Nature Value at Risk
Helen Avery, Director for Nature Programmes at the Green Finance Institute, evidences the material risks environmental deterioration creates for the UK economy and financial sector.
New research led by the Green Finance Institute (GFI) has quantified the potential impact that nature degradation could have on the UK’s economy, and assessing the extent to which such risks may be material for financial stability.
The report estimated that damage to the UK’s natural environment could lead to an estimated 12% GDP reduction in the years ahead – a larger impact than the economic hits cause by the 2008 global financial crisis or the Covid-19 pandemic.
“The main takeaway from the research is that nature degradation is a material risk, which is what we set out to prove,” Helen Avery, Director for Nature Programmes at the GFI, and Project Lead on the report told ESG Investor. “Nature is not just a nice to have, but its loss will impact the performance of businesses and the financial sector.”
The analysis shows that nature-related risks – such as those stemming from water pollution, soil degradation and biodiversity loss – are as detrimental to the economy as climate-related ones. “Nature is often seen as a lesser imperative compared to climate,” Avery added. “Many think that nature can wait, but it can’t.”
The “net zero first, nature second” approach taken by many corporates and governments was what prompted GFI and its partners, including the UN Environment Programme World Conservation Monitoring Centre and the Environmental Change Institute at the University of Oxford, to conduct comprehensive research into material risks for the UK economy.
“We wanted to make the business case that would make sense to company boards,” said Avery. “One way was to expose the fact that this is an economic risk that is material to certain sectors.”
With UK politicians focused on growth, jobs and infrastructure ahead of the next general election, the GFI is hopeful the report will show that natural capital can’t be decoupled from growth – a point that “hasn’t been strongly made previously”, according to Avery.
Innovative approach
The research team broke new ground in its methodology to evaluate nature-related risks. For example, it developed the first Nature-Related Risk Inventory for the UK (UK-NRRI), equivalent in format to the country’s National Risk Register.
The UK-NRRI database includes 29 key risks, with zoonotic diseases and antimicrobial resistance (AMR), and soil health decline and global repercussions of food insecurity emerging as the highest risks in terms of likelihood and impacts. Importantly, the database maps both domestic and international nature-related risks to the economy – many of which are not currently captured in national risk assessments.
Another innovation was the development of sector-specific nature-related value at risk (nVaR) scores, which aim to capture the likelihood that an ecosystem service will be materially disrupted in a given year, the severity of the impact, and its potential scale on firms and the overall sector.
The team looked at what each sector depends on and its nVaR, which hasn’t been done before, according to Avery. This is also a significant departure from the standard dependencies analysis used by most central banks.
As she explained, there are many differences between a dependencies analysis and nVaR – such as key ecosystem services. For example, in the dependencies analysis the ecosystem services to which the financial data analysed was exposed to were surface water, flood and storm protection, and mass stabilisation, according to the report.
Yet, using the nVaR analysis, the research found that the key ecosystem services at risk were water, nature’s ability to regulate climate and mediation of sensory impacts – such as the mental and physical health benefits from interacting with nature.
“The nVaR [analysis] will help to move the conversation forward for central banks,” Avery said.
While agriculture is the sector most at risk in percentage terms, the analysis shows that the largest risks in monetary terms are to the services and manufacturing sectors, because of their inputs.
The challenge, however, is the underlying data – which is hard to access due to the absence of granular supply chain data in most cases, she explained.
Scenario-building was the second piece of the study, underpinned by the UK-NRRI and sectoral nVaR analysis. The research team produced a set of three nature-related risk benchmark scenarios co-developed with financial institutions, and estimated their impact on GDP as well as on UK banks’ domestic loan portfolios.
The scenarios explored different ways in which these risks could occur over time. They combined chronic risks that are ongoing risks – such as soil health decline and biodiversity loss – with acute ones or “shocks”, which are event-driven, such as a wildfire or disease outbreak.
As such, the report predicted that chronic nature-related risks would result in a 1.5% to 3% slowdown in economic growth – representing £35 billion (US$44 billion) to £70 billion – compared to what it would have otherwise been by the late 2020s. When acute risks starting in 2030 were added to chronic risks, the loss increased to 6% for the domestic and international scenarios, and 12% for the health (AMR pandemic) scenario – equivalent to wiping out £140 billion to £300 billion of GDP.
Additionally, two scenarios were applied to the portfolios of the seven largest UK banks as a preliminary stress test. Under the domestic and international scenario, the value of some UK bank portfolios (excluding finance and services) could fall by up to 5%. All seven of the banks experienced significant declines in value of more than 1-2%.
According to Avery, these scenarios were validated by the scientific and financial communities as “extreme but plausible”. Again, accessing the data needed for the scenarios proved to be challenging for the researchers.
“We looked at Pillar 3 reporting and public data, and could only get to domestic holdings,” she said. “However, there is quite a hit to the value of portfolios even within domestic holdings.”
International collaboration
As evidenced by the report, around half of UK nature-related risks come from overseas through supply chains and financial exposures, pointing to the importance of working internationally to close the gaps in disclosures and risk management.
Analyses of UK financial exposures suggested that 56% of the total upstream financial exposures had a “high” or “very high” dependence on ecosystem services, while exposures to overseas risks were most material for the services and manufacturing sectors – especially in relation to water.
“Getting UK-headquartered companies engaged on nature-related risks is important,” said Avery. “But we also need international dialogue to ensure we’re living up to commitments made through the Kunming-Montreal Global Biodiversity Framework to support developing economies, for example, in their transition.”
Other governments can take the GFI methodology and apply it within their own jurisdictions, she explained. This could play an important role as countries update their National Biodiversity Strategies and Action Plans (NBSAPs) ahead of 16th UN Biodiversity Conference of the Parties in Colombia at the end of the year.
“Looking at the impact on GDP for each country would be useful [for revised NBSAPs],” Avery argued. “Additionally, central banks should move away from dependency analysis to material risk analysis, and start to embed nature-related risks in their overall climate scenarios.”
She advised commercial banks to also take action, such as incorporating the Taskforce on Nature-related Financial Disclosures framework and disclosing nature-related risks. This, she thinks, would put pressure on the companies they lend to or invest in to follow suit, further helping to solve the data gap.
However, some companies are reluctant to reveal sustainability data due to concerns around shareholders’ reaction as they start to transition.
“There is a tension in the market,” Avery observed. “On the one side, the financial sector wants companies to report. But on the other, there’s a nervousness that investors will disinvest if companies start to disclose where they are.”
The GFI report also recommended that financial sector players work more closely with companies to help them understand the benefits of reporting, such as access to cheaper capital.
“We need transition plans for each sector – collectively, that needs to be sped up,” Avery insisted.
She believes governments should prioritise specific areas that businesses should focus on. She cited the GFI’s 2023 Financing a Farming Transition report, which included a set of priority environmental outcomes metrics as part of its recommendations.
“We engaged with 70 stakeholders across the farming sector who said they wanted the government to identify their highest priorities, whether that is improving soil health, biodiversity or water quality,” Avery explained. “Then the private sector can determine what needs to be done to help land managers, and the farming sector can mobilise its resources to address these areas. Everyone’s a bit lost on what the priorities are at the moment.”
Importantly, by listing priorities, governments would also provide guidance to investors as to where capital is most needed in the short term.
The post Nature Value at Risk appeared first on ESG Investor.