In our view, there isn’t an asset class or sector that would not benefit from a close consideration of how those effects might change outcomes or affect financial returns.
When we look specifically at fixed income, we see important reasons why investors should begin to integrate biodiversity into their decision making.
First, biodiversity loss presents risks that could impact the performance of fixed income portfolios. As with climate change, the starting point is to understand the risks in play, divided into two components. They may be physical risks from biodiversity loss and ecosystem degradation, or transition risks linked to global efforts to tackle the problem, which include increasing liability risks.
We expect that companies which do not proactively address these risks, and which fail to adopt more sustainable nature-positive business models, could face higher costs or lower revenues, therefore reducing their ability to repay debt in the future.
- Nature-related physical risks – For instance, the nuclear sector and the paper industry are among sectors responsible for large-scale water withdrawal, and often have their operations positioned close to water sources. Over time, water availability may become a real operational risk for these industries.
- A good example of liability-related transition risks is the case of US litigation around perfluoroalkyl and polyfluoroalkyl substances (PFAS) i.e. a large complex set of synthetic chemicals used in consumer goods. This litigation has given rise to new regulatory measures in both the US and European Union with a potential ban targeting these so-called “forever chemicals”. Another recent example would be the introduction of taxes on plastic packaging in some countries, like the UK, seeking to encourage intensive plastic users to adapt the company’s business model.
(More) regulations are on their way
The Taskforce on Nature-related Financial Disclosures (TNFD) was established in 2021 and aims to help factor biodiversity into financial and business decisions by creating a framework for disclosure and for assessing risks, impacts, opportunities and dependencies. The TNFD’s complete recommendations are scheduled to be completed in September 2023 and will centre around the same four pillars as the Task Force on Climate-related Financial Disclosures (TCFD) – namely, governance, strategy, risk and impact management, and metrics and targets.
Biodiversity as part of your investment process
A basic starting point is to tilt portfolios away from issuers that have a high biodiversity footprint and little ambition to reduce it towards companies in the same sector that have identified the risks and impacts and who are managing (reducing) and monitoring them. Detailed issuer-level analysis is critical here to assess the ambition and credibility of any corporate objectives.
Fixed income investors may also use the lever of bond maturities to mitigate biodiversity-related risks within their portfolios. For example, issuers with a high dependency on natural resources or a high biodiversity footprint could be invested in only at shorter maturities and only re-invested into upon maturity if they have made sufficient commitments to mitigate those risks or lower their footprint.
Engaging with key sectors and issuers
Having a constructive dialogue and actively encouraging issuers to shift their business practices to reduce their biodiversity footprint is a key method to foster positive change. From a financial perspective, it helps identify those “hotspots” within a portfolio and structure discussions with issuers around material nature-related topics – helping them to become more aware of, and resilient to, the implications of supply chain and consumer risks from biodiversity loss. In other words, avoiding any surprises that might impair their ability to repay debt.
It is important to centre engagement around those sectors and issuers most relevant to the challenge at hand. As with climate change, engagement on biodiversity loss can be extended from individual dialogue with companies to participation in collaborative initiatives such as Nature Action 100, or even to expressing convictions through public policy consultations and industry dialogue.
Where does biodiversity fit in relation to other sustainable investing?
Climate, biodiversity and social factors are inextricably linked. There is little value in pursuing improvements in one at the expense of the others. There are clear links, for example, between climate change and biodiversity:
- Climate change is one of the five direct drivers of biodiversity loss – limiting climate change is therefore part of the solution for biodiversity erosion mitigation.
- Natural capital and nature-based solutions, such as mangroves and forestry, not only represent high biodiversity-value areas but are also perfect carbon sinks which can help offset human-made carbon emissions.
- Some climate change solutions may have important biodiversity impacts and contribute to biodiversity degradation. An example of this could be the building of a new dam. While providing clean energy, it can have significant impacts on the surrounding biodiversity ecosystems. A holistic assessment of environmental risks is therefore key for an effective transition to more sustainable economies.
When integrating climate change into investments, we think that a full life cycle and value-chain analysis should be undertaken to consider the impact on biodiversity and on social issues related to economic activities.
In the same way that investors need to prepare for and consider a “just transition” that weighs social impacts on the path to net zero, so biodiversity loss is another factor that must not suffer from investors’ carbon “tunnel vision”.
Fixed income investors can make a difference now
Biodiversity loss is rapidly rising up investors’ agendas due to the potential risks it can pose to their portfolios, the impact their investments have on the world, and because of upcoming regulations.
As a massive source of liquid capital, fixed income investors have a huge part to play in this emerging theme and can take steps today to actively improve the biodiversity footprint of their portfolios.
Bruno Bamberger, AXA IM senior solutions strategist, and Liudmila Strakodonskaya, responsible investment analyst, AXA Investment Management
