The financial sector is taking an increasingly negative view on companies that have an adverse impact on biodiversity and climate change as it has become a crisis. Moody’s has seen the focus grow from policy makers and investors on supra national and national levels and has taken up the initiative itself.
- Moody’s highlights nature-related risks as a previously overlooked area of debt rating that it has now taken on.
- It is another financial actor nailing its colours to the movement that calls out the negative rating of environmentally damaging economic activity.
- Measurements to rate natural capital are highly complex and opaque but that is not dispelling Moody’s from joining the effort.
Moodys has produced a report communicating its approach to natural capital risk.
Natural capital refers to the assets of the natural world and biodiversity lies at its heart – the many diverse forms of life that are essential for sustaining healthy ecosystems. It cites the World Economic Forum report that more than half of the world’s economic output – $44 trillion of economic value generation – is dependent on nature. The research provides compelling evidence of the extent to which the economy depends on nature and its services.
Despite the difficulties of quantifying natural capital risk, Moody’s has chosen to integrate it in its screening after seeing both investors and policy makers take an increasingly stronger view on nature-related risks as biodiversity loss intensifies. It noted the European Parliament’s approval of regulation on deforestation-free products.
It expects that with the growing movement towards disclosure, investors will be able to value and account for their use of natural capital.
Debt risk of exposed sectors
In its analysis, it has identified $1,884 billion in combined debt from sectors that face high or very high inherent exposure to natural capital that it posits may lead to material financial costs for these companies.
Oil and gas, independent exploration and production companies have $365 billion in exposure. Oil and gas oilfield services companies $141 billion, mining metals and other materials excluding coal $258 billion, coal mining and coal terminals $10 billion.
On the other side of the coin are sectors that are damaged by biodiversity loss and climate change. The food and agriculture sector, which it calls protein and agriculture, is a major contributor to biodiversity loss but also has the greatest dependency on healthy ecosystems. Its material exposure is quantified at $52 billion.
Risk screening categories
Moody’s applies its risk screening to ‘nature’s four realms: land, oceans, freshwater and atmosphere.’
Its Natural Capital strategy is focused on preserving and restoring biodiversity. Areas of governance it will rate include: restoring a forest/ soil/ biodiversity damaged as a result of mining, not killing fish at hydroelectric dams, forest clearance for cattle feed agriculture, pulp/paper company sustainability, oil drilling in environmentally sensitive areas, palm oil deforestation in Malaysia/ Indonesia, impacts on coral reefs. All decommissioning activities will come under the natural capital assessment.
Complexity and scarcity in measuring nature-related risks
There is no simple metric like using the tonne of carbon dioxide equivalent removed for climate change. On the contrary conditions are context specific, and the complexity in defining metrics is overwhelming.
The Taskforce on Nature-related Financial Disclosures identified over 3,000 metrics on a landscape assessment for pilot testing. Moody’s is looking to the Taskforce on Nature-related Financial Disclosures, whose stated goal is to support a shift in global financial flows away from nature-negative outcomes and toward nature-positive outcomes to provide a meaningful and consistent framework.
Disclosure, being voluntary, is scarce and fragmented and linking financial outcomes to these metrics is very limited currently. Where companies provide verified, quantifiable, consistently reported data that enables direct comparisons of issuers, then quantitative analysis can be applied but otherwise Moody’s will use largely qualitative analysis at this stage.
New risk asset class
Climate change represents a new type of risk for finance. On a supra national scale the Network for the Greening of the Financial System (NGFS) urges investors to disclose and assess climate risks. Companies with negative impacts on land, forests, and water will come out with a negative score.
Asset managers that have taken on net zero commitments are beginning the process of screening companies against climate change and nature risks. Taking action to divest of such companies is not yet wholly there. Banks have not wound down their exposure to climate-related risks. Once the debt risk becomes clearer and more spelled out, as Moody’s has started to do, then the push to disassociate will become stronger.
More than 90 civil society organisations called for the identification and mitigation of biodiversity and climate risk to be included within the primary mandates of central banks and financial supervisors. Their call was heeded by a group of major global financial institutions urging finance ministers to commit to significant biodiversity commitments.