Financing Biodiversity II: A biodiversity-informed framework to evaluate business risk & opportunity
This article is part of a series of thought leadership articles by the Paia team. Read Financing Biodiversity I to find out about the complexity of putting a dollar value on nature.
How should biodiversity and ecosystem services be integrated into the evaluation of business risk and opportunity? With rapidly depleting natural resources, and an increased focus on biodiversity preservation, businesses must pay attention to nature-related considerations.
After all, all economic activity is dependent on healthy ecosystems, directly or indirectly. Including the concept of natural capital in business risk assessments enables us to better capture the benefits of ecosystem services, such as water purification and pollination, in economic terms. Biodiversity refers to the variety of life at the genetic, species, and ecosystem level, and forms the living component of natural capital stocks. The interactions between biodiversity and non-living natural resources generate most of the flows, from the provision of essential resources to climate regulation, that benefit society[i].
Biodiversity is vital to the long-term success of many businesses. For example, in the pharmaceutical industry, biodiversity is critical to drug discovery, providing molecular diversity and medicinally important organisms[ii]. In the agriculture industry, plant and animal breeders take advantage of underlying genetic diversity to improve yield and quality, enhance pest resistance, and lengthen the growing season. Biodiversity can also underpin product innovation in these two critical industries by providing natural ingredients that provide flavour, aroma, nutrition, or medicinal attributes.
But businesses may not realise their dependence and impacts on biodiversity. With over 60% of natural capital impacts embedded in supply chains[iii], biodiversity restoration and protection are critical to safeguarding the sustainable procurement of raw materials. For example, fashion apparel brands like Kering source wool, cashmere, and cotton from farms and forests across the world. Kering’s in-house environmental profit-and-loss accounting tool (EP&L) converts its natural impacts into monetary terms. It has shown that Kering’s natural impacts are highest during raw material production, specifically around land-use and biodiversity.
Even businesses with no direct relationship to natural capital stocks must consider their biodiversity dependence and impacts along their value chain. For example, banks like ING have acknowledged their business’ impact on biodiversity, through their loans to companies[iv]. Their portfolio companies may be affected by biodiversity loss, which in turn exposes ING to biodiversity risks as a financier.
The global momentum for biodiversity protection is accelerating. Being nature-positive is becoming a key element of net zero emissions; governments and financial institutions around the world are connecting climate and nature. Recognition worldwide that nature loss poses financial, and even existential, risks to businesses is also growing. The Taskforce on Nature-related Financial Disclosures (TNFD) guidelines, complementary to the Taskforce on Climate-relate Financial Disclosures (TCFD) [v], is an upcoming framework that seeks to better understand the financial risks and opportunities posed by biodiversity on businesses. With TCFD becoming a regulatory response for governments around the world[vi], businesses can expect tightening biodiversity regulations if the TNFD follows the TCFD’s success. The Science Based Targets Network is also developing guidance for companies to set targets for nature, as another indicator of a global movement towards greater corporate responsibility for biodiversity.
Framework
In light of this global movement, the Paia team presents a biodiversity-informed framework for evaluating business risk and opportunity. The intention of the framework is not to provide answers, but to facilitate decision making and scaffold the evaluation of biodiversity-related opportunities and risks.
This framework positions biodiversity dependence at the centre of all risk and opportunity assessments, as all economic and business activity is rooted in biodiversity. Around biodiversity dependence revolve 4 interdependent pillars: Revenue, Cost, Compliance, and Capital.
There are tensions and trade-offs across each pillar. For example, revenue may be generated in the short-term through resource extraction. But unsustainable resource extraction is likely to generate higher costs in the long term, and additionally rule out opportunities for the development of new revenue streams synergised with nature.
As another example, growing recognition of our dependence on biodiversity and ecosystem services could also spur the scaling of biodiversity-related finance, lowering the cost of capital. With lower capital costs, biodiversity-related revenue opportunities could be more accessible. But access to capital is also accompanied by higher compliance requirements, which impose higher operational costs.
