Biodiversity is next for green bond expansion

By the Nikko AM Green Bond Team, 1 November 2023

Climate change is not the only environmental threat to how we live, work and interact with our planet. Our economic system is based on a model of take, make and waste that consistently over-utilises and fails to replenish Earth’s valuable, but dwindling resources. This is best depicted by Earth Overshoot Day, the annual date when humanity’s demand for ecological resources and services exceeds what Earth can regenerate in that year.^[1] In 2023, this fell on 2 August and has been occurring earlier each year.

Figure 1 – Progression of Earth Overshoot Day 1971 – 2023

Source: https://overshoot.footprintnetwork.org/about/

More than just birds and bees…

The plight of bees is often used to illustrate the need to better preserve nature. As nature’s pollinators, bees are a vital part of our food value chain. But their numbers are plummeting as their natural habitat is lost. Yet, biodiversity is about so much more than just bees and birds, it covers all of the planet’s ecosystems, flora and fauna. And each of these components is at risk. More than a million species currently face extinction; since 1970, the wildlife population has declined by 69%.^[2] Deforestation is another pressing issue – 10 million hectares of forest were lost between 2015-2020.^[3]

Nature is also a massive contributor to economic growth. According to PWC, more than half (55%) of the world’s gross domestic product (GDP) – equivalent to an estimated USD 58 trillion – is moderately or highly dependent on nature.^[4] And the deterioration of natural ecosystems could have far-reaching implications that are often not favoured in business risk analysis at present.

A new direction for green bonds

The need to transform how we interact with nature creates a major opportunity for the green bond universe. So far, issuers have successfully embraced funding the transition toward carbon neutrality, but far fewer are looking at regenerative biodiversity projects or initiatives that seek to protect our ecosystems from loss.

As awareness of the biodiversity threat grows, demand will rise from asset owners, especially ESG fixed income strategies that are not exclusively focused on the net zero transition, and also through evolving regulation – the same forces that first built momentum for climate-related green bonds.

At this early stage, the biodiversity theme could prove profitable as high demand and limited supply will drive up the greenium^[5] of these investments. Furthermore, as fixed income risk mitigation strategies factor in the threat to biodiversity, investors will increasingly seek to avoid those companies that threaten biodiversity or heavily rely on nature in their value chains without implementing replenishment strategies.

Investing in new research models

As biodiversity is still a new investment research field, and spans such a multitude of aspects, it could be preferable to approach the topic from different angles. Firstly, companies can be categorised into three different groups:

1. Companies whose activities directly impact biodiversity (i.e., oil & gas, transportation and mining);
2. Companies whose activities depend on biodiversity (i.e., utilities, consumer goods and forest products)
3. Companies that try to improve biodiversity – this group does not necessarily relate to specific sectors but considers the extent to which companies embed an intrinsic motivation to protect and nurture biodiversity within their business strategies.

Following this categorisation, measuring impact and dependency is the next logical step.

Ratings and research agency S&P presents one way to measure impact/dependency by providing an ecosystem footprint of its proprietary Nature & Biodiversity risk dataset. In its calculations, S&P combines three areas: it measures how land is impacted; ecosystem degradation; and the significance of location-specific ecosystem impacts. According to S&P’s database, consumer staples and utilities have the greatest ecosystem footprint (Figure 2).

Figure 2 – S&P’s Nature & Biodiversity Risk Dataset

Source: S&P Global Sustainable1 (Data as March 31, 2023. Chart Design: Matt MacFarland)

In such an emerging area of analysis, any methodologies to assess impact/dependency are only as good as their underlying data. Several new initiatives aim to promote voluntary disclosure standards that factor in biodiversity-sensitive areas as well as all scopes of carbon emissions. So far, the most promising effort has come from the EU, but clearly much work needs to be done in achieving greater transparency in this area.

Meanwhile, detailed commitment from the corporate sector to protect biodiversity is currently lacking. As we have already seen with net zero efforts, only time will tell whether companies voluntarily come forward with biodiversity commitments and action, or if a regulatory push will be needed. In the meantime, investors can play a greater role through engagement initiatives like Nature Action 100 (NA100).^[6] In October, we were honoured to join NA100’s growing coalition of investors requesting that companies adopt a more radical approach to reduce their reliance on plastics.

