For the last two decades, ESG ratings from data providers have been an easy-to-use measure to assess the sustainability profile of companies on several ESG criteria. However, while climate-related data has become more widely available, biodiversity-related data points still lack comprehensive coverage leading to some industry experts to conclude that KPIs could provide a more objective measurement of biodiversity impact.
According to Johan van der Lugt, lead ESG advisory expert at specialised wealth manager Van Lanschot Kempen, the gap in data availability has been evident since ESG rating providers were required to address the data demands of biodiversity (and other sustainability topics) for the EU Sustainable Finance Disclosure Regulation, effective from March 2021.
“Given the relative nascence of biodiversity data, there is a high level of information asymmetry. In my experience, the momentum of individual ESG data points tends to be higher compared to data points embedded in ESG ratings. This is because often, the big ESG data providers tend to work with backward-looking data and can only integrate certain data points into their ESG rating framework, assuming it meets their set requirements,” said van der Lugt.
“Rating agencies have had to invest in adding nature-related datasets to their product suite, similar to what happened in the climate data space, and they typically achieve this through partnerships or acquisitions.”
Biodiversity confusion
A recent paper – Biodiversity Confusion: The Impact of ESG Biodiversity Rating on Asset Prices – further highlighed the problem. The research matched MSCI ESG and CRSP/COMPUSTAT datasets from January 2013 to December 2020 as a starting point for a discussion about the efficacy of disclosure mechanisms.
Using this data, the researchers concluded biodiversity ratings are largely uncorrelated to firm characteristics other than via firm size and do not predict stock returns, with institutional investors and sell-side analysts often ignoring them in their decision-making.
“It is difficult to see how, on its own at least, the measurement and disclosure of biodiversity via ESG ratings currently helps achieve any target related to biodiversity and nature recovery, or improves the management of nature-based risks,” the report noted.
MSCI stressed the dataset the academic study is based upon has never been a part of MSCI ESG research’s commercial datasets offered to investor clients, and the study is based on a legacy dataset that, while still in use by some in academia, has since been decommissioned. Nevertheless, measuring and quantifying biodiversity related risks is “complex”, models are “nascent” and data “often scarce, especially in the case of supply chains,” according to Arne Klug, biodiversity research director at MSCI ESG Research.
He continued: “It is essential for investors to consider specific metrics for biodiversity and nature, in line with the recommendations of the Taskforce on Nature-related Financial Disclosures (TNFD) that have established a set of sector agnostic and sector specific disclosure metrics.”
Key drivers of biodiversity loss
Understanding the key drivers of biodiversity loss is a good place to start to begin to tackle the issue, says Samantha Duncan, founder and CEO of impact measurement platform Net Purpose. This includes land use change and climate change – themselves accountable for more than 50% of biodiversity loss – but also pollution, invasive species and the exploitation of natural resources.
“Starting with impact drivers provides a foundation for clear theories of change and measurable metrics driving biodiversity loss. Some of these are well established: such as GHG emissions, and air pollution, also outlined by TNFD. Others are less established: such as square kilometres of land changed or restored. But what is clear is that investors need facts on biodiversity performance, and transparency on key biodiversity drivers. With this information they can build strategies to halt and reverse biodiversity loss,” Duncan added.
“Going one step further, we have started to use region-specific species databases to quantify the impact on actual biodiversity species loss, which holds promise to be a standardised metric for comparing impact. Our work on this topic, however, is just beginning, and with TNFD recommendations released in September 2023, we expect it will rapidly evolve.”
Van der Lugt, meanwhile, suggested there is a disconnect between what is going on in the real world in terms of the state of nature, and how it is currently being picked up by companies in their corporate sustainability reporting.
As is becoming more common with wealth managers in the ESG space, Van Lanschot Kempen aims to avoid and minimise investments in biodiversity controversies and in assets with operational sites in biodiversity-sensitive areas that lack adequate mitigation strategies. The firm also seeks to avoid and minimise investments in assets exposed to high-risk commodities that do not have relevant policies and mitigation measures in place such as palm oil, soybeans, beef and timber. For these themes, the firm taps into biodiversity data points that go beyond the ones typically found in the generic ESG rating design.
“The most interesting element is the ambition to increase the proportion of investments that generate positive outcomes. This is where data availability is really scarce and where there is a lot of subjectivity involved. It is also the area that typically receives less interest from ESG rating providers that traditionally have a heavy tilt towards ESG risks rather than opportunities.”
Biodiversity KPIs
So, can key performance indicators (KPIs) be solely relied on to assess performance on biodiversity? According to Thomas Roulland, director and head of sustainability standards and analytics at Allianz Global Investors, the renewed focus on biodiversity measurement and metrics has meant the firm is seeing more requests for transparent, measurable and tangible KPIs in the sustainability space, with clients asking for more understanding on the sustainability outcomes of their investments.
“The increase of ESG data in availability and quality over the last few years has reached a level where we can now evaluate the sustainability of investments based on KPIs such as carbon footprint,” said Roulland.
“We now provide an additional offering to investors through a new targeted approach, leveraging KPIs on specific themes, such as climate change or planetary boundaries, and are working on a similar concept with a KPI on biodiversity tailored to client needs.”
Roulland highlighted a number of positives this approach can bring. A KPI, he said, is more focused and specific than an ESG score which is an aggregation of different criteria, and can provide a more objective measurement, as qualitative or research opinion is not embedded into the assessment. KPIs offer high measurability as they are often more granular, leading to high levels of reportability and transparency.
While the lack of integration with qualitative or research opinion means a singular KPI won’t represent a comprehensive assessment for a complex theme such as biodiversity, Roulland is confident their KPI-based approach will meet client needs.
Similarly, AllianceBernstein’s chief responsibility officer, Erin Bigley, and director of environmental research and engagement, Sara Rosner, noted the market is coalescing around more consistent disclosures of material biodiversity risks and opportunities.
“In our experience, issuers are still very early in understanding, identifying and managing biodiversity risks and opportunities – similar to where they were with climate change several years ago. We see a lot of variability in metrics – from water to deforestation and commodities-related metrics, to proximity to conservation areas and species abundance. TNFD and the Science Based Targets Network help investors gain a better picture of what KPIs are most important proxies for managing and mitigating nature-related risks by standardising nature reporting and target setting.”
Unlike the focus on aligning economic and business activity to 1.5C to address climate change, there are no specific universal goals that issuers are trying to achieve to address biodiversity loss. Forms of biodiversity risk and opportunities are highly nuanced, depending on location and business activity among a myriad of other considerations. Even so, van der Lugt asserted the broader goals are very clear.
“The European Union has articulated this in its Biodiversity Strategy for 2030, and we as an asset manager want to help drive this by seeking exposure to assets that are transitioning towards a paradigm of operating within ecological and social boundaries. A lack of data or criticism on the quality of data should not stand in the way for us to rise to this challenge.”
