TNFD framework game-changer for businesses, financial institutions to act on nature loss

TNFD framework game-changer for businesses, financial institutions to act on nature loss
24 / 09 / 2023
By Marwa Nassar - -

The framework and final recommendations of the Taskforce on Nature-related Financial Disclosures (TNFD) is seen as a game-changer offering a new pathway for businesses and financial institutions to act on nature loss.

“The Nature-related Financial Risks: a Conceptual Framework to guide Action by Central Banks and Supervisors of the TNFD”- published by the Network for Greening the Financial System (NGFS) – said the issuance of the TNFD final recommendations is a historic moment to encourage and support action on nature.

The groundbreaking framework enables companies to assess, disclose and manage nature-related risks and impacts which will lead to consistent and comparable reporting on nature-related risks and impacts by businesses and financial institutions worldwide.

The TNFD’s pragmatic and science-based framework is the result of the deployment of an open innovation approach, which encourages co-creation by market participants, iterations of market consultation and global pilot testing. It provides an integrated risk and opportunity assessment method – the LEAP approach for businesses and financial institutions to assess, monitor, disclose and report on nature-related risks, dependencies, impacts and opportunities, and is a great enabler for business, financial institutions and other investors to integrate nature into their financial and business decisions.

The final recommendations help businesses and financial institutions anticipate upcoming regulatory shifts as a result of the adoption of the Kunming-Montreal Global Biodiversity Framework (GBF). The disclosure recommendations are expected to improve transparency and accountability, therefore encouraging nature-positive actions. Moreover, as final recommendations from the TNFD are designed to mirror and complement the Task Force on Climate-related Financial Disclosures (TCFD), financial institutions that are already acting on climate risks can now use TNFD’s integrated approach to address nature-related financial risks at the same time.

As is widely acknowledged, nature is fundamental to human well-being, a healthy planet, and economic prosperity. Without always realizing it, humans depend on nature for food, medicine, energy, clean air and water, security from natural disasters, recreation, and cultural inspiration (among many other things). But human demands have exceeded the ability of the planet to provide such services, resulting in a degradation of nature and its diversity at unprecedented rates. For example, monitored wildlife populations have declined by an average of 69% since 1970, and the global rate of species extinction is tens to hundreds of times higher than it has been over the past 10 million years. Furthermore, numerous boundaries that maintain the resilience and stability of the Earth have been exceeded. This continued degradation poses a threat to well-being and, more fundamentally, to the planet’s habitability. In response, the Kunming-Montreal Global Biodiversity Framework (“GBF”) was adopted in 2022 with a set of goals and targets to halt and reverse biodiversity loss. Its overarching vision is for humans to live in harmony with nature by 2050. 23 targets are set for 2030 to achieve this vision.

The degradation of nature, and actions aimed at preserving and restoring it, will affect economies and financial systems.

Five main drivers of nature degradation have been identified, starting with the most impactful drivers at a global level; namely changes in land and sea-use; over-exploitation (i.e., extraction of living and non-living materials); climate change; pollution; and invasive alien species.

The GBF requires, among other things, the alignment of all financial flows by 2030 with its targets and goals. Based on the findings of a joint NGFS-INSPIRE study group, the NGFS has acknowledged that nature-related financial risks could therefore have significant macroeconomic implications, and that failure to account for, mitigate, and adapt to these implications is a source of risks relevant for financial stability. To effectively address these risks, the NGFS has set up a task force on Biodiversity Loss and Nature-related Risks (“Task Force”).

The NGFS Framework for nature-related financial risks (the “Framework”) adopts an integrated approach, meaning that climate-related financial risks are strongly interconnected with the broader environmental-related financial risks, and therefore considered within the scope of nature-related financial risks (without prejudice to the relevance of the NGFS’ work on climate).

The Framework seeks to create a common science-based understanding of, and language for, these nature-related financial risks among NGFS members. The aim is to provide greater clarity on the meaning of key concepts and the way these interrelate. It also contains a principle-based risk assessment framework to help operationalize that conceptual understanding. In this way, the Framework aims to help central banks and supervisors consider the relevant elements of nature-related financial risks and to develop policies and actions in respect of it, while taking into consideration their jurisdictional context.

Economic actors are not only exposed to nature-related physical and transition risks, via the negative impacts they have on nature, these actors also contribute to the risks they need to manage. That effect is not always symmetrical. Some businesses may have a large negative impact on nature but are not most directly and significantly exposed to the physical risks stemming from nature degradation. Instead, they increase physical risks for the system as a whole. Those activities that give rise to endogenous risks are also likely to be a source of transition risks, particular when the negative impacts attract the attention from policy makers, innovators, investors or consumers. The financial sector is not solely responsible for economic activities that exert negative impacts on nature, but it does play a role as enabler of economic activities. In this context, it should be noted that economic actors may also exert a positive impact on nature via their activities, e.g. by financing activities that contribute to the restoration of nature and thereby decreasing physical risks.

Negative nature-related economic effects:

In this regard, the report highlighted key nature-related economic effects, including the damage of assets arising from physical shocks and hazards such as flooding or landslides, changes in prices of commodities, energy or water that could create inflationary pressure, in addition new regulations or changing consumer preferences resulting in premature write-offs of assets, for instance because a factory is located in an area that becomes designated as protected.

