While 2020 will go down in history as net negative, it had at least one major positive: it was the moment environmental, social and corporate governance (ESG) financing finally went mainstream — when social inequalities were put under the spotlight by the pandemic and the movement for racial justice ignited following the death of George Floyd. The climate crisis continued to escalate, and demand for responsible investment rose sharply, as investors woke up to the potential for ESG factors to affect the valuation and financial performance of the companies they invest in. Sustainability has become the new aspiration. Now, robust measurement and disclosure are fundamental to achieving it.
Investors plunged nearly four times the amount of money into ESG funds in 2020 as they did in 2019, according to the Investment Association. New research released earlier this month by the Global Sustainable Investment Alliance finds that sustainable investments make up 36% of all assets in five of the world's biggest markets. The challenge now is to ensure the myriad ESG funds actually deliver on the sustainable investments their labels promise. With the rapid growth of sustainable finance offerings, we have seen a widening range of criteria used to define what is sustainable or ESG-aligned. Improved standardisation is critical to enabling informed decision-making by financial market players. This requires urgent advancements across nature-related disclosures in particular.
Focusing on the wrong areas
As executives and board members across corporations have witnessed rising investor demand for sustainable products, they have increasingly looked to comply with ESG principles — and provide the disclosures to prove it. But when doing so, corporates and financial institutions have tended to focus more on the ‘G’, while deprioritising the ‘E’ and the ‘S’. This skewed focus on governance disclosure does not imply that business and finance sector players fail to see environmental and social factors as meaningful for financial performance; instead, environmental and social issues are notoriously much more difficult to measure than governance factors, such as executive pay, board independence and disclosure practices.
My experience as the chief executive of Refinitiv, a global provider of financial data and infrastructure, is that corporates lack clear guidance when it comes to environmental data in particular. This aligns with a recent study by S&P Global that identified that businesses found the ‘E’ in ESG to be the most difficult to assess and incorporate into credit risk analysis. Various studies suggest the considerable differences in environmental disclosure practices, driven by a lack of reporting standards, are the main obstacles to the widespread use of environmental data. Standardisation is essential to enable comparability on a given metric across organisations, which is critical for the data to be integrated systematically in financial decision-making.
When done right, the ‘E’ should take into account the financial risks associated with a company’s dependence on natural resources, as well as the effect of its operations on the environment, both in its direct operations and across its supply chains. Both represent tangible short- and long-term financial risks and opportunities for investors.
Understanding the situation
Over the past few years, investor and corporate awareness of environmental issues has grown rapidly, but the improved understanding has largely been confined to climate change, where the market has been increasingly able to provide meaningful metrics to demonstrate a company’s exposure to risks.
The Task Force on Climate-related Financial Disclosures (TCFD), set up by the Financial Stability Board, has been instrumental in advancing corporate data on climate-related risks. To date, more than 1400 companies have voluntarily signed up to the TCFD’s recommended reporting framework. G7 finance ministers announced in June that they support moving towards mandatory climate-related financial disclosures in line with the TCFD’s recommendations.
However, climate change represents just one part of the environmental equation. We are currently undergoing a sixth mass extinction: the rapid loss of biodiversity and ecosystems is possibly the most serious environmental problem of our time. The loss of a species is permanent, each of them playing a greater or lesser role in the living systems on which our societies, economies and financial systems depend.
Natural capital loss is not currently on the ESG radar in the way that it should be. This is problematic because, according to the World Economic Forum, more than half of the world’s output — $44tn of economic value generation — is moderately or highly dependent on nature. The recorded extinction of 83% of wild mammals and 50% of plants, therefore, represents a significant risk to corporate and financial stability.
Moreover, restoring and protecting nature is one of the greatest strategies for tackling climate change risks, and not just for the obvious reason that the soil, forests and oceans suck carbon out of the air. These ecosystems also act as buffers against extreme weather, protecting houses, crops, water supplies and vital infrastructure, making our economies, societies and financial system more resilient.
Until now, investors have had limited visibility — and even less influence — on the extent to which their capital drives nature-negative outcomes. The recently launched Taskforce on Nature-related Financial Disclosures (TNFD) will look to close this information gap. Its purpose is to develop voluntary, consistent disclosures to help investors, lenders and insurance underwriters report and act on nature-related risks. Without incorporating nature-related risks in our financial valuations and risk assessments, they are simply wrong, and we will take the wrong investment decisions on the back of them.
Doing things properly
While the TNFD aims to learn from and build upon the success of the TCFD, the new taskforce faces unique challenges: when it comes to data, metrics and methodologies, there are critical differences between climate and nature.
One key challenge is that, unlike for climate, it is not just what your activities are, but where they are, that matters. This means that collecting more location-specific data from corporations will be part of the solution.
Improving corporate disclosures will also only be one of many levers to close the data gap on nature-related financial risks. In the climate space, better corporate disclosures were at the centre of the solution to the data challenge. Satellite data and other geospatial data may also play a significant role in closing data gaps on nature-related risks. Advancing technology combined with the data processing power of artificial intelligence means we can collect and make sense of vast amounts of geospatial data, including nature-related data. The rapidly growing field of spatial finance integrates geospatial data and analytics into financial practice. On the risk side, this means financial institutions can, for example, remotely monitor economic activity in and around protected areas. On the opportunity side, they can use it to identify and monitor investment opportunities in nature restoration.
As the TNFD now kicks off its work to plan, test and deliver a framework for organisations to report and act on evolving nature-related risks by 2023, the challenge is to learn from what has worked for climate, while carefully considering how nature requires a different approach.
Ultimately, the TCFD and TNFD will complement each other and work in tandem. As the old adage in business goes: what gets measured gets managed, and we have to manage nature- and climate-related financial risks simultaneously. The two are strongly interlinked, and both are equally urgent.
But while we work to close the data and valuation gap for nature, we must remember that the challenge ahead is bigger than that: extensive capacity building across corporates and financial institutions is equally urgently needed if we are to mobilise the full force of financial institutions and corporates towards nature-positive outcomes. In addition, corporates and financial markets are moving towards adopting a price for carbon and carbon-equivalent emissions; now, they also need to put a price on nature — to date there is no such price.
Delivering on the ambition of shifting financial flows globally from nature-negative to nature-positive will require significant and complex work, but I am optimistic that the TNFD can deliver a practical and impactful framework by 2023 and be at the centre of strengthening the ‘E’ in ESG across the world’s financial markets.
David Craig is founder and former chief executive of Refinitiv, a senior advisor to London Stock Exchange Group and the co-chair of the Taskforce for Nature-related Financial Disclosures.
This article first appeared in the August/September print edition of fDi Intelligence. View a digital edition of the magazine here.