The Next Risk: Biodiversity
The Swiss pharmaceutical executive had always pushed back on what he saw as a shortsighted business philosophy: make money first, and then spend later to restore nature destroyed for profit by the industry. Then came the arrival of COVID-19, and many in his industry became more familiar with how diseases are transmitted from animals to humans. And for the executive, it became easier to explain to his board how habitat and biodiversity loss have costly global consequences.
In a volatile market, it may be difficult for leaders or investors to care about species and habitat loss or ecosystem destruction—until they see how $1.884 billion in rated debt could potentially be at risk as a consequence of depleting the natural world of its biodiversity. A recent report from Moody's credit-rating agency warns that ecosystem health, biodiversity loss and natural resource management are growing policy and investor concerns, with serious credit implications. If a company doesn't have credible management strategies, the agency says, it could lead not only to reputational damage, but also serious financial repercussions.
Extractive industries and agriculture are among the nine sectors with the highest credit-risk exposure to nature-related risks, Moody's warns, mostly because there are material financial costs to the damage they cause to natural systems. Companies in these high-risk sectors—including coal mining and oil and gas production—may face greater scrutiny from regulators and investors. One example, Moody's says, is how the European Parliament recently approved the regulation of deforestation-free products.
The assets of the natural world are often known as "natural capital," and include soil and ocean health as well as air and water quality. The World Economic Forum suggests that about half of global economic-value generation is dependent on nature in some way. The Moody's report suggests that economic activity and wealth "have historically overlooked the value of natural capital and the damage done to these assets." Failing to value natural systems can lead to not valuing anything that is not priced, says Victoria Baxter, a senior partner in Korn Ferry's ESG and Sustainability Solutions practice. The consequences can lead to misallocating scarce and valuable resources, she says.
Ultimately, "pressure from investors will drive the most behavioral changes from leadership teams," says Jeff Constable, a senior client partner who leads Korn Ferry's Financial Officers practice in North America and co-leads it globally. He's echoed by Cheryl D'Cruz-Young, a founding member of Korn Ferry's ESG Center of Expertise. "Investors have brought it into the open," she says. "They're very demanding."
Recently, she points out, seven more firms have created chief sustainability officer roles that are direct reports of chief financial officers, a sign of how seriously they see the risk of climate change and biodiversity loss. In general, she thinks it's better that they report to chief executive officers, because this shifts a company's response around biodiversity loss toward activity, not just compliance. Well-run companies are already aware of their biodiversity impact as part of their procurement practices, D’Cruz-Young says. They have the processes in place and are working to elevate them from mere compliance to active engagement. "You need to ensure that you've got strong strategic leadership," she says, "and it's prioritized with the business."
However, it remains difficult to measure progress around biodiversity. Compared to greenhouse-gas emissions, there are fewer quantifiable data points or models and it's difficult to capture consistent data about damages or loss. That makes it challenging to demonstrate how a company’s valuation can be affected by environmental degradation or the effects of regulatory policy around damages. Still, Moody's anticipates that policymakers will establish regulatory frameworks to push companies toward forms of disclosure that allow investors to value and account for their use of natural capital. Baxter points out that Europe already has some mandatory ESG disclosures. As a result, global firms are accustomed to mandatory disclosures—and may adapt to biodiversity assessments more readily. “Many companies are trying to figure out smart technologies and AI and other ways to be able to do that faster," Baxter says.