Investment Association                               CAP0005

Written evidence submitted by the Investment Association

Environmental Audit Committee inquiry into the role of natural capital in the green economy

About the Investment Association

1. The Investment Association (IA) champions UK investment management, a world-leading industry which helps millions of households save for the future while supporting businesses and economic growth in the UK and abroad. Our 250 members range from smaller, specialist UK firms to European and global investment managers with a UK base. Collectively, they manage £10trn for savers and institutions, such as pension schemes and insurance companies, in the UK and beyond.

2. As investors, we see it as part of our fiduciary duty and in the interest of our clients, to help achieve an orderly transition to a net zero economy. The IA is proud to support the Net Zero Asset Managers initiative and to date investment managers responsible for three-quarters of assets under management in the UK have made this net zero commitment. The IA, representing the UK-based investment management industry, is committed to climate action and we produce an annual climate change plan, which outlines our commitments and actions we plan to take as an industry.[1]

Summary

3. The global “biodiversity financing gap” – the difference between current spending and what is needed for biodiversity conservation – was estimated at $598bn to $824bn in 2020. A measure of the potential for private capital investment in nature recovery might be taken from the current level of commitment to net zero and biodiversity commitments. Some initiatives, such as the Net-Zero Asset Owner Alliance and the Finance for Biodiversity Pledge, seek to address carbon emissions and biodiversity loss through stewardship of existing investments and acknowledge the scale of economic value which currently depends on natural resources.

4. Investment managers can consider natural capital in their investments in various ways, such as: allocating funds to projects that benefit nature, considering an investment’s impact on natural capital when assessing its risks and long-term sustainability, and engaging with companies to raise awareness and encourage them to factor in natural capital in their decisions. To attract private sector investment to achieve the Government’s environmental targets, policymakers also need to consider how these targets align with financial risk factors and might provide returns for companies and investors.

5. Investors face potential barriers to investing directly in natural capital projects. One barrier is the failure to price the benefits (including avoided costs) from nature, which makes it hard to generate financial returns from natural capital investments. Another barrier is the small scale of many natural capital projects, which makes them unattractive for large institutional investors. A third barrier is the lack of standardised data, which prevents measuring the impact of investments and reporting it accurately. To grow these markets, it is necessary to provide more reliable returns to investors, increase the scale of natural capital projects, and improve the supply of comparable data.

6. Investors increasingly consider sustainability as it can give insight into the long-term value of investments. They need financial reports to give them a complete and coherent understanding of a company and its prospects, including how it relates to nature. The Government plans to consult on a UK Green Taxonomy this autumn, based on the advice of the Green Technical Advisory Group (GTAG). Investors will support the aim of establishing high-quality standards and disclosures for green finance activity. However, the UK Green Taxonomy is not the only initiative for sustainability information. There are also other global taxonomies, such as the EU Taxonomy, and the UK Sustainability Disclosure Standards (UK SDS), which will be based on the International Sustainability Standards Board (ISSB) standards. The UK must ensure that these initiatives are coherent, consistent, and aligned with global markets.

7. Climate change policy has clear objectives: to limit the global temperature rise and achieve net zero emissions. These are agreed in international treaties and domestic policies and while organisations may differ on their roles and responsibilities, the objective is clear. Biodiversity objectives can be less clear. There are treaties, laws, and initiatives, but these are not always aligned or consistent. This may confuse or burden global investors and companies.

8. To stimulate investment in natural capital, it may help to focus on threats which are financially material to business and where a real-world impact can also be achieved. This also needs data that measures these impacts clearly and consistently, but nature-related data can be inconsistent, irregular, or inaccessible.

9. UK investment management is a global leader, managing £10trn, the second largest in the world. Nearly half of UK-managed assets (£4.6trn) are for overseas savers, mostly in Europe. UK-based investment managers invest globally but could benefit from a UK natural capital market with scale, integrity, and data. The UK has led in natural capital and sustainability standards. It has backed the TNFD and the ISSB, which will include nature in their frameworks and standards. The UK should keep supporting these initiatives and help set coherent international standards for natural capital investment.

