The €40,000,000,000,000 industry – time to consider biodiversity as an investment class
For a 10-member ESG team of an asset manager with around 250 billion assets under management, our Senior Advisor for Sustainable Finance Hendrik Leue and our then Managing Partner and marine biologist Dr. Alexis Katechakis hosted a Deep Dive Session on the topic of biodiversity, which was intended to enable the team to pass on the knowledge imparted within the company.
Hendrik, why is a financial service provider interested in the topic of biodiversity?
Financial service providers generally play a key position in the financing of companies and projects. The increased interest can be viewed from three perspectives:
1. Legal guidelines
While the CSRD (Corporate Sustainability Reporting Directive) regulates sustainability reporting, the SFDR (Sustainable Finance Disclosures Regulation) defines the disclosure requirements for the sale of financial products. The SFDR requires asset managers to provide mandatory and standardized disclosures on how ESG factors are integrated at both company and product levels. A significant portion of the SFDR applies to all asset managers, whether or not they have an explicit ESG or sustainability focus.
2. Customer demand
Customers are increasingly demanding more sustainable investment and financing options. Biodiversity criteria are also becoming more relevant. By identifying risks and opportunities related to biodiversity, financial companies can offer their customers tailor-made solutions and thereby differentiate themselves from the competition.
3. Risk avoidance in investment products
Companies that are positively committed to biodiversity are successful in the long term and minimize their risk. By protecting and conserving natural resources, potential business risks – such as negative impacts of climate change, water shortages or supply chain disruptions – can be averted. Financial products that take this into account may perform better.
Alexis, what are ecosystem services? And can these be quantified?
Ecosystem services are referred to as providing, regulating, supporting and cultural services. The economic value of all these ecosystem and biodiversity services is estimated at €40,000,000,000,000 annually and is equivalent to half of global GDP.
Steel avalanche protection barriers instead of avalanche protection forests cost around one million francs per hectare. In the canton of Bern, around 24,000 hectares of forest protect settlements and traffic routes from avalanches.
If we look over to America, it is mangrove forests that make a significant contribution to value creation and risk minimization in the insurance sector. By protecting coastal areas, they reduce property damage by more than 16 % – that's more than $82 billion per year. The property damage caused by Hurricane Irma in Florida was reduced by 25 % and the extent of property damage was reduced by $1.5 billion.
Another example is sharks. They ensure a healthy balance in our oceans and thus help in the fight against the climate crisis and also have DNA that can be a key to important medical advances: e.g. faster wound healing, treatment of cancer and autoimmune diseases. The first drugs are already in the testing phase and others are in the development phase. The global marine pharmaceuticals market was $26.50 billion in 2020 and is expected to grow to $48.13 billion in 2027.
So biodiversity could be viewed as a very worthwhile asset class. Why do we treat it so badly?
We see four fundamental problems here.
On the one hand, the wrong attitude has spread that natural goods are free. As Professor Dr. Rainer Grießhammer (Chairman of the Future Heritage Foundation and former managing director of the Öko-Institut) summed it up: “We cling to the wonderful works of the past (...) to the belief that paintings are worth 80 million, footballers up to a billion, but nature is free.”
On the other hand, we see a lost connection – we have disconnected from nature. What may sound esoteric becomes very clear in the language used. We are talking about an environment that surrounds us. In doing so, we subconsciously place ourselves at the center.
Furthermore, we have a biased focus. Literal hidden champions – like bacteria, which, among other things, preserve and regenerate the soil, control floods indirectly, mitigate droughts indirectly, filter pollutants and assimilate waste, have almost no proponents. Because it's easier to advertise that a company supports polar bears than to tell customers that it's investing in improving soil quality. That needs to change.
Last but not least: the way we deal with our surrounding world is characterized by excessive arrogance. On land, humans today move more sediments and rocks each year than all natural processes such as erosion or rivers combined.
