October 01, 2022
Biodiversity Loss and the Implications for Investors
October 01, 2022
Biodiversity Loss and the Implications for Investors
October 01, 2022
Recent global droughts, fires and floods highlight the impact climate change can have on biodiversity. Europe is experiencing its worst drought in 500 years, whilst Pakistan is currently suffering devastating flooding—both have accelerated the loss in natural habitats. With society at large reliant on natural resources, biodiversity loss can have a devastating social and economic cost. Companies across many sectors are at risk due to their dependencies and impacts on natural resources. The evolution of the regulatory and policy environment over the coming months is likely to be key to defining the risks companies face when transitioning to more biodiversity-conscious operations and products. In the following piece, we discuss why investors should pay attention to companies’ impact on biodiversity loss and what they can do to drive positive change.
What exactly is biodiversity and why is it relevant to the economy?
From an economic standpoint, biodiversity is the variety of natural capital on the planet. It includes all living organisms, from trees, crops and wildlife to microbes and genes. These contribute to the economy through the provision of materials, such as food, wood or oil; and both regulate and support natural phenomena, such as water cycles, photosynthesis and climate.
Like climate change, biodiversity loss is a long-tailed risk, which can potentially have negative social and environmental consequences, and severely impact companies, and thus investors, financially. Estimates suggest that 75% of land and 40% of marine environments have been severely altered,1 whilst human demand is currently 1.7 times the resources available on the planet.2 In fact, as of 2022, biodiversity loss is one of the top-three global risks, according to the World Economic Forum,3 with more than half of the world’s economic output dependent upon nature and healthy ecosystems.
Estimates suggest that 75% of land and 40% of marine environments have been severely altered, whilst human demand is currently 1.7 times the resources available on the planet.
The key drivers of biodiversity loss on land, freshwater and ocean ecosystems vary and are wide-ranging, including land use change, resource exploitation, greenhouse gas (GHG) emissions, pollution and the emergence of invasive species. In addition, society at large relies on materials and stability provided from biodiversity, yet studies show that areas of the world experiencing extreme poverty are often rich in biodiversity and at highest risk of biodiversity loss, highlighting the need for inclusive solutions across the entire value chain (see Display 1).
Regulatory and policy pressures are defining the financial materiality of different biodiversity loss drivers. While the drivers are many and dependent on the ecosystem, we believe land use change resulting from global deforestation stands out as the most material for investors over the next one to three years.
The financial risks of biodiversity loss
Companies have different types of biodiversity dependencies. These may be linked to the ecosystem service that biodiversity offers, including the supply of resources that firms use as business inputs, as well as well-functioning ecosystems that ensure companies’ operational stability, such as water and air filtering, as well as the storing of carbon dioxide.
The pharmaceutical industry represents one of the most tangible examples of a high-dependency sector. 80% of the global population rely on plant-based traditional medicines for primary health care,9 and the industry relies heavily on nature for the manufacturing of medicines.10 The sector faces important physical risks, for example, the direct over-exploitation of resources, resulting in scarcity and increased costs; or pollution, resulting in lower productivity, which may lead to a potential slowdown of the sector’s innovation and growth over the long term.
Companies can also have a high impact on biodiversity. When it comes to mining, construction and energy, if not managed carefully, these industries may impact biodiversity negatively as a byproduct of their operations, for example, through over-exploitation of resources or water pollution.
Sometimes economic activities may both depend on and impact biodiversity, potentially creating even higher risks to a company. Food and agriculture companies, for example, rely on resources and ecosystem stability, both supported by biodiversity, yet they can also cause biodiversity loss through unsustainable land and agricultural practices. These companies are likely to face higher transition risks, for example, restricted market access due to changing regulatory environments, stranded assets from restricted land access, and litigation and reputational risks driven by increased stakeholder scrutiny.
The successful long-term transition of sectors with a high negative impact on biodiversity, “high impact sectors”, is key to ensuring long-term stability of the economy, especially for “high-dependency sectors”. For all sectors, including finance, avoiding exposure to financial risks caused by biodiversity loss, as well as understanding the interlink between climate change and biodiversity, is crucial.
It is our view that these risks will materialise as regulations and policies are defined, ultimately posing a serious threat to corporations that continue along the “business-as-usual” path. We believe that the coming six to 12 months will be critical to clarify the financial risks.
The UN Biodiversity Conference (COP 15) will attempt to create Paris Agreement-like momentum for nature this December.