10. A challenge remains to build momentum behind the Kunming-Montreal Global Biodiversity Framework, and better communicate the biodiversity transitions through which global policymakers wish to make the economy nature-positive. The UK should seek to take a global role in articulating the form these transitions will take, how we should assess their success, and what data exists to measure them. 

What potential contribution can private capital investment make to measures to secure nature recovery?

11. In 2020, researchers estimated that the gap between the amount currently spent on biodiversity conservation and what is needed globally (the “biodiversity financing gap”) was between $598bn and $824bn. Using the latest available data (from 2019) the researchers found that current spending on biodiversity conservation was between $124bn and $143bn each year.[2]

12. A measure of the potential for private capital investment in nature recovery might be taken from the current level of commitment to net zero and biodiversity commitments. For example, the Net-Zero Asset Owner Alliance (NZAOA) reports that its 86 members – all institutional investors – are responsible for $11trn in assets under management.[3] NZAOA is a member-led initiative focused on transitioning investment portfolios to net zero greenhouse gas (GHG) emissions and the net zero transition will have a significant focus on decarbonising heavily emitting industries, but it is also likely that these institutional investors will consider the co-benefits of investment in nature recovery. Academic researchers have estimated that about 30% of the climate mitigation needed to deliver on the Paris Agreement’s temperature target could feasibly and sustainably be drawn from measures related to agriculture, forestry, wetlands and bioenergy.[4]

13. Another initiative, the Finance for Biodiversity Pledge, claims 140 financial institution members responsible for nearly €20trn in assets. The pledge commits financial institutions to engage with companies on their biodiversity impacts, to assess positive and negative impacts, to set targets for improvement and to make public disclosures. The pledge also places an emphasis on asking global leaders to take action to reverse nature loss.[5]

14. Approaches such as the above, which seek in part to address GHG emissions and biodiversity loss through stewardship of existing investments, acknowledge the scale of economic value which currently depends on natural resources. It is consistent with the findings of the World Economic Forum that more than half of total global GDP ($44trn) was moderately or highly dependent on nature and its services. The three largest dependent sectors (and their gross valued added/GVA) are construction ($4trn), agriculture ($2.5trn), and food and beverages ($1.4trn).[6] These sectors can be considered the most exposed to risks related to nature loss and have the potential to be at the forefront of any contribution of private capital investment to aid nature recovery.

15. There will always be an important role for public finance and philanthropic funding to support biodiversity, but by fostering the right conditions it should be possible to harness the ambitions of institutional investors to help close the biodiversity financing gap.

How can investment best be aligned with environmental benefits, so as to achieve or surpass the Government’s targets for nature recovery?

16. Institutional investors (such as pension funds, insurance companies and charitable endowments) will often employ the services of investment managers to look after their investment portfolios. Investment managers have identified a number of ways in which they can take account of natural capital in their investments. These include making a specific allocation to projects that establish, preserve, protect, and enhance nature, incorporating an investment’s impact on natural capital when assessing its risks and long-term sustainability, and engaging with companies in which they are invested to increase awareness of the companies’ impacts on nature and encourage them to build consideration of natural capital into their decision-making processes.[7]

17. The committee is right to focus on environmental benefits and how to achieve the Government’s environmental targets. Should policymakers wish to achieve these targets with private sector investment, it will also be necessary to consider how pursuit of these targets can be aligned with financially material risk factors for companies and offer an acceptable expected financial return for institutional investors.

18. Investors have highlighted potential barriers to investment directly in natural capital projects. A current failure to adequately price the benefits (including avoided costs) that goods and services gain from nature makes it difficult to draw financial returns from natural capital investments. Of the total that is estimated to be spent on biodiversity conservation each year ($124bn-$143bn), it is further estimated that just 14-20% comes from private sector finance and a smaller portion still of this total is from private investors seeking a market-rate return. A survey conducted of public and private investors by the Coalition for Private Investment in Conservation (CPIC) found that 92% of the investments which were reported to researchers were made in the expectation of market-rate returns.[8] In order to grow these markets, it will be necessary to more reliably provide a return to investors.

