Seeing the forest through the trees – How investors can assess biodiversity risk

Economic and social dependencies on biodiversity

Biodiversity encompasses the astonishing variety of all living things on earth, from gazelles and cheetahs to trees and lichen. Together with all other natural assets, including geology, water, soil and air, our planet provides us ‘stocks’ of renewable and non-renewable resources, which we call natural capital. These many stocks of natural capital support economic activities and societies by providing a flow of ecosystem services, which are defined as the direct and indirect contributions and benefits from nature to our human well-being. These ecosystems use the sun’s energy and the soil’s minerals to grow and pollinate our crops, filter our water, and provide us with fresh air. These ecosystem services, including carbon storage, water filtration and food provisioning, are worth more than $150 trillion annually, which is roughly twice the world’s GDP¹. However, since the industrial revolution, the global economy has depleted the productivity of natural capital and has caused notable declines in biodiversity.²

The Living Planet Index – a measurement of species population trends

Source: Living Planet Report 2022, WWF, Zoological Society of London. The Living Planet Index is a time-series based on population, density, and abundance of the world’s biodiversity.

To learn more about the risks biodiversity loss brings and the recent outcomes of COP15 in Montreal, where global leaders came together to agree on a Global Biodiversity Framework, read “Why Investors should care about Biodiversity”.

Coordinated effort from businesses, standard setters, policy makers and individuals are required to reach the desired outcomes of the Kunming-Montreal Global Biodiversity Framework (announced in December of 2022 at COP15) as well as the United Nations Sustainable Development Goals (SDGs) by 2030. Investors have a distinctive position to contribute to making change happen. As shareholders we have a unique voice to promote best practices and encourage prudent biodiversity risk management at investee companies, while providing a valuable perspective to policy makers and standard setters. In this article, we focus on the pressures caused by our economy and society, how the impacts and dependencies on biodiversity can be assessed by investors, and how reporting frameworks and evolving standards can help investors manage risks related to biodiversity loss. We’ve demonstrated the links between investors, businesses, and biodiversity in the following schematic, which serves as a guide to this article.

Source: BMO Global Asset Management

Five Major Pressures on Biodiversity and their Implications for Investors

In 2019, the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES) released their landmark global assessment report on biodiversity and ecosystem services, which outlined five major pressures that companies exert on species and ecosystems leading to loss of biodiversity³.

Source: IPBES, “The global assessment report on Biodiversity and Ecosystem Services”

The implications of these five major pressures on nature are concerning from a systemic risk point of view. Broad exposure to the financial markets comes with an inherent dependence on the well-functioning of socioeconomic systems, which rely on the health of the planet. The greater the pressures on our planet become, the more systemic risk our investors face.

1. Land-use and sea-use change reduces the quality and productivity of our ecosystems. Economic activities such as agricultural operations and deforestation can cause soil erosion, salinization, and desertification⁴, while growing consumption and population cause swift expansions in infrastructure at the expense of forests and wetlands. This leads to difficulties in sustaining crop yields and requires additional investments in infrastructure like water filtration.

2. Direct overexploitation harms the balance of our food systems. Unsustainable overharvesting of resources causes lasting damage. Important populations of fish that people depend on have been reduced to near extinction⁵ and unsustainable deforestation leads to immediate impacts on our climate, such as changes in rainfall and, along with other land-use change, accounts for 15-20% of global carbon dioxide emissions⁶.

3. Climate Change caused by greenhouse gas (GHG) emissions leads to warming land, air, and water temperatures, which impacts habitats and ecosystems. Roughly half of human-caused emissions remain in the atmosphere, while the other half is absorbed by the land and ocean⁷. The ecosystems that capture and store carbon from the atmosphere, like the boreal forests of North America or the kelp forests off the coast of Australia, are so-called nature-based solutions for climate change. Avoiding deforestation and limiting GHG emissions causing rising air and water temperatures helps to protect the stability of these ecosystem services. While companies around the world have acknowledged risks associated with climate change and committed to reducing their GHG emissions, the economy is still dependent on the protection and restoration of nature-based solutions.

4. Pollution of soil, water, and air, caused by the introduction of harmful chemicals or microorganisms, can further deplete ecosystems, and put human health at risk. Agricultural run-off can cause eutrophication, whereby algal blooms grow rapidly feeding off increased levels of ammonia and phosphate. Soil can become contaminated by chemicals emitted from mining operations. Furthermore, the oil and gas industry is the largest industrial source for emitting volatile organic compounds (VOCs), which contribute to local ground-level smog⁸.

