Menu

Environment & Biodiversity - Risk Management

Nature Risk Measurement Is Evolving

As more leading firms identify nature-related risks in their portfolios, we examine how they’re doing it and how they’ve progressed so far.

Thursday, June 27, 2024

By Maxine Nelson

Advertisement

Attention on nature-risk management is increasing following the agreement of the pivotal UN Global Biodiversity Framework (GBF) in December 2022 which set a country-level framework to halt and reverse biodiversity loss. It is the nature version of the Paris Agreement, and therefore important for risk professionals to understand as it has potential policy implications.

Under the GBF, countries agreed that by 2030 they will:

  • Protect 30% of Earth’s lands, oceans, coastal areas, and inland waters — the so-called 30 by 30
  • Reduce annual harmful government subsidies by USD 500 billion
  • Cut food waste in half

After the Paris Agreement, there was a lot of activity in establishing corporate disclosure regimes, such as the Taskforce on Climate-related Financial Disclosures (TCFD). We see a similar pattern following the Global Biodiversity Framework, with the publication of Taskforce on Nature-related Financial Disclosures (TNFD) recommendations in September 2023.

mnelson-150x170Maxine Nelson

The TNFD uses the same framework as the TCFD, but with the addition of three nature-specific requirements. Given the speed with which TNFD was published after the Global Biodiversity Framework was agreed, and its similarity to the TCFD, we may expect it to follow the same path as the TCFD and become embedded in international accounting standards within a few years.

As reporting on nature risks is a means to better understand and manage them, to get started the first step is to understand where, and how big, our dependencies and impacts on nature are.

 

How Large Are Our Dependencies Upon Nature?

A few organizations have identified industries’ dependencies upon nature. For example a WEF report found that while “all businesses depend on natural capital assets and ecosystem services either directly or through their supply chains … more than half of the world’s total GDP — is moderately or highly dependent on nature and its services, and therefore exposed to risks from nature loss.” These dependencies could be either direct or via supply chains, as can be seen in Figure 1 which shows how dependent different industry sectors are on nature.

f1-nature-risk-measurement

Source: WEF - Nature Risk Rising: Why the Crisis Engulfing Nature Matters for Business and the Economy

 

To manage the risks, the next step is to quantify the dependency. The World Bank did this and found that forestry, pollination, and fishery degradation will have a significant impact on GDP in parts of the world with large populations, as can be seen in Figure 2.

f2-nature-risk-measurement

Source: World Bank Group - The Economic Case for Nature

 

f3-nature-risk-measurement

 

The Impact of Nature Loss on Financial Institutions                        

When real economy companies are affected by nature losses, these impacts can be expected to flow through to financial institutions. These impacts have been quantified for a few countries, such as Brazil, Malaysia, Netherlands, France and the U.K. While the studies used different methods, they all found that a substantial amount of lending and investment was reliant or highly dependent upon ecosystem services. (Refer to Biodiversity Loss: An Introduction for Risk Professionals for more information about these studies.)

A recent report from the United Nations Environment Programme World Conservation Monitoring Centre (UNEP-WCMC) took this type of analysis one step further and broke down the impacts on the financial assets of U.K. banks and insurers into the industries that are most affected, and the underlying ecosystem services that those industries rely on.

This is shown in Figure 3, with the width of each line proportional to financial exposure. For example, the public administration and defense sector has the largest bond investment and loans (see top of the middle column); mass stabilization and erosion control (vegetation cover protecting and stabilising terrestrial, coastal and marine ecosystems, coastal wetlands and dunes) is the ecosystem service that is relied on the most (see top of the right side column).

This research found that 42% of the U.K bank and insurer assets (GBP 751 billion) are moderately dependent upon ecosystem services, and a further 10% (GBP 179 billion) are highly or very highly dependent, excluding supply chains. The study also examined upstream economic activity through supply chains and found GBP 2.5 trillion of exposure to industries that have a high or very high dependency on nature in areas of the world that have a high rate of natural capital depletion. These figures exclude exposure to other financial institutions, so are likely to be underestimated. Given the very high exposures, all financial institutions should be trying to understand the potential impact on their portfolio.

f4-nature-risk-measurement

Source: UNEP-WCMC - Risk and Resilience: Quantifying the UK Investment Portfolio’s Dependence on Nature

