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Five policy recommendations for natural capital and net zero

We are calling on policymakers to take urgent action to join up the climate and nature agendas and accelerate transformation in the real economy and financial services to deliver a nature positive future.

11/09/2023
Bio-diversity

Authors

Sarah Woodfield
Biodiversity and Nature Engagement Lead

Manmade pressures are undermining the biodiversity that supports life on land and below water. Ecosystem services delivered by nature, such as water purification, crop pollination, flood protection and carbon sequestration are vital to human wellbeing and effective, functioning societies. Protecting terrestrial and marine ecosystems is critical in our efforts to mitigate and adapt to climate change and fundamental to achieving food security, poverty reduction and more inclusive and equitable development.

At Schroders we believe that biodiversity loss presents a significant investment risk. Globally, the value of ecosystem services has been estimated at as much as US$125-140 trillion annually, more than 1.5x global GDP. The costs of inaction on biodiversity loss are huge. With more than half of our global GDP dependent on the natural world, the reality is stark: nature risk is an integral factor to investment risk. That’s why action on nature and biodiversity goes to the heart of our fiduciary duty to our clients.

Global collective action to halt and subsequently reverse biodiversity loss needs to be scaled up dramatically and urgently. As a global investment manager, we have a responsibility to mitigate risks in the portfolios we manage for our clients. We use our influence to encourage the companies in which we invest to mitigate damage to the natural environment, to promote and preserve their financial wellbeing. And we want to go further than this; we also believe there is an opportunity for our clients to invest their capital in solutions to restore and protect natural capital, while also delivering a financial return.

We are calling on policymakers to take urgent action to join up the climate and nature agendas and accelerate transformation in the real economy and financial services to deliver a nature positive economy.

What is our plan for nature?

Our Plan for Nature outlines the role of investment in accelerating a nature positive future and creating real investment potential for our clients. It highlights our ambition to harness the power of investment to accelerate a nature positive future via three areas:

Insights – developing our understanding and analysis in order to identify the exposure to nature risk companies and assets have;

Influence – engaging with and influencing companies to reduce their exposure to nature risk and their impacts on nature;

Innovation – offering investment solutions in both public and private markets that channel capital to protect and restore nature and deliver attractive long-term returns.

Our five policy asks to align nature and climate agendas

We have five key recommendations for policymakers on the steps they can take to facilitate the development of a nature positive economy. We are calling on policymakers to:

  1. Set out robust plans to address biodiversity loss and take action to protect and restore nature with urgency this decade – National Biodiversity Strategy and Action Plans submitted ahead of COP16 in 2024 should contain clear policy signals and legislative pathways to meeting the Global Biodiversity Framework.
  2. Require companies, asset owners and investors to report on their risks, impacts and dependencies on nature by 2025. This should be complemented by a clear timeline for future convergence with the global harmonisation of sustainability reporting standards (via the International Sustainability Standards Board).

  3. Require central banks to assess state and sub-state level financial stability risk arising from nature loss, including robust stress testing of the financial sector and supporting scenario analysis.

  4. Support the development of natural capital markets, biodiversity credit markets and nature bonds to scale up private and public capital flows to nature and address the funding gap for the transition to a nature positive future.

  5. Underpinning each of these recommendations is a need to align global action of nature and climate to enable a nature positive, net zero and climate resilient future.

Setting robust plans

At COP15, the Convention on Biodiversity (CBD), global leaders agreed the Kunming-Montreal protocol. This included committing to four goals to achieve the vision of “Living in Harmony with Nature – by 2050 biodiversity is valued, conserved, restored and wisely used; maintaining ecosystem services, sustaining a healthy planet and delivering benefits essential for all people”, underpinned by 23 targets for 2030 ranging from targets on conservation, financial subsidies and excess nutrients.

With the economy dependent on the ecosystem services provided by nature, as investment managers we believe that action to reverse nature loss and replenish natural capital assets which will continue to sustain long-term returns for our clients is critical. Policy action is needed to address negative externalities which markets alone cannot price in. We are therefore supportive of the governments taking action to meet the 23 targets for 2030 and look forward to engaging with them on the publication of their National Biodiversity Strategy and Action Plans ahead of COP16.

To achieve these targets, governments should work with industry to develop sector specific pathways for a nature positive, net zero and climate resilient economy; focusing initially on the most materially impacted sectors such as energy; infrastructure and agriculture. These pathways should aim to quantify and guide on any trade-offs that may be needed between biodiversity and climate change, for example on the need to convert ecosystems to mine transition metals.

Many of these targets will have direct impacts on the long-term growth and profit of the assets and companies we invest in. Take for example the target to “reduce excess nutrients by half”. This will have a significant impact on companies operating in the agriculture industry who rely heavily on the use of fertilisers and pesticides. Policy uncertainty on the scope and timing of these actions can result in investment valuation risk for these companies and will not give those companies the opportunity to adapt their business model and turn to capital markets for support in this transition.

We therefore would like to see clear roadmaps and policy certainty on the policy environment that will take forward these actions. Given the global nature of company supply chains and the diffuse characteristic of nature related impacts, governments should seek to align implementation of these actions to avoid dislocations and regulatory arbitrage. As active owners, we can then engage with companies to support them in this transition.

Reporting on nature impacts and dependencies by 2025

This should be complemented by a clear timeline for future convergence with the global harmonisation of sustainability reporting standards (via the International Sustainability Standards Board).

