What are nature risks?

A short guide on the analytics and categories of nature risks

Managing nature risks has become an important yet thorny area to navigate for organizations.  As drastic anthropogenic changes made natural catastrophes omnipresent, many companies are starting to assess environmental risks on operations and supply chains. In the insurance industry, specialists like Descartes and Kettle started to offer specialized insurance services for corporate clients while players in industries ranging from fashion to food are actively reviewing operations for both required disclosures and mitigation. We have compiled a few frequently asked questions on nature risks below.  We will continue to explore this area in more detail in future posts.

How are nature risks defined?

Nature risks refer to potential threats to organizations or society arising from dependencies and impacts  on natural assets, such as biodiversity and ecosystems. The most prominent natural risks are from natural disasters that result in catastrophic losses like wildfires and floods. These are inherent environmental risks that have become more volatile over time and can affect the wellbeing and operation of business and communities.

For companies operating in the EU, natural risks also have compliance implications. Due to EU regulations such as the Deforestation Act, companies are required to report on biodiversity loss and collect data needed for meeting regulatory disclosures starting in 2024. The regulatory risks highlight the trends for increasingly stringent requirements for companies to delineate the positive and negative environmental impacts across their value chains. Across the pond,California’s AB-1305 requirement is an early precursor of this type of disclosure, which requires Californian companies to disclose information behind net zero emissions, carbon offsets, and sales of voluntary carbon offsets.

In terms of compliance reporting needs, what type of company data are needed for reporting nature risks? 

Most required data are sourced directly from companies’ operations (i.e. supply chains). For example, CSRD requires companies to provide ESG disclosure (through standards like ESRS and ESRS E4). To be compliant, companies are expected to provide action plans, targets, policies, and resources relating to the company’s biodiversity and ecosystem management programs. Data relating to species, impact, and dependencies on ecoservices are highlighted as reporting requirements. European firms have started to devise baseline estimates relating to biodiversity and ecoservice impacts that cover impact on biodiversity loss, states of species, impacts on natural ecosystem conditions, as well as dependencies on ecosystems.

How  are nature risks currently classified?  

There is no shortage in environmental data. The main challenge is to create holistic and reliable measures for biodiversity and other core SDG impact areas. UNEP proposed a risk profiling methodology that focuses on both nature impacts and dependencies of companies/organizations. The methodology will move toward accounting for double materiality. This concept refers to the fact that a company’s actions in nature may not only negatively affect their own operations, but also external stakeholder groups like indigenous peoples.

Dependencies, as defined by TNFD, are aspects of ecosystem services that an organization relies on to function. This includes activities like ensuring water supply and managing natural disaster impacts such as fires, floods and the sequestration of carbon. These dependencies are most apparent in areas of supply chain management, where natural disasters or lack of certain natural resources have negative impacts on business continuity.

Nature impact risks are defined as changes in states of nature that change the capacity of the environment to provide socio and economic functions. Impacts can be direct, indirect or cumulative. The negative impacts of organizations on the environment face regulatory risks for the businesses. Classifying impacts and dependencies allows organizations to mitigate risks as well.

Methodology for Profiling Nature Related Risks

Source: UNEP Nature Risk Profile

The UNEP risk methodology referenced TNFD‘s risk framework, which helps companies incorporate nature risks and opportunities into strategic planning, risk management and asset allocation decisions. TNFD especially identifies four social dimensions covering human rights, indigenous peoples, access/benefits sharing, and social justice/just transition. 

How are nature risks quantified? 

Analysis varies depending on risk driver types. Common impact drivers for biodiversity losses include state of species, impact on ecosystem conditions,  and dependencies on ecosystem services are metrics that can be quantified. Since nature risks often touch on multiple areas of an ecosystem, the use of hybrid systems, combining system-dynamics and agent-based models for capturing the cause-and-effect relationships, together with ML/AI for integrating large volumes of available data and capturing correlations and complex patterns, can provide decision support for organizations looking to assess more complex and second order impacts. Increasingly, businesses and investors need to access comprehensive nature related data as well as comparable and meaningful analytics methods to screen operations and portfolios for nature risks.

What are some examples of effective nature risk metrics? 

ETH Zurich’s Crowther Lab’s SEED biocomplexity index is a good example. SEED’s biocomplexity index quantifies the full extent of genetic, species, and ecosystem diversity, as well as measuring variation through time. Organizations can create multidimensional biocomplexity assessments on their “nature portfolios”, where  1 indicates natural level of biodiversity and 0 is the worst score in terms of maintaining biodiversity.

Source: ETH Zurich

Accountability = Increased Climate Financing Flow

The importance of devising sound nature risk metrics is highlighted by the lack of accountability in human production. According to UNEP, while the globally produced capital increased by over 90% from 1992 to 2014, natural capital decreased by over 30% (Dasgupta 2021). The reduced investment in maintaining the natural ecosystem called for wider and more rigorous use of nature risk metrics. 

Increased government and consumer interest in biodiversity and other aspects of nature capital and ecosystems also signifies increased scrutiny and the need for accountability.  Ultimately, a more widely adopted nature risk taxonomy would enable greater financing flow into a more balanced natural capital system.