Nature-related financial risks can be grouped into physical, transition and systemic risks. Image: Milos Bicanski / Climate Visuals Countdown.
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Climate and Nature
- Nature is no longer a corporate social responsibility issue, but a core and strategic risk management issue.
- Biodiversity loss and nature degradation must be recognized as a significant financial risk to businesses.
- Through its recommendations, the Taskforce on Nature-related Financial Disclosures (TNFD) is helping companies expand their sustainability work to consider nature-related issues and the connections with climate.
As nature deteriorates and biodiversity declines faster than ever, the world is beginning to recognize how deeply we all depend on nature. It is not just society in general; it is also businesses. Still, most companies have never asked themselves what the depletion of nature and mismanagement of nature-related risks will mean for their future. With six of the nine planetary boundaries already breached, nature risk is clearly financial risk that needs to be incorporated into an organization's risk management practices.
What is the World Economic Forum doing about nature?
So far, climate change has been the focus of financial risks associated with changes in natural capital. By now it is evident that interconnected changes related to other aspects of natural capital, such as biodiversity loss, water stress, and resource scarcity, also pose significant financial risks. As nature-related issues are rapidly becoming financial risks, companies have little time left to grasp the implications of their dependency on nature.
"Nature loss is one of the greatest threats facing our planet and the economy, said Mindy Lubber, CEO and President of Ceres. “It is a grave material, financial risk - particularly to investors and companies that depend on nature systems for the lifeblood of their products - and it is inextricably linked to our climate crisis.”
Nature as a source of financial risk
It is time to move away from seeing nature as an endless source of free resources into our economies and societies. Instead, we need to see it as a source of important services, with significant financial risk to businesses caused by the scale and speed of nature degradation and biodiversity loss. It is not just a corporate social responsibility or reputational issue any more. It is a core and strategic risk management issue, just like climate change. Halting and reversing nature loss also presents tremendous opportunities for positive outcomes for both businesses and the planet.
As nature is a source of risk, businesses will have to take responsibility for managing that risk in the interest of their stakeholders and shareholders. S&P Global Sustainable1 data shows that 85% of the world's largest companies have a significant dependency on nature across their direct operations, illustrating the importance of nature to corporations and investors.
“Continuing down our current path – where our demands on nature far exceed its capacity to supply – presents extreme risks and uncertainty for our economies and financial systems,“ said Partha Dasgupta, Emeritus Professor of Economics at the University of Cambridge.
“What is ultimately required is a set of global standards underpinned by credible data, which businesses and financial institutions can use to assess and disclose their use of, and impact on, nature and integrate nature in their decisions. Based on the science and taking a holistic approach, the TNFD recommendations provide the basis on which such standards should now be built.”
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Understanding nature-related financial risks and opportunities
Our goal at the TNFD is to help market participants understand the issues companies are facing when it comes to nature. Four such issues need to be identified, assessed, managed and disclosed to the company’s stakeholders. These are dependencies, impacts, risks, and opportunities.
We need to use those four words carefully. Impacts and dependencies are on nature, whereas risks and opportunities are to the organization. Nature-related risks and opportunities stem from an organization’s dependencies and impacts on nature. Many business and finance professionals mistakenly use impacts and risks interchangeably. We need to make sure that the use of these basic building blocks is clear to all market participants.
Nature-related financial risks can be grouped into physical, transition and systemic risks. Physical nature-related risks arise due to a decline in the state of nature disrupting the ecosystem services on which a firm’s operations depend. Typically, they are classified as acute risks, such as oil spills, forest fires or pests affecting a harvest, or chronic risks, such as a gradual decline of pollinators resulting in reduced crop yields. Nature-related transition risks come from five sources: policy, market, technology, reputational and liability risks. These risk factors are likely to interact with each other.
For example, companies in the oil and gas industry are exposed to significant nature risks. These risks can be physical, including oil spills, transition, such as non-compliance with shifting environmental regulations or systemic, as macroeconomic changes tied to nature are moving global demand away from fossil fuels.
Mismanaging nature-related risks may lead to serious financial losses
Several companies across many sectors and geographies have already suffered material financial losses due to mismanagement of nature-related risks. To demonstrate how various types of nature-related risks manifest, BloombergNEF in collaboration with TNFD has profiled 10 companies that incurred financial losses as a result of their impacts, dependencies and risks associated with nature.
These case studies provide powerful examples of companies that experienced an over 90% fall in market cap, credit rating downgrades, litigation settlements of almost $5.4 billion, major reputational damage resulting in a loss of consumer loyalty and senior executives losing the confidence of investors and, ultimately, their jobs. What’s even worse than fines is losing access to capital. Some NGOs unsatisfied with a company's superficial actions to strengthen its sourcing process are attempting to block its long-planned listing in the US. This means that the company would miss out on a potential market capitalization boost of $20 billion.
The opportunity side of the equation is also important. Investing in the health and resilience of nature is good business practice and a source of business opportunities.
TNFD recommendations to help address nature-related financial risks
We want to enable market participants to expand their sustainability work beyond climate-only issues to include a broader set of nature-related issues that are interconnected with climate. Currently, most market participants are inadequately accounting for nature-related dependencies, impacts, risks and opportunities. However, there are tools to take action. The TNFD recommendations help address the growing risks of declines in the resilience of nature for business and finance.
We encourage market participants to use their existing data, procedures and practices to get started. The TNFD Tools Catalogue gives access to data and analytics tools and platforms and the Integrated Biodiversity Assessment Tool can help organizations to identify sensitive locations in the “locate” phase of the LEAP Approach. TNFD in a Box, a learning and capacity-building tool, facilitates the adoption and implementation of the TNFD recommendations.
Quite often, risk departments have discovered they have a lot of information within their own organization that they have never asked for before or did not even know existed. When we talk about measuring severity, magnitude and scale of impact, many of those principles already exist within standard risk management practices today. The way to cut through complexity is to use existing core risk management practices, which are familiar to market participants, for nature risks alongside financial, operational and climate risks.
Nature risk is now in the spotlight in the face of increasing nature-related regulations. We have heard many inspiring stories of organizations making more rapid and significant progress on complying with our recommendations than they initially imagined and that this actually is not as complex and daunting as they thought at first.
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The views expressed in this article are those of the author alone and not the World Economic Forum.
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