On the brink? Biodiversity loss and investment implications
Regulations and policies related to biodiversity are on the rise. We believe 2022 may be a watershed year with respect to global efforts to reduce biodiversity loss and define the meaning of a nature-positive world.
The UN Biodiversity Conference (COP 15) will attempt to create a Paris Agreement-like momentum for nature this December. A tangible goal to protect biodiversity may be needed to set in motion public support for the issue and to help clarify the financial transition risks. However, a simple, defined target—similar to that of the Paris Agreement to limit global average temperature rise to 1.5°C above preindustrial levels—has yet to be established by the Convention. Indeed, given the multifaceted nature of biodiversity issues, multiple postponements of the COP and complex negotiations, there is a risk that a global goal could remain unarticulated. Although, there is hope that a detailed draft for a post-2020 global biodiversity framework could be ratified this year, at least in some form.13 Currently, markets are unable to price the risks of biodiversity loss with a high degree of confidence.
Commodities—why traceability is key to separating the wheat from the chaff
Governments, including the UK, U.S. and the EU, are tackling biodiversity through deforestation regulations with the aim of preventing, within their jurisdictions, the importation of commodities linked to deforestation. While details are yet to be finalised, stakeholders across markets are showing clear intent to move these regulations forward.
As regulations are released, we believe traceability, i.e. the ability to trace a commodity’s impact on deforestation throughout the value chain, will be key. If a company has good supply chain monitoring capabilities, then it is likely to be ahead of the curve. Conversely, those that cannot trace the commodity they require, could potentially be prevented from market access.
If deforestation regulation is phased in across commodities and jurisdictions (see Display 4), substitution effects could take place. In practice, substitution is complicated and time consuming. For example, palm oil, a crop linked to deforestation and other negative biodiversity impacts, offers large outputs, low prices and a unique fatty acid profile, providing neither an economic nor an environmental case for substitution in most cases. On the other hand, there is ample evidence that reformulating agricultural feedstock to include alternative crops, such as sunflower seeds in place of soybean, can be straightforward and economical.
Therefore, companies with dependence on palm oil, with good due diligence, may not be as negatively impacted by regulations. However, companies with higher dependence on soy may face more headwinds and greater transition risk.
Proactive engagement is critical
Despite the potential business risks, the complexity of biodiversity loss is delaying meaningful corporate action. Currently, there is no single metric guidepost, reporting is not standardised, and global commitments have been delayed consistently.
Despite efforts being made, businesses are generally unprepared to respond to potential upcoming regulations. In 2022, only 8% report that they can trace, with 100% certainty, the production unit of origin (i.e. to a plantation, farm, forest, etc.).13
We believe this creates a tangible opportunity for investors to proactively engage company management and drive change. While global policies and regulations are likely to ultimately require clarity, investors need to better understand how companies depend on and affect biodiversity.
The Global Balanced Risk Control (GBaR) team has introduced biodiversity as a key engagement topic, especially within the consumer staples sector, which includes many businesses with a high dependency, and impact, on biodiversity.
Through engagement, we seek to encourage companies to assess their reliance and impact on biodiversity whilst leveraging the Taskforce on Nature-related Financial Disclosures (TFND) framework, the leading industry standard. In addition, we aim to assess corporate risks and opportunities from deforestation, and encourage stronger commitments to end deforestation across all relevant commodities. Finally, we believe that companies would benefit from enhancing their due diligence process when assessing any commodity’s direct and indirect suppliers, and publicly disclosing their CDP17 Forest Report.
Biodiversity loss is a significant risk to the planet and to investors, with deforestation in particular being an issue with major consequences. Governmental regulation is in development, but without a catalysing “call to action” metric, companies are likely to be left building strategies in the dark. Despite being at an early stage in addressing this problem, there is a clear need for all stakeholders to contribute and help advance collective action. The GBaR team looks to be part of the solution, proactively engaging company management to help them understand the impact and costs of biodiversity neglect and to integrate sensible findings into their business strategies.
