Nature diversifies risk like an investor
Climate change considerations are already starting to be a given for investors, and in risk-return assessments eyes are now turning to biodiversity.
On the road to the summer cottage as a child, every now and then it was necessary to stop and clear away the bugs that had splattered on the windscreen. Then you could see the road again.
There is no need to stop anymore, unfortunately, as there are fewer insects these days. WWF Finland’s Secretary General Liisa Rohweder’s childhood memory from the 1970s shows just how much nature has been lost in 50 years.
Bees and other insects play a role in the food chain and ecosystems. There is nothing superfluous in nature. Insects are pollinators, and our food production is in jeopardy without pollinators.
"Pollination is a good example of an ecosystem service that nature provides, meaning the benefits that people receive from nature. These benefits are numerous: besides food, we depend on clean water, air and the protection nature offers, such as carbon sinks that combat climate change, flood prevention and disease control," lists Rohweder.
Two of the main reasons for biodiversity loss are land use and overconsumption of natural resources. Biodiversity loss is also caused by climate change, pollution and invasive species.
"Biodiversity loss and climate change are two sides of the same coin. You can’t solve one without the other," states Rohweder.
"If we fail to limit global warming to 1.5 degrees Celsius, climate change may become the single biggest reason for biodiversity loss," she says, illustrating the interdependency.
It is also important to determine the impact that solutions to mitigate climate change will have on biodiversity loss. For example, building more hydropower would generate additional renewable energy, but it almost always comes with major adverse impacts on nature.
With biodiversity loss, the number and populations of species are declining, in addition to which there is a loss of genetic diversity within species. Ecosystems are being destroyed.
According to the UN-affiliated Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES), over 1 million animal and plant species are threatened with extinction, and several ecosystems are on the verge of collapse.
Biodiversity loss gaining prominence in decision-makers’ risk assessments
Climate action failure, extreme weather events and biodiversity loss are the top three economic risks cited in the World Economic Forum’s (WEF) Global Risks Report 2022. The result is based on a global opinion survey of executives and other leaders. According to the report, biodiversity loss affects the full spectrum of the economy.
The WEF’s Global Risks Report is published annually. Ten years ago, the list of the most concerning risks did not contain a single nature-related risk. “Irreversible consequences for the environment, humankind, and economic activity, and a permanent destruction of natural capital, as a result of species’ extinction and/or reduction. The planet cannot wait,” the report states.
Abundant opportunities for companies that react on time
A smart investor can, at their best, operate like a vital natural environment: diversity spreads risks and creates resilience against various shocks. When biodiversity is depleted, the risks faced by people also grow. The result is floods, forced migration, pandemics and crop destruction. Biodiversity loss affects everything on Earth.
A vital natural environment is like the markets: different species and ecosystems form a complex network of cause-and-effect relationships and dependencies. Nature is, of course, a broader system that sustains itself and everything built within it.
"Nature is a prerequisite for all our activities, including business activities. If a solution to biodiversity loss is not found, business stands no chance," Rohweder stresses.
Economists and investors have also woken up to the importance of biodiversity.
One significant turning point was the Dasgupta Review published by the UK Treasury in 2021. Cambridge University economist Professor Sir Partha Dasgupta concluded in his review that business can no longer be based on the overexploitation of natural resources.
According to Dasgupta, overexploitation destroys our most valuable capital, and without that capital, i.e. nature, we lack the prerequisites for business or any other life.
People are a part of nature and benefit from it in all their activities. That is why nature is capital just like tangible (buildings, machines, roads) and intangible (knowledge, skills, health) capital. Natural capital has a special value because it cannot be traded – without food and energy, other forms of capital are of little value.
Dasgupta’s conclusion is at once self-evident and revolutionary, as national economic formulas, business models, accounting, and investment analyses will be turned upside down if the calculations must also include nature.
"This means major change," says Rohweder.
Trendsetters in full swing
Rohweder stresses that we are at a turning point right now. Some companies have already tightly integrated biodiversity loss management into their corporate strategy.
"For companies that react in good time, the change presents opportunities. This is also a matter of risk management and competitiveness," she says.
"In the grand scheme of things, however, a lot of work remains to be done. This is a question of will for companies, because the expertise is there," says Rohweder in reference to research conducted in the field.
For small businesses and service and expert companies, taking biodiversity loss into account in their operations may be complicated.
"On the other hand, small companies in particular are often more agile and can offer much-needed solutions to meet people’s needs with One Planet Living business models. I’m guessing these companies will enjoy tremendous growth potential," reckons Rohweder.
"We all have a responsibility. In day-to-day life and at the office, a big difference can be made, for instance, by taking energy-saving measures. WWF’s Green Office system provides concrete tools to help offices mitigate climate change and biodiversity loss," stresses Rohweder.
In expert work, too, it is important to know the entire supply chain.
"The company is responsible for determining the origin of the parts needed in various stages. Customers can demand to know, just like investors can," Rohweder points out.
If it all seems too daunting, you can always turn to the experts. More ways for companies to analyse impacts on nature are constantly being developed. For example, the WWF network will launch a Biodiversity Risk Filter tool in early 2023. The tool is designed to help companies screen and prioritise biodiversity risks and opportunities. Building on the Science-Based Targets initiative for climate action, Science Based Targets for Nature are now also being developed. The targets have already reached the pilot phase.
Rohweder says that companies’ boards of directors must have in-depth knowledge of ‘these issues’.
"Those are the companies that can turn the risks of biodiversity loss into business opportunities," she says.
