- Nature-related risks are moving up the regulatory agenda as their significance to the global economy is becoming increasingly well understood.
- Tackling nature-related risks can be challenging, so starting early with risk and opportunity identification exercises can be a constructive way to begin building understanding and prepare your organisation.
- KPMG has developed an approach for supporting clients to overcome data challenges and understand their impacts and dependencies on nature.
Why should financial institutions care about nature-related risks?
Over half of the world’s economic output is estimated to be meaningfully dependent on the “ecosystem services” provided by nature. This growing recognition of nature’s foundational role in the global economy is forcing business leaders to consider the interdependencies of their organisations with nature, and the need to address the increasing destruction and degradation of ecosystems globally.
To support businesses with this endeavour, the Task Force for Nature-related Financial Disclosures (TNFD) recently published a beta version of a disclosure framework that outlines the fundamental concepts and definitions necessary for identifying nature-related risks and opportunities. Disclosure is expected against the Beta v1.0 framework by Q3 2023. KPMG previously summarised what boards and executives should know about nature-related risks and the beta TNFD framework here. The TNFD has launched a Financial Institutions specific working group to ensure the guidance is fit for purpose for this audience, and we can expect more clarification in this regard in June and October 2022 and February 2023 as beta version iterations are released.
Supervisory bodies such as the European Central Bank and the Monetary Authority of Singapore are increasingly asking financial institutions to assess a broader spectrum of environmental risks beyond climate, including nature-related risks. For financial institutions it is increasingly important to upskill on nature to understand how it will impact the business as an emerging financial risk and opportunity, a key ESG consideration and a future disclosure obligation.
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What do financial institutions need to do about nature-related risks?
The interconnectedness of climate change and nature means that financial institutions need to start considering a broader scope of risks under the ‘E’ pillar of ESG. The shift towards a nature-positive economy introduces a range of opportunities such as financing sustainability projects and the trading of emissions offsets from forestry or peatland restoration projects in addition to new risks from the introduction of environmental policies.
The first step for a bank that is beginning to consider how nature interacts with its balance sheet is to identify and assess the ‘impacts’ and ‘dependencies’ of its activities.
Figure 1: Nature-related impacts and dependencies definition
To support firms with the evaluation of their exposures to nature-related risks and opportunities, the TNFD has proposed an assessment process called ‘LEAP’:
- Locate your interface with nature;
- Evaluate your impacts and dependencies;
- Assess your risks and opportunities; and
- Prepare to respond to nature-related risks and opportunities, and report to investors.
Undertaking LEAP assessments can be challenging for financial institutions as it requires a detailed understanding of the complex interactions between business activities and the natural environment for many counterparties across multiple sectors, geographies and often global supply chains. As such, financial institutions may initially wish to run materiality screening followed by small pilot projects to assess the materiality of nature-related risks in relation to their specific assets and loan books. On completion of a pilot project for high-risk sectors, the next step would be to develop frameworks and undertake full scenario analysis exercises.
Case Study: Risk materiality pilot exercises
KPMG is working with financial institutions to support them with pilot exercises for risk identification and materiality assessments.
By combining the outputs of 50+ scientific nature-related tools and datasets with overlays from KPMG’s Climate IQ tool, it is possible to assess the materiality of direct and indirect nature-related impacts and dependencies across a wide range of sectors.
Figure 2: An example of KPMG’s sectoral analysis
Source: Natural Capital Finance Alliance (Global Canopy, UNEP FI, and UNEP-WCMC) (2022). ENCORE: Exploring Natural Capital Opportunities, Risks and Exposure. On-line, March 2022, Cambridge, UK: the Natural Capital Finance Alliance.
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Footnotes: ‘Direct’ represents the impact a sector has on nature, or its dependency on nature, notwithstanding the relative size of the sector, or respective supply chain considerations. ‘Economic Value’ refers to the relative economic contributions of each sector to the economy. ‘Supply Chain’ indicates the extent of dependence of the sector to other sectors, or impact on another sector. ‘Prioritisation’ identifies the most at risk sectors by weighting the outputs of the other columns and can be calibrated to account for client specific priorities. The ‘Materiality Key’ ranks the risks from Very High ‘VH’ to Very Low ‘VL’.
Risk identification exercises can provide financial institutions with a number of early insights into their key risk exposures and enables them to identify priority areas for further analysis and business planning. For example, in the heatmap above:
- The Consumer Discretionary sector is the highest priority due to its direct impacts and dependencies on nature and its significant contributions to the global economy. The sector is highly dependent on water use and negatively impacts the environment through multiple channels including waste production and air pollution;
- The Information Technology sector isn’t directly dependent on nature but its supply chain is relatively exposed to nature-related risks through its reliance on the mining of key metals and the manufacture of components used for various technologies;
- The Materials sector has limited supply chain risk but its direct impacts and dependencies on nature are high. The sector has significant dependencies on the ecosystem services provided by water and directly impacts several land-based ecosystems.
How KPMG can help
KPMG can help clients evaluate nature-related risks and opportunities, establish a strategy for managing nature-related risks, and prepare for nature-related reporting.
Risk identification and assessment pilot exercises to map nature-related risks, such as the one outlined above, can provide financial institutions with valuable insights into the data requirements and technical insights they will need to engage with nature-related issues and disclose in line with the TNFD recommendations.
Get in touch with us for further insights on how we are helping banking clients manage nature-related risks.