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This blog was originally published on investESG.

This behaviour seems absurd in the scenario above, yet is common practice in the investment world when it comes to nature-related risks. What I’m referencing is financial institutions investing in (or lending to) companies that negatively impact other investments in their portfolio. This behaviour exposes investors to what is categorized as systemic nature-related risks. More specifically, cascading risks, extending beyond single assets, which link the impacts and dependencies on nature to both physical and transition risks across different sectors in a portfolio. Below I present some concrete examples of systemic risks, how relevant frameworks cover systemic risks, and most importantly, what investors can do to address these risks.

The evidence is mounting

A study in the scientific journal Nature has found that deforestation in the Amazon leads to productivity losses of up to USD1 billion annually for downstream agribusiness.

In this case, deforestation due to livestock production disrupted regional rainfall patterns which negatively impacted downstream crop yields. These findings have been echoed across multiple studies which have concluded that rapid deforestation is fundamentally changing the hydrological systems in the Amazon which make it a rainforest. However, rainfall is just one ecosystem service which we as society are reliant on. Ecosystem services like pollination, soil fertilisation, and climate regulation are a few of the many fundamental services which nature provides us with, and upon which our global economy relies. These services are part of complex environmental systems, and by investing in one harmful or risky asset, financial institutions can create risk for other assets in their portfolios. In fact, the Dutch Central Bank (De Nederlandsche Bank) reported that Dutch financial institutions have provided over EUR 500 billion in finance to companies that are highly or very highly dependent on one or more ecosystem services. If systemic nature-related risks are left out of investment decision making, Dutch financial institutions may face significant financial risk.

And although you cannot compare these two examples directly – I mean, most people know that ice-cream is unhealthy, while the topic of systemic nature-related risks is relatively new to the investing world – the data is becoming more compelling every day. Tropical deforestation has now conclusively been linked to reductions in precipitation – a fact that will have huge implications for investors with broad portfolio coverage in tropical regions or linked sectors like Dutch livestock production which is reliant on Brazilian soy for animal feed. Another classic example is the marine dead zone in the Gulf of Mexico mainly caused by nutrient runoff from US agriculture. Reports have found that this systemic nature-related impact has caused up to $2.4 billion in damages to fisheries and marine habitat annually since 1980. The implications are serious for investors linked to the Gulf’s fishing (and tourism) economy as well as those investing in the agricultural sector behind the issue. Portfolio investment 1 (agri) significantly impacts portfolio investments 2 (fisheries) and 3 (tourism).

Opportunities & steps forward

While the facts above may seem grim, managing nature-related risks is doable using the Taskforce on Nature-related Financial Disclosure’s (TNFD) LEAP framework, and through concrete actions like collective, multistakeholder action and landscape level governance. For those unfamiliar with the latter, these activities aim to mobilize multiple stakeholders across a given region. Stakeholders can include other economic actors (like companies or smallholders), local communities, government, civil society etc. The aim is to support the collective identification of issues and joint-creation of solutions.

These processes are participatory in nature and are often the only way to successfully address challenges that go beyond a corporate’s operational fence line, especially those concerning joint use and management of shared resources like water. For investors, collective action includes jointly engaging relevant corporates with other investors. Actions can range from place-based stewardship to high-level trade or sectoral policies. Ideally, companies or investors engage their peers or policy-makers to address informal and formal policies and norms to make lasting changes beyond a single investment. For systemic risks, coordinated and integrated action is often necessary and much more effective than the sum of action by individual actors.

An excellent example of this is the Amazon Soy Moratorium (ASM) which is a sectoral agreement where commodity traders agreed to avoid the purchase of soybeans from deforested areas. The ASM contributed to an 84% decrease in the rate of Brazilian Amazon deforestation – a result that will have very real impact for investors. Similarly, through collective action investors can engage and lobby key stakeholders to support activities like large scale forest conservation and demarcation of Indigenous territories which are effective at reversing the impacts of (and reducing) deforestation. Beyond physical and transition risks, the TNFD mentions key actions to assess and address systemic risks throughout the framework. Some examples include:

• Risk & Impact management Pillar, disclosure requirement D: “A description of participation in sector-wide and multi-stakeholder agreements”
• TNFD’s reference to SBTN’s AR3T framework, which includes “Transform” focus on systemic change (see V0.4, page 56)
• TNFD’s stakeholder engagement guidance, which includes a section on the importance of “Multi-stakeholder processes and collaborations” (p16)
• TNFD’s recognition of assessing systemic risks, in LEAP (e.g. step A1)

Cherry on top

Nature is important to all of us. Whether we’re talking about the ecosystem services we all rely on to survive, its cultural importance, or the financial risks and opportunities it represents for investors – protecting and restoring natural systems requires collective action. However, coming back to the ice cream sundae analogy above: while the risks associated with a high-sugar diet are well known, the systemic risks associated with nature loss remain high-level and vague for most. This blog highlights some of the proven impacts which systemic risks can have on investors. Responding to these risks means investors must start the process of locating their interface with nature, and harnessing the potential of collective action for systemic change. In a future post I would like to dive into the opportunities for investors associated with the transition towards nature positive – stay tuned for more!

If you would like to learn more about the TNFD, processes mentioned above or what resources are out there to support, feel free to reach out.

Special thanks to Nicolas Poolen, Senior Manager, Finance Engagement Global Nature Positive Initiative at WWF International, for his contribution.