Nature-related disclosures are coming – are you preparing?
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At this point, you have already seen all kinds of figures valuing the stock of UK natural capital, the rapid pace of decline of biodiversity, the proportion of global services dependent on nature, or the economic value of the ecosystem services we receive for free. This article takes a more pragmatic approach – and tells you exactly why nature-related risks and natural capital should be on your radar.
The UK Environmental Improvement Plan – legally binding targets on biodiversity
According to the Zoological Society of London (ZSL), biodiversity includes the diversity of ecosystems and species, as well as the diversity within species. The loss of nature and biodiversity is a systemic risk affecting everything and everyone – and it compounds the effects of climate change significantly.
Biodiversity and nature loss were at the heart of COP15, which took place in December 2022 and saw 196 countries agree a Global Biodiversity Framework. As a result, governments have committed to mobilising billions of capital in each country every year.
The UK government outlined an environmental and economic vision for the UK in March 2023. The Environmental Improvement Plan sets out a ‘world-leading, legally binding target in England to halt species decline by 2030; then to reverse the decline by 2042.’ There are also ‘legally binding targets to reduce the risk of species extinction […] and restore or create more than 500,000 hectares of wildlife-rich habitat’, through 70 new projects. The plan also includes a roadmap for improving water efficiency, reducing pollution and waste, as well as financing better farming and forestry practices.
TCFD disclosures augmented with TNFD additions
The Pensions Regulator made it mandatory for schemes over £1bn to provide climate metrics aligned with the recommendations of the Taskforce for Climate-Related Financial Disclosures (TCFD) in October 2022. There is an ongoing consultation about local government pension schemes (LGPS) also providing mandatory reporting. Toby Okoli, a summer intern at mallowstreet, points out that the largest 23 pension schemes in the UK already produce TCFD reports.
The Taskforce for Nature-related Financial Disclosures (TNFD) may sound like a ‘new kid on the block’ (and yet another acronym), but in fact has been operational since 2021. The TNFD framework takes its inspiration and approach from TCFD recommendations. The idea is that biodiversity and nature-loss data should, and eventually will complement companies’ existing climate disclosures. In other words, those who report against TCFD requirements will be able to use their existing TCFD governance framework and augment it by adding nature-related risks and opportunities.
The full and final TNFD framework should be published in September 2023 and will be voluntary to adopt. However, the Financial Conduct Authority (FCA) plans to consult on making TNFD mandatory shortly thereafter, and this is far from the only supervisory initiative focusing on corporate biodiversity disclosures.
Nature-related disclosures – and the new metrics to consider
Corporate issuers, asset managers and asset owners will likely be expected to follow a LEAP approach to get started with nature-related risks and opportunities:
Locate their interface with nature
Evaluate their dependencies and impacts
Assess their risks and opportunities, and
Prepare to respond to nature-related risks and opportunities, and provide reporting.
Like TCFD, the TNFD framework has several key components:
Metrics and targets will be key for the UK institutional investor community – as we have seen with TCFD, making disclosure and reporting mandatory has helped redirect capital to solutions, so it is likely that TNFD adoption will follow a similar pathway. TNFD metrics are aligned with the five key drivers of biodiversity loss, which different sectors will either exert a high impact or be highly dependent on:
Land and sea use change – habitat destruction and disturbance, land and soil degradation, deforestation, ecosystem conversion, etc
Direct exploitation – excessive resource extraction like overfishing, overlogging, the over-extraction of freshwater, etc
Climate change – global warming can disrupt ecosystems and intensify species decline
Pollution – of air, water, and soil in various forms, including plastic, nutrient, and chemical pollution
Invasive alien species – the entry of non-native plants, animals and other organisms through agricultural production, tourism, global trade, etc
The core impact disclosure metrics proposed by TNFD, on which targets will be based, include:
Scope 1, 2 and 3 GHG emissions (as per TCFD)
Total extent of land, freshwater and ocean use change, in km2 by type of ecosystem and business activity – with a drill-down into priority ecosystems identified via the LEAP process
Total pollutants released to soil, in tonnes by type
Volume of freshwater discharged, in m3 or equivalent, and the pollutants it contains
Total amount of hazardous waste generated, in tonnes by type
Total non-GHG air pollutants, including particulate matter, nitrogen oxides, volatile organic compounds, sulphur oxides and ammonia
Total water withdrawal and consumption from areas of water stress, in m3
Quantity of high-risk natural commodities sourced from land, ocean and freshwater
Quantity and share of natural commodities sourced from priority ecosystems
Translating TNFD into familiar practices
Expecting this on the regulatory track, we asked UK pension trustees about their progress on nature-related risks – but as the Trustee Report 2022 has revealed, they are not on the radar yet.
As with climate change and the resulting risks and opportunities, investors will likely need to repeat the usual steps but with natural capital in mind:
Nature-related risk management: risks can be physical (e.g. flooding, loss of materials and resilience), as well as transition-related (e.g. changes in public policy and consumer preferences, litigation risks in different European jurisdictions). The TNFD LEAP approach starts with identifying where your assets are exposed to nature-related risks. Additional resources include the Sustainable Accounting Standards Board (SASB) materiality map, the Integrated Biodiversity Assessment Tool database (IBAT) or the ENCORE framework.
Nature-positive engagement: investors already engage with managers and issuers about reducing their carbon footprints. In the context of TNFD, engagement should focus on the issuers and managers’ exposure to and impact on at-risk and high-value ecosystems, akin to the goals of SFDR Article 8 funds.
Nature-positive investing: this can start with investing in companies more mindful of their impact on nature – and taking proactive steps to reduce and reverse it, akin to what SFDR Article 9 funds do. But there are ways to play a much more direct role.
Investing in natural capital: much of the investments in natural capital and biodiversity benefit from government subsidies and/or generate certified carbon credits which can be sold as a profitable investment. Carbon credits go beyond simply trading to offset emissions, which allows issuers to stay within their permitted allowance and avoid carbon tax. While the UK currently does not have an established carbon crediting mechanism, there are 27 such mechanisms in various international jurisdictions. The most popular independent one is the Verified Carbon Standard (VCS). If not possible to verify the carbon credits, there are many organisations which can at least vet the projects receiving the investments.
Themes to consider, be in in risk management, target setting, engagement or investments, include:
Sustainability-linked bonds influencing issuers to improve business models and minimise negative impacts
Green bonds where the proceeds finance biodiversity and nature-related projects
Companies and funds working to halt deforestation and/or finance afforestation
Supporting biodiversity restoration and conservation
Ocean conservation, improving seafood supply chains and sea trade
Improving water treatment, quality and use
Sustainable and regenerative agriculture
Better waste management and water treatment
Biodegradable or reusable packaging to replace plastics
Encouragingly, our intern Toby Okoli also highlights that the DB Climate Risk Report, which mallowstreet produced in partnership with AXA Investment Managers in 2020, shows that 75% of schemes with an endgame longer than 10 years are interested in investing in biodiversity protection. There is also strong interest in sustainable agriculture and water management. Most importantly, green bonds are a way for schemes with significantly shorter time horizons to still play a role.
What’s next for asset managers?
According to a survey by ShareAction, 73% of asset managers conduct research on biodiversity risk, but few of them use the data to inform their policies, targets or asset allocation. This will undoubtedly start changing as the TNFD framework is adopted first voluntarily, but likely also as a mandatory requirement for many institutional investors. To prepare for this, mallowstreet is planning an in-depth research project to assess current practices, sentiment and challenges around nature-related investing. Contact us if you would like to become a research partner and play a central role in the evolving industry discussion.