Flora, fauna and finance: natural capital in the spotlight

This article looks at why it is important to get ahead of the curve and help channel capital towards nature-positive solutions.

The spotlight on natural capital has gained momentum in global discussions on sustainability and finance and will continue to do so in the lead up to COP16 in Colombia.

An increasing awareness of the interconnectedness of environmental issues – and specifically climate change and biodiversity – has encouraged governments, businesses and financial institutions to incorporate nature-related considerations into their policies and strategies.

While sustainability issues have risen rapidly up the agenda for financial institutions, the role of natural capital and how it can be incorporated into financial markets has been less clear. However, this is a fast-moving landscape, and financial institutions are rapidly recognising the role that natural capital can play in tackling the climate emergency.

In this article, we ask market participants to explain the concept of natural capital and the key drivers behind it becoming a core tenet of sustainable finance.

What is natural capital?

Caroline Bush, Associate Director, Osborne Clarke:

“Natural capital is ‘the world’s stocks of natural assets which include geology, soil, air, water and all living things'1. It is relied on for a wide range of services – often referred to as ecosystem services – which includes things like food, water and plant materials used for fuel, building materials and medicines as well as the climate regulation and natural flood defences provided by forests, the billions of tonnes of carbon stored by peatlands or the pollination of crops by insects.”

Sumati Semavoine-Jain, Sustainability Research, BNP Paribas:

“There has been a change in the way biodiversity is perceived and tracked which has also helped elevate the topic and highlight its interlinkages with climate. Developments in this area include a shift from a species count perspective (which can be slow to track) to also focusing on the wider function of ecosystems (which can be modelled and impacted much faster). Emerging frameworks such as planetary boundaries, SDGs and ecosystem services have helped frame the issue at hand by highlighting the critical importance of understanding the interconnectedness of nature and climate. This has brought a number of new areas into focus including: land use, freshwater use, chemical use, among others.”

Why is natural capital important for financial markets?

Marco DeBenedictis, Head of Structuring & Sustainable Lending, Barclays Investment Bank:

“Recognising the role of natural capital in financial markets is essential. It serves as a cornerstone for sustainable investment strategies focusing on resources such as minerals, biodiversity, water and land. Natural capital is essential for economic activity and a responsible focus offers resilience, long term value and opportunities for prudent risk management.”

Sumati Semavoine-Jain:

“Under-pricing of natural capital has caused unsustainable depletion of natural resources. But progress to measure and correct externalities is under way.

Policy is one of the three catalysts we see that is accelerating this progress. The other two drivers are transparency (better data and tools uncover the large dependencies and pressures that corporates have on nature) and innovation (commercial opportunities arising in the space). Taking each of these in turn:

  • Policy: Greater regulatory and policy focus is pushing corporates and investors to assess their impact on nature and shift from a purely “extractive” perception of nature, to that of “regeneration” that values all the co-benefits healthy ecosystems provide. This shift will highlight the large dependencies that most businesses have on nature and the risk that these pose for the financial system.
  • Transparency: As companies provide supply chain data across a wider set of variables, we expect a greater number of sectors to come under the radar, such as textile and cosmetics, overlooked until now regarding their impact on nature in their supply chains.
  • Innovation: A number of companies have taken advantage of opportunities in the space of natural resource preservation. We see room for continued innovation and growth in a number of those enabling activities, acting as a bottom-up driver for the theme.”

To what extent do investors take natural capital into account?

Caroline Bush:

“Investors have for some time now used ESG criteria to screen potential investments. These non-financial factors form part of the investment analysis, which will look to identify material risks and growth opportunities. Natural capital is of course one part of the "E" of ESG, which looks at how a company performs as a steward of nature. The criteria can also be used in evaluating environmental risks a company might face and how the company is managing those risks.

Examples include the extent to which a business's operations might be impacted by continued biodiversity loss, such as a clothing manufacturer or retailer's ability to source cotton or a food business's access to raw materials. Increased regulation in this area might also force businesses to change the way they operate, for example if they rely heavily on commodities which are linked to deforestation.”

Esohe Denise Odaro, Head of ESG & Sustainability, PAI Partners:

“The global investment industry has begun to acknowledge nature-related risks alongside a growing awareness of the urgent need to preserve and replenish biodiversity for a sustainable future. The loss of biodiversity and its impact on businesses are now important considerations with wide-ranging effects on society and the global economy. With Food & Consumer as one of our core sectors, we recognise the global importance of biodiversity and PAI’s responsibility to address its impacts and dependencies. For this reason, in January 2023, we identified Biodiversity as one of the three key pillars underpinning our sustainability strategy at PAI. This year, we have expanded this to Nature & Biodiversity to reflect the inclusion of other nature-related topics, particularly water stewardship – an increasingly vital global risk.

We are a member of the TNFD Forum, a network in support of the Taskforce on Nature-related Financial Disclosures (TNFD), and are an early adopter of the TNFD. Our early adoption of the TNFD signals our intention to start making public disclosures aligned with the TNFD Recommendations in 2025. Through the TNFD Forum, we work to help improve reporting on nature at both investor and portfolio company level, and through our membership of FAIRR, a food-focused sustainability network of 370+ investors ($70tn AUM), we use comprehensive Food & Consumer ESG research and insights to inform portfolio company strategies.

In October 2023, PAI unveiled BLOOM, a practical action guide that lays out five key steps designed to aid private market participants to reduce negative impacts on biodiversity and safeguard related returns. The guide supports the integration of biodiversity risk and dependency considerations both within and beyond a firm’s portfolio.”

Sumati Semavoine-Jain:

“Unlike carbon emissions, biodiversity doesn’t have one all-encompassing variable. Hence, finding companies with nature-positive processes requires a tailored approach.

