MSCI has just published its Investors' Guide to Nature and Biodiversity Risks and Impacts. Arne Philipp Klug and Sylvain Vanston explain what investors need to understand about nature and biodiversity risks and impacts.
Environmental Finance: What are the main questions that your clients are coming to you with when it comes to nature?
Arne Philipp Klug: They are similar to the questions investors ask about ESG and climate: "Which companies or assets in my portfolio contribute most to biodiversity loss? How do my investee companies manage biodiversity risks or impacts? What does the decline in the state of biodiversity mean for my portfolio? How can I align with voluntary or mandatory reporting frameworks?"
EF: How do the challenges in this space differ from those in climate transition investment approaches?
AK: There are a lot of overlaps with climate change, and the two issues are connected. Climate change is a key driver of biodiversity loss, while nature plays a vital role in meeting climate goals, as we need intact ecosystems to absorb carbon emissions. However, there are key differences. With climate risks, we have harmonisation when it comes to measuring climate impacts and a single metric in CO2 equivalents. We don't have that in biodiversity.
Another important distinction is that we don't have a 'nature budget' defined in the way we have a budget for the volume of carbon emissions we can emit under certain scenarios.
Sylvain Vanston: This issue constraint often gets overlooked. Unless perhaps via the 'planetary boundaries' model, I don't think it will be possible to create quantified budgets for nature, which would allow investors to understand when companies are at risk of missing targets. This challenge requires alternative approaches to create solutions.
EF: How can investors translate biodiversity-related policy, such the COP15 outcomes, into meaningful signals for their investment strategies and frameworks?
AK: What we believe is needed is for countries to translate those goals into national laws and regulations. The EU has started to do that, with regulations on deforestation and reporting standards. That's less the case, for example, in the United States and other countries.
However, it's already clear that some of the COP15 outcomes, such as the pledge to protect 30% of land and oceans by the end of this decade, could have serious consequences for companies and investors. Although we are yet to see how that will be implemented, investors can already start to, for example, assess what impact their portfolios are having on biodiversity and begin to explore investments that deliver nature-positive outcomes.
EF: You've just published an investor's guide to biodiversity – what do investors need to know?
AK: The report sets out how investors can look at nature and biodiversity, what questions they should ask themselves, and presents the tools they have at their disposal. It provides a systemic approach to tackling the topic, a practical checklist on how to integrate biodiversity into investment decisions, and our Nature and Biodiversity Metrics Framework to help investors start identifying which metrics to consider as they begin incorporating biodiversity into their investment processes.
EF: Can you outline your approach to biodiversity metrics?
AK: At MSCI, we have spent decades developing metrics and data for investors to measure risks and opportunities related to ESG and climate change issues. We have applied that experience to our nature and biodiversity metrics framework. The framework follows the logic of our climate change metrics framework: we look at the impact of investment decisions on nature and biodiversity, and the impact of biodiversity loss on portfolios. We have also considered the new Taskforce on Nature-related Financial Disclosures (TNFD) framework because it provides great guidance on how to categorise the types of risk and how to look at various impact drivers and so on.
EF: How will new technologies and geospatial data help with some of the challenges faced?
AK: We see a lot of great potential here. In contrast to climate change, biodiversity impacts are highly location-specific. Investors may want to know if the physical assets of their investee companies – a factory, mine, or plantation, for example – are located in or close to a biodiversity-sensitive area, and so on.
Leveraging our issuer-linked asset location dataset, MSCI GeoSpatial, we are able to carry out this location-specific analysis for relevant biodiversity indicators. This means that our issuer-level biodiversity screens take into account the individual asset locations the issuer has around the globe and how these may be in locations considered biodiversity-sensitive, such as deforestation fronts, etc.
In the future, these assessments could be further enhanced by using even more accurate satellite images and remote sensing. That type of technology can really help to generate more granular, consistent, and up-to-date data when it comes to measuring biodiversity. Often the challenge remains to link this biodiversity data to corporate behaviour. At the same time, there is good progress being made to see, for example, the contribution of a specific company to forest loss.
EF: Can you tell me about the work you are doing on biodiversity footprinting?
AK: Biodiversity footprinting is a hot topic, and also a complex one, because there's no harmonised approach in the market or academic world of how to quantify a company's impact on nature and biodiversity. For example, should you include only direct impacts, or also those from a company's supply chain? What should be the time horizon of the footprint? What are the best metrics to use?
A biodiversity footprint metric is seen by many as a way to simplify the complexity of biodiversity into one communicable metric, akin to a carbon footprint for climate change. To cater to client needs, we plan to enhance our existing Nature and Biodiversity Metrics package in 2024 with the addition of a biodiversity footprinting tool. We are using an approach based on academic models to assess a company's biodiversity impact at both global and local levels. We take species diversity as a proxy for the state of biodiversity.
The biodiversity footprinting would provide metrics on potentially disappeared fraction (PDF) of species, as well as means species abundance (MSA) because investors have different preferences on which methods to use. The biodiversity footprint – similar to its carbon footprint counterpart – will aim to help investors quantify impacts and enable them to compare their investments against a benchmark.
EF: What are your thoughts on the progress of the work of the TNFD? What developments and potential outcomes will you be keeping an eye on?
SV: The TNFD is obviously following in the footsteps of the Task Force on Climate-related Financial Disclosures (TCFD), which was launched in 2015. It has taken about four or five years for the TCFD to become a mainstream financial discussion. It is our hope that it doesn't take as long for the TNFD to become mainstream: we don't have that much time when it comes to biodiversity.
However, the market already recognises the value of the TNFD framework, which has been thoroughly tested through several rounds of consultation. In our opinion, the Taskforce has been prudent and inclusive and has onboarded legitimate parties and experts, including companies in sensitive industries, investors, researchers, and NGOs.
It is our hope that the state of disclosures will improve significantly with two or three rounds of TNFD reporting. As a data company, we know the state of data when it comes to biodiversity, and currently, it's not as good as it needs to be. It's scarce, it's often hard to compare and it's sometimes inaccurate. Better disclosures are a key part of the sustainable finance's theory of change.
EF: What are the next steps for the industry as it relates to nature-related impacts and dependencies?
AK: I feel we've reached a minimum level of consensus about what needs to be done. It's now a question of increasing the level of sophistication, as we've seen with climate finance. While there are still data limitations, it shouldn't be used as an excuse. The data isn't perfect, but it's better than many people think.
SV: The data that is really missing is, for example, easy-to-access information about issuer-related asset locations and local activity type, land and water use, etc. It's not rocket science, but this data is scarce and rather difficult to collect because until now companies hadn't been asked to report it. This is where data providers like MSCI can apply their experience in data collection and analysis, working with public and third-party data sources, and playing a role in facilitating greater transparency of data and information across issuers and investors.
Finally, investors are increasingly aware that you can't work on climate and nature in sequence: you have to work on them in parallel, as the crises are connected, as are some of the solutions. The urgency is there, the regulations are coming, and there's lots of new work to be done. Better start now.
Arne Philipp Klug is MSCI's biodiversity research director, based in Frankfurt, and Sylvain Vanston is the firm's head of climate and biodiversity investment research, based in Paris.
For more information, see: www.msci.com/our-solutions/climate-investing/nature-and-biodiversity