In this way, we can begin to imagine tensions and trade-offs across all 4 pillars. To facilitate deeper consideration, the rest of this article will expand upon the opportunities and risks of each pillar.
Revenue
Opportunities
What new revenue streams might be unlocked from biodiversity restoration and protection?
Business action for biodiversity may lead to entirely new business models. By seeking to restore and protect biodiversity, businesses may generate new services and products. For example, Unilever has begun integrating biodiversity into its supply chain management, resulting in products sourced from regenerative framing practices.
Entirely new businesses may also be created in ecosystem restoration, as these 5 startups have realised. New markets may develop or existing markets may expand – the ecotourism sector has been forecasted to grow by 10-30%, and the organic food and beverage sector by around 16%[vii]. New revenue streams may also be unlocked, in the form of payments for ecosystem services in wetlands and forests, or if novel scientific discoveries generate licensable patents in future.
Risks
Will biodiversity legislation impact revenue generation?
Companies will have to examine their revenue generation sources and predict the trends of biodiversity legislation in their target markets. For instance, a land reclamation company must be aware of the potential protections that may be legislated for coastal ecosystems, which may halt projects in those waters.
What is the impact of declining ecosystem services on the revenue stream?
Many revenue streams are directly or indirectly dependent on ecosystem services. For example, the $7 billion almond industry in California depends on US bee colonies for pollination[viii]. But honeybee populations have been rapidly declining, due to industrial agricultural methods that put biodiversity last and monoculture first[ix].
Costs
Opportunities
How can biodiversity protection reduce recurring costs?
Recurring operational costs may also be reduced by investing in measures or technology that protect ecosystems. For example, by investing in higher security for fish farms to prevent escape, companies can reduce costs incurred to replace the fish as well as prevent genetic contamination with wild stocks.
Risks
What are the potential business costs of degrading natural capital?
The continued degradation of natural capital stocks and biodiversity often results in tangible and intangible costs. These costs might include potential legal liabilities and pollution clean-up, the loss of ‘social license’ or reputation, and the costs incurred from supply chain disruptions due to emerging infectious diseases (e.g. Covid-19).
What are the potential costs of altering natural features?
The removal of certain parts of the natural environment could lead to cascading costs. For example, the Catskills watersheds in New York[x] provide a natural way to filter contaminants from water. Man-made changes to the watersheds such as road construction could reduce the water quality available to businesses and individuals, leading to an increase in costs for energy and resources needed to artificially clean the water.
Compliance
Opportunities
What opportunities could accompany compliance requirements?
Compliance requirements can facilitate the discovery of business opportunities. Mandatory climate reporting requirements have encouraged companies to undertake deeper reflection into how climate positive policies could benefit them. For example, tax benefits and subsidies could enable them to develop cleaner technologies that are more competitive in a greener market. Nature-related or biodiversity reporting could similarly translate into business opportunities.
Could compliance build internal capacity for biodiversity-related assessments?
Biodiversity risks, like climate risks, must eventually be integrated into strategic business planning. Additional compliance requirements may present an opportunity for businesses to adapt early by building up internal knowledge and familiarity with biodiversity-informed cost and benefit analyses.
Risks
What will be the operational resources committed to compliance?
Complying with the requirements of green financing is likely to necessitate certain steps by the business operation to minimise or even preserve or restore biodiversity. Such compliance would include resources needed to measure, report and verify impacts to biodiversity, and expertise needed to conduct studies to establish biodiversity baselines either revolving around the direct operations of a business, or along supply chains. Companies must question if they have the requisite expertise or whether they can outsource these changes to a third-party.
What are the financial costs of the baseline level of compliance?
The operational resources detailed above will come with a financial cost. Companies need to establish a basic understanding of how much additional costs would be added to the project’s income statement.
Capital
Opportunities
What are the current and potential opportunities for access to financial capital?
