Biodiversity quickly rises up the ESG investing agenda
Two recent deals by one of Britain’s top asset managers point to the next big theme in responsible investing: biodiversity, without which the planet has “no route to net zero”.
Schroders, which manages £770bn in assets, last year bought a minority stake in data provider Natural Capital Research and then, in July, entered into a partnership with Conservation International to invest in “natural capital” across south-east Asia. The deals reflect a belief that what gets measured gets managed — and client demand for investments that have a positive impact on the environment while also making a financial return.
“I’ve made natural capital a big priority for us,” says Peter Harrison, chief executive of Schroders. “I think you’re going to see a very significant amount of money flow into natural capital as people figure out that nature is a very large proportion of the answer to decarbonisation. There is no route to net zero without biodiversity.”
Biodiversity is the living component of natural capital — a term for the stock of renewable and nonrenewable natural resources such as carbon, water, soils, species, communities, habitats and landscapes. It refers to species but also ecosystems, such as forests and coral reefs, which perform functions such as crop pollination, carbon sequestration, climate regulation, and flood protection.
However, scientists believe human mismanagement of the environment — notably through resource extraction, intensive agriculture, and climate change — is precipitating a sixth great extinction of plants and animals in Earth’s history. And coronavirus has further focused attention on mankind’s relationship with nature, after the wet market in the Chinese city of Wuhan, where both live and dead animals were sold for human consumption, emerged as the likely origin of the pandemic.
Loss of biodiversity is now considered as serious as climate change, and investors are increasingly realising that they have an important role to play in conserving it.
The urgency is acute: “An ongoing, catastrophic loss of biodiversity is among the world’s major environmental challenges,” says sustainable investment house Generation Investment Management, co-founded in 2004 by former US vice-president Al Gore and financier David Blood.
As a result, biodiversity is “now the fastest developing ESG theme in global capital markets,” notes Catherine Howarth, chief executive at responsible-investment group ShareAction. “In just three years, the issue has moved from being virtually ignored by mainstream institutional investors to being acknowledged by all.”
Investors are addressing it in two ways: raising capital to put towards nature-based economic opportunities, and trying to analyse how portfolio companies are contributing to, or vulnerable to, biodiversity loss.
“We see biodiversity loss as a top global risk and, as an investor, we are trying to work out how this affects the value of our portfolios,” says Rupert Krefting, head of stewardship at M&G Investments. “Analysis requires drilling down to specific issues at the local level and then engaging with companies at quite a granular level.”
Several capital-raising initiatives are under way. The Natural Capital Investment Alliance was created by Britain’s King Charles and launched at Davos in 2020, with Climate Asset Management, Lombard Odier, and Mirova as founding members. The NCIA has committed to “mobilise” at least $10bn towards natural capital assets this year.
Firms have also launched investment products aligned to natural capital themes, including Switzerland’s Pictet Asset Management which has expanded its Global Environmental Opportunities portfolio to £7.1bn since it launched in 2011. The fund uses impact measurement tools to quantify the corporate world’s contribution to species loss, and then construct a portfolio that it says has a much lower biodiversity footprint than the MSCI All-Country World equity index.
But the investment industry still has a long way to go, according to ShareAction. Its most recent report, in 2020, found that, of the world’s 75 largest asset managers, none had a dedicated policy on biodiversity, and only 11 per cent of asset managers had policies requiring portfolio companies to mitigate harmful impacts on biodiversity. It warned that biodiversity loss was often included in the generic integration of environmental, social and governance factors, and not scrutinised on a standalone basis.
Ways in which portfolios might be exposed to direct or indirect biodiversity risk have now been outlined by Legal and General Investment Management, one of the UK’s largest asset managers. They include physical risk, such as the loss of access to raw materials; litigation and reputational risks, such as being involved in illegal deforestation via supply chains; the risk of increasing regulation; and systemic risk.
Biodiversity is “a hugely material and systemic risk for investors,” warns Michael Marks, head of investment stewardship and responsible investment integration at LGIM. “The ongoing challenge is assessing the severity of risk and nature of these opportunities, as natural capital and biodiversity loss is multi-faceted and it can be location specific, geographically specific, but also sector and company specific.”
One problem for investors is that there is no standard methodology for assessing and reporting biodiversity. This is about to change, though. Just as the Task Force on Climate-Related Financial Disclosures developed a framework for reporting risks and opportunities, and the GHG Protocol emerged to classify emissions into three scopes, so biodiversity disclosures are coming to ESG reporting.
A Task Force for Nature-Related Financial Disclosures is in the pipeline with a reporting framework that seeks to identify and assess nature-related risks and opportunities.
Harrison, the Schroders chief, says reporting on biodiversity is where reporting on climate change was five to 10 years ago. “Carbon is easier, we’ve now got Scope 1, Scope 2, Scope 3 classifications and reporting is improving quite rapidly,” he points out. “But nature is much harder and requires a much deeper level of thinking in terms of what you do about it.”
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