At BNP Paribas Markets 360, we differentiate between ‘leaders’ and ‘enablers’: enablers are providers of solutions; while leaders are early adopters of change. We generally focus on supply chains for leaders and revenue drivers for enablers.

To identify ‘leaders’, it is key to assess how companies interact with natural resources throughout the value chain: ie. how corporates source, manage, monitor and recycle them. This requires a multi-dimensional and full supply chain approach. By gaining exposure to nature-related ‘enablers’, we tap into growth areas and diversify sector exposures. We have noticed a good level of collaboration (e.g. M&A, partnerships) happening between ‘leaders’ and ‘enablers’.

We expect nature-related KPIs to be integrated within existing environmental screenings, which are currently climate-centric, over time, rather than natural capital being a standalone theme. If anything, nature is broader than climate, with GHG emissions one of the many supply chain indicators to track.

A good example is anti-deforestation policies being, increasingly, one of the core variables that investors assess companies on, alongside climate targets. We also expect progress on other biomes over time, beyond forests.

Beyond biodiversity, other key topics will make it onto policymaker and investor agendas in 2024 - 2025, such as plastics and oceans. Both will see greater global coordination (discussions on common goals) and benefit from further innovation and research. Both put emphasis on the need to move towards more circular business models.”

How does natural capital fit within corporate transition planning?

Caroline Bush:

“Natural capital has a significant role in the carbon offsetting market. Many carbon offset projects rely on natural capital enhancement to help mitigate carbon emissions – examples include afforestation or peatland restoration. As the trend for offsetting environmental impacts continues and markets for purchasing offsetting credits develop, it is likely that the value of natural capital and the associated ecosystem services it offers will be increasingly recognised.”

What are the recent key developments around natural capital?

Caroline Bush:

“Firstly, as of 12 February 2024, the biodiversity net gain regime or BNG is now mandatory in England, meaning that most developments which require planning permission will need to show a 10% increase in the biodiversity value of the site post-development against a pre-development baseline. Should a 10% increase not be achievable on-site, developers will need to off-set the impact elsewhere, either on other landholdings or through purchasing biodiversity units from a third party. There are only limited exceptions to this requirement.

Secondly, in September 2023, the TNFD launched its recommendations and guidance. These voluntary disclosures aim to help companies to account for nature in their decision making, and in the longer term to drive a shift in global financial flows towards more nature-positive outcomes. If a similar pathway is taken as for the Taskforce on Climate-related Financial Disclosures, then we may see the TNFD integrated into mandatory disclosure regimes going forward and, in any event, it is likely the TNFD’s recommendations will better enable market participants to channel capital towards nature-positive investments.

A further driver in this area is the Science-based Targets Network (SBTN). While many companies may be familiar with the Science-based Targets Initiative (SBTi), which focuses on carbon reduction by requiring organisations to set a net zero target, the SBTN aims to enable targets to be set which account for impacts on both climate and nature. This may become the measure of choice for companies who are keen to show a holistic approach.

Finally, we are seeing the introduction of enhanced supply chain due diligence requirements both at a UK and an EU level. In the EU legislation is either in place, for example the Corporate Sustainability Reporting Directive, or set to take effect imminently, such as the Deforestation Legislation. The UK is following closely behind. Together these requirements, once in place, will require a broad spectrum of companies to consider every step of their value chain and to account for and mitigate the impacts of their activities on sustainability factors.”

Sumati Semavoine-Jain:

“The way forward is bottom-up data rather than a top-down approach, and TNFD will help. With more advanced data coming from corporate reporting, with full traceability of supply chain and aggregation of location-specific data, we will see increasingly advanced methodologies for judging nature positivity.

TNFD will help build out the data infrastructure, supported by the greater adoption of emerging tools by corporates: from geospatial to eDNA to help them fulfil their reporting commitments bottom-up.

It will help investors to become more sophisticated in their approach. Firstly, thanks to more detailed materiality analysis (revenues, suppliers, locations) conducted by the company, it will be easier to identify what the priority themes and KPIs to track should be. Secondly, it will be easier to put company targets into context and assess the actions companies are taking to reduce their negative impact. On target setting, SBTN will start validating freshwater and land targets after the pilot is done. TNFD and SBTN will help navigate the complexity of identifying priority areas and the factors that are impacting nature most from corporate activities.”

Looking ahead

Sumati Semavoine-Jain:

“Natural capital is quickly becoming an essential consideration for the creation of government policy, reporting practices, and investment strategy. With the Global Biodiversity Framework defining the ambition in 2022, we expect efforts this year to centre on how to track, enforce and finance these common goals. In particular, we expect progress on how to value ecosystem services and aggregate that data as bellwethers for the space ahead.”

Hannah Vanstone, Sustainable Finance Regulation Lead, LMA:

“Acknowledging the importance of natural capital is crucial for addressing climate change, preserving biodiversity, and ensuring the sustainability of our planet. While it may not yet be as high up the corporate agenda as carbon emissions, it cannot, and should not, be ignored. Understanding of the importance of natural capital and the interrelationship between the ecological and climate crises is increasingly being recognised.

Regulatory and voluntary, market-led initiatives are rapidly developing, forcing market participants to consider and account for the impact of their activities on nature. While some of this will not impact directly on investors and lenders, it may lead to additional costs and potentially new due diligence and risk considerations when capital is deployed. Market participants should therefore pay close attention to these developments and keep processes under review to ensure they are adequate.

Being an early adopter may unlock key opportunities, and I therefore encourage market participants to engage with natural capital – to seek to get ahead of the curve and to help channel capital towards nature-positive solutions.”

1. As defined in the Convention on Biological Diversity, the first global agreement to cover all aspects of biological diversity signed by 150 government leaders at the 1992 Rio Earth Summit.