Nature-related reporting has been lagging other aspects of sustainability reporting and we need to close this gap rapidly to support the better pricing of nature-related risks and opportunities into capital markets. Better nature-related reporting will also enhance our ability to engage with companies on their impacts and dependencies on nature by giving us greater visibility on the risks they are exposed to and the actions they are taking to manage those risks. This is why we supported the call to “make it mandatory at COP15”, for all large businesses and financial institutions to assess and disclose their impacts and dependencies on nature.

As an investor, the information and data we receive from companies about their sustainability-related risks and opportunities enables us to better factor this into our investment decisions. It also provides us with the right context and information to exercise our role as active owners (on behalf of our clients) of companies – holding them to account on how they are achieving long-term value. That is why we have supported the development of sustainability reporting standards such as the Taskforce on Climate-related Financial Disclosures, the Taskforce on Nature-related Financial Disclosures and are supporting the global harmonisation of reporting under ISSB for better comparability between companies when we make investment decisions.

We have been supportive of the development of TNFD and would like to see clear timelines to regulatory reporting requirements from governments on publication. Learning the lessons from TCFD, it will be important to get the sequencing right – asset managers like Schroders can only report in a comprehensive manner if obligations line up with those of the underlying corporates in which we invest. This needs to be complemented by a clear roadmap to the integration of the TNFD frameworks under the ISSB. This will support companies to focus on providing the most material information to their stakeholders in an efficient manner.

A critical dimension of the TNFD framework is the LEAP assessment framework, which addresses the location specific characteristic of nature-related risks, impacts and dependencies. We would like companies to start to provide more transparent information with urgency on the geolocation of their operations, assets and suppliers, so that investors and other stakeholders can hold them to account on their interface with ecosystems that are at risk of ecosystem decline, of high conversion value or water stress. For this reason, we have supported regulation which seeks to heighten due diligence by companies on forest risk commodities in a number of markets, recognising that forests host around 80% of the world’s terrestrial biodiversity.

Central banks assessing risks from nature loss

As we have seen from climate change, given the systemic nature of financial risk arising from nature loss, this risk doesn’t just present in individual companies we invest in, but also in countries and states whose debt we own. This risk could play out in different ways for countries depending on their dependency on natural resources for exports and industry; as well as depending on their vulnerability to the physical risks from climate change and nature loss.

As significant issuers in their own right and acting as an underpin for the financial stability of the economy; central banks should assess state and sub-state level financial stability risk arising from nature loss, including robust stress testing of the financial sector and supporting scenario analysis For example, we have seen the Bank of England and European Central Bank signal that they intend to include nature-related risks in their stress testing scenario analysis. We have also seen Mexico publish an assessment of the dependency of their banking sector on nature. We welcome these steps and encourage others to follow suit.

Central banks should also be conducting stress testing on nature loss and scenario analysis on ecosystem breakdown relevant to the realms of nature and ecosystems they interface with. This will support investors to better assess implications for systemic risk (including investment in insurance and banking sector).

Facilitating private and public capital flows to nature

“Nature markets enable private investment in nature, through creating units or credits that can be bought and sold. They allow businesses to invest with farmers and other land and coastal managers to enhance the ability of land and freshwater and marine habitats to provide carbon, nature recovery, clean water and other benefits.” This summary is from the Department for Environment, Food and Rural Affairs in the UK.

We believe the investment industry can play an important role in allocating capital towards the target to conserve at least 30% of land, inland water, coastal areas and oceans by 2030, with the development of nature-related markets.

An assessment by Schroders on how investors are approaching natural capital has synthesised insights from approximately 200 client engagements. The outcome is that there are currently a number of challenges investors face when considering investments into natural capital; these span across: lack of familiarity, fiduciary risk and return duties, scalability, illiquidity, sizing/comparing an investment, measuring the contribution to climate change and biodiversity goals, and limited number of suitable investment strategies. Given these challenges and the nascency of natural capital as an asset class it is understandable that it accounts for only approximately 0.2% of the total assets managed by the asset management industry today.

Despite these difficulties, there are a number of benefits linked to investing in natural capital such as capital growth, yield enhancement, diversification, inflation mitigation, positive environmental and social impact, carbon sequestration capacity, and biodiversity protection and enhancement potentials. Biodiversity is becoming more important within investment policies.

Our core recommendation for policymakers is that Development Finance Institutions (DFIs) and Multi-lateral Development Banks (MDBs) should be increasing de-risking measures to unlock private sector capital. This can range from patient/long-term (e.g. 15+ years) capital, junior/first-loss tranches, provisions of grant financing to move natural capital projects from feasibility stage to bankability and general market building activities especially e.g. for the voluntary carbon market, the development of biodiversity credits, or blue economy investments, and impact measurement methodologies. The catalytic effect of DFIs and MDBs in mobilising private capital into blended public private partnership structures is seen as critical in scaling up investments into natural capital.

Aligning global action on nature and climate

We know that the root causes of biodiversity loss are also drivers of climate change. We also know that the solutions to addressing biodiversity loss are solutions to climate change. The protection and restoration of forests, for example, will play a key role in sequestering carbon from the atmosphere as well as providing mitigation for the physical impacts of climate change (such as flood defences).

This is why it is essential that policymakers start expanding their focus beyond net zero, to also set out a clear transition pathway to achieve nature positive and climate resilient economies. There needs to be closer dialogue and coordination between environment and treasury departments as well as clearer coordination between the climate and biodiversity Conference of Parties (COPs).

Joined up efforts shouldn’t detract from adequate private and public funding for either one of these initiatives.

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Authors

Sarah Woodfield
Biodiversity and Nature Engagement Lead

Topics

Active Ownership
Natural Capital
Biodiversity
Sustainability
ESG
Environmental
Climate Change
Net Zero
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