Underwater efforts are underway to “regulate” deep-sea mining, yet 95 % of the open ocean has not even been explored. Deep sea mining is the extraction of minerals from the seabed. The focus here is on mining manganese nodules, which are enriched with valuable raw materials (cobalt, nickel, manganese). Given that the demand for metals will multiply in the coming decades, companies sense big business here. However, this practice is expected to disrupt millions of tons of seafloor sediments annually and release carbon that has accumulated over millions of years into the oceanic carbon cycle, according to the Environmental Justice Foundation. The general lack of knowledge about the potential advantages and disadvantages of this industry exposes financial institutions to significant political, regulatory and reputational risks. In addition, there remains significant uncertainty about the economic viability and outcomes of deep-sea mining. Against this backdrop, the Finance for Biodiversity (FfB) Foundation recently released a coordinated statement from Global Financial Institutions to Governments on Deep Seabed Mining to the International Seabed Authority (ISA) Assembly, signed by 37 financial institutions. “The assumption that deep-sea mining is a key solution to providing minerals necessary for the economic transition to achieve climate change goals is hotly contested. New research already shows that more investment in the circular economy could be a more effective way to achieve the transition to a net-zero economy,” the statement said. “Deep-sea mining could cause irreversible damage to complex, unique and highly biodiverse marine ecosystems, which provide important economic sources for almost half of the world’s population. The value of marine and coastal resources is estimated by the United Nations Development Program at $3 trillion per year. Therefore, more scientific research and analysis is needed to understand the risks surrounding deep-sea mining, make more informed decisions and avoid irreparable damage,” said Saker Nusseibeh, CEO of Federated Hermes Limited. Although there were heated discussions at the conference of the responsible International Seabed Authority (ISA) in Jamaica in July (meetings were repeatedly interrupted), there is still a lack of regulations. There will be further meetings in the next two years, and the regulations will be a little further along in 2025. Nevertheless, applications for deep-sea mining can already be submitted, which in turn could put pressure on further negotiations. There is also criticism that the debates are often conducted behind closed doors: “These debates must take place transparently and, above all, they must be open to scientific findings from different disciplines. And whether a new raw materials industry is introduced down there is everyone's concern.” (Britta König, WWF) BMW, VW and Renault have committed not to use any raw materials from the deep sea for the time being.
The debate about deep-sea mining symbolically shows how we too often intervene in ecosystems. The journalist Dirk Steffens summed it up well: “We behave like a monkey at the control panel of a nuclear power plant. He's smart enough to use the buttons, but he has no idea what happens when he presses a particular button. When things are going well, the light only goes out in the toilet. When things go badly, there’s a meltdown.”
Hendrik, what opportunities exist for investors with a view to biodiversity?
There is a staggering $4.1 trillion funding gap in funding ecosystem restoration and restoration. So far, however, there have only been modest approaches, such as the recent Debt-for-Nature Swap to protect the Galapagos Islands, to make these investment sums interesting for private investors. Therefore, the topic of biodiversity has so far emerged less as an opportunity than as a concrete risk for existing portfolios at financial institutions.
Why should financial institutions – such as banks and insurance companies – manage biodiversity risks better?
The systemic risks from the reduction in biodiversity are directly noticeable, especially for highly diversified, so-called “universal investors”. This particularly affects insurers and large pension funds, but increasingly also more specialized investors.
To date, financial institutions do not understand their risks related to biodiversity. Which also means that these risks cannot be priced into the risk-return profile.
The Taskforce on Nature-related Financial Disclosures (TNFD), which is based on the model TCFD (Task Force on Climate Related Financial Disclosures), is intended to provide relief. There will still be a long way to go before investors can help to put the protection of biodiversity into concrete measures. However, analyzing your own dependencies and the risk of potential resulting losses is an important first step.
Basically, we should keep in mind the words of Johann Rockström – Director of the Potsdam Institute for Climate Impact Research: “Tree protectors and activists are very important, but they cannot do it alone. We also need the bankers and managers.” The financial industry has enormous leverage and should be aware of its responsibility.
To this end, TNFD has developed LEAP, an integrated assessment process for nature-related risk and opportunity management. We recommend following it as TNFD is likely to become the standard for nature-related financial disclosure. The final versions will be released in fall 2023. The first two pillars of the LEAP process – locate and evaluate – focus on analysis. In the sense of double materiality, it is about recognizing what effects one's own financing activities have on biodiversity (inside-out perspective) and, on the other hand, what consequences the change in biodiversity has on the risk profile of the portfolio (outside-in). From a technical and methodological point of view, this is certainly not easy to do, especially if you manage portfolios across different asset classes and markets. There is still no standardized measurement method or key figure for measuring one's own biodiversity footprint, as is the case with CO2 in climate protection. However, in recent years, an enormous amount of work has gone into new tools and measurement methods that are gradually becoming practical.
In any case, it's worth taking the first step. Before a comprehensive analysis is carried out, some institutes take the route of a preliminary, often qualitative heat map, which is useful for initial strategic conclusions and can get the ball rolling when it comes to biodiversity.
We would be happy to tell you which specific questions are useful when developing this heat map. Contact us.
Here you can get an insight into how we helped the international asset manager mentioned at the beginning of this article to make its ESG team fit for biodiversity.