19. Many natural capital projects are also regarded by investors as being too small in scale to attract significant levels of institutional investment. The average UK forestry transaction in 2022 was £3.4mn and total commercial forestry transactions in the same year were estimated to have been approximately £195mn.[9] For investment managers and asset owners responsible for investing portfolios worth billions of pounds, such sums are generally regarded as too small since they will need to allocate considerable resources to analyse each project. Even where an investor does feel able to include such assets in their portfolio, the sums available in which to invest are still way short of the total it is estimated that would be required to close the biodiversity financing gap.

20. Lastly, investment managers identify the lack of standardised data as a potential barrier to investment in natural capital as it prevents the aggregation of investment data needed to measure impact. To overcome the lack of standardised data and report accurately to clients, investment managers would be required to invest significant resource. 70% of respondents to CPIC’s survey stated that the high cost of measuring impact acted as a barrier to investment. To better align investment with the Government’s environmental targets, it will be necessary to improve the supply of reliable and comparable data.

How can the proposed UK Green Taxonomy support high-quality investments which deliver genuine benefits to nature? What financial disclosures should the taxonomy require?

21. As stated above, investment managers can support natural capital investment by assessing any investment’s biodiversity risks and long-term sustainability, and by engaging with companies in which they are invested to increase awareness of impacts on nature and encourage consideration of natural capital in decision-making. Sustainability considerations are becoming increasingly important to investors as they can provide insight into the drivers of long-term value of investments. Investors need general purpose financial reports to give them a comprehensive, coherent, and cohesive understanding of a company and its prospects. This in turn requires an understanding of how matters in the financial statements and sustainability-related disclosures (as well as any narrative at the front end of the annual report) are connected.

22. The 2023 Green Finance Strategy confirmed the Government’s intention to consult on the introduction of a UK Green Taxonomy this autumn. While the independent Green Technical Advisory Group (GTAG) has published non-binding advice, including a significant tranche of publications as its remit expires, it is not presently clear what the proposed UK Green Taxonomy will look like, nor what disclosure requirements will be introduced alongside it. Nonetheless, as investment managers develop systems to consider biodiversity and the net zero transition as part of their investment processes, they will welcome the intent of supporting high-quality standards and disclosures relating to green finance activity. Depending on its design, the introduction of a UK Green Taxonomy can serve as a useful tool in directing financial flows to policymakers’ environmental objectives, including the net zero transition.

23. It should be noted that the UK Green Taxonomy will not be the only initiative designed to provide the market with sustainability information. GTAG recently noted that 47 taxonomies are under development worldwide, not least the EU Taxonomy for sustainable activities.[10] In addition, the UK has been a prominent supporter of the development of sustainability disclosure standards by the International Sustainability Standards Board (ISSB). The Green Finance Strategy stated that the UK will continue to provide international leadership in its support for the ISSB and the UK is establishing a formal mechanism for assessing and endorsing the global corporate reporting baseline of ISSB standards. Once adopted, these standards will be known as UK Sustainability Disclosure Standards (UK SDS).

24. The Green Finance Strategy said that UK SDS “will provide the basis for future obligations within company law and FCA requirements for listed companies, ensuring a single set of standards is applied across the UK regulatory framework.” It is currently unclear how UK SDS and the UK Green Taxonomy will co-exist, but it will be important to ensure they do not add complexity for companies reporting in the UK through needless duplication or contradictory approaches.

25. The GTAG has noted that, of the 47 taxonomies being developed in August 2023, 41 have stated that they aim to be used to guide policymakers. This might include a role in directing public investments and informing fiscal decisions. Following this example could potentially broaden the scope of a UK taxonomy, as implied in the original remit of GTAG, which was to provide advice to facilitate better informed investment decisions through the creation of a taxonomy for use by financial and non-financial firms, and which facilitated informed decision-making by investors.[11] GTAG now proposes that the taxonomy could have two core purposes: to promote market integrity, consumer protection and the avoidance of greenwashing; and to mobilise capital to facilitate achievement of UK environmental policy goals and track progress towards achieving these goals.[12] This second core purpose, concerned with tracking financial flows to UK environmental policy objectives, would provide a function that was distinct from the role of UK SDS.

