Guest article from Grant Rudgley, Senior Manager in Centre for Sustainable Finance at CISL
For over two years, CISL's Centre for Sustainable Finance has collaborated with members of the Banking Environment Initiative and Investment Leaders Group to understand, identify and assess nature-related financial risks. Published last week, the latest work developed use cases that quantify financial risk stemming from specific nature loss scenarios. These insights informed a new report, Integrating Nature: The case for action on nature-related financial risks, which showed that:
- Financial firms can already measure nature-related financial risks with existing tools and data.
- Nature loss creates material financial risks, leading to valuation declines approaching 50 per cent and multiple-notch credit rating downgrades.
- Risks quantified are the tip of the iceberg; wider risks to tax revenues, supply chains, social cohesion and financial markets will greatly amplify the negative consequences of nature loss.
Use Case Insights
Each of the use cases is framed within a particular geography, risk type and sector and demonstrates the financial materiality of nature loss, underscoring that action is needed now.
How soil degradation amplified financial vulnerability conducted in collaboration with Robeco quantifies the financial risk of land degradation to the agricultural value chain, quantifying valuation impact. Following extreme weather events, Brazilian farmers operating largely on degrading land could see their valuation decline by 13%, while those on healthy soils could see their value increase by 6%. The analysis showcases the financial materiality of land degradation, highlighting the need for investors to incorporate factors like soil health into investment decisions and to actively engage with companies in the agribusiness sector to guide them to tackle nature-related risks in their business strategies.
Land degradation, UK farmers and indicative financial risk conducted in collaboration with NatWest Group quantifies to what extent UK farmer profits were at risk if producing crops on degraded land. Following an extreme weather event, financial losses for farmers begin once crop yield declines reach and exceed 27 per cent for two consecutive years.
Impact of water curtailment on the credit rating of heavy industry conducted in collaboration with HSBC analyses the impact of a stress scenario in which access to water is curtailed for select heavy industry companies in East Asia. Following a scenario of how areas of very high water stress may need to curtail commercial access to protect residential supply, the use case found that most of the companies in the sample are subject to a downgrade of internal rating of at least one notch, with cases of extremely severe downgrades also occurring. These conclusions emphasise the need for lenders to engage with at risk clients portfolio companies and other stakeholders about how to mitigate and adapt to the risks posed by water stress.
The EU Farm to Fork Strategy and Fertiliser Companies conducted in collaboration with Deutsche Bank and Union Bancaire Privée (UBP) quantifies the impact on fertiliser company valuations of EU policy that supports the much needed transition to a sustainable and resilient food system. The use case found that polices reducing fertiliser usage could lead to valuation declines of between 12 and 46 per cent for two major fertiliser producers. If extrapolated to listed fertilisers globally, equity value across the sector could decline by USD 25–67 billion.
Mapping exposure to nature-related risks across financial indices conducted in collaboration with Aon uses the ENCORE tool and its measurement of the materiality of sub-sector dependence on different ecosystem services to map nature-related risks across financial indices. The use case found that of all the services provided by nature, water is the most important across the MSCI World Index. The scoring system developed provided a starting point for further analysis into what sectors and ecosystem services were driving the risk exposure, as well as identifying where in portfolios those exposures exist.
Call for action
By identifying and assessing nature-related financial risks, nature can be integrated into financial decision making, recognising nature as the heart of the economy and remaking the relationship between people and the planet. Now is the time for the financial sector to lead; integrating nature into decision making, managing nature-related risks and catalysing capital reallocation that protects and restores nature.