Why ‘nature’ matters for financial stability

Why is there an Urgency in Addressing Nature-Related Risks?

Various planetary boundaries related to nature continue to be transgressed. This includes ‘novel entities’, including the introduction and accumulation of all new chemical compounds created by humans, such as microplastics, pesticides, and nuclear waste. The ‘biosphere integrity’ boundary reflects the impaired functioning of ecosystems, which was transgressed back in the late 19th century when global agriculture and forestry saw their first major expansions. These degradations pose significant risks to both the environment and the economy, through water shortages, crop losses, and wildfires becoming more frequent and severe.  More than half of the world’s economic output, approximately US$44 trillion, is moderately or highly dependent on nature (TNFD). However, the TNFD also estimates that promoting nature-positive transitions could generate up to US$10.1 trillion in annual business value and create 395 million jobs by 2030.

Growing Concern by Regulatory Bodies

Regulators globally are increasingly focused on nature-related risks and opportunities. They have recognised the need for standardized reporting frameworks that capture the environmental impact of financial activities. By implementing these frameworks, regulators aim to enhance transparency, improve risk management, and facilitate the transition to a more sustainable financial system.

The European Union is Leading the Way

The European Union (EU) has been leading the charge with efforts to address nature-related risks in the financial sector. The EU Sustainable Finance Action Plan, launched in 2018, integrates sustainability considerations into all aspects of the financial system. Included in this plan, the EU has proposed the development of a taxonomy for sustainable activities, including criteria for nature-related activities.

The EU’s taxonomy regulation requires financial institutions to disclose the proportion of their investments aligned with the taxonomy criteria via the Sustainable Finance Disclsoure Regulation (SFDR). This disclosure is intended to provide investors with clear information on the environmental impact of their investments and enable them to make more informed decisions.

Furthermore, the EU has also proposed the introduction of mandatory climate and environmental-related reporting for financial institutions. This reporting requirement, Corporate Sustainability Reporting Directive (CSRD), would oblige financial institutions to disclose information on their exposure to climate and environmental risks, as well as their strategy for managing these risks.

The TNFD Framework Offers a Comprehensive Approach

Recognizing the need for greater transparency and accountability in assessing nature-related risks is the Task Force on Nature Related Financial Disclosures (TNFD). Similar to the Task Force on Climate-related Financial Disclosures (TCFD), the TNFD provides a structured approach for financial institutions to help them report and act on these evolving nature-related risks.

Reporting and Acting on Nature-Related Risks

The TNFD framework encourages financial institutions to report on their nature-related risks and take concrete actions to address them. This includes assessing the impact of their operations on nature, identifying emerging risks, and implementing measures to mitigate these risks. Financial institutions are also encouraged to support nature-positive transitions by investing in sustainable projects and businesses that promote biodiversity conservation and ecosystem restoration.

Integration with Climate-Related Risks

The TNFD framework complements the TCFD framework, providing financial institutions with a holistic view of their environmental risks. By integrating both climate-related and nature-related risks into their risk management processes, financial institutions can gain a comprehensive understanding of their overall exposure to environmental risks.

This integration allows for more accurate risk assessments and better-informed investment decisions. It also helps financial institutions align their strategies with global sustainability goals, such as the Paris Agreement, the Convention on Biological Diversity, and the Sustainable Development Goals (SDGs).

What are the Benefits of Nature-Related Financial Disclosures?

Getting it right, and embracing nature-related financial disclosures presents financial institutions with a range of opportunities.

Enhanced Risk Management

Nature-related financial disclosures enable financial institutions to identify and manage nature-related risks more effectively. By understanding their exposure to these risks, financial institutions can develop appropriate risk mitigation strategies and protect their long-term financial stability.

Improved Decision-Making

Nature-related financial disclosures provide financial institutions with valuable information for making informed investment decisions. By considering nature-related risks and opportunities, financial institutions can allocate capital to projects and businesses aligned with sustainable development objectives. This not only benefits the environment but can also contribute to long-term value creation for investors.

Stakeholder Engagement

By disclosing their nature-related risks and actions, financial institutions can engage with stakeholders, including investors, regulators, and the wider public. This transparency builds trust and credibility, demonstrating the institution’s commitment to responsible and sustainable practices. It also allows stakeholders to hold financial institutions accountable for their environmental impact and contribute to the transition to a nature-positive economy.

Access to New Markets and Customers

The growing demand for sustainable finance presents financial institutions with opportunities to access new markets and attract environmentally conscious customers. By offering innovative financial products and services that align with nature-positive outcomes, financial institutions can differentiate themselves from their competitors and tap into the growing market for sustainable investments. This can lead to increased revenues, customer loyalty, and market share.

Long-Term Value Creation

Investing in nature-positive activities can create long-term value for financial institutions. By supporting projects that promote biodiversity conservation, sustainable agriculture, and renewable energy, financial institutions can contribute to the preservation of natural resources and the transition to a more sustainable economy. These investments not only generate financial returns but also have positive environmental and social impacts, which align with the values and expectations of stakeholders.

Fostering Innovation and Collaboration

Engaging in TNFD reporting can stimulate innovation and collaboration within the financial sector. By working together with other financial institutions, regulators, and stakeholders, financial institutions can exchange best practices, share knowledge, and develop innovative solutions to address nature-related risks. This collaborative approach can drive the development of new financial products, technologies, and business models that support sustainable development and contribute to the achievement of global environmental goals.

The Need for Urgent Action

The growing importance of nature for financial stability requires urgent action from financial institutions, if not voluntarily, increasingly to comply with regulation. By proactively building on climate-related disclosure to manage and report on nature-related dependencies and opportunities, financial institutions can mitigate financial risks and contribute to the transition to a sustainable economy.

Regulatory requirements are evolving, and financial institutions must stay ahead of the curve by proactively disclosing their exposure to nature-related risks. By doing so, they not only protect their own long-term financial stability but also contribute to the overall stability of the financial system.