8 minute read 27 Jan 2023
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How data can support financial services when assessing nature impact

Authors
Gill Lofts

EY Global Financial Services Sustainable Finance Leader

Passionate about creating a legacy in the financial services industry. Proud mother of two daughters.

Mike Zehetmayr

EY EMEIA Financial Services Risk, Compliance and Regulatory Technology Leader

Leader in understanding the application of data in transition to a low carbon and sustainable economy. Fellow of the Royal Geographical Society.

8 minute read 27 Jan 2023
Related topics Financial Services Sustainability in Financial Services COP Sustainability Climate change and sustainability
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Financial institutions need to start assessing their exposure to nature, but with market data still evolving, there are many factors to consider.

In brief
  • Nature impacts have the potential to be more financially material than climate risks.
  • Data to assess nature risk is nascent; new tools, datasets and guidance will be critical to ensure data quality and reporting standards.
  • Financial institutions should start by identifying the most material parts of their portfolios in preparation for more granular assessments.

More than half of the world’s gross domestic product is moderately or highly dependent on nature and its services, and a fifth of countries worldwide risk ecosystem collapse. Nature loss and ecosystem degradation dramatically increase the likelihood of severe loss events, thus amplifying the need for financial institutions to incorporate nature in their risk management.

Last year, we released our Waking up to nature – the biodiversity imperative in financial services (pdf) report, highlighting the need to address nature risk in financial services. Since then, we have seen increased consumer expectations and greater integration and adoption of nature from regulators and industry bodies. The World Economic Forum and 90 other organizations have urged central banks and financial supervisors to consider nature-related financial risks as part of their primary mandates, all of the G20 participants back action to halt nature loss by 2030 and we have seen the introduction of The Taskforce on Nature-related Financial Disclosures (TNFD), a risk management and disclosure framework that we expect will form the basis for future mandatory reporting.

Starting point

Nature collapse offers significant risk to the financial sector. To understand these risks, financial institutions will need to assess their impact. The first step is identifying a starting point for these assessments.

There are three things to consider:

1. The most material sectors in relation to the financial institution
2. Sectors with high nature impact and dependencies
3. The sectors that have good availability of data

These points will help financial institutions prioritize their initial efforts.

Once the first two points have been considered, financial institutions will face the challenge of finding data that helps to calculate the impact of material sectors. Firms will need to identify what metrics are required for sector-level nature assessment, then there will need to be an assessment of what data is currently available to the business and where there are data gaps. Where gaps are apparent, financial institutions will need to find external data providers that can help provide real or estimated data to address those gaps.

The TNFD provides guidance on how to approach nature assessments and the opportunity for financial institutions to participate in piloting the framework to prove out the process and identify any challenges in advance of submitting full disclosures.

EY is proud to support the important work of the TNFD. Improving the standards on nature-related disclosures and increasing their integration with core financial investments will help investors support a greener economy, and for organizations to shape their biodiversity strategies and provide long-term value creation for people and our planet.

Those who are taking part in TNFD pilots, are typically focusing on a very small portion of their financing activities and are partnering with other organizations to support them with data collection.

In the section below, we outline the different types of data providers and tools which can address data gaps to help with TNFD pilot assessments.

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Where does the data currently exist?

Our research suggests that assessment tools are both disparate in nature and in a relatively juvenile state. No single provider offers the same service or uses the same methodology. Different providers may therefore need to be used for different purposes, e.g., sector nature impact and dependency mapping, project finance, and supply chain analysis.

Site-specific data

Site-specific data, using satellite and other remote sensing techniques or eDnA can be readily deployed at large-scale to capture a significant quantity of data across land usage. The captured data can be useful for analyzing the impact that project finance or land intensive portfolios - such as agriculture - can have on surrounding nature. It also allows a deeper understanding of the nature impact, which in turn enables more informed decision making. However, gathering the data depends on the extent of ownership the financial institution has, and reflects their ability to influence through engagement.

