By Andrew Wetzlel, CFA®, Managing Director of Sustainable Investing
In the annual World Economic Forum (WEF) Global Risks Report released earlier this year, biodiversity loss and ecosystem collapse ranked 4th in severity on the top-10 risks over a 10-year period, behind only climate-related risks. Economists, investors, regulators, and other stakeholder groups are all increasingly focusing on natural capital and biodiversity as the next frontier in sustainability analysis. As major global reporting frameworks and regional regulations develop, both risks and opportunities are emerging for corporations and investors.
To start, it is important to define terms. Natural capital refers to the world’s stocks of natural assets, covering soil, minerals, water, air, and all living things, so in total, a stock of natural ecosystems. Biodiversity is the variety and variability of all living things, a fundamental component of natural capital, essentially a measure of diversity at the genetic, species, and ecosystem levels. Biodiversity plays a critical role in ensuring the resilience of other natural capital assets. Ecosystem services are the flows of benefits derived from natural capital, including a wide array of benefits underpinning human civilization, including clean air, crop pollination, climate regulation, among many others. Our natural world is a vast array of interconnected and symbiotic ecosystems that support human life on this planet.
A recent OECD report sized the total value of ecosystem services at $135 trillion, or roughly 1.5x global GDP at the time of the estimate. A joint paper from WEF and PwC in 2020 assessed the materiality of nature loss on business, showing that $44 trillion of economic value generation, or 50% of global GDP is moderately or highly dependent on natural capital and ecosystem services. As noted in the OECD report, economic growth has been exponential over the last 50 years, lifting more than 1 billion people out of poverty, and advancements in health, technology, and other areas have been astounding. While advancements have been remarkable, our standard measurements of success do not account for the costs to nature.
As McKinsey & Company notes in a recent report titled Nature in the Balance, we are using resources and drawing on natural capital as if we had 1.8 earths. McKinsey uses the concept of planetary boundaries to frame their research, with one important finding showing that human activity is extending beyond the safe space for four of the seven boundaries with reliable data. Biodiversity loss, chemical and plastic pollution, nutrient pollution, and greenhouse gas emissions are all well beyond the safe zone, while forest cover loss and freshwater consumption are in the zone of uncertainty. The bottom line is that natural capital is in decline. Declines in biodiversity, as illustrated in the chart below, and many other indicators of natural capital loss are clear signals that human activity is putting significant pressure on nature.
The title of this article refers to an expanding corporate and investor view of the environment beyond climate change. It’s important to note that natural capital and particularly biodiversity are inextricably interconnected with climate change. Climate change is a major driver of habitat loss through extreme weather, shifting weather patterns, and other impacts, while biodiversity loss through deforestation reduces natural carbon sinks and contributes to shifting rainfall patterns. While clearly linked, natural capital and biodiversity measurement and analysis is significantly more complex than climate change.
Natural capital does not have just one metric like greenhouse gas emissions, and impacts are generally local, not global in scope. Additionally, reporting and data are at the early stages of development, making investor assessments of systemic risk or multi-dimensional risk to corporations challenging.
Thankfully, governments are finally committing to address nature loss, and frameworks and regulations are emerging that will affect both corporations and investors. The UN Biodiversity Conference (COP 15) in December 2022 resulted in a landmark agreement by over 190 countries covering pledges to conserve at least 30% of land, inland water, and sea by 2030. While many governments have now committed to action, in the background a group of corporations and investors have pushed forward a risk management and reporting framework called the Taskforce on Nature-related Financial Disclosure (TNFD). The fourth and final draft TNFD framework was released in March and final recommendations are expected in September 2023.
As TNFD emerges, swift uptake is expected as the framework is modeled on the well-understood Task Force on Climate-related Financial Disclosures (TCFD), a framework widely used by corporations to report climate risks. The TNFD goes a step further by covering impacts on nature along with corporate risk and opportunity. The goal, as with TCFD, is to bring some standardization to reporting that will enable more decision-useful information for investors and other financial service market participants.
As the TNFD and regulations in Europe, such as the Corporate Sustainability Reporting Directive, lead to more transparency, robust data, and targets for improvement, investors will need to come up the curve on integration and reporting. While reporting and integration of natural capital risks, opportunities, and impacts are still early stage, the spark has been lit and action is finally coming.
The Living Planet Index (LPI) is a measure of the state of the world’s biological diversity based on population trends of vertebrate species from terrestrial, freshwater, and marine habitats. Globally, monitored populations of birds, mammals, fish, reptiles, and amphibians have declined in abundance by 69 percent, on average, between 1970 and 2018. In other words, the average change in population size in the LPI is a decline of 69 percent. This does not mean that 69 percent of the species or populations are declining nor that 69 percent of populations or individual animals have been lost.