This is part three in a series of blogs about nature-related risk from the IFoA’s Biodiversity Working Party. Here we look at some examples and tools on how financial organisations can assess nature-related risks and incorporate them into risk management frameworks.
There is increasing focus on nature-related risks and how an organisation depends on and impacts the environmental assets and ecosystem services nature provides. Financial organisations may need to look at the nature-related risks of their investment portfolio for two reasons:
They invest in and provide finance to companies that are to some extent dependent on environmental assets and ecosystem services for their products. This exposes their investment performance and financial stability to nature-related risks.
They finance companies with production processes that have an adverse impact on environmental assets, exposing the industry to reputational and litigation risks. There is a duty to provide responsible and sustainable finance to businesses.
Insurers may also be exposed to physical nature-related risks such as how mangrove loss impacts financial losses from hurricanes. This is explored further in the next blog in this series.
Market participants have called for a consistent and integrated approach to the identification, measurement, management and reporting of nature-related risks. In response, the Taskforce for Nature-Related Financial Disclosures (TNFD) has made draft disclosure recommendations. These follow the Taskforce on Climate-Related Financial Disclosures’ four pillars of disclosure: governance, strategy, risk management and metrics and targets. This was deliberate as the intention is to help and encourage a move toward integrated disclosures for climate and nature-related risks.
Emphasis is on practical guidance. The TNFD has developed a first version of a nature-related risk and opportunity assessment process that helps companies understand how they impact, and are affected by, nature-related risks. It refers to the process as ‘LEAP’, which involves four analytic phases:
The results of this assessment can then be used to make informed strategy, governance, capital allocation and risk management decisions on these issues. On TNFD’s website you can learn more about the LEAP Nature Risk Assessment Approach.
To help in the assessment process, the TNFD references possible resources, which it believes could assist financial organisations. These include:
The ENCORE database provides information on how dependent business processes are on ecosystems. This covers dependencies on 21 ecosystem services such as disease control and genetic materials for 86 business processes, including financial services, distribution, and life science.
The SBTN initial guidance for business explores how companies can complete a materiality impact assessment on their exposure to nature-related risk. This approach uses the ENCORE database to assign materiality measures to selected business sectors and subsectors. It reflects how these are dependent or have an impact on natural assets and ecosystem services through:
The SBTN has published its materiality impacts in a summarised table, available on page 20 and 21 of the initial guidance. More detailed information is available on its website. This is a simple tool for companies to assess their natural impact and dependency in a qualitative way, which we believe to be quite helpful.
The recently released PBAF Standard provides practical guidance to financial institutions. It helps them identify investments dependent on ecosystem services. They can then take actions to mitigate the potential impact on their financial resilience and performance.
Nordea Asset Management, which manages about $280 billion, dropped Brazilian meat giant JBS from all its funds, not just those labelled ESG. Nordea cited JBS’s links to farms involved in Amazon deforestation as one of the reasons. Read more in Green Biz’s report.
In 2018, the California Public Employees’ Retirement System became the first US state pension fund to recognise biodiversity loss, deforestation and ecosystem degradation as material risks to consider in its investment decisions. Read more in this Friends of the Earth blog post.
And an industry-wide study showed that 42% of the value of the securities portfolio held by French financial institutions was issued by companies highly dependent on at least one ecosystem service. This is according to a 2021 report from Banque de France. Similarly, 510 billion euros of investments by Dutch financial institutions is highly dependent on one or more ecosystem services, according to a 2020 report from the Dutch central bank.
These analyses are data driven. There is an increasing focus on making data available to the financial industry so that it can assess its nature-related risks. Given our expertise in data modelling and analysis, actuaries are well placed to help in this area. We will explore this further in a future set of blogs.
To find out more about the work of the Biodiversity Working Party visit their website page.
