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Biodiversity: Why investors should take note

Christopher Goolgasian, CFA, CPA, CAIA, Director of Climate Research
Jenny Xie, Venture Associate
2023-12-31
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The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only. 

Earth’s diverse, abundant ecosystems have long been a source of “natural capital” for economic growth and development. Today, scientists broadly agree that human activity is rapidly degrading ecosystems and causing biodiversity loss that may have grave consequences for human health, economic stability, and financial asset values. Given scientific consensus, our Climate Research Team and broader Sustainable Investment (SI) Team believe that the investment community needs to understand the potential impacts of biodiversity loss and explore ways to mitigate the associated financial risks. 

To this end, we are deepening our research on biodiversity, with the long-term objective of helping our investors better assess the financial materiality of biodiversity loss on regions, asset classes, and sectors. Our team is also evolving our stewardship practices with a view to identifying the areas where we believe we can add the greatest value for our clients.

Understanding biodiversity loss

One of the key challenges with understanding biodiversity is its exceptional complexity and range. The Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES) defines biodiversity as “the variability among living organisms from all sources including terrestrial, marine and other aquatic ecosystems and the ecological complexes of which they are a part.”1 This variability not only covers differences in attributes, but also “changes in abundance and distribution over time and space within and among species, biological communities and ecosystems.”  

The factors that cause biodiversity loss are myriad, but, according to IPBES,2 the direct drivers can be grouped under:

  • Land-use change 
  • Climate change 
  • Pollution
  • Natural resource use and exploitation 
  • Invasive species 

The resulting impacts of biodiversity loss are wide-ranging. They include environmental degradation and destruction of critical ecosystems, risks to human health, damage to social fabric and the potential for conflict, and economic losses over the long term.

Climate change and biodiversity

As carbon emissions accumulate, research indicates that a growing number of species will be exposed to potentially dangerous climate conditions, which may threaten their long-term viability. Our team believes that biodiversity research is the next logical step in understanding and addressing climate-related risks. Many natural resources, including soil, permafrost, and forests, are major carbon sinks. Healthy above-ground and below-ground ecosystems, including coral reefs, mangrove forests, and many others, can help mitigate the adverse impact of a changing climate. 

There is no single metric to capture the extent of biodiversity loss, but scientists observe growing evidence of rapid acceleration. According to the WWF’s Living Planet Report 2022, global wildlife populations have plummeted by 69% on average since 1970, 3 while a 2019 IPBES report found that one million species face extinction, which, for many, could be within decades.4

Economic cost of biodiversity loss 

Healthy ecosystems are vital to the long-term viability of our economy and society. In our view, natural capital can no longer be considered as a cost-free input into business processes, but rather as an asset that needs to be preserved and accounted for. Capturing the full extent of the potential economic impact of biodiversity loss is challenging, however. Data is currently unreliable and inconsistent, companies and governments both benefit from biodiversity and contribute to its loss, and industrial production supply chains contain hidden dependencies and have extensive impacts on biodiversity. 

Estimates from the World Economic Forum (WEF) give an idea of what is at stake. WEF calculations suggest that approximately US$44 trillion of economic value generation — more than half of the world’s total GDP — is moderately or highly dependent on nature, with the three sectors that it considers the most dependent on nature (construction, agriculture, and food and beverages) generating close to US$8 trillion of gross value added, roughly twice the size of the German economy.

We are already witnessing significant economic damage from biodiversity loss. In its 2019 assessment, IPBES found reduced productivity in 23% of the global terrestrial area and up to US$577 billion of annual global crop output at risk due to pollinator loss. The IPBES assessment also paints a bleak picture of marine biodiversity loss as various forms of pollution have produced more than 400 ocean “dead zones,” totaling more than 245,000 km2 — a combined area greater than the United Kingdom.

A potential roadmap

As a fiduciary of our clients’ assets, our SI Team sees it as our responsibility to better understand biodiversity loss and help assess its financial materiality across asset classes, securities, and geographies. While the asset management industry currently lacks the appropriate datasets and frameworks to fully integrate biodiversity into the investment process, regulators, financial institutions, and other stakeholders are starting to focus on the relevance of nature, which may accelerate data availability. 

As with climate change, we expect awareness of biodiversity to eventually permeate capital markets. We see four main stages in the journey toward the integration of biodiversity considerations into investment decisions:

  1. Scientists produce evidence for concern. A large and growing body of scientific research illustrates the vital importance of addressing biodiversity loss. 
  2. Global policymakers align regulation. Armed with growing scientific evidence, governments are looking to develop policies to address biodiversity concerns. The COP15 gathering in Montreal may provide further impetus for regulatory action.
  3. Asset managers evolve stewardship practices. Changing regulations will likely spur active managers to broaden their stewardship, including through engagement and proxy voting, to promote awareness and help companies and issuers integrate biodiversity concerns into their policies and practices. 
  4. Industry improves disclosure, with converging standards. Better understanding of biodiversity risks and growing availability of relevant data are likely to lead to disclosure standardization, helping investors further evaluate the risks and companies progress toward remedial action.

What steps can investors take? 

Deepen biodiversity knowledge
While the industry is still in the early stages of translating biodiversity data and risks into standardized metrics, investors can begin by developing their knowledge of biodiversity. A few good information sources include:

Wellington’s SI Team will also share insights as we deepen our knowledge and hone our approach to biodiversity research. 

Enhance stewardship
In parallel to knowledge building, we suggest investors start to evolve their stewardship practices through corporate engagements and proxy voting. 

Join industry collaborative initiatives
We advocate for participation in industry frameworks and initiatives. These include the Taskforce on Nature-related Financial Disclosure (TNFD), CERES, the Platform for Biodiversity Accounting for Financials (PBAF), the Global Impact Investing Network (GIIN), the Investors Policy Dialogue on Deforestation (IPDD), and several others.

Invest in research; explore new ideas
Our research collaborations with Woodwell Climate Research Center and the Joint Program on the Science and Policy of Global Change at the Massachusetts Institute of Technology have resulted in a rich dialogue and invaluable insights on the physical and transition risks of climate change. These partnerships are aimed at bridging the gap between climate science and finance. We have begun to explore connections between finance and biodiversity as well.

Biodiversity research: Exploring new concepts 

In our collaboration with Woodwell on the physical risks of climate change, we have found that translating scientific insights into financial terminology can be particularly effective in enabling investment teams to analyze and compare climate-related risks in their models and financial calculus. 

As our work with Woodwell expands to biodiversity, we are brainstorming a future research concept that we call the “cost of nature sold” (CONS), a potential analog to cost of goods sold (COGS), a common accounting term broadly familiar to investors. While a significant data vacuum must be closed before CONS could be a reliable metric, it illustrates how we strive to think creatively about potential metrics that might be useful in the investment context. In our view, the more financial market participants and scientists can use common nomenclature, the faster investment decision makers can process and apply relevant information.

In summary

Based on scientific consensus, our SI Team has concluded that, as with climate change, biodiversity loss can be a material financial risk to many companies and investors. Unfortunately, the lack of appropriate data and disclosure standards means that the asset management industry has a long journey ahead to integrate biodiversity considerations into investment decisions at scale. At this stage, our team believes investors should focus on building biodiversity knowledge, prioritizing those areas where biodiversity risk is most pronounced, and developing stewardship practices. We aim to help our clients and portfolio companies navigate the rapidly changing market and regulatory backdrop and look forward to sharing our insights on the investment risks of biodiversity loss.

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