The report also underlined effects on GDP from a diversion of investment or lower risk appetites for innovation, reduced labor productivity (e.g. as a result of heat or pollution), the loss of provisioning or regulating service productivity (e.g. affecting agriculture) or damage and disruptions to assets.

The report referred to the higher or more volatile prices of commodities due to, for instance, failed harvests of food crops as well as higher investment needs for mitigation or adaptation to prevent nature degradation and potentially accelerated depreciation of the current capital base.

The report also highlighted disruptions of production processes and value chains, referring to increases in costs as a result of temporary disruption to businesses or households processes, such as a suspension of services due to flooding.

The report also underlined the role of socio-economic changes in this regard, referring to effects from changing societal preferences, arising inequalities, migration or conflict.

Positive nature-related economic effects:

The report also highlighted the relocation and adjustment of economic activities which account for a reduction or loss of ecosystem services, or to reduce negative impacts, such as planting different crops on a farm.

It also underlined that changes to trade and capital flows may result from shocks in ecosystem service provision, potentially amplified via value chains, which affects exchange rates and sovereign credit ratings.

It also referred to cost increases as a result of pricing in negative (or positive) impacts on nature, for instance a tax on certain pollutants.

It added that lack of access to ecosystem services may necessitate an increase in social protection spending on, for instance, water or food. Losses in production and employment may also reduce fiscal revenues.

Based on feedback received and knowledge gained, the TNFD Framework will be refined and supplemented over time. In particular, before the end of its mandate in the first half of 2024, the Task Force aims to supplement the framework with illustrative case studies and evaluate – based on the case studies and progress made in the other Task Force teams – whether the Framework needs to be updated.

Some issues deserve particular consideration as part of this process; namely identifying relevant data, metrics, tools and examples to help NGFS members further operationalize the principle-based framework. In doing so, it may be possible to leverage on emerging global disclosure guidelines, frameworks and standards developed by, such as the TNFD and the International Sustainability Standards Board (“ISSB”).

Among these issues also is identifying which ecosystems and ecosystem services are likely to be most macro-financially critical given the size and location of dependencies, and which of those are at risk of decline/collapse (thereby taking into account the relevance of regional differences).

Another issue is considering more detail the linkages between climate change and broader nature degradation as well as the associated economic and financial risks, including opportunities to achieve an integrated identification, assessment and management of risk.

Moreover, the issue also includes exploring how to assess economic effects through value chains in order to capture a more complete picture of macro-financially relevant effects.

In accordance with the NGFS Statement on Nature-Related Financial Risks, the next task is to bridge modelling and data gaps that emerge from the Framework. One notable gap that already emerged is the need for scenarios to facilitate forward-looking risk assessments of nature-related financial risks. With that in mind, the Task Force has set up a team dedicated to scenarios that is working in parallel to develop a technical document with specific recommendations towards the development of such nature-related scenarios. In parallel, the Task Force will continue to explore how efforts to bridge data gaps – including via disclosure guidelines, frameworks and standards by stakeholders such as the TNFD and ISSB – may strengthen the Framework and its application.

The final task, as expressed in the NGFS Statement on NatureRelated Financial Risks, is using the Framework and emerging datasets to align policies with environmental sustainability and inform the assessment of nature-related financial risks. To support that effort, the Task Force will be collaborating closely with the four NGFS workstreams to recommend how nature-related financial risks could be integrated in their work plans.

At the same time, it is important to consider how the Framework could inform – and be made interoperable with – efforts of stakeholders beyond the NGFS such as regional and global standard setters (e.g., the Basel Committee on Banking Supervision (“BCBS”) and the International Association of Insurance Supervisors (“IAIS”). In the meantime, the Framework offers a common starting point for action across NGFS membership.

Considering the respective relevance of nature-related financial risks for their mandates, central banks and supervisors are encouraged to assess and – where relevant – act on economic and financial risks stemming from material dependencies and impacts on nature, and their nexus with climate change, on the basis of the Framework. While doing so, differences in mandate, capacity, experience and context should be taken into account. These differences not only inform the starting point, but can also enrich the understanding of nature-related financial risks and the spectrum of actions available to address them.

As a co-founder of the TNFD, UNEP FI played a key role in the establishment, development and finalization of the framework. Apart from providing technical support, as well as embedding and supporting high-level voices in the governance structure, such as that of TNFD’s co-Chair – Elizabeth Maruma Mrema, the UNEP FI has been one of the implementation partners of the TNFD pilot program for the financial sector, which allowed participating financial institutions to test the beta version of the TNFD framework and provide feedback, thereby ensuring the framework’s relevancy to the wider private financial sector.

While the framework is a voluntary one, adoption is expected from the private sector, as sustainability frameworks such as the TNFD will lead to greater market transparency through disclosures. The UNEP FI encourages governments, supervisors and regulators around the world to now play a crucial role in the uptake of the framework, as has happened with the TCFD and other international standards-setting bodies, such as the International Sustainability Standards Board (ISSB), which is looking at risks beyond climate.

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