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The Sustainability Story
Mel Peh, CFA: Guidance for Integrating Nature-Related Risks into Investment Strategies
00:27:10
In this episode of the Sustainability Story, host Nicole Gehrig, Director of Global Industry Standards at CFA Institute, discusses the importance of integrating nature-related risks into investment strategies with Mel Peh, CFA, an independent...
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- [00:00]
A
Foreign welcome to the Sustainability Story, where we explore the latest trends and insights in sustainable finance. I'm Nicole Garrick, Director of Global Industry Standards at CFA Institute, and I will be your host for today's episode. And in this episode we're going to delve into the importance of integrating nature related risks into investment strategies. And nature related risks are less widely discussed and understood than climate related risks and we're hoping to shed some light on nature related risks during this episode. I'm excited to have Mel Paw as my guest today. Mel is an independent consultant for the United Nations Environment Program Finance Initiative, or unfi, who supports the work of the Net Zero Asset Owner Alliance's monitoring, reporting and verification track and the Transition Financing track. And previously she worked in equity research, consumer good sector analysis, green and sustainability origination, and climate risk integration for private credit. She holds an MPA in Environmental Science and Policy from Columbia University School of International and Public affairs and a Bachelor's of Business in Banking and Finance from Nanyang Technological University in Singapore. She is a CFA Charter holder. So, Mel, thank you for joining us today.
- [01:26]
B
Thank you so much for having me.
- [01:28]
A
So before we delve into our discussion, maybe can you start with providing some background on how you became interested in sustainable finance?
- [01:36]
B
Yeah, absolutely. I'm so happy to share. I'd like to thank Nicole for inviting me and I've been following this podcast actually and it's so relevant to the work that I'm doing and it's such a pleasure to be here. I'll start off by saying some of these views that I'm expressing on this podcast are my own and do not represent unipfi. So I really started this journey when I was working in consumer goods analysis for United Overseas bank and the bank started looking into providing sustainable finance solutions from a sector perspective. So through that, after two years into my role as a pioneer member of the ESG Solutions team, I decided that I needed to know more about climate change and you know, what are some of the real reasons behind these drivers and how can we make it better as a society as a whole. And that really drive me to pick up my Master's degree on Environmental Science and Policy in order to gain this additional perspective to tackle this topic. So all in all there's been some twists and turns to get here, but being able to work across functions as well as geographies has really helped to ascertain that sustainable finance is something that is going to continue to play play an important role in long term value creation, wealth management and is something that I'm very passionate about.
- [02:58]
A
So thank you for providing us with your sustainability story. Let's dive into the discussion on nature related risks. Nature related risks are potential threats posed to an organization that arise from its and really wider society's dependencies and impacts on nature. And those risks can be physical risks, transition risks, or systemic risks. We think about nature related physical risks. They develop from the physical degradation of nature and for example through pollution or deforestation. And nature related transition risks arise from those actions or processes undertaken by organizations or society to really protect, restore and reduce negative impacts on nature. And systemic nature related risks arise from the breakdown of the entire system rather than the failure of individual parts. And I read a PricewaterhouseCoopers research report that showed that US$58 trillion of economic value generation, which is more than half of the world's total gdp, is moderately or highly dependent on nature and its services, which I thought was quite fascinating. So I'd love to hear what your views are on integrating nature and biodiversity into sustainable finance and why you think it's important.
- [04:17]
B
Yeah, absolutely. Thank you for the question. I see that nature and biodiversity is actually integral components of sustainable finance on top of climate action. And these two are highly interdependent on each other. So one example that I'll give is land use change. So in the case of a deforestation, this will lead to decline in biodiversity and from the loss in species as well as population decline. But I just want to take a step back and ask like wait a minute, are we just having this conversation for three huggers and wildlife enthusiasts? And no. And here's the reason why. So I'll give an example of what's happening closer to home, I guess to everyone's heart as well. What's happening to the egg crisis in the United States these days? Since the start of 2020, the cost of eggs have increased by nearly 240% according to a data from the US Bureau of Labor Statistics. And here I to explain some of the reasons why this nature related risks is important for the society and finance in general. And so we know that there's been changes to migration routes of wild birds and these can actually lead to an increase in transmission of viruses to domestic poultry flocks and particularly egg laying hens. This could then as a result lead to a large scale culling of infected birds and that will cause a reduce in supply in eggs and that really causes the egg prices to rise. And there's also knock on effects on the rest of the value chain. Like you and us, we're Having to pay higher prices because producers then have to pass on a cost. And in the cases of like food service industry, if they're not able to increase the selling price of their products, then they might just experience some level of margin squeeze as a result. So like I would just say like ensure like business activities have some sort of dependencies on how the ecosystem actually work. And having a stabilized ecosystem services would then help to generate to ensure that revenues continue to flow in a certain way. And we try to make reduce the kind of systematic risk to the overall economy. And that's why nature and biodiversity, it's really important to this overall sustainable finance agenda.