 

Managing Nature-Related Financial Risks

Some firms are already doing this type of dependency analysis, and disclosing the results. For example, Norinchukin Bank has identified the ecosystem services that are relied on by different industrial sectors it lends to, as well as the corresponding source of natural capital (see the Sankey diagram in Figure 4).

f5-nature-risk-measurement

Source: Norinchukin Natural Capital and Biodiversity Webpage

 

GARP’s 2024 Nature Risk Survey found that the most common frameworks financial institutions are using to understand their potential exposure to nature-related risks are ENCORE (Exploring Natural Capital Opportunities, Risks and Exposure), heatmaps, and TNFD’s LEAP.

LEAP is a framework for identifying, assessing, managing and disclosing nature-related dependencies, impacts, risks and opportunities, to assist companies to implement TNFD’s recommendations. It has four phases:

  • Locate your interface with nature;
  • Evaluate your dependencies and impacts on nature;
  • Assess your nature-related risks and opportunities; and
  • Prepare to respond to, and report on, material nature-related issues, aligned with the TNFD’s recommended disclosures.

ENCORE can be used for the locate and evaluate phases of the LEAP process. It identifies ecosystem services that underlie industry sectors, and which natural capital assets provide those services. It then links the assets to potential drivers of environmental change so that financial institutions can understand what is important for service provision and what could lead to disruption. Figure 5 is an example of the output of this type of analysis — showing the drivers of nature loss for different industry sectors in Norinchukin Bank’s portfolio.

f6-nature-risk-measurement

Source: Norinchukin Natural Capital and Biodiversity Webpage

 

TD Bank has done a similar analysis, though in more depth, for its agricultural clients (see Figure 6).

f7-nature-risk-measurement

Source: TD’s Climate Action Plan: 2023 Progress Update

 

While the focus so far has been on identifying dependencies on nature, risks also arise from companies’ impact on nature. Some financial institutions are also looking at this angle. For example, asset manager Robeco has assessed its exposure to industry sectors that have high and very high impacts on biodiversity loss, and its exposure to sectors with high and very high dependency on ecosystem services (see Figure 7); and ING bank has done a similar analysis (see Figure 8).

f8-nature-risk-measurement

Source: Robeco’s Approach to Biodiversity

 

f9-nature-risk-measurement

Source: ING’s Nature Approach

 

We are also seeing government institutions starting to disclose this type of information, with Norway’s sovereign wealth fund examining equities it has bought and creating both a Sankey diagram of their dependencies on ecosystem services as well as a heatmap of their impact on nature (see Figure 9). As more government bodies disclose, we can expect to see a greater push for corporates and financial institutions to also disclose.

f10-nature-risk-measurement

Source: Norges Government Pension Fund Global Nature Risk Disclosures 2023

 

Once the type of risk that will impact the portfolio has been identified, the next step is to identify the traditional financial risk category that will be impacted, and how it could be impacted. Figure 10 explains how some of the traditional risk types will be impacted and gives tangible examples.

f11-nature-risk-measurement

Source: TNFD Guidance on the identification and assessment of nature-related issues: The LEAP approach

 

Parting Thoughts

Due to the importance of nature loss — impacting not just our food, water, and associated processes but also underpinning all our economy, with many industries highly dependent on well-functioning nature — we are quickly moving from a UN agreement for halting and reversing nature loss to a need for financial institutions to understand how their portfolios impact and depend upon nature.

Measurement approaches have already been developed and leading firms have adopted them. They recognize that the approaches are a work in progress, and they are publishing to help others and collectively increase knowledge about risks from nature loss. All firms are well advised to follow their example and understand the nature-related risks in their portfolio, so they can start being managed.

 

Maxine Nelson, Ph.D., Senior Vice President, GARP Risk Institute, currently focuses on sustainability, climate and nature risk management. She has extensive experience in risk, capital and regulation gained from a wide variety of roles across firms including Head of Wholesale Credit Analytics at HSBC. She also worked at the U.K. Financial Services Authority, where she was responsible for counterparty credit risk during the last financial crisis.




Advertisement

We are a not-for-profit organization and the leading globally recognized membership association for risk managers.

weChat QR code.
red QR code.

BylawsCode of ConductPrivacy NoticeTerms of Use © 2024 Global Association of Risk Professionals