Navigating Nature-Based Risk Impact on Businesses

Overview of nature-based risks and climate finance

It took the world over a decade to accept and take action towards the climate-related risks for businesses. Despite the sluggish progress toward net zero, regulators have picked up the pace in formulating industry standards, defining the parameters of ESGs and publicly shaming companies for un-real sustainable practices known as “greenwashing”. Another critical yet invisible risk of climate change is related to biodiversity and ecosystem loss. 

The Living Planet Report 2022 by the World Wildlife Fund (WWF) offers an eye-opening examination of the current state of our natural world, revealing that human activities have impacted 75% of the Earth's ice-free land surface, degraded 85% of global wetlands, and pushed 1 million species (comprising 500,000 insect species and 500,000 animal and plant species) to the verge of extinction. 

Ecosystem loss can be a major threat to businesses because of the loss of resources and services. Ecosystem loss means increased competition for resources, damage to infrastructure, loss of biodiversity, and increased vulnerability to natural disasters.

Combined research by the World Economic Forum and PwC revealed that the three major sectors with high dependency on nature collectively produce nearly $8 trillion in gross value added (GVA): construction at $4 trillion, agriculture at $2.5 trillion, and food and beverages at $1.4 trillion. According to the same research, more than half of the global gross domestic product (GDP) – an estimated USD 44 trillion — is moderately or highly dependent on nature. 

Actions limited to climate risk alone are not enough to achieve our net zero goals. Nature risk, although existing alongside climate risk for centuries, is being recognized by regulators and businesses.

In 2022, the Taskforce on Nature-related Financial Disclosures (TNFD) was launched, which provides a unified framework of definitions and disclosures for businesses to report on nature-based risk. This framework is drawn from the Taskforce on Climate-related Financial Disclosures (TCFD), which was launched in 2017 setting the global standards for climate disclosures. 

In addition to making decarbonization pledges, the private sector is committing to nature-impact targets. In February 2022, BlackRock reevaluated its investment stewardship principles with the incorporation of strict nature-based goals. BlackRock will make its investment decisions by examining companies' disclosures to evaluate their risk oversight and determine how they incorporate nature-related impacts and dependencies into their strategic planning.

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Key nature-based risks of climate change

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Sea level rise and coastal flooding 

Climate change is causing sea levels to rise and coastal flooding to become more frequent and intense. The process of seal level rise can lead to a variety of hazards and impacts on low-lying coasts, such as permanent submergence of land, more frequent or intense flooding, enhanced erosion, loss and change of ecosystems, salinization of soils, ground and surface water, and impeded drainage. Coastal flooding can have direct damage to infrastructure, lives, and livelihoods. 

Extreme weather events 

Climate change is also causing an increase in the frequency and intensity of extreme weather events, such as hurricanes, floods, and droughts. These events can cause significant physical damage to businesses, as well as disruption to their operations, supply chains, and customer service. According to the forecast by the UK’s Met Office, the 2023 global average temperature is projected to be 1.08°C to 1.32°C higher than the pre-industrial average.

Loss of biodiversity and ecosystem services 

Climate change is leading to the loss of biodiversity and ecosystem services, such as pollination, water filtration, and nutrient cycling. This can lead to losses in crop yields and reduced water availability, which can have a direct impact on businesses that rely on these services. 

The WWF's Living Planet Index (LPI), a tool that measures biodiversity loss indicates an average decline of 69% in biodiversity between 1970 and 2018. The most significant biodiversity losses have occurred in tropical regions and historically species-rich areas, such as Latin America, Africa, and Asia.

Wildfires 

Climate change is causing an increase in the frequency and intensity of wildfires. Wildfires have a devastating effect on wildlife including mortality during the fires and migration before and after wildfires. These can cause significant damage to businesses, as well as disruption to their operations and supply chains. Wildfires can also lead to air quality issues and health concerns for employees.

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Climate finance solutions for nature-based risks 

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Climate finance professionals can contribute towards minimizing nature risk by providing businesses with investment solutions that reduce the risk as well as improve business practices that lead to harmful climate impact. 

Green bonds and loans

One of these solutions is the use of green bonds and loans. Green bonds are debt instruments that are used to finance projects that have a positive environmental impact. These bonds allow organizations to access capital for projects such as renewable energy, green buildings, and nature conservation. 

Similarly, green loans are used to finance projects with a positive environmental impact, such as clean energy, water conservation, and sustainable forestry. Green bonds and loans are becoming an increasingly popular way for organizations to access the capital they need to finance projects that reduce nature-based risks.

In 2021, the issuance of green, social, and sustainability-related bonds surpassed $1 trillion and accounted for 5% of the global bond market. However, due to difficult macroeconomic conditions experienced in 2022, debt volumes declined across the board. Climate finance professionals are predicting an uptick in the issuance of green and sustainability-driven bonds in 2023. 

Climate risk insurance

Another climate finance solution for nature-based risks is climate risk insurance. This type of insurance is designed to protect businesses from financial losses that arise due to extreme weather events and other climate-related disasters. By purchasing climate risk insurance, businesses can protect themselves from the financial losses associated with these events.

In 2022, natural climate disasters led to economic losses totaling $313 billion. Nearly 42% of the direct aggregated economic losses were compensated by public and private insurance organizations. The protection gap, which stood at 58%, marked the lowest level ever recorded. Nonetheless, it continues to pose a significant challenge worldwide.

Carbon markets and offsets

Finally, organizations can use carbon markets and offsets to reduce their exposure to nature-based risks. Carbon markets allow organizations to buy and sell permits for emissions of carbon dioxide, which can be used to reduce a company’s emissions. Carbon offsets are similar to carbon markets, but instead of buying permits, organizations can purchase credits from projects that reduce emissions. By investing in carbon markets and offsets, organizations can reduce their exposure to nature-based risks.

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The voluntary carbon market had a similar trend as the green bond and green loans market. In 2021, the activity and hype in these markets were extremely high, but in 2022 the markets started having a downtrend. The Russia-Ukraine war was a leading reason why many left the market. Moreover, the regulatory uncertainty in the carbon offsets market during 2022 is also a major contributor to investor hesitation. 

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Conclusion

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As the frequency and severity of natural disasters and biodiversity loss continue to rise, the need for effective risk management and mitigation strategies becomes increasingly critical for both the public and private sectors. Climate finance firms, in particular, have a significant role to play in this regard, as they possess the resources and expertise to provide frameworks and investment solutions to drive a shift toward a net zero transition that ensures the protection of ecosystems. 

To confront the challenges posed by nature-based risks, climate finance firms must integrate these risks into their decision-making processes and investment strategies. By doing so, they can not only protect their assets and interests but also contribute to global efforts in mitigating the adverse impacts of climate change and preserving the world's ecosystems.

Moving forward, it is our collective responsibility to ensure that the financial sector takes a proactive stance in addressing nature-based risks. 

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