Fund firms – be good or be coerced

Amy Clarke, Chief Impact Officer, for Citywire

We are little further to achieving our biodiversity goals, and fund firms will soon face a stark choice.

Four years ago a jarring UN report estimated that around one million species will be extinct in just decades from human activity if nothing is done to stem its effects.

This month, a ShareAction report that vetted 77 largest asset managers on their net zero commitments has found that fund firms are still lagging when it comes to curbing biodiversity loss. It seems despite the growing recognition that biodiversity is on par with climate change in terms of its environmental significance, asset managers are still playing catch-up.

‘On the climate front, investors were often ahead of policymakers. But within biodiversity, policy moves such as the Kunming-Montreal Global Biodiversity Framework and the EU’s Nature Restoration Law from last year, have caught many off-guard,’ says Louisiana Salge, head of sustainability at EQ Investors.

The industry as a whole is far from formulating common relevant data frameworks or risk assessment criteria, she adds, although the Taskforce for Nature-Related Disclosures (TNFD) is beginning to take hold.

It’s essential for the industry that biodiversity risks be factored into investment decision-making, and we’re still very much at the start of that process.

Amy Clarke, Chief Impact Officer

Biodiversity regulation is creating financial risks that could be compared to the risks of climate transition but the challenge goes beyond simply quantifying these risks.

‘It’s essential for the industry that biodiversity risks be factored into investment decision-making, and we’re still very much at the start of that process,’ says Amy Clarke, chief impact officer of Tribe Impact Capital.

‘But we need to create a framework that enables us to code in respect for the natural environment, in such a way that we don’t simply give it a price, which allows us to commoditise and trade it. Price is not the same as value. In this way it’s not the same as climate crisis because, to some extent, carbon can be commoditised. Within biodiversity, we are dealing with the very essence of what sustains our species, the climate and everything on the planet,’ she notes.

This will require new skillsets and collaborations within finance.

‘We will need new types of economists – Kate Raworth is one example – as well as NGOs, people who understand the workings of natural ecosystems, to be able to better inform the kind of investment decisions we are making. And although we’re far from where we need to be, the good news is that change is happening, partly driven by regulation,’ Clarke says.

Weighing the implications

While wider collaboration and skills-importing may be the longer-term solution, many are questioning how asset managers should think about portfolios today.

According to Salge, a widely used framework among forward-thinking asset managers involves thinking about dependencies on biodiversity and impact on biodiversity at a company level.

A mining company that cuts through forests to extract minerals would be an example of impact on biodiversity, while an agriculture business that is dependent on pollinators would have a high dependency. In both cases, the company might not be fully considering the implications.

‘These are the two lenses that investors are currently using to assess biodiversity risks,’ says Salge. ‘Our view as a company is that we can do three things: we can look at the risks and try to avoid them; we try to engage where that’s possible; and then, we invest in some of the solutions companies that are trying to tackle the drivers of destruction and create an alternative way of operating.’

Another vital avenue for EQ is pushing for ambition at the asset manager level. ‘The best asset managers are using tools such as Encore to create heatmaps of exposure at the sector level based on impact and dependency.

‘But it’s a coarse tool and doesn’t tell you anything about the way an individual company is managing those risks. And at that level, part of the problem is that underlying companies haven’t yet thought about the risks and are not producing the necessary data.’

Salge believes investors need to push asset managers to use these materiality mapping techniques to identify companies that are most exposed, and then use strategic engagement with those companies.

‘Part of the problem is that biodiversity is intrinsically linked to almost every supply chain. Our approach is to engage where we find that link. We use the Forest 500 list, which is developed by Global Canopy, to look at companies we hold. Then we approach our fund managers to make sure the risk is part of their assessment, and that they are engaging with the companies.

‘We also challenge fund managers at the wider level, to make sure they’re investing in data, resources and training for their fund managers because this is such a different way of thinking.’

Chinks in the chain

Clarke agrees that the information deficit is enormous. ‘We’re having to work in a shady world of data that often doesn’t give us the full picture. At the same time, companies are often nervous at best about disclosing information – some are openly resisting.’

The possibilities of using different means for gathering information are a new frontier for financial institutions. ‘Geospatial mapping is a good example. Academic institutions around the world have for decades been using different lenses to monitor the state of the planet – often a combination of aerial photography, ground truthing, and satellite remote sensing.

‘We’re starting to see some of the big investment houses putting significant resources into partnerships with academic institutions to build geospatial teams whose primary focus is either in the climate or biodiversity spaces.’

But whether better awareness and disclosure comes from companies or investors, a seismic improvement in the way finance and business deal with biodiversity risks is needed.

‘It’s not just the regulatory risk, or the risk of financial underperformance as a result of not having a handle on your business’s exposure. There is also a sizeable legal risk. We have seen more than a doubling of climate litigation cases since the 2015 Paris Agreement – will we see the same happen in the wake of the Kunming-Montreal Global Biodiversity Framework?’

The combination of regulation, legal frameworks, and accounting disclosure regimes seems set to make biodiversity impact an ever more material factor for companies.

This poses a stark choice for investors, as Clarke points out: ‘Do you want to be the one who willingly co-opts into the opportunity to build this extraordinary future that we are more than capable of delivering, or do you want to be among those who have to be coerced and thus are highly unlikely to be future-fit?’