5 things financial institutions need to know about nature-related financial risk

Today, Global Canopy and Vivid Economics launch a new report ‘The Case for a Task Force on Nature-related Financial Disclosures’

An initiative to bring together a Task Force on Nature-related Financial Disclosures (TNFD) is rapidly gathering momentum. This new report details why tackling nature-related risks is an urgent priority for the finance sector, and how a TNFD can help.

Read the full report here. Short on time? Here are our top five takeaways:

1. Nature-related risks are material for financial institutions

Financial institutions are exposed to nature-related risks through investment, insurance and banking services to companies that depend and impact on nature.

These nature-related risks are growing. In its 2020 Global Risks report, the World Economic Forum ranks biodiversity loss and ecosystem collapse as one of the top five risks in the next 10 years.

The agricultural sector, followed by the apparel and brewing sectors, are the three sectors with high direct dependency on natural capital most relevant to financial institutions. But the key takeaway is that no sector is immune: even industries with little exposure to direct risks are indirectly exposed through their supply chains.

2. The finance sector is exposed to three types of nature-related risks

• Physical risk occurs when businesses depend directly on nature for operations, supply chains, real estate value or resilience against natural disasters. For example, pharmaceutical companies are exposed to nature risk because they depend on tropical forests and plants for drug developments: up to 50% of prescription drugs are based on a naturally occurring molecule in a plant – and half of all plants have already disappeared.
• Transition risk results from changes in regulations, markets or consumer preferences that impact the financial viability of companies. With rising awareness of how palm oil production can drive deforestation, the demand for sustainable palm oil has increased, which poses a nature-related risk to companies who can’t offer a sustainability certification. Already, 28% of Indonesia’s palm oil land concessions are stranded assets, as forest remains on that land that can’t be deforested while complying with responsible sourcing policies.
• Systemic risk occurs when either physical or transition risk (or both) hits a wide range of companies at the same time. We don’t have to look further than the ongoing COVID-19 pandemic, which is a glaring example of a systemic nature-related crisis. The destruction of natural habitats increases the chances of a virus jumping from animals to humans. Such zoonotic diseases now account for 60-80% of new infectious diseases.

3. Currently, financial institutions are unable to fully identify, measure and manage nature-related risk

First, many financial institutions are not aware that they are exposed to nature-related risks. The leading institutions who are aware of the challenge and want to identify their risks in more detail are often unable to do so. Lack of data and methodologies, as well as capacity constraints, prevent robust risk assessments.

For physical risk, leading tools can only provide high-level estimates of risk-exposure. ENCORE, for example – which the Dutch Central Bank used to estimate the biodiversity risk of the Dutch finance sector – identifies the level of risk based on which sub-sectors a company is operating in, but the tool can’t tailor estimates by location or specific companies.

Transition risk is even harder to measure. Leading initiatives, most notably by ASN Bank and CDC Biodiversité, are trying to quantify impacts specific to a given financial institution or company-level. But lack of company- or asset-level data restricts the risk assessments.

Finally, forward-looking scenarios are largely missing. Assessing different possibilities for how physical and transition risks could evolve over time is critical for sound risk management. The handful of publicly available examples that exist only offer a narrow focus, diving into a specific sector, geography or limited set of policies.

Despite the data limitations, for most financial institutions even the rough granularity offered by existing tools would significantly improve their understanding of their nature-related risks.

4. A Task Force on Nature-related Financial Disclosures (TNFD) will help close data gaps

Better data would enable financial institutions to compare nature dependencies and impacts across the companies they invest, insure or lend to. Having this information on relative nature-risk could lead them to shift their behaviour.

To improve access to standardised data, a TNFD will develop an international reporting standard for nature, building on the format and principles of the Task Force on Climate-related Financial Disclosures (TCFD). Importantly, a TNFD will also signal to data providers that there’s demand for nature-related data, incentivising them to fill gaps.

5. A TNFD is only one component of tackling nature-related risks

Improved nature-related data and metrics will enable more robust financial decision-making. But to tackle the nature crisis, a TNFD must sit within a broader set of developments.

Financial institutions should set targets and change their strategies and policies. Governments also need to put in place ambitious, legally binding nature targets – and the policies, plans and regulations that will ensure those targets are met. Financial regulators must develop nature-related regulations.

Want more details? Read the full report here.

The next steps towards a TNFD

The initiative to bring together a TNFD has already gained broad support. A substantial group of financial institutions, as well as several governments, are joining the TNFD Informal Working Group. The full list of members will be revealed this Friday, so stay tuned.

Catalysed by Global Canopy, UNDP, UNEP FI, and WWF, the finance-sector led working group aims to bring together the full TNFD next year.

Once disclosure guidelines are ready, a TNFD will actively work with investors, banks, insurers and companies to help them adopt the framework at speed.

For more information on the initiative to bring together a TNFD, have a look at tnfd.info.

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