26. Investment managers, the companies and other assets they invest in, and the supply chains that serve companies, will often have a global outlook. Companies operate across borders, and sustainability challenges and investments are not confined to national boundaries. In seeking to ensure a robust investment information ecosystem, the UK must also ensure that it remains aligned with overseas markets. The UK should continue to support efforts to ensure global coherence of standards through initiatives like the ISSB which can provide a baseline global sustainability reporting standard.

27. The ISSB also intends to incorporate water, biodiversity, and ecosystems in its future standards, building on the work of the Taskforce on Nature-related Financial Disclosures (TNFD). As such, it appears likely that financial disclosure standards relating to natural capital will be incorporated in UK SDS, consequently encouraging investment which delivers benefits to nature.

28. With the fixed term of the GTAG ending, and the Government considering next steps for sustainability-related reporting, it will be important to have a mechanism to understand market conditions and priorities. The Government should continue to provide a voice for industry in the future evolution of a taxonomy, either through a renewed GTAG or replacement group. Any such decision should also consider the ongoing role of the UK Sustainability Disclosure Technical Advisory Committee (TAC), which exists to provide a technical assessment of ISSB standards and give independent recommendations to the Department for Business and Trade (DBT) on their endorsement through UK SDS. If there is significant overlap between the UK Green Taxonomy and UK SDS, then it might be appropriate for an advisory body to be created incorporating the functions of both GTAG and TAC.

How can the operation of natural capital markets ensure genuine net gains for nature? How do such markets address the risk of ‘greenwashing’ of investments and the offsetting of natural recovery in the UK against environmental degradation elsewhere?

29. The ambition to address climate change is a complex area comprised of difficult political decisions, emerging technologies, and new methods of measuring and reporting. But at its heart there are clear objectives which are shared around the world: to limit the global average temperature rise and achieving net zero greenhouse gas emissions. These objectives are agreed in international treaties and consequently embedded in domestic policy. While organisations (including governments) will have differing views on the extent to which they are responsible for the targets, and the relevance to them of the different risks and opportunities associated with the targets, it is very clear what the overall objective is.

30. While there is a clear and growing consensus among policymakers, business, and other interested parties on the importance of biodiversity, it is arguable that there is less clarity on the overall objective. This is not to say that there are not international treaties, domestic laws, or industry-led initiatives. The recent Kunming-Montreal Global Biodiversity Framework – adopted by 196 countries – established an overarching objective (to halt and reverse biodiversity loss by 2030) and 23 “action-oriented” global targets in support of the objective. The Secretary of State for Environment, Food & Rural Affairs has also created legally binding environment targets which were given effect through the Environment Act 2021. These UK targets were announced during negotiations of the Global Biodiversity Framework, meaning that while there are (intentionally) many common elements, the domestic approach is not wholly derived from the international agreement. For investors and companies operating globally, this may be a cause of confusion or become burdensome as different domestic targets are developed. The UK Government has described its environmental targets as “world-leading”.[13] The implication may be that the UK now must work hard to ensure other nations follow its approach.

31. Different domestic standards might also contribute to the scenario the committee identifies, where nature recovery is achieved in the UK by effectively offshoring the activity that causes environmental degradation. The clarity and relative simplicity of GHG targets has allowed policymakers to develop policies to address the potential for offshoring of emissions to jurisdictions with differing policy approaches to certain heavily emitting sectors. Most notably, the EU has introduced the Carbon Border Adjustment Mechanism (CBAM). The EAC has already established a clear and commendable view on the value of such an initiative for the UK in its report, Greening imports: a UK carbon border approach.