Political decision-making has reached a point where ignoring biodiversity loss is a risky game for companies.
In December, the UN and its member states will be in Montreal, Canada, where they will commit to halting biodiversity loss by 2030. After that, biodiversity should begin to increase again. The EU has a biodiversity strategy, based on which EU member states are currently drawing up their own commitments.
In EU legislation, several regulatory proposals have been made on the theme. For instance, a regulation concerning deforestation products, a nature restoration regulation to restore degraded ecosystems, and a directive on corporate due diligence and corporate accountability are currently in the pipeline. As new sets of regulation enter into force, taking nature into account will increasingly change from voluntary to mandatory.
The change is expected to receive a boost in December, when the Conference of the Parties to the United Nations Convention on Biological Diversity, which was postponed many times, will be held in Montreal, Canada. The conference will focus on halting biodiversity loss, and the hope is that it will be as groundbreaking as the Paris Climate Change Conference of 2015 was.
The countries that signed the 2015 Paris Agreement commit to keep global warming below 2 degrees Celsius and pursue efforts to limit the temperature increase to 1.5 degrees. Reaching the targets has not been without its problems, but the Agreement, as well as the laws mandated on the basis of it, are already fundamentally affecting the operations of companies.
The same type of agreement for nature is expected to come out of Montreal.
Investors play key role in mitigating biodiversity loss
Mitigating biodiversity loss is part of sustainable business operations also for financial sector companies. Increasing regulation means that investors must take the biodiversity loss impacts of their investments into account already for risk management purposes. That also means that companies at the forefront of the development may turn out to be profitable investments.
Money talks, so an investor-backed company is likely to listen if its investor urges the company to take biodiversity loss into account.
"Investors are really in a key position when it comes to resolving some of the world’s most wretched problems," says Rohweder.
According to Mandatum Asset Management’s (MAM) Senior Portfolio Manager Topias Kukkasniemi, an investment may be exposed to regulatory risk, meaning the effects of tightening legislation. In such a development, the strongest companies will typically be those that bring their processes in line with regulation proactively rather than waiting until they are forced to do so. Reputation risk may also be a factor, especially for consumer product companies. There is also a risk of financial penalties.
From an investor’s point of view, all three risks diminish interest in the company as an investment object. Companies that make no effort to mitigate biodiversity loss can suffer the same fate as those that wilfully release carbon dioxide into the atmosphere: they struggle to secure financing or they have to pay more for financing than companies that take environmental issues into account.
Kukkasniemi estimates that biodiversity loss mitigation will advance in legislation more rapidly than climate change mitigation did. Because it is an urgent matter, but also because in the wake of climate change legislation, it has already made headway. At some point, biodiversity loss mitigation will begin to show at the system level, just like climate change.
"The transition is likely to be quick. Biodiversity is already included in the EU’s sustainable finance legislation, the first parts of which have already entered into force," says Kukkasniemi.
Companies and investors must be alert to the transition risk.
"It is encouraging to see so much happening now. Biodiversity loss is not just more prominent in regulation but also, for example, in the media," adds Kukkasniemi.
There are no other options.
"A well-functioning natural ecosystem is the foundation for all economic activities. If nature’s foundation crumbles, the economic ecosystem built on top of it will eventually begin to falter. Of course, no one wants to end up in there. There are only losers in that scenario," Kukkasniemi sums up.
Aiming for a good life
According to Kukkasniemi, investors are not yet pricing biodiversity loss in at the system level. So far there are only individual cases: for example, if it appears that the company has weak processes, this will be reflected in the share price.
"Investors have understood the importance of the matter, but they are still somewhat unsure exactly how to incorporate biodiversity loss in their analyses. The situation is somewhat similar to the climate change situation in 2015. Back then, the Paris Agreement got investors thinking about how they can take climate change into account in their investment activities," recalls Kukkasniemi.
He believes it is more challenging to think of mitigating biodiversity loss as a commensurable whole than it is mitigating climate change.
"In the latter, the investor can analyse the emissions of companies in the portfolio and a company’s fossil reserves, meaning, for example, the unused oil fields it owns, which are potential emission sources. The investor can also determine the physical and other risks the company will be exposed to if climate change progresses. Taking these three matters into consideration and striving to influence them goes a long way," stresses Kukkasniemi.
Nowadays, taking climate change into account in investment analyses is a given.
For biodiversity loss, however, there are ‘an endless number of possible data points’, requiring more detailed tailoring of data than carbon dioxide emissions.
"Different matters must be taken into account in different geographical areas. The challenges may even relate to individual plant or animal species. We cannot decide to start monitoring the same things everywhere in the world like we can with climate change," says Kukkasniemi.
According to him, the tools available so far are limited and do not sufficiently take the theme into account.
Rohweder urges investors to start using the metrics, even if they are not yet perfect.
"The metrics are improving, and being a forerunner will be a competitive advantage," she believes. Kukkasniemi agrees.
His job involves regularly monitoring investment objects, including from a biodiversity loss perspective.
"If any abuses or deficient processes come to light, we try to engage with the company and find out how they intend to rectify their operations," he says.
"When we invest in a company, we look into whether they have operations in areas that are sensitive in terms of biodiversity, for instance, near a nature conservation area. If they do, we seek to determine how the company manages the related risks in its operations," he adds.
According to Rohweder, mitigating biodiversity loss as quickly as possible is money saved. It improves the quality of life and brings stability to society.
"It is not gloom and doom but rather a good life and financial security that we are promoting. It will be much more costly for society if these issues are not set right," she concludes.