There is no assurance that the Strategy will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this portfolio. Please be aware that this strategy may be subject to certain additional risks. There is the risk that the Adviser’s asset allocation methodology and assumptions regarding the Underlying Portfolios may be incorrect in light of actual market conditions and the Portfolio may not achieve its investment objective. Share prices also tend to be volatile and there is a significant possibility of loss. The portfolio’s investments in commodity-linked notes involve substantial risks, including risk of loss of a significant portion of their principal value. In addition to commodity risk, they may be subject to additional special risks, such as risk of loss of interest and principal, lack of secondary market and risk of greater volatility, that do not affect traditional equity and debt securities. Currency fluctuations could erase investment gains or add to investment losses. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Equity and foreign securities are generally more volatile than fixed income securities and are subject to currency, political, economic and market risks. Equity values fluctuate in response to activities specific to a company. Stocks of small-capitalization companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Exchange traded funds (ETFs) shares have many of the same risks as direct investments in common stocks or bonds and their market value will fluctuate as the value of the underlying index does. By investing in exchange traded funds ETFs and other Investment Funds, the portfolio absorbs both its own expenses and those of the ETFs and Investment Funds it invests in. Supply and demand for ETFs and Investment Funds may not be correlated to that of the underlying securities. Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on the portfolio’s performance. A currency forward is a hedging tool that does not involve any upfront payment. The use of leverage may increase volatility in the Portfolio.
ESG Strategies that incorporate impact investing and/or Environmental, Social and Governance (ESG) factors could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. As a result, there is no assurance ESG strategies could result in more favorable investment performance.
Natural capital: The world’s stocks of natural assets which include geology, soil, air, water and all living organisms. https://www.cbd.int/business/projects/natcap.shtml
Biodiversity: The diversity of living organisms that make up natural capital.
CDP Forest Report: A means for companies to disclose and provide corporate environmental reporting. The CDP provides guidance on how to disclose in line with the TCFD recommendations. www.cdp.net/en/companies-discloser
Ecosystem Services: The principal framework for expressing the ‘usefulness’ of biodiversity is through the concept of ecosystem services. They illustrate the link between, on one hand, the interactions of species with each other and with the physical environment; and on the other, the well-being of people, whether in terms of wealth, nutrition or security. This definition is from the Convention on Biological Diversity (CBD), details of which are accessed here: www.cbd.int/undb/media/factsheets/undb-factsheet-ecoserv-en.pdf and www.framework.tnfd.global
Taskforce on Nature-related Financial Disclosures (TFND) framework: This is the leading industry standard, a framework for companies and financial institutions to integrate nature into decision making, and to report their risks and opportunities. www.tnfd.global/
There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.
A separately managed account may not be appropriate for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required.
For important information about the investment managers, please refer to Form ADV Part 2.
The views and opinions and/or analysis expressed are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time without notice due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively “the Firm”), and may not be reflected in all the strategies and products that the Firm offers.
Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors or the investment team. These conclusions are speculative in nature, may not come to pass and are not intended to predict the future performance of any specific strategy or product the Firm offers. Future results may differ significantly depending on factors such as changes in securities or financial markets or general economic conditions.
This material has been prepared on the basis of publicly available information, internally developed data and other third-party sources believed to be reliable. However, no assurances are provided regarding the reliability of such information and the Firm has not sought to independently verify information taken from public and third-party sources.
This material is a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision
Charts and graphs provided herein are for illustrative purposes only. Past performance is no guarantee of future results.
The indexes are unmanaged and do not include any expenses, fees or sales charges. It is not possible to invest directly in an index. Any index referred to herein is the intellectual property (including registered trademarks) of the applicable licensor. Any product based on an index is in no way sponsored, endorsed, sold or promoted by the applicable licensor and it shall not have any liability with respect thereto.
This material is not a product of Morgan Stanley’s Research Department and should not be regarded as a research material or a recommendation.
The Firm has not authorised financial intermediaries to use and to distribute this material, unless such use and distribution is made in accordance with applicable law and regulation. Additionally, financial intermediaries are required to satisfy themselves that the information in this material is appropriate for any person to whom they provide this material in view of that person’s circumstances and purpose. The Firm shall not be liable for, and accepts no liability for, the use or misuse of this material by any such financial intermediary.
This material may be translated into other languages. Where such a translation is made this English version remains definitive. If there are any discrepancies between the English version and any version of this material in another language, the English version shall prevail.
The whole or any part of this material may not be directly or indirectly reproduced, copied, modified, used to create a derivative work, performed, displayed, published, posted, licensed, framed, distributed or transmitted or any of its contents disclosed to third parties without the Firm’s express written consent. This material may not be linked to unless such hyperlink is for personal and non-commercial use. All information contained herein is proprietary and is protected under copyright and other applicable law.
This material is only intended for and will only be distributed to persons resident in jurisdictions where such distribution or availability would not be contrary to local laws or regulations.
MSIM, the asset management division of Morgan Stanley (NYSE: MS), and its affiliates have arrangements in place to market each other’s products and services. Each MSIM affiliate is regulated as appropriate in the jurisdiction it operates. MSIM’s affiliates are: Eaton Vance Management (International) Limited, Eaton Vance Advisers International Ltd, Calvert Research and Management, Eaton Vance Management, Parametric Portfolio Associates LLC, and Atlanta Capital Management LLC.
