October 25 - Biodiversity and nature are as critical as climate change for determining humanity’s long-term prospects, but until now they have played a relatively minor role in sustainable investing. That’s changing. Biodiversity and nature-themed funds are mushrooming, with assets under management in European funds targeting biodiversity quadrupling in the 12 months to September, according to data from the European Securities and Markets Authority, though admittedly these funds still represent a tiny fraction of the market.

Having barely featured on the environmental, social and governance (ESG) agenda a few years ago, pledges to become “nature positive” – a fluid term describing activities that restore and regenerate natural resources and ecosystems rather than degrading them – are now featuring alongside companies’ and investors’ net-zero climate targets. Demand for investment solutions and products to facilitate allocation capital to nature themes continues to grow (for clarity, nature refers to the whole natural world, while biodiversity refers to the living components of nature, although in practice the terms are often used interchangeably).

Last year’s United Nations biodiversity summit (COP15) in Montreal was a key inflection point. More than 190 countries committed to restore and conserve 30% of ecosystems by 2030, and to scale up biodiversity-related financing from public- and private-sector sources. Investor groups – such as Finance for Biodiversity, whose 153 members have over $21 trillion in assets under management – are advocates, and increasingly nature considerations are being integrated into financial institutions’ investment policies and engagement strategies. But this remains a long way behind climate factors. Policy measures, such as the European Union’s deforestation regulation and the UK’s biodiversity net gain (BNG) requirements for the real estate sector, are reinforcing market attention on these issues.

What does all this mean in practical terms for the investment community? For investors and financial advisors familiar with ESG, the avenues available for engaging with biodiversity are broadly similar to other sustainability issues. Screening of companies with known negative impacts on nature in their operations or supply chains (certain agribusiness companies, for example), or those with no stated plan to improve their impacts, is one way to manage the nature footprint of a given portfolio.

Thematic and impact investing offers more proactive options to support the transition to a nature-positive economy. An example would be making equity investments in companies developing solutions, such as technology for precision agriculture that reduces use of harmful pesticides. Within fixed income there are increasing opportunities to channel capital to nature and biodiversity-related activities and projects. This includes investing in use of proceeds bonds, like green bonds, where the financing raised is ring-fenced for specific purposes, usually in accordance with a recognised standard such as the International Capital Market Association’s Green Bond Principles.

Having boomed in 2021, last year the total value of green and sustainability bonds issued with “terrestrial and aquatic biodiversity” listed as a use of proceeds remained steady in value terms, but rose by more than 50% in terms of number of bonds issued. This contrasts with the wider ESG debt market, which weakened over 2022. Data for the year to date indicate 2023 will be another strong year for biodiversity-related issuance and, as a theme, it continues to grow in prominence. Biodiversity conservation featured as a use of proceeds in 16% of ESG bonds this year, up from 5% in 2020, according to Environmental Finance data.

Although nature-related sustainability targets are still relatively rare, interest in biodiversity credits is rising as another way to bolster a company’s nature profile. These “bio-credits” represent units of biodiversity, which are assigned a monetary value based on the ecosystem services they provide. However, the market for them is in its very early stages. Standards are still being developed and in the interim they are likely to be dogged by many of the same challenges faced by carbon credits.

And as a goal and investment theme, nature and biodiversity pose fresh challenges: the central problem is that, unlike using carbon emissions to measure progress on climate goals, nature and biodiversity encompass a vast array of issues that cannot be boiled down to a neat metric, making it more complex to determine what “good” looks like. Impacts on nature from business activities tend to be highly localised and can be embedded far upstream in supply chains, hampering visibility and measurement.

Across different sectors and companies, nature indicators also have varying levels of relevance – water consumption, for example, can be highly material for beverage companies, but less so for tech firms. To construct coherent thematic portfolios, specialist expertise and comparable and consistent data are required to make sense of these impacts, determine the materiality and credibility of companies’ nature-related targets and plans, and to assess performance against those targets.

Both are currently lacking. Far fewer companies report their nature-related risks and impacts than make climate disclosures, and of those that do, water topics feature the most, with others such as exposure to deforestation following some way behind.

These challenges should begin to ease in the coming years. Investor surveys suggest firms plans to allocate more resources to building out their biodiversity capabilities. In addition, we expect the recently launched Taskforce for Nature-related Financial Disclosures framework to facilitate greater standardisation of nature-related reporting through its core recommended disclosures and metrics, while the Science Based Targets Network aims to strengthen the integrity and comparability of nature targets.