With growing investor motivation, more funds with biodiversity related objectives will be launched. Just as how investors have recognised that climate impacts present “unhedgeable risk”[xi] to investment portfolios, investors are now realising that long-term value creation is dependent on biodiversity protection and restoration. The Finance for Biodiversity Pledge, a coalition of 26 asset managers, insurers and banks formed in 2020, is a strong indication of investors’ shifting perception towards the importance of being nature-positive[xii]. As another harbinger of funding opportunities to come, AXA launched a climate & biodiversity fund in 2019[xiii].
As momentum for biodiversity-related financing builds, companies could also consider engaging with a wider set of financiers. With more private sector financing options, there may be more opportunities for public funds to cushion biodiversity financing through blended financing.
Risks
What is the future cost of capital?
Cost of capital could increase if funds begin to divest from assets that do not take care of biodiversity, similarly to how the availability of capital for fossil-fuel related stocks is shrinking. Just as for any other investment, companies can consider the extent of capital increments depending on whether the capital was obtained from debt investors or equity investors, both of which have different risk and return expectations. Current access to capital may also be at risk of being withdrawn. Although legislation may not mandate certain actions, institutional investors and banks tend to be quick to respond to the demands of the collective pool of investors that finance them. These financial institutions may hence shed investments in companies deemed to be laggards in biodiversity protection, raising the cost of capital for companies.
What would be the impact of violating sustainable finance requirements?
Access to financial capital for biodiversity-related projects can come with onerous requirements. Businesses must consider carefully if they can keep up with the requirements throughout the lifespan of the project, and the consequences of being unable to comply.
Conclusion
The concept of natural capital allows us to frame our dependence and impact on nature in economic terms – and the connection between biodiversity and financial flows has never been more salient. Economic development can no longer be segregated from ecosystem services, and growing recognition will spur legislative and capital shifts. As your business learns to navigate the integration of biodiversity considerations into their evaluation of business risks and opportunities, the Paia team hopes this framework constructively facilitates your reflection.
Stay tuned for Financing Biodiversity IIII, our final article in this series, where we will reflect more deeply on biodiversity as an asset.
If you are ready to embark on your nature-positive journey, contact us today.
References
[i] Biodiversity and natural capital, Cambridge Conservation Initiative: https://www.cambridgeconservation.org/project/biodiversity-and-natural-capital/
[ii] Biodiversity, drug discovery, and the future of global health: Introducing the biodiversity to biomedicine consortium, a call to action, Journal of Global Health: https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5735771/
[iii] Biodiversity, and a Conservation Hierarchy for Kering S.A, Bull, J, P. Addison, M. Burgass & S. Sinclair.
[iv] Biodiversity, ING: https://www.ing.com/Sustainability/Our-Stance/Biodiversity.htm
[vi] Companies, investors face new pressure from compulsory disclosure of climate risk, S&P Global: https://www.spglobal.com/esg/insights/companies-investors-face-new-pressure-from-compulsory-disclosure-of-climate-risk
[vii] Biodiversity: Finance and the Economic and Business Case for Action. OECD: https://www.oecd.org/environment/resources/biodiversity/G7-report-Biodiversity-Finance-and-the-Economic-and-Business-Case-for-Action.pdf
[viii] Business benefits of biodiversity in agriculture, BCG: https://www.bcg.com/publications/2020/business-benefits-of-biodiversity-in-agriculture
[ix] California’s almond trade is exploiting one of nature’s most essential workers, IFIS: https://www.ifis.org/blog/californias-almond-trade-exploiting-bee-population
[x] A billion Dollar Investment in New York’s Water, New York Times: https://www.nytimes.com/2018/01/18/nyregion/new-york-city-water-filtration.html
[xi] The Business Case, Climate Action 100+: https://www.climateaction100.org/business-case/
[xii] Finance for Biodiversity Pledge: https://www.financeforbiodiversity.org/
[xiii] AXA & Biodiversity, AXA: https://www.axa.com/en/about-us/axa-and-biodiversity#tab=axa-and-biodiversity-strategy
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