Biodiversity – a material risk

Robert Barrington, director of governance and socially responsible investment at F&C Asset Management, discusses the relationship between business and biodiversity

F&C Asset Management has published a 55-page report entitled Is Biodiversity a Material Risk for Companies? An Assessment of the Exposure of FTSE Sectors to Biodiversity Risk. It is based on a 12-month research project commissioned from Earthwatch Institute (Europe), and supported by the Department for International Development.

The report places biodiversity-related issues within the context of risk management and materiality. Its headline conclusions are that around two-thirds of FTSE 100 companies in high-risk sectors are not taking substantive or consistent action to manage their biodiversity-related risks, even though poor understanding or management of biodiversity risks by companies should be of concern to investors where the risks are likely to be material.

There is growing evidence to suggest that biodiversity risks are relevant to companies in a wide range of sectors, including retail, construction, food producers and banking.

Nine high-risk sectors – the ‘red zone’

Following a survey of experts in the area of business and biodiversity, a review of companies and industry bodies already active in this area, and a review of the activities of NGOs and pressure groups, the report identifies nine sectors as high risk.

These are described as the red zone, indicating that most companies in these sectors will be exposed to biodiversity risks and that the risks faced by individual companies in these sectors are likely to be significant:
u construction and building materials;

  • electricity;
  • food and drug retailers;
  • food producers & processors;
  • forestry and paper;
  • leisure and hotels;
  • mining;
  • oil and gas; and
  • utilities.
  • However, individual companies in other sectors may carry the same level of risk as red-zone companies. For example, a general retailer with a large food division may find that it has the same levels of risk as a food retailer.
    In order to help individual companies identify whether they are high risk, the report lists a series of business
    characteristics that may lead a company to face significant biodiversity-related risks.

    Examples of these characteristics are:

  • companies that are dependent on access to specific areas of land or water;
  • companies involved in infrastructure development; and
  • companies that are operating in or sourcing from developing countries which are themselves rich in biodiversity or have poor biodiversity protection.
  • How well are companies doing?

    Although entire sectors may be categorised as high risk due to the nature of their business, individual companies can mitigate this risk. The report notes that, as with all business impacts, company exposure to biodiversity risks can be mitigated; firstly, by the extent to which the risks are recognised; and secondly, by the extent to which they are properly managed.

    An assessment of how effectively and consistently individual FTSE 100 companies in the red-zone sectors are managing biodiversity related risks found that a significant majority (61%) of FTSE 100 companies in the red zone sectors are not managing – or not taking substantive action to manage – biodiversity risks effectively.

    In addition, through an overlay of the responses to Business in the Environment’s biodiversity section on the red-zone companies, four sectors – construction and building materials, food producers and processors, forestry and paper, and leisure and hotels – have been identified as being particularly at risk. This is based on the assumption that effective risk mitigation begins with proper identification and assessment of risks.

    However, a small number of companies across all sectors have developed a good understanding and effective management in the area of biodiversity. Examples include companies such as Marks & Spencer, Rio Tinto, Travis Perkins, Unilever, Carillion, Barclays and BP.

    Seven key risks

    In many ways, biodiversity is an unhelpful term as it covers a multitude of issues relating to ecosystem services and ecosystem management, as well as its pure sense of species diversity. This gives considerable scope for confusion.

    To clarify the terminology, seven categories of biodiversity-related risk have been identified that break down the concept of biodiversity into management categories that are more familiar to companies and their investors. These are:

  • Access to land: access to new sites is affected by a company’s track record on protecting/restoring biodiversity and water resources.
  • Access to capital: environmental credit risk is assessed as high due to a company’s poor biodiversity track record or management plans and the cost of capital increases.
  • Security of supply: reduction in the quality and availability of essential materials such as fish.
  • Liabilities: unforeseen impacts of activities on biodiversity leads to financial liability even though a company’s regulatory licences have not been exceeded.
  • Relations with regulators: concerns about a company’s track record on biodiversity management, or lack of confidence in the quality of its biodiversity survey and management plans, leads to permit delays or fines.
  • Reputation: a campaign over an issue such as genetically modified organisms or dolphin-friendly tuna can reduce consumer confidence in a brand or company, resulting in lower sales.
  • Access to markets: an inability to meet specifications from substantial buyers such as government departments and agencies for sustainably-sourced raw materials like timber restricts access to a major market.
  • Increasingly significant

    Biodiversity is the kind of risk that investors may expect to see covered in Operating and Financial Review reports. It is likely that biodiversity-related risks will become more acute and more widespread across all sectors as biodiversity rises up the agenda as an environmental and public policy issue.

    Among the factors that are likely to increase biodiversity risks to companies are continued – and probably increasing – loss of global biodiversity. Research predicts that this will happen as a result of a range of factors including climate change.

    Increased costs or uncertainty for companies dependent on ecosystem services as a result of continued biodiversity loss are likely, alongside a greater understanding of biodiversity as a factor in credit risk by lending institutions.

    Also, legislation to make companies responsible for their biodiversity impacts is beginning to emerge. Trends are towards increased use of regulations and other mechanisms to link biodiversity impacts back to the companies responsible for them.
    Possible mechanisms include a wider definition of biodiversity under the EU environmental liabilities regime; biodiversity levies, which may be introduced in order to make companies pay for biodiversity impacts in a similar way that has been done in other fields; and increasing scrutiny of supply chain practices and impacts by government and commercial customers, as well as pressure groups.

    How can companies do better?

    All companies potentially exposed to high levels of biodiversity risk should assess if these risks are material to their business. Also, companies with material or potentially material biodiversity risks should develop and publish specific policies or statements that recognise the significance of the relationship between biodiversity and their business.

    Having identified material risks, companies should put in place measures to manage these risks, including:

  • those arising directly from activities of the company;
  • those arising indirectly from activities of the company, including supply chains and the impact of secondary development; and
  • those that may threaten their business as a result of the mismanagement of biodiversity by others.
  • Management of biodiversity should be integrated with the company’s pre-existing risk management systems and performance targets should be set.

    Companies exposed or potentially exposed to high levels of biodiversity risk should report on their biodiversity management; an appropriate place to do so in the case of UK companies would be the OFR.

    Is biodiversity a material risk?

    Biodiversity does present material risks to certain companies, although putting a precise financial value on such risks is often not possible. Where such values can be ascribed, they are often significant.

    However, the majority of companies analysed in the red zone sectors are not taking substantive action to manage their biodiversity risks effectively. The long-term nature of biodiversity risks means that they can take an unusually long time fully to identify and understand.

    Moreover, it is not easy to take rapid action to mitigate them once they have been identified. This means that companies with potential risk exposure cannot assume that action can be postponed.

    The report concludes with a very clear message: “This report should serve as an early warning to companies, particularly those in our red zone: start investigating and managing biodiversity-related risks now.”

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