This material has been issued by any one or more of the following entities:
This material is for Professional Clients/Accredited Investors only.
In the EU, MSIM and Eaton Vance materials are issued by MSIM Fund Management (Ireland) Limited (“FMIL”). FMIL is regulated by the Central Bank of Ireland and is incorporated in Ireland as a private company limited by shares with company registration number 616661 and has its registered address at The Observatory, 7-11 Sir John Rogerson’s Quay, Dublin 2, D02 VC42, Ireland.
Outside the EU, MSIM materials are issued by Morgan Stanley Investment Management Limited (MSIM Ltd) is authorised and regulated by the Financial Conduct Authority. Registered in England. Registered No. 1981121. Registered Office: 25 Cabot Square, Canary Wharf, London E14 4QA.
In Switzerland, MSIM materials are issued by Morgan Stanley & Co. International plc, London (Zurich Branch) Authorised and regulated by the Eidgenössische Finanzmarktaufsicht (“FINMA”). Registered Office: Beethovenstrasse 33, 8002 Zurich, Switzerland.
Outside the US and EU, Eaton Vance materials are issued by Eaton Vance Management (International) Limited (“EVMI”) 125 Old Broad Street, London, EC2N 1AR, UK, which is authorised and regulated in the United Kingdom by the Financial Conduct Authority.
Italy: MSIM FMIL (Milan Branch), (Sede Secondaria di Milano) Palazzo Serbelloni Corso Venezia, 16 20121 Milano, Italy. The Netherlands: MSIM FMIL (Amsterdam Branch), Rembrandt Tower, 11th Floor Amstelplein 1 1096HA, Netherlands. France: MSIM FMIL (Paris Branch), 61 rue de Monceau 75008 Paris, France. Spain: MSIM FMIL (Madrid Branch), Calle Serrano 55, 28006, Madrid, Spain. Germany: MSIM FMIL (Ireland) Limited Frankfurt Branch, Große Gallusstraße 18, 60312 Frankfurt am Main, Germany (Gattung: Zweigniederlassung (FDI) gem. § 53b KWG). Denmark: MSIM FMIL (Copenhagen Branch), Gorrissen Federspiel, Axel Towers, Axeltorv2, 1609 Copenhagen V, Denmark.
Dubai: MSIM Ltd (Representative Office, Unit Precinct 3-7th Floor-Unit 701 and 702, Level 7, Gate Precinct Building 3, Dubai International Financial Centre, Dubai, 506501, United Arab Emirates. Telephone: +97 (0)14 709 7158).
NOT FDIC INSURED | OFFER NO BANK GUARANTEE | MAY LOSE VALUE | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY | NOT A BANK DEPOSIT
Latin America (Brazil, Chile Colombia, Mexico, Peru, and Uruguay)
This material is for use with an institutional investor or a qualified investor only. All information contained herein is confidential and is for the exclusive use and review of the intended addressee, and may not be passed on to any third party. This material is provided for informational purposes only and does not constitute a public offering, solicitation or recommendation to buy or sell for any product, service, security and/or strategy. A decision to invest should only be made after reading the strategy documentation and conducting in-depth and independent due diligence.
Hong Kong: This material is disseminated by Morgan Stanley Asia Limited for use in Hong Kong and shall only be made available to “professional investors” as defined under the Securities and Futures Ordinance of Hong Kong (Cap 571). The contents of this material have not been reviewed nor approved by any regulatory authority including the Securities and Futures Commission in Hong Kong. Accordingly, save where an exemption is available under the relevant law, this material shall not be issued, circulated, distributed, directed at, or made available to, the public in Hong Kong. Singapore: This material is disseminated by Morgan Stanley Investment Management Company and should not be considered to be the subject of an invitation for subscription or purchase, whether directly or indirectly, to the public or any member of the public in Singapore other than (i) to an institutional investor under section 304 of the Securities and Futures Act, Chapter 289 of Singapore (“SFA”); (ii) to a “relevant person” (which includes an accredited investor) pursuant to section 305 of the SFA, and such distribution is in accordance with the conditions specified in section 305 of the SFA; or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This publication has not been reviewed by the Monetary Authority of Singapore. Australia: This material is disseminated in Australia by Morgan Stanley Investment Management (Australia) Pty Limited ACN: 122040037, AFSL No. 314182, which accept responsibility for its contents. This publication, and any access to it, is intended only for “wholesale clients” within the meaning of the Australian Corporations Act. Calvert Research and Management, ARBN 635 157 434 is regulated by the U.S. Securities and Exchange Commission under U.S. laws which differ from Australian laws. Calvert Research and Management is exempt from the requirement to hold an Australian financial services licence in accordance with class order 03/1100 in respect of the provision of financial services to wholesale clients in Australia.