Earth system modeling

There is extensive academic research on nature, which has been leveraged by NGOs and data providers to build earth-systems models that measure global nature impacts and can also be extended to both climate and social impact. Most data providers model a single dimension of nature, such as species or deforestation, with only a few notable providers covering a range of dimensions and their correlations. Although some of these models can be used to map sectors to their nature impacts and dependencies, more granular assessments would involve financial institutions attributing risk exposure to the specific companies and business activities they are financing. In order to attribute this risk, we require asset location data to be overlaid onto earth system models. Therefore, these tools are deployable where a financial institution has asset location data (e.g., retail mortgage portfolios) or for sectors where this data is available (e.g., utilities).

Some data providers are expanding their asset location databases, but these tend to be focused sectors, such as utilities and mining. Apart from these sectors, coverage is not yet broad enough to perform risk and impact assessments across entire portfolios.

Supply chain tools

A large portion of nature exposure resides in a company’s supply chain. Therefore, some providers focus specifically on assessing risks in the supply chains. These tools are readily deployable and map economic activity throughout the supply chain to reveal impacts on nature. Each inherently has its own qualities, some using proxy data to make estimations while others utilize a combination of public data and primary research. However, these tools only cover limited indicators and do not assess all material impacts on nature which may be apparent in the supply chain.

Data limitations and direction of travel

Data availability

While disclosures and therefore availability of nature assessments at an entity level is currently low, finalization of TNFD recommendations and guidance on disclosure metrics (September 2023) is expected to drive further disclosure and greater availability of data. There will likely be a time lag before company specific data is available for portfolio-level assessments. Once the TNFD is finalized, financial institutions should begin to engage with corporates to help drive the assessment and disclosure of their nature impacts in line with the guidance.

In the interim, financial services institutions can use the data that is available to build a directional understanding of their exposures in preparation for more granular assessments in the future.

Data useability

The challenge is not only about data availability, but also how it is interpreted for useful decision-making. By using existing data, financial institutions can assess their initial exposure to nature. The output from these assessments can provide useful information that highlights nature exposure across portfolios and enables better understanding for more accurate decision-making to reduce risks.

As data availability improves, financial institutions can start to test their portfolios under different scenarios, which will provide more granular information on their nature exposure. However, physical nature risks are more complex than climate to model because of the multiple, correlated dimensions (i.e., soil erosion, deforestation, urbanization, water quality and species), as well as their interdependency with climate, for which modeling is already difficult, since it is an area where the science is constantly evolving. Therefore, requisite tools and data are likely to take longer to develop than for climate. Understanding the full picture would also likely require integrating nature and climate models. The market is not yet mature enough to do this.

Furthermore, nature transition risk modeling is driven by economic, policy and technology factors. Regulatory policy for nature is not yet clearly defined, and nature-based solutions are not well established.

Data Management for ESG and nature

Our observation of the market shows that ESG data is not often being integrated or managed in a strategic way, with data sourced and governed in a distributed manner. The addition of nature data adds more complexity and potential further risk of error and inconsistency. By taking this fragmented approach, financial institutions risk building silos of data which may limit their ability to reconcile their progress against ESG commitments.

ESG is expected to continue to become more tightly regulated, with mandatory assurance on ESG disclosures. Therefore, financial institutions should start to build a strategic approach to ESG data management while data needs and sources are still relatively small. This will provide the requisite governance, traceability and auditability that enhanced regulation will require. Conversely, there is a risk of significant cost and time commitment to retrospectively apply such a data strategy to a growing set of ESG data use cases. Additionally, there is significant risk of misrepresentation of sustainable products, lending or in regulatory disclosures e.g., EU Taxonomy.

Summary

Many questions arise around upcoming regulations and market frameworks for nature. As financial institutions have a material impact on nature and are materially dependent on ecosystem services, they need to assess their exposure. This may be difficult due to data restrictions in a market where data is still evolving. However, financial institutions can start by identifying the most material sectors to their portfolios, identifying which of these sectors have high nature exposure, and determine which sectors have good availability of data. These actions will kickstart their nature journey and prepare for more granular assessments.

About this article

Authors
Gill Lofts

EY Global Financial Services Sustainable Finance Leader

Passionate about creating a legacy in the financial services industry. Proud mother of two daughters.

Mike Zehetmayr

EY EMEIA Financial Services Risk, Compliance and Regulatory Technology Leader

Leader in understanding the application of data in transition to a low carbon and sustainable economy. Fellow of the Royal Geographical Society.

Related topics Financial Services Sustainability in Financial Services COP Sustainability Climate change and sustainability
Upvote