5. Spread of invasive species can be caused by the movement of people and goods across the planet. Whether in the food imported from a different country or in the water ballast of a ship, the harm of invasive species on local ecosystems and economies can be great. Collectively, invasive species such as the Japanese Knotweed and Zebra Muscles cost Canada an estimated $16.6-34.5 billion per year.⁹

Biodiversity Risk Exposure Assessment for Investors

Understanding biodiversity risk can be complex for investors. Beyond the aforementioned systemic risks, individual companies are increasingly exposed to reputational, regulatory, policy and litigatory risks. For instance, the financial risks of liability and litigation related to biodiversity and ecosystem services are increasingly flagged by central banks, regulators, and market participants¹⁰. Nature dependencies and negative impacts also increase credit risk, cost of capital, and can impact asset pricing.

Source: BMO Global Asset Management

A company’s exposure to biodiversity risk can be assessed by understanding and measuring its impacts and dependencies on nature. For example, an agricultural company may have ‘dependencies’ on ecosystem services such as ground water, pollination, and soil quality, while causing ‘impacts’ such as soil pollutants, water consumption and GHG emissions. Investors can use various tools to assess biodiversity risk exposure and understand the impacts as well as dependencies and pressures a company or portfolio has on nature.

Issuer Exposure to Nature

Increasingly, companies are reporting through biodiversity frameworks such as the CDP (formerly the Carbon Disclosure Project). In 2022, more than 7,700 companies disclosed biodiversity data through CDP¹¹ , representing about 41% of all companies that participated in CDP.

In recent years, a plethora of voluntary reporting frameworks have emerged that allow companies to disclose what their biodiversity impacts and dependencies are, what commitments they have made to reduce such impacts, and what actions they are taking towards those commitments. These frameworks have been able to develop relatively quickly by building on the foundation of climate counterparts such as the Taskforce for Climate-related Financial Disclosures (TCFD). Some widely accepted standards and frameworks that are launching or re-vamping soon include:

• The Taskforce for Nature-Related Financial Disclosures (TNFD)

  • The TNFD is an emerging framework that will allow businesses and investors to assess and manage financial exposure to biodiversity-related risks¹². Similar to how company reporting in the Taskforce for Climate-Related Financial Disclosures (TCFD), investors will be able to use TNFD reporting to evaluate how investee companies manage exposure to impacts and dependencies on biodiversity. Investors will be able to see:

    • Board and management’s roles in overseeing, assessing, and managing nature-related dependencies, impacts, risks, and opportunities

    • Disclosure of such actual and potential impacts on the organization’s operations, strategy, and financial planning

    • Description of how such impacts are identified, assessed, and managed

    • Which metrics and targets are used to track performance on biodiversity

• The Global Reporting Initiative (GRI)

  • The GRI is a set of standards that help companies respond to sustainability information demands from stakeholders, including investors¹³. In early 2023, the GRI finalized a new collection of feedback related to their biodiversity standards. The GRI 204: Biodiversity 2016 Standard is currently under review to align with new ambitious global developments on the topic, such as the outcomes of the 2022 UN Convention on Biological Diversity. When complete, this enhanced standard will aim to:

    • Broaden the scope of assessing biodiversity impacts throughout the entire supply chain

    • Provide companies the ability to scale and prioritize their most significant impacts on biodiversity

    • Add new links between climate change, pollution, and overexploitation of resources

    • Enhance considerations of location-specific biodiversity impacts dependent on the company’s operational sites

    • Introduce requirements for biodiversity-related human rights impacts, which includes indigenous peoples.

• CDP (Formerly the Carbon Disclosure Project)

  • CDP runs a global environmental disclosure system, which allows thousands of companies, cities, and regions to measure and manage climate change, water security and deforestation risks and opportunities¹⁴. While biodiversity as a topic was only recently added to CDP annual disclosure framework, it has been established as a best practice. In 2023, CDP plans to have new questions related to biodiversity, furthering the applicability and usability of company disclosures¹⁵. Investors will be able to use these responses to assess a company’s commitments or endorsements related to biodiversity, what actions they have taken or plan to take to address biodiversity impacts, and the impact of the company’s value chain. Investors can better understand a company’s performance across several biodiversity-related topics, which includes specific questions related to timber, soy, and cattle products. Topics may include:

    • Oversight and governance for biodiversity-related matters

    • Public commitments and/or endorsements for initiatives related to biodiversity

    • Assessment of impact of supply chains

    • Biodiversity performance monitoring

In addition to a company’s management, governance, and commitments related to biodiversity, investors can leverage innovative tools to evaluate topics such as:

Biodiversity Impact: The Corporate Biodiversity Footprint (CBF) assesses the annual impact of a company’s activities on global and local biodiversity¹⁶. The tool assesses impact generated from the products that are purchased or sold by the company, considering their value chain and their dependencies on ecosystems. Environmental pressures caused by the company’s operations are aggregated into scope 1, 2 and 3 according to definitions and boundaries set forth in the GHG Protocol and translated into biodiversity impact units.