Taiwan: This material is provided for information purposes only and does not constitute a solicitation where such a solicitation is unlawful. The products mentioned herein this material may or may not have been registered with the Securities and Futures Bureau of the Financial Supervisory Commission in Taiwan, Republic of China (“ROC”) pursuant to relevant securities laws and regulations. Such products may only be made available in the ROC if they are (a) registered for public sale in the ROC or (b) availed on a private placement basis to specified financial institutions and other entities and individuals meeting specific criteria pursuant to the private placement provisions of the ROC Rules Governing Offshore Funds.
Korea: This material is not, and under no circumstances is to be construed as an offering of securities in Korea. No representation is being made with respect to the eligibility of any recipients of this material under the laws of Korea, including but without limitation, the Foreign Exchange Transaction Law and Regulations thereunder. The Fund’s mentioned herein this material may or may not have been registered with the Financial Services Commission of Korea under the Financial Investment Services and Capital Markets Act and may not be offered directly or indirectly, in Korea or to any resident of Korea except pursuant to applicable laws and regulations of Korea.
Japan: For professional investors, this document is circulated or distributed for informational purposes only. For those who are not professional investors, this document is provided in relation to Morgan Stanley Investment Management (Japan) Co., Ltd. (“MSIMJ”)’s business with respect to discretionary investment management agreements (“IMA”) and investment advisory agreements (“IAA”). This is not for the purpose of a recommendation or solicitation of transactions or offers any particular financial instruments. Under an IMA, with respect to management of assets of a client, the client prescribes basic management policies in advance and commissions MSIMJ to make all investment decisions based on an analysis of the value, etc. of the securities, and MSIMJ accepts such commission. The client shall delegate to MSIMJ the authorities necessary for making investment. MSIMJ exercises the delegated authorities based on investment decisions of MSIMJ, and the client shall not make individual instructions. All investment profits and losses belong to the clients; principal is not guaranteed. Please consider the investment objectives and nature of risks before investing. As an investment advisory fee for an IAA or an IMA, the amount of assets subject to the contract multiplied by a certain rate (the upper limit is 2.20% per annum (including tax)) shall be incurred in proportion to the contract period. For some strategies, a contingency fee may be incurred in addition to the fee mentioned above. Indirect charges also may be incurred, such as brokerage commissions for incorporated securities. Since these charges and expenses are different depending on a contract and other factors, MSIMJ cannot present the rates, upper limits, etc. in advance. All clients should read the Documents Provided Prior to the Conclusion of a Contract carefully before executing an agreement. This document is disseminated in Japan by MSIMJ, Registered No. 410 (Director of Kanto Local Finance Bureau (Financial Instruments Firms)), Membership: the Japan Securities Dealers Association, The Investment Trusts Association, Japan, the Japan Investment Advisers Association and the Type II Financial Instruments Firms Association.
FOR USE ONLY WITH “PERMITTED CLIENTS” UNDER CANADIAN LAW. MAY NOT BE USED WITH THE GENERAL PUBLIC. This presentation is communicated in Canada by Morgan Stanley Investment Management Inc. (“MSIM”), which conducts its activities in Canada pursuant to the international adviser exemption from the Canadian adviser registration requirements. This presentation does not constitute an offer to provide investment advisory services in circumstances where the investment adviser exemption is not available. MSIM may only advise separately managed accounts of “Permitted Clients” and may only manage accounts which invest in non-Canadian issuers. “Permitted clients” as defined under Canadian National Instrument 31-103 generally include Canadian financial institutions or individuals with $5 million (CAD) in financial assets and entities with at least $25 million (CAD) in net assets. Permitted Clients may only invest in a separately managed account referenced in this presentation by entering into an investment management agreement with MSIM, of which this presentation is not a part. Materials which describe the investment expertise, strategies and/or other aspects of MSIM-managed separately managed accounts may be provided to you upon request for your consideration of the available investment advisory services offered by MSIM. MSIM and certain of its affiliates may serve as the portfolio manager to separately managed accounts described in this presentation and may be entitled to receive fees in connection therewith.