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The Economics of Biodiversity: The Dasgupta Review

JANA is committed to being a leader in Sustainability – in all its forms, and this research provides guidance on how we, as investors, must take into consideration the significant importance and role of nature, or natural capital, in long term investment outcomes. 

This article provides an overview of the seminal research by Professor Sir Partha Dasgupta on the “Economics of Biodiversity”, which highlights the heightened risks from the degradation of our natural environment.  Nature-related risks are real and need to be factored into our investment decisions.  
 

19th May 2021 / 14 mins read
Suzy Yoon
Senior Consultant
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“The Economics of Biodiversity: The Dasgupta Review” (the “Review”), led by Professor Sir Partha Dasgupta was commissioned by the UK Government in 2019 to show how the global economy is underpinned by nature.  Increasing evidence shows that in recent decades humanity has been degrading our most precious asset, nature, at extraordinary rates.  We have achieved economic growth by eroding our natural capital, which has been fundamental to this growth.     

The Review enlightens us on how we have severely degraded our natural capital, the stark consequences and the actions required for resolution.  We are urged as individuals and institutions to make transformative changes to how we think, act and measure economic success.  Change is required to protect and enhance the sustainability of the natural world.  For without any changes today, we will encounter extreme systemic risks and heightened economic uncertainty.  

The Review is a call to action to ensure the sustainability of our lives on earth. 

What is Biodiversity?

Biological diversity, or biodiversity, is the variety of all life forms on earth – from plants and animals to microorganisms such as bacteria.  These species and organisms form ecosystems, which maintain balance and support everything in nature that we need to survive, such as food, clean water and even medicine.  

From a financial perspective, just as diversity within a portfolio of financial assets reduces risk and uncertainty, biodiversity increases nature’s resilience to shocks.  This then reduces the risks to the ecosystems on which we rely for survival.  

“Biodiversity is not just a nice-to-have, it’s an essential element of ensuring economic growth.” Boris Johnson

What’s Happened?

Since WWII, we have achieved phenomenal growth, with our focus on the accumulation of produced capital (roads, buildings, factories) and human capital (health and education).  The average person’s material standard of living has never been higher.  

1. Biodiversity

Over this time, our primary measure of success has been on the output of final goods and services, by looking at produced and human capital as primary factors of production, with little consideration for natural capital.  According to the World Economic Forum, more than half the world’s economic output - US$44 trillion of economic value generation – is moderately or highly dependent on nature.  

However, given natural assets are generally free of charge or have low market prices, we have overconsumed and underinvested in them, thinking our human ingenuity and technologies could overcome their scarcity.  

“Unfortunately, the macroeconomic growth and development theories that have shaped our beliefs about economic possibilities and our understanding of the progress and regress of nations do not recognise humanity’s dependence on Nature.  One purpose of this Review is to correct that mistake.”

Our demands on nature have exceeded its ability to supply and we’d require 1.6 earths to maintain our current living standards.  Extinction rates are rising rapidly, and such declines are undermining nature’s productivity, resilience and adaptability, and are in turn fuelling extreme risk and uncertainty for our economies and well-being.  

Thus, the Review calls us to realise that we and our economies are embedded within nature, and not external to it.  We also need a more appropriate measure of growth, being “inclusive wealth”, to halt the continued degradation of natural capital and instead protect and promote intergenerational well-being.  It’s time we see the economy and ecology as one and interdependent.

   

2. Biodiversity

 

3. Biodiversity

  
Biodiversity and Climate Change

We are well informed of the enormous risks and consequences associated with climate change and the Review hopes to ensure biodiversity is treated with the same urgency and commitment.  Protecting biodiversity and addressing climate change are interconnected.  Enormous amounts of carbon are locked within animal life and vegetation.  Thus, mitigating against the worst effects of climate change will have huge benefits for biodiversity, and mitigating biodiversity loss will have a positive effect on climate change.  

 

5. Biodiversity


2021 is an important year for biodiversity and the sustainability agenda.  The Conference of the Parties to the Convention on Biological Diversity (COP15), scheduled for October, is expected to see countries adopt a new Global Biodiversity Framework on how to measure and tackle nature loss.  In addition, the 26th United Nations Climate Change Conference (COP26) is expected to place an important emphasis on the role of nature and biodiversity in addressing climate change.  

What Can We Do?