- [06:49]
A
Thank you for that explanation and example of how the bird flu poses a significant threat to biodiversity. And as you pointed out, the shortage of healthy hens leads to a reduction in egg production which then results in higher egg prices. And that can impact really the entire supply chain affecting everyone from the farmers to really the end consumers of eggs like you and me. And not only do we really rely on nature for the food that we eat as we described, but also for the water we drink, the clothes we wear, the medicine we need and really the air we breathe. So we are highly dependent on nature. And if nature becomes less resilient, it could really cause significant financial risk to companies and investors. I'd love to hear your opinion on what you think are the key nature related risks that could impact portfolio performance in the coming years. And which sectors are most exposed to nature related financial risks.
- [07:51]
B
Yeah, absolutely. I think some of these nature related risk will be translated based on the dependency of ecosystem services to generate these revenues and returns. So when we talk about dependencies, this would mean ecosystem services services to take a step back would mean that they rely on maybe water supply or having abundance in terms of genetic diversity from nature in order to generate revenues. And we're seeing that come across a lot in sectors such as food production, as we mentioned earlier, as well as the pharmaceutical industry that relies heavily on this genetic part diversity of nature in order to create revenues from drug production and research and development. So a study by Finance for Biodiversity found that the sectors most impacted by this nature related risks, food products, chemicals, consumer staples, metals and minings, and pharmaceutical. And we also see these sectors coincide with the eight priority sectors of nature Action 100, which is a global investor engagement initiative focused on driving cost, corporate ambition and action to reverse nature and biodiversity loss.
- [09:12]
A
So now that you've mentioned some of those sectors that are most financially at risk for some of these nature related concerns and risks like Water scarcity or biodiversity loss. What steps should asset managers and asset owners take to really begin to integrate some of these considerations into their investment processes?
- [09:36]
B
So one of the fastest ways for asset managers and asset owners to start taking action on integrating some of these considerations is through the use of the Task Force for Nature Related Financial Risk Framework or the tnfd. This framework actually has a very structured approach and is modeled after the tcfd which is related to climate. And this will actually help to assess nature and biodiversity risks and opportunities. So they actually recommended the LEAP approach which provides a detailed guidance on first having to locate the interface of these businesses and with nature, evaluate dependencies and impacts on nature, assess exposure to nature related risks and opportunities, and finally prepare care to respond and report on this material nature related issues. There's also another angle to add to that which they the tnfd. TNFD is actually also suggesting on top of the core framework, which is to adopt a sector approach. And through that we can actually start by assessing the materiality of nature dependencies for a particular sector and how whether or not the impact on this particular sector would be high or low. And from there start to look at some of the ways and actions available to help reverse some of these risk exposure to nature loss.
- [11:05]
A
That's great advice for managers to use the TNFD framework to better understand how the companies they are invested in are exposed to nature related risk, really whether those risks are financial material and to then integrate them into their valuations. And also to use this nature related risk information to engage with issuers and really have those that have higher risks to engage with them to change behaviors and to mitigate their impacts to nature and biodiversity. So as an example, the framework that helps identify locations where biodiversity loss is a concern in the company's value chain, they could then contribute to the protection of nature and biodiversity. And there's other ways that asset managers could help, maybe by using their ownership rights to support shareholder resolutions that promote stronger biodiversity commitments. Or they can really exclude companies with high biodiversity risks, such as those might be causing deforestation, as really other ways that they can integrate nature related risks into their investment decision making.
- [12:16]
B
Absolutely.
