Nature degradation and the loss of biodiversity are among the greatest threats facing our planet, our society and our economy. Biodiversity supports all systems of life on Earth. It encompasses all species, from plants and animals, to fungi and microscopic bacteria, and how they all interact. It is that interaction, that balance, that keeps life as we know it ticking over.
Our recent paper on deforestation and our broader advocacy paper on nature and biodiversity look at the risks in more detail, and at where investors and investment managers can find opportunity in action.
Real risks
The risks from biodiversity loss are significant and widespread; from increasing the frequency and extent of natural disasters, through exacerbation of climate change, to disruption of global supply chains. While governments, businesses and other organisations are fighting back against climate change through targets to reduce carbon emissions, degradation of nature and biodiversity loss continues, posing significant, sustained threats to ecosystems.
This is despite the fact that climate change and loss of nature and biodiversity are inextricably linked. Biodiversity loss, for example, is known to disrupt weather patterns. Deforestation practices, which we’ll return to in more detail later, increase greenhouse gas emissions linked to global warming. Conversely, climate change affects environmental processes like water cycles and growing conditions.
Economic impacts
While these ‘natural’ risks are hugely significant to humankind, it is also the far-reaching economic impacts which resonate with governments, central banks and economic actors across the globe. ‘The Economics of Biodiversity: the Dasgupta Review’ published by the UK government in 2021, noted how nature is embedded within the economy and highlighted three categories of nature-related risk:
- Physical risk – resource scarcity or compromised resources damaging fixed assets, infrastructure or supply chains. Acute, event-based risks such as flooding, wildfires, crop loss or disease, as well as chronic, long-term changes such as the loss of cultivatable land.
- Transition risk – through the introduction of new regulations, policies, changes in market behaviour, or technological progress.
- Litigation risk – as a consequence of past actions, for example.1
Nature loss and environmental degradation pose complex and non-linear risks, which are compounding in their effects. The World Economic Forum has identified different ways that nature loss can create business risk, which in turn creates investment risk:
1. Through dependency on nature.
2. The fallout of business impacts on nature.
3. The impacts of nature loss on society.2
Whether directly, through financial loss as a result of operational restrictions or difficulties obtaining raw materials, or indirectly, due to changing customer behaviour or shifting regulation, the threats to businesses and their shareholders are real.
An ambitious response
Pension trustees’ fiduciary duty requires the management of all material financial risks. The extent and severity of nature-related risks places an obligation on pension funds to consider how the degradation of nature and biodiversity loss could impact their members. This was the inspiration behind our report ‘Nature and biodiversity loss: the pensions imperative’. Our report follows the conclusion of COP15 and the creation of a Global Biodiversity Framework (GBF) that sets out to halt and reverse biodiversity loss by 2030.
It is a noble ambition, but one that requires urgent action from governments, businesses and industries like ours if it is to be achievable. Indeed, among its 23 targets, the agreement calls for ‘at least US$200 billion per year in domestic and international biodiversity-related funding from all sources – public and private’ to be mobilised by 2030. In addition, it expressly requires that ‘large and transnational companies and financial institutions [to] monitor, assess, and transparently disclose their risks, dependencies and impacts on biodiversity through their operations, supply and value chains and portfolios’.3
Taking action
One of the main challenges in tackling nature and biodiversity loss is the vastness and complexity of the issue. This has led to difficulties in measuring risk and reporting actions. The development of the Taskforce for Nature-related Financial Disclosures (TNFD) offers a way forward. By creating a standardised and consolidated approach to risk assessment and disclosure of nature-related risks, it aims to support better strategic development, risk management, and decision making.
The launch of TNFD, scheduled for September 2023, and the broad acceptance of the GBF, are increasing pressure on governments, large businesses and financial institutions to incorporate nature-related metrics and targets into their broad environmental, social and governance (ESG) commitments, particularly in an integrated manner. In this spirit, our advocacy paper, through a series of recommendations, highlights urgent actions and opportunities for both government and the pensions industry. These include regulation of voluntary carbon markets, creating the right environment for transformative action across government departments and business, and beginning to assess exposure.
But it all starts with awareness, which is why understanding how biodiversity loss and the risk of nature degradation threaten a sustainable future is so important. From awareness, we can build ambition and take action.
Addressing deforestation risk
The pensions industry is on a journey to manage and mitigate the risks of nature degradation and biodiversity loss in order to safeguard the retirement outcomes of pension savers and the wider investment community. As a first stage of that journey, we are establishing our approach to addressing deforestation.
Halting and reversing deforestation is essential for a sustainable future. Driven by human activity through illegal or unregulated timber extractions, or by stripping land of forest to convert it to other commodity production, it is a key driver of biodiversity loss and climate change. Since 1990, 420 million hectares of forest – an area roughly 200 times the size of Wales – have been converted to other land uses4, while two-thirds of the world’s original tropical rainforests have been destroyed or degraded since the dawn of the industrial revolution.
Financial, transition and litigation risks from deforestation are clear, and with around 50% of global gross domestic product moderately or highly dependent on nature and ecosystem services5, it’s a risk that cannot be ignored. Our pension savers share this view – early indications from our own surveys, for example, highlight their concerns about biodiversity.
Helping build sustainable futures
In ‘Our Approach to Climate Change’ paper, we recognised the significance of land-based emissions in setting climate change goals. This led us to widen our stewardship focus from ‘Climate’ to ‘Climate and the Environment’ in 2022. All these reasons, and more, are why we are taking steps to deepen our awareness of the scope and impact of deforestation within our funds and explore how best to embrace nature as an investment theme.
In collaboration with Global Canopy and Make My Money Matter we have contributed to the development of deforestation guidance for the pension industry. The guidance is structured in six phases:
1. Mapping risk
2. Setting an effective policy
3. Monitoring and engagement
4. Disclosing
5. Eliminating deforestation, conversion, and associated human rights abuses
6. Nature and people positive financing
Each phase has one or two ‘steps’, broken down into specific ‘recommended actions’. These steps are not necessarily linear, and can be completed in any order within the phase.
This guidance encourages pension fund providers to measure and disclose deforestation risk within their investment portfolio, and develop strategies to minimise the risk of contributing towards deforestation.
As an initial step, we are exploring how current frameworks and metrics will allow us to map our portfolios against deforestation risk. This will support us as we monitor our portfolios’ total exposure to potential deforestation, which will initially be based on investee company exposure to key tropical commodities. In this way, we can build a picture of our portfolios and measure and disclose exposure to key sectors and commodities going forward.
As members of an industry that’s focused on safeguarding futures, we need to seize the impetus of COP15. We need to ensure that the ambitions and agreements reached as part of that landmark summit translate into actions that halt and reverse nature degradation and biodiversity loss, and create sustainable futures for pension savers to live in.
You can find out more about our own approach to sustainability and how we’re supporting customers and advisers on our website: Responsible Investment And Stewardship Framework | Scottish Widows
References
1. ‘The Economics of Biodiversity: the Dasgupta Review’, HM Treasury, 2 February 2021.
2. ‘Nature Risk Rising: Why the Crisis Engulfing Nature Matters for Business and the Economy’, World Economic Forum, 19 Jan 2020.
3. Convention on Biological Diversity, COP15: nations adopt four goals, 23 targets for 2030 in landmark UN biodiversity agreement, 19 December 2022.
4. ‘Securing our future through biodiversity’, The World Bank 7 December 2022.
5. ‘Nature Risk Rising’, World Economic Forum, op. cit.