Nature Based Risk: Corporate transition and compliance

‍Nature Based Risk: Corporate transition and compliance

According to the World Economic Forum, more than half of the world’s economic output - comprising USD 44 Trillion - is “moderately” or “highly” affected by nature. Nature based risks include biodiversity loss and ecological degradation, two issues which form the basis of environmental risk more broadly. In recent years nature-based risks have begun to emerge as the new frontier of Environment, Social and Governance risks. To bring the scale of this issue into perspective, Dutch Financial Institutions alone represent EUR 510 billion of nature risk exposure, comprising 55% of the country’s total GDP. As a result of a renewed focus on corporate interactions with nature, the Taskforce on Nature-Related Financial Disclosure (TNFD) was launched in June 2021. An organization funded by governments, the United Nations and private philanthropists, the TNFD was set up with the purpose of aiding organizations in the measuring and public reporting of nature-based risk.

So what is nature based risk, and how does it differ from environmental risk in the broader sense?

Much like environmental risk, nature based risk can be categorized into several key areas of concern, including physical, transitive, compliance and financial.

Physical risks

A recent study conducted by The Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES) shows that on a global scale ecosystems have declined in both size and condition by 47% compared to their estimated baseline. The abundance of native species in most land-based habitats has seen a dramatic decline of 20% since 1990. These ecological changes have had a direct effect on nature-dependent corporate activity - the agriculture industry alone places a financial annual value on pollinators at between USD 235 billion and USD 577 billion. Other physical factors which contribute to ecological degradation include poor land management, the unsustainable use of natural resources, deforestation, chemical mixing, the removal of native species and the deliberate or unintentional introduction of invasive species into native environments.

Transition risk

Transition risk occurs due to changing policies, practices and technologies as businesses work towards decreasing their carbon output. Nature-based transition risks can include policy changes regarding the use of land and water, and other changing practices associated with adherence to global and local environmental reporting requirements. Transitive risk is further complicated by the fact that many policies related to climate change are still in a state of flux as new regulations and requirements are introduced at local, national and global levels. Organizations which are unprepared to adapt to changing regulations often leave themselves open to legal liability: some may even rush to fulfill requirements, with the resultant lack of preparedness leading to both corporate financial loss and a failure to meet the required legal standards.

Technological factors represent another transition risk. The past few years have seen a rapid growth in the use of technological solutions to mitigate nature risk, including the use of digital data platforms, geo-spatial intelligence, earth observation, e-DNA, AI, and Digital Ledger Technologies. A failure to effectively implement the relevant technology at each applicable level of operation can cause companies to not only fall behind on their corporate social responsibility goals but also means that they often lack the tools necessary to effectively report and comply with environmental requirements laid out by authorities, investors, and the general public. To effectively mitigate transition risk, corporations need to apply an approach which combines both holistic and technological solutions to ensure effective nature-based adaptation.  

Compliance Risk

Increasing calls to increase biodiversity have also led to both internal and external corporate scrutiny. Companies have been forced to become more mindful not only of their own internal value system but of how their compliance and liability affects external and client facing operations. Recent cases of corporations misrepresenting their nature positive credentials has only further emphasized the need for objective and transparent reporting.

In our increasingly interconnected world, consideration of nature-based risk cannot stop at the internal corporate level. Shareholders may be interested in biodiversity commitments, businesses may require greater transparency at every level of the supply chain, and potential investors often want assurance that a corporation has the capacity and preparedness to adapt to incoming legislation by adjusting business plans accordingly.

The onset of the EU Taxonomy - the regulatory classification system which helps companies to define which of their commercial activities can be considered environmentally sustainable - will prove critical as a compliance risk. Part of the European Green Deal, the Taxonomy and associated regulations are wide in scope and ambition, requiring European listed and large public-interest companies with more than 500 employees and that have either a balance sheet total exceeding 20 million euros or a net turnover of more than 40 million euros, to submit detailed annual reports attesting to their green credentials. For an economic activity to qualify as “green” in accordance with the EU Taxonomy, it has to have a substantial contribution to one of the six environmental objectives and do no significant harm to the remaining five. The environmental objectives are:

1. Climate Change Mitigation
2. Climate Change Adaption
3. The sustainable use and protection of water and marine resources
4. The transition to a circular economy
5. Pollution prevention and control
6. The protection and restoration of biodiversity and ecosystems

To ensure a smooth and successful transition process, companies must ensure they are financially and technologically equipped to adapt.

Financial Risk

Nature risk and biodiversity loss both pose a serious threat to financial institutions, particularly in countries that are heavily dependent on natural resources. Recent research that sought to quantify the monetary value of land based ecosystems showed that they are currently being lost at the rate of USD 50 billion every year. The sheer scale of this loss emphasizes the alarming need for a deeper understanding of nature-based risk.

The question then, is how can companies effectively adapt to these changing global circumstances – not only in terms of nature-based risk, but in terms of growing demands for reporting and proven compliance?

Nature based risk is likely to remain high on the global legislative agenda for years to come as we battle to decrease climate change and reduce corporate carbon emissions. However, companies should acknowledge that with risk comes opportunity. By using the right set of tools (including the prudent use of new technologies) and a holistic approach to corporate social responsibility, companies can ensure they move towards a nature friendly and eco-centric business model while retaining profit and ensuring legislative compliance and adaptability.