- [12:17]
A
So I wanted to pivot maybe to metrics. Now I know when we think about climate related risks, scope 1, 2 and 3, greenhouse gas emissions are really crucial metrics for emission reporting. And they're pretty standardized metrics that most companies already disclose. And we have the Greenhouse gas protocol which really provides a universal measurement basis for those types of metrics. Is there anything that's standardized Metrics or a measuring framework for organizations to really measure an organization's exposure to nature and biodiversity related risks that's available to investors?
- [12:54]
B
That's a really, really good question, but unfortunately I have to say no just because nature is a little more complex than that and this is going to get a little technical. Please bear with me. So in the case of carbon emissions, the scientists behind IPCC report has actually converted five other greenhouse gases into carbon dioxide equivalents based on their relative AB ability to trap heat compared to carbon dioxide called the global warming potential. And so in addition, carbon dioxide as a gas is transboundary, meaning it's not bound by a national border, so it's not location specific. So that actually helps to help us to understand carbon emissions on a global scale and how to tackle it as one earth. But in the case of nature and biodiversity assessment is highly location dependent. So for instance, a tropical rainforest would be vastly different from a marine ecosystem. And so therefore the metrics behind that will also be very, very different. And as such there's no a single metric that can paint a full picture of the actual nature related risk exposure. And that being said, there is this database called the Exploring Natural Capital Opportunities Risks and Exposure or Encore. And this would actually be one stop shop for financial institutions to look at various indicators for assessing how each economic sector can depend on various ecosystem services. There are also other data sets out there including but not limited to the Biodiversity Risk Filter developed by the World Wildlife Fund for Nature, as well as the Natural Capital Index framework. So with that as a backdrop, the TNFD in partnership with the Partnership for Biodiversity Accounting Financials, actually proposed the use of biodiversity footprinting approaches for financial institutions in order to assess the impact on a portfolio basis. So this would mean aggregating some of these metrics into one indicator, or we call it the biodiversity footprint in order to make a better assessment across different sectors as far as portfolios.
- [15:30]
A
So thank you for the technical analysis on why we don't have a single metric to evaluate nature related risks. And you've shared some excellent resources and tools that can help investors better understand how the economy is vulnerable to nature related risks and how environmental changes can pose risks to businesses. And for example, the Encore tool will assist financial institutions really in assessing their dependencies and impacts on portfolio level. And it can also help those that are trying to meet the TNFD recommendations. And as you mentioned, there isn't a single metric like greenhouse gas emissions to measure nature related risks. But alternative is measuring and reporting the biodiversity framework of a portfolio or fund might be able to provide a way to assess and quantify the impact on biodiversity. And although that measure might not be standardized, it still offers a potential comparable metric. We talked a little bit about the challenges and differences between climate related risks and nature related risks. That nature related risks are broader. But what do you believe are the main challenges asset managers and asset owners encounter when trying to integrate nature related risks into investment decisions?
- [16:54]
B
I think that some of these challenges might be similar to climate, so I'm going to talk about the ones that are specific to nature. So I think one of the biggest pain points is probably the lack of standardized metric as mentioned earlier and case in point or even the biodiversity approaches that I was talking about earlier. There are also like three different approaches and on top of that within each approach there is no standardized way of aggregating some of these metrics. So the lack of consensus over this and how to actually use this approach actually makes the data very highly complex and not usable or not suitable for comparison across perhaps asset managers in this case. So I like to mention like on top of that there are many different tools out there and different guidances. So one of the recent publications by colleagues from the Nature team, the UNEP fi called Accountability for Nature is actually one useful resource to help asset managers and financial institutions clarify the methods and frameworks for nature related issues in the private sector. One other pain point I would mention will be the complexity of data and data gaps. So this is not new to nature. We see similar themes and the climate space, but specifically for nature. I think the requirement and the need to use locational information becomes quite a challenge. But that being said, I feel like nature is one of the topics that developed later. There has been leaps and bounds of improvement in the climate physical risk space that has started to use some of this locational information. So I think the nature related industry or space can actually leapfrog this development in this space and just tap on this development that has already happened in the fiscal risk space to actually help to continue to use location information to help to understand some of these risks at the asset level all the way up to an aggregation at the corporate level. I think one other challenge that is specific to nature based solutions right now I like to think mentioned is even if there's significant interest in investing in some of these solutions, one of the major challenges the revenue uncertainty just because similar to renewable energy projects, some of these conservation related investments tend to have long gestation period. The more likely would be found in the Global south where a currency country as well as geopolitical risks might actually also make these investments more challenging. On top of that, some of the offtake agreements can be quite risky. For instance, if we look at a nature conservation that relies on carbon credits on top of other hybrid revenue sources, such as selling of agricultural produce from a particular project, there could also be risks involved in some of these offtakes. And therefore I feel like in general that also makes it challenging. But that being said, there are also other ways to de risk some of these through the blended finance solutions that has been developed since the climate topic started. And I think again, there could be opportunities to actually gain some ground in this space as this space continues to develop.