As for the asset management industry, we have already seen how successfully it can lead action on climate change and mobilise both investors and companies to engage with this topic. Moving forward, asset managers will have to fine-tune their research efforts relating to the protection of biodiversity, build up reliable databases and support companies with capital by funding genuine projects that seek to restore and replenish our natural world. To learn more about sustainable fixed income investing, read Nikko AM’s investment guide here.

If you have any questions on this report, please contact:
Nikko AM team in Europe
Email: EMEAenquiries@nikkoam.com

¹ https://overshoot.footprintnetwork.org/about/
² https://animalsurvival.org/habitat-loss/animal-populations-experience-average-decline-of-almost-70-since-1970/?gad=1&gclid=CjwKCAjwoqGnBhAcEiwAwK-OkTP_7YeN8EBo03eUblIlrEyUFxOfKKr4gTPuA3JlXng97wHvRBq4FxoCmSIQAvD_BwE
³ PRI, Digital Forum
⁴ https://www.pwc.com/gx/en/news-room/press-releases/2023/pwcboosts-global-nature-and-biodiversity-capabilities.html#:~:text=More%20than%20half%20(55%25),is%20highly%20dependent%20on%20nature
⁵ Spread difference between a labelled vs. a non-labelled bond
⁶ https://www.natureaction100.org/investor-expectations-for-companies/

The climate change megatrend

By the Nikko AM Green Bond Team, 25 October 2023

“The era of global warming has ended; the era of global boiling has arrived.” Those were the words of United Nations Secretary-General António Guterres in a recent speech at the UN headquarters in New York City. And it has certainly been a chastening few years in terms of weather extremes, including wildfires, hurricanes and record-breaking heatwaves in Europe, Asia and North America. Formerly once-in-a-generation exceptional events now risk becoming alarmingly routine.

The financial risks of climate change

A 2022 report from the Deloitte Centre for Sustainable Progress suggested that “if left unchecked climate change could cost the global economy USD 178 trillion over the next 50 years, or a 7.6% cut to global gross domestic product (GDP) in the year 2070 alone”. 

But there is still time to turn the tide. This need for immediate action is why we define climate change as an investment megatrend, and we believe Green and Sustainable Bonds have a vital role to play. We’ve long believed this and are pioneers in the Green Bond space. Alongside The World Bank in 2010, we launched the world’s first dedicated World Bank Green Bond Fund.

Helping brown industries turn green

Finding solutions to climate change will likely centre on innovation and technology advancement, and will therefore require significant funding. These efforts require research and development (R&D) funding. Green and Sustainable Bonds are structured like standard bonds, with the proceeds either applied exclusively to fund projects such as renewable energy projects, waste management, and other initiatives designed to promote sustainable practices or linked to a positive environmental change.

Within the Nikko AM Global Green Bond team, we have a particular focus on companies in the traditional and developed industries – those that actually contribute most to the carbon output. This is, in part, because they can most help to move the needle in terms of the transition to net zero. These high-carbon emitting ‘brown’ industries are often excluded from sustainable finance markets. Yet, by definition, these industries harbour the lion’s share of potential for CO2 emission reductions and often do not yet have substitutes (such as steel, aluminium and cement industries). We therefore believe it is crucial to support these industries in their transition, while pursuing the integrity and stringent requirements that the climate emergency demands.

We believe that investing in this space is going to have a significant impact in transitioning these traditional brown industries from being climate negative to being climate positive. Tax incentives, such as the Inflation Reduction Act in the US, are expected to have a significant impact in terms of meeting net zero targets by helping these traditional brown industries re-adjust. 

How investment can support net zero targets

In the transition to net zero, the focus is on impact and engagement. We are actively engaged in the global fixed income markets, and support green and sustainable investments in the transition towards overall sustainability in order to meet net zero targets. We are particularly trying to focus on those companies with ambitious targets for net zero and carbon reduction.

Fixed income provides a unique opportunity, especially in Green and Sustainable Bonds, as they enable direct impact. For example, electricity generation is a critical area of focus due to its high impact on global carbon output and IEA forecasts suggest electricity consumption is going to double or perhaps quadruple over the next 30 years. Therefore, providing capital to enable the transition to green and renewable power sources is critical. Much of the capital needed for that expansion is going to come from the debt markets so picking and choosing the utility providers that have ambitious targets is going to be key.

Figure 1 – Electricity demand by sector and regional grouping

To learn more sustainable fixed income investing, read Nikko AM’s investment guide here.

If you have any questions on this report, please contact:
Nikko AM team in Europe
Email: EMEAenquiries@nikkoam.com