32. The World Economic Forum (WEF) has identified 15 non-climate threats to biodiversity which it argues are the most important for business to engage with on the basis that they are significant threats, business has some role in causing these threats (and the potential to address the problem), and because the threats might subsequently be disruptive to businesses. WEF analysis suggests these threats endanger around 80% of the species identified as threatened or near-threatened by the IUCN Red List of Threatened Species. The WEF has characterised these threats and action to address them as 15 “systemic transitions” with the potential to generate business opportunities worth $10trn each year and create 395mn jobs by 2030. The business sectors most at risk from these threats cover over a third of the global economy and provide up to two-thirds of all jobs.[14]

33. Any approach that seeks to stimulate private sector investment in natural capital might benefit from focusing on threats such as these which are financially material to business and where a real-world impact can also be achieved. In turn, this will be best supported by the production of data which focuses clearly on these real-world impacts. As noted above, investment managers regard a lack of standardised data as a potential barrier to investment in natural capital by preventing the aggregation of investment data needed to measure real-world impact. An analysis by the TNFD found that while there is a significant quantity of nature-related data available and in use by companies and financial institutions, it is often inconsistent, irregularly updated, or hard to access.[15]

34. The relatively nascent nature of biodiversity targets may be a factor which contributes to the patchy provision of decision-useful data. There are areas of overlap in international and domestic targets and other identified biodiversity priorities. For example, the below list (a-c) sets out two legal targets and a proposed biodiversity transition which seek to address related concerns focusing on biodiversity in marine and coastal ecosystems. While the problem may be one of perception or communication, it may be helpful for the UK Government to work domestically and internationally to better articulate the discrete biodiversity transitions which will be necessitated by the Kunming-Montreal Global Biodiversity Framework. At present, a company, data provider, investment manager, or institutional investor looking at the below list might be unsure what information should be collected and communicated up the investment chain.

1. Kunming-Montreal Global Biodiversity Framework target: Ensure that by 2030 at least 30 per cent of areas of degraded terrestrial, inland water, and marine and coastal ecosystems are under effective restoration, in order to enhance biodiversity and ecosystem functions and services, ecological integrity and connectivity.

2. UK Environment Act target: 70% of the designated features in the MPA [UK Marine Protected Area] network to be in favourable condition by 2042, with the remainder in recovering condition.

3. World Economic Forum systemic transition: If sustainably managed, our fisheries could be conducive to a healthy and productive ocean. To fulfil this potential will require managing wild fisheries sustainably by respecting and upholding biologically viable quotas and limiting fishing to specific zones. This also involves transitioning towards sustainable and healthy aquaculture in oceanic, wetland, and freshwater areas to reduce degradation in these critical ecosystems and replenish overexploited fish stocks. Impacts of other ocean industries, such as renewable energy, transportation and mineral extraction, also need to be considered.

What role can the UK’s financial markets play in developing the flow of international capital into the development of the UK’s natural capital? What role does the UK have in establishing international standards for natural capital investments, alongside other jurisdictions and financial centres?

35. UK investment management is world leading. The £10trn in total that UK investment managers look after makes the UK the second largest investment management centre in the world, following only the US in scale, and bigger than the next three centres in Europe (France, Germany and Switzerland) combined. Over £4.6trn is managed in the UK on behalf of overseas savers and overseas clients’ assets accounted for 46% of total assets under management in the UK. The majority of this (59%) is managed on behalf of European clients with the largest markets in Netherlands, Germany and Sweden.[16] UK-based investment managers invest on behalf of their clients around the globe, but a UK-based natural capital market which provides scale, high standards, and decision-useful data should be well-placed to benefit from its proximity to a leading global financial centre.

36. The UK has demonstrated leadership and ambition in its approach to natural capital and global sustainability standards. In seeking to be a leader, the UK must also remain alert to the global nature of both capital markets and threats to biodiversity. The UK has provided funding and important political support to the TNFD, which has recently published its risk management and disclosure framework. The UK has also been a prominent supporter of the ISSB, which plans to incorporate nature into its standards. By continuing to support these initiatives through the platforms available to it, the UK can help to establish coherent international standards for natural capital investment.

37. A challenge remains to build momentum behind the Kunming-Montreal Global Biodiversity Framework, and better communicate the biodiversity transitions through which global policymakers wish to make the economy nature-positive. The UK should seek to take a global role in articulating the form these transitions will take, how we should assess their success, and what data exists to measure them.

September 2023