- [20:42]
A
Great. That leads me into my next question on some of the opportunities, which I think is hopefully areas that are going to be able to mitigate some of these risks and really allow for more opportunity for capital to flow into those areas. So for banks and investors that are really looking to align with more nature positive finance, what advice would you give to them?
- [21:05]
B
I love your question. So I'm going to start off by saying there is a global biodiversity framework which is similar to the Paris Agreement, but it is working on the nature topic. It actually calls on the private finance sector to play a part in delivering its apex goal, which is to halt and reverse nature loss by 2030 by aligning portfolios and urgently shifting financial flows toward the transition of sustainability. So they sized a need for about 200 billion of investment per year to actually get there through both private and public finance. And I think this is one space that is definitely evolving and definitely an opportunity for banks and investors to lean in. So one advice would be to actually start leaning into these nature and biodiversity conversations, including making voluntary commitments. They can also go one step further by requiring clients as well as investee companies to start setting science based targets for nature and disclosing nature related data. For banks and investors, a better understanding of dependencies and impacts on the returns on portfolio will also allow them to manage the associated risks better. So one example would be to start engaging with corporates and borrowers in sectors that are high risk and high dependency on nature, as mentioned earlier. And I think this engagement would then help to move the corporates as well as portfolios forward in this nature transition. And investors can also look into investing directly or indirectly into some of these nature positive solutions, including blended finance impact funds, payment for ecosystem services, thematic bonds. We see green bonds, blue bonds and even biodiversity bonds that are being developed in this space. And finally, nature based solutions that can generate credits including Carbon and biodiversity credits and other co benefits. So all in all the space will continue to evolve and I strongly believe that collective action and partnership with multiple stakeholders will help to provide that crucial knowledge to better manage the risks and opportunity and create long term value in return.
- [23:46]
A
So those are some excellent ideas for asset managers and asset owners to align their investments with nature positive outcomes. And as you pointed out, collective action and partnership among different investors will enhance the management and sharing of knowledge about these risks. So I'd like to know what steps can asset managers take to advance this initiative and to raise awareness about these risks?
- [24:13]
B
Yeah, that's a really good question and I really believe like from my experience working in like asset management, there are so many things you have to do on a day on day basis. So some of these additional information coming from being part of capacity building and knowledge sharing would be very, very helpful. So for instance, leaning in on some of these voluntary commitments that we have out there, there is a finance for biodiversity pledge for financial institutions who are committed to protect and restore biodiversity through investment and lending practices could be one way to actually gather more information, exchange information about some of the practices and how to actually take this forward. So I also believe, as mentioned earlier, because a lack of consensus, even though the tools have been recommended by some of these framework, is to actually create that space for investors to come together and understand what are the challenges and what are the ways around these challenges and creating some sort of consensus around how to actually approach this topic together. Because I strongly believe that in order to make a tool useful for the investment community, investment community's input is crucial and probably the most important. So having this ability interact together and to understand the nature commitment across different geographies and different investment mandates would be really, really helpful. So there are also other initiatives that also integrate nature related commitments. We're seeing that in the UNPRI as well, where they have a spring initiative for stewardship for nature. So there are many of such ways that you, asset manager or investor or even a bank could lean into some of these conversations.
- [26:14]
A
Yeah, I think collaboration is definitely crucial to like you mentioned, working together with different stakeholders to really develop best practices, share knowledge on some of this information can really help overcome some of the challenges even related to interpretation of these into the data availability. So really helps meet some of those goals and integrate nature related risks. So Mel, thank you so much for your insights with us today to provide us a lot of valuable information to address the nature related risks. Investors can safeguard financial returns, ensuring long term sustainability in their portfolios it's been a pleasure speaking with you today, and I hope we can collaborate again in the future. So thank you so much for your time today.
- [27:00]
B
Thank you so much, Nicole. It's a pleasure.