Insights

Nature-based solutions: the backbone of sustainable investment.

This is an ongoing insight series that will look at the financial opportunities of nature-based solutions.

Global markets are at the start of a seismic shift in capital reallocation in favour of sustainable investing. It’s a trend demonstrated in research carried out by PwC, which estimates that ESG funds will increase from a 15% share of the European sector to 57% by 2025. This transition away from business-as-usual can, at least in part, be accounted for by three key factors:

1) A growing recognition that ESG funds have fewer risks and generate greater returns.

ESG scoring provides a granular view of assets and acts to filter out investments that carry higher environmental, social and governance risks. Investors are increasingly looking to mitigate their exposure to the physical risks associated to climate change, in an effort to avoid real estate assets becoming stranded and asset value depreciation. These risks include flooding, overheating, water scarcity, storms and cold snaps.

But the benefits of ESG extend beyond the confines of mere risk avoidance. It can also lead to improved financial returns through greater operational efficiency, better stock price performance and enhanced reputational and asset value.

2) Regulators and governments are expanding their focus on ESG reporting.

In the UK most business will be obligated to report on their physical and transitional climate-related risks using the Task Force on Climate-related Financial Disclosures (TCFDs) framework by 2025. This surge in data availability will enable investors to make more informed decisions about the investments they make. The Black Rock chair Larry Fink summarised this simply in an annual letter to CEOs: ‘climate risk is investment risk’.

If developers and asset managers are to align with investor priorities, there is an imperative for them to actively minimise the climate-related risks their assets are (and will be) exposed to. The reward for this recalibration will be renewed investor and lender confidence in the long-term viability of assets, higher asset valuations and preferential lending rates.

3.) Financial decision-makers seek more sustainable solutions.

Increasing disclosure and public awareness of sustainability is impacting investor allocation and demands are being made of companies to take action. BlackRock surveyed 425 investors in 27 countries representing $25 trillion assets under management, finding 54% consider sustainable investing to be fundamental to investment process and outcomes.

Nature: the multifunctional solution to physical risk.

Historically, climate-related risks have been mitigated through grey infrastructure: typically expensive, singular in function and difficult to retroactively expand. However, the built environment industry is waking up to nature-based solutions as a multifunctional approach to climate adaptation whilst meeting wider ESG priorities. Along with many other benefits, they can reduce energy consumption, improve air quality, create social value and benefit  mental and physical health. These functions are otherwise known as ecosystem services.

Nature-based solutions were introduced towards the end of the 2000s by the World Bank and IUCN, and are defined by the European Commission as:

“Solutions that are inspired and supported by nature, which are cost-effective, simultaneously provide social, economic and environmental benefits and help build resilience. Such solutions bring more and more diverse, nature and natural features and processes into cities, landscapes and seascapes, through locally adapted, resource-efficient and systemic interventions.”

Put more simply, they are structures like green walls, green roofs, parks and Sustainable urban Drainage Systems (SuDS).

The financial value of ecosystem services in the UK is estimated at £958 billion according to The Office for National Statistics. Defra also predicts the value to increase over time due to:

• demand for the benefits heightening
• the impacts of climate change intensifying
• the user base increasing through population growth
• nature becoming scarcer in abundance and distribution

Nature’s value can be added to or subtracted from by organisations, however this interdependency is poorly understood. To better enable firms and financial institutions to understand their impacts on nature, a Taskforce on Nature-related Financial Disclosures (TNFDs) has been established. Spurred by the success of the TCFDs, the framework will provide the tools to identify, assess and report risks associated with nature. We will wait to see the impacts this has on the financial community and if it gains the weighting of the TCFDs.

Look out for part 2 coming soon…