impact the financial statements of the business.

The new EU Taxonomy Regulation, which entered into force on 12 July 2020, may well also result in increased reporting for financial services companies based in, or who do business with, the EU. EU taxonomy is described as "a classification system, establishing a list of environmentally sustainable economic activities".

Environmental principles established by the Regulation include the sustainable use and protection of water and marine resources, as well as the protection and restoration of biodiversity and ecosystems. The precise impact of the Regulation will be clearer once the European Commission has defined the technical screening criteria for each principle in delegated acts. More detail on this is expected in 2022.

Natural capital accounting

Natural capital can be described as the ecosystem services provided by UK's natural assets, for example soil, air, water and all living things. The Natural Capital Committee (now disbanded) saw natural capital as one of five different types of capital, but considered it to underpin the other four (manufactured capital, financial capital, human capital and social capital). 

Accounting for natural capital is important as many of the most valuable services it provides are intangible, so are often overlooked. Although a natural capital approach is sometimes criticised as putting an artificial value on nature, there is a risk that without natural capital accounts, decisions are made without best representing the environment.

For a business, natural capital accounts provide aggregate valuations of the benefits and costs associated with maintaining natural capital, and highlight the importance of natural capital to that business. They can also create a system for measuring and valuing natural capital over time, which can help to determine the funding that is required for its capital maintenance and enhancement.

Businesses which adopt a natural capital approach now will be well prepared for any future legislation, including any reporting requirements which may be introduced.

Unique opportunity

Biodiversity presents both risks and opportunities to the financial services industry. There is likely to be increased regulation and reporting requirements in this area, which may force companies to assess the impact of their activities on the natural world, much as has been the case for climate change impact in recent years.

As the Green Finance Institute identified, there is a gaping need for future investment to help tackle biodiversity in the UK and internationally. This presents a unique opportunity for those working in the financial services industry to develop products and services that can help to plug this gap. As the consequences of biodiversity loss become ever more evident, this approach could help gain market advantage, as well as potentially putting businesses on the front foot as legislative requirements start to bite.

First published on Thomson Reuters Regulatory Intelligence on 04/11/21