Threatened Species: The Integrated Biodiversity Assessment Tool (IBAT) leverages global biodiversity datasets such as the IUCN Red List of Threatened Species™, the World Database on Protected Areas (WDPA), the World Database of Key Biodiversity Areas (WDKBA), and the Species Threat Abatement and Restoration (STAR) Metric¹⁷.

Nature-positive Outcomes: The World Benchmarking Alliance (WBA) publishes their corporate Nature Benchmark, which measures the impacts of companies across eight key industries, including their performance towards driving nature-positive outcomes¹⁸.

If investors want to dive even deeper, they can assess a company’s quantitative data to calculate and monitor biodiversity impact metrics, such as the Mean Species Abundance (MSA) or Potentially Disappeared Fraction (PDF).

Biodiversity Metrics

Mean Species Abundance (MSA) is a metric that demonstrates the abundance of native species in an ecosystem relative to their abundance in an undisturbed ecosystem. When an MSA is measured as 100%, this indicates an undisturbed level of biodiversity in an ecosystem. The MSA considers land use, greenhouse gas emissions, nitrogen oxide emissions and freshwater use. The MSA can be used as a target and Key Performance Indicator (KPI) by a company wanting to reduce negative impacts or increase positive impacts on nature. This may subsequently be disclosed in the future by companies through upcoming disclosure frameworks such as the Taskforce for Nature Related Financial Disclosures (TNFD) or biodiversity-related Science-Based Targets Network (SBTN).

The Potentially Disappeared Fraction (PDF) of species is an impact assessment metric that measures the local damage to ecosystems caused by specific pressures, such as pollution, invasive species, and climate change¹⁹ over a specific period of time. This is commonly demonstrated as the PDF per square meter (land) or cubed meter (water) per year and is interpreted as a contribution to the extinction of a portion of a species that currently exists. The PDF can be applied broadly to a company’s operations and supply chain by assessing direct impacts, such as land use change, and non-direct impacts, such as GHG emissions or air, water, and waste pollution.

Portfolio Exposure to Nature

At the portfolio level, investors can assess their biodiversity risk exposure by aggregating company-level dependencies and impacts, or by using a sectoral or geographic approach.

Regional or country-level exposure can be assessed by aggregating operational/asset locations, using data such as GIS mapping or national environmental-economic statistics. Seeing which assets have proximity to land- and sea-use change or are at risk to biodiversity depletion can help map biodiversity risk exposures. Investors can also calculate their biodiversity risk exposure at the sector, sub-industry, and/or economic activity level.

Open access tools such as Exploring Natural Capital Opportunities, Risks and Exposure (ENCORE) identify natural capital assets, impact drivers, and potentially material ecosystem services relevant for different sectors or geographies²⁰. ENCORE allows investors to see dependencies and impacts, with associated materiality ratings, factsheets, and visual maps. For example, looking at the forest products industry, which has a significant and growing impact on biodiversity, one can determine that there are many dependencies and impacts to assess. At the portfolio level, this could be used to inform and prioritize company engagements in order to understand how these risks are being managed.

Impacts and Dependencies of the Forest Product Industry as Identified by ENCORE

Source: ENCORE

Taking Action on Biodiversity

A deeper understanding of biodiversity can bolster investor’s sustainability risk management practices. Understanding relationships, dependencies, impacts on natural capital, the value of thriving ecosystem services, and how to assess such risks at investee companies can greatly benefit investors. We expect that the investment community will increasingly prioritize biodiversity risks, as companies continue to develop assessment and reporting capabilities.

Recently, we launched an engagement campaign focused on protecting natural capital in the food and agriculture sectors. Through the campaign, we seek to have investee companies better understand their vulnerabilities to physical climate risks, increase the adoption of best practices for land and water conservation and improve the sustainability footprint of products and supply chains. Companies targeted through our natural capital campaign are held by several solutions offered by BMO Global Asset Management (BMO GAM), such as:

• BMO Women in Leadership Fund (ETF Series Ticker: WOMN)

• BMO Sustainable Opportunities Canadian Equity Fund

• BMO Sustainable Bond Fund

• BMO Equal Weight REITs Index ETF (Ticker: ZRE)

• BMO ESG Corporate Bond Index ETF (Ticker: ESGB)

Learn more about this engagement work, and other similar campaigns in our 2022 Responsible Investment Annual Report.