The Review encourages change in how we think and act – our lack of response to years of warning signs is evident of our unyielding temperaments, and perhaps also evident of our detachment from nature itself.  Transformative change is required from governments, businesses, intergovernmental organisations and communities.  There will be some tough choices to make, but they are necessary to enhance our collective wealth and well-being. 

“Humanity now faces a choice: we can continue down a path where our demands on Nature far exceed Nature’s capacity to supply them on a sustainable basis; or we can take a different path, one where our engagements with Nature are not only sustainable but also enhance our collective well-being and the well-being of our descendants.”

Given all situations will be unique, the Review is not prescriptive, but provides us with options for achieving the necessary change.  They are geared towards three broad, interconnected transitions, requiring humanity to:

i.    ensure that our demands on nature do not exceed its supply, and that we increase nature’s supply relative to its current level; 
ii.    change our measures of economic success to help guide us on a more sustainable path; and 
iii.    transform our institutions and systems – in particular our finance and education systems – to enable these changes and sustain them for future generations.

Biodiversity


The Role of Financial Institutions

Our global financial system is critical to supporting a more sustainable engagement with nature.  Currently, financial institutions and companies have a relatively low understanding of how their operations or investments impact or depend on nature, and therefore to what extent they are exposed to nature-related risks.

Unfortunately, the existing financial system is tilted against nature, with the financial flows devoted to enhancing our natural assets dwarfed by subsidies and other investments that exploit nature.  We need a financial system that channels financial investments – public and private – towards economic activities that enhance our stock of natural assets and encourage sustainable consumption and production activities.  

There is growing evidence that individual investors want investment providers to consider sustainability and nature in their investment decisions.  Just as the Stern Review on the Economics of Climate Change (2006), on which the Dasgupta Review was modelled, helped to underscore climate-related risks and action, it is possible this Review will lead to similar actions of incorporating nature-related risks in investment decisions.

The Taskforce on Nature-related Financial Disclosures (TNFD)

In July 2020, the Taskforce on Nature-related Financial Disclosures (TNFD) was established to provide a framework for corporates and financial institutions to assess, manage and report on their dependencies and impacts on nature.  It is hoped the new framework will aid in the appraisal of nature-related risk and the redirection of global financial flows away from nature-negative outcomes and towards nature-positive outcomes.  

The TNFD builds on the work of the Task Force on Climate-related Financial Disclosures (TCFD), which provides a framework for financial institutions and corporates to identify and report on climate-related risks.  The TNFD will build upon the structure and foundation of the TCFD, and over time, the two frameworks will be synergetic and complementary.

“With the Task Force on Climate-related Financial Disclosures, TCFD, we managed to shift private finance and we need to do the same with TNFD.”  Emmanuel Macron

Going forward we can expect businesses and financial institutions will be required to integrate nature-related considerations within their objectives, akin to the assessment and disclosure of climate-related risks.  Measuring nature-related risks will no doubt be a challenge, and we can expect more clarity when the Taskforce releases its reporting framework, which is expected for release in the second half of 2023.

Portfolio Impacts

Overtime, natural capital will gain increasing prominence in investments, and asset owners will need to understand and quantify the nature-related risks embedded within their portfolios.  There is also a risk that asset owners may be penalised for having exposure(s) to assets that degrade the natural environment.  

One challenge will be for regulators and leading working groups such as the TNFD Taskforce in developing an accounting price for nature and ensuring agreement and consistency of application across global financial institutions.  It is something JANA will be monitoring closely and carefully, providing our feedback where it is required or warranted.

While we are still in the foundational stages of understanding and quantifying nature and its risks, we can expect reporting requirements on nature-related risks will evolve for institutional investors.  Further, we foresee an increasing expectation placed upon asset owners to invest in nature-enhancing investments.  Caution and prudence will be required to sift through the noise and potential ‘greenwashing’ whereby products will be labelled as sustainable and environmentally responsible when they are not.  

JANA will work together with our clients as we understand the new requirements and work through the flood of newly formed nature-related investments and obligations.  

We are embarking on a new and necessary path that will require significant change to our settled ways.  As responsible investors, we have a fiduciary obligation to our investment portfolios and to this world.  It is the decisions we make and the changes we demand that will create a sustainable investment environment that leads to longevity and intergenerational well-being.   

“Although time is not on our side, it is not too late for us, both individually and collectively, to make the conscious decision to change paths.  Our descendants deserve nothing less.”

 

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