The rise of nature-related financial disclosures

Nature-related financial risks have emerged as a critical threat to the global economy, with the World Economic Forum’s Global Risks Report 2024 ranking extreme weather-related risks as three of the top four global risks over the next decade. This alarming trend highlights the vulnerability of our economic systems to environmental degradation and biodiversity loss.

Recent research estimates that US $44 trillion of economic value generation, representing over half of the world’s gross domestic product, is moderately or highly dependent on nature and its services. Yet, according to the latest State of Finance for Nature report released at COP28 by the UN Environment Programme, nearly US $7 trillion is invested annually in activities that negatively impact nature, accounting for about 7% of global GDP. This dependency exposes a significant portion of global economic activity to nature-related risks, underscoring the urgent need for businesses and financial institutions (FIs) to address these challenges. The risks associated with nature-related financial issues fall into three primary categories: physical, transition, and systemic.

Physical risks: These risks arise when natural systems are compromised, directly impacting ecosystem services that businesses rely on
Transition risks: Risks that stem from regulatory or market efforts to address environmental harm, potentially leading to increased costs or operational challenges for companies
Systemic risks: They refer to the broader, interconnected impacts on the global economy that can result from widespread nature loss and biodiversity decline

These risks can manifest as significant financial losses across various industries, ranging from relatively small fines to multi-billion-dollar settlements and substantial share price declines. For example, Bernard Matthews, a UK poultry producer, suffered £77 million ( US $95.3 million) in losses due to an avian influenza outbreak. This incident led to the culling of 159,000 turkeys and a significant drop in consumer trust, highlighting the vulnerability of agricultural businesses to biosecurity risks. Consequently, these risks, when realized, also expose the banking sector to heightened vulnerability. US banks alone are estimated to have at least US $1.7 trillion of loan exposure to sectors facing potential natural capital loss.

In 2024, the Network for Greening the Financial System (NGFS) published a conceptual framework to guide central banks and supervisors in assessing nature-related financial risks, building on the 2022 Kunming-Montreal Global Biodiversity Framework’s ambitious targets. This development coincides with the EU’s new regulation, effective late 2024, prohibiting non-“deforestation-free” products on its market.

As awareness grows about the critical role nature plays in our economy and financial system, there is an increasing push for nature-related financial disclosures. Initiatives like the Taskforce on Nature-related Financial Disclosures (TNFD) have been established to help integrate nature into corporate reporting and strategic planning. TNFD framework, launched in June 2021 and released in September 2023, stands at the forefront of this movement, providing comprehensive guidelines for organizations to report on their nature-related dependencies, impacts, risks, and opportunities.

Structured similarly to the Taskforce on Climate-related Financial Disclosures (TCFD), the TNFD framework is built upon four key pillars: Governance, Strategy, Risk and Impact Management, and Metrics and Targets. This structure is designed to facilitate quicker adoption by organizations already familiar with climate-related disclosures, thereby streamlining the integration of nature considerations into existing corporate reporting practices.

Governance: This first pillar requires companies to disclose their processes for managing nature-related issues at the board and management levels
Strategy: Organizations are encouraged to outline how nature-related concerns impact their business models and financial planning
Risk and impact management: The pillar recommends businesses disclose their processes for identifying and managing nature-related risks within existing frameworks
Metrics and targets: It requires companies to report on performance metrics related to nature-related risks and progress toward set targets. This quantitative aspect of reporting is essential for tracking progress and ensuring accountability

To further assist organizations, navigate these disclosures, the TNFD introduced the LEAP approach: Locate, Evaluate, Assess, and Prepare. This structured methodology provides a step-by-step guide for companies to identify their interactions with nature, assess their dependencies and impacts, determine associated risks and opportunities, and develop appropriate responses aligned with TNFD recommendations.

The rise of nature-related financial disclosures is not occurring in isolation but is part of a broader movement towards sustainable finance. As of June 2024, over 400 organizations, including major players like IKEA, Hindustan Zinc and Bank of America, have adopted TNFD recommendations, representing substantial market capitalizations. These early adopters include leading publicly listed companies representing US $4 trillion in market capitalization and US $14 trillion in assets under management.

However, the implementation of nature-related disclosures is not without challenges. These include:

Data availability and quality: Many organizations lack robust systems for collecting and analysing nature-related data, making accurate disclosures difficult. While some data exists, it is often fragmented, outdated, or not easily accessible, leading to challenges in effective reporting and assessment
Determining materiality: Companies often struggle to identify which nature-related issues are most relevant to their specific operations and stakeholders.

This lack of clarity can hinder effective decision-making and strategic planning

To address these issues, organizations are advised to conduct gap analyses between existing processes and TNFD requirements, capture more data from customers, implement robust data quality controls, and start with a few disclosures based on available information.

The financial sector plays a crucial role in this transition. Banks, for instance, can mobilize finance for nature-positive outcomes, which could generate over US $10 trillion in new annual business value. Several opportunities include to plug the global biodiversity funding gap. By developing products like green bonds and biodiversity credits, banks can attract environmentally conscious investors while simultaneously funding projects that restore ecosystems and promote sustainable practices. There is a rising growth in the issuance of green bonds, which is evident with a broad spectrum of major investors—including asset managers, insurers, and pension funds—eager to invest in these products. A notable example is the State Bank of India, which successfully raised US $250 million through green bonds via private placement at its London branch.

Similarly, biodiversity credits are emerging as an innovative financial instrument aimed at promoting environmental sustainability while addressing socio-economic needs. For example, BNP Paribas implements various levers of action to integrate the preservation of biodiversity through specific internal policies, financial products and services (sustainability-linked loans (SLL), green bonds, etc.).

Addressing nature-related financial risks is crucial as their impact on the global economy intensifies. With over half of the world’s GDP reliant on nature and substantial investments still harming the environment, businesses must integrate nature into their strategies. Initiatives like the TNFD offer vital guidelines for transparency and accountability in disclosing nature-related risks. By adopting sustainable practices and innovative financing solutions, such as green bonds and biodiversity credits, the financial sector can drive the transition to a nature-positive economy, safeguarding both financial interests and vital ecosystems.

References

auctusESG Copyright © 2024, All Rights Reserved.