What is your take on the financial sector & biodiversity?

In this discussion thread, Jerome Tagger asks me: "Mike Tyrrell: What is your take on the financial sector?"

From the context of the discussion, I assume he means: "Should financial sector companies be included on the Nature Action 100 listing?"

I'm not familiar enough with the priorities of NA100 initiative itself and I don't really see it as my role to have a view on how individual investors should or shouldn't engage.

(For context: It's my job to ensure that they have the research that they need to ensure that they can make informed sustainable investment decisions and engage with companies in support of these).

However, it may be helpful for me to give my broader thoughts (and I have been thinking about it a lot) on which (if any) parts of the financial sector may have material exposure to biodiversity loss and the loss of biotic natural capital.

In this discussion paper: How can the ESG/SRI research value chain respond to the 'nature crisis'?, we have already addressed:

• why we think that agriculture is the business activity with most exposure (both impact on and risk from) biodiversity loss and biotic natural capital (BNC)
• why we think it's important to differentiate between biodiversity and biotic and abiotic natural capital
• the nature of the exposure of equity and fixed income investors.

We enthusiastically invite comment on and contradiction of the points directly or via the thread below this blogpost: Investors' biodiversity bandwagon needs a better chassis

So, I now turn to the remaining part of the question: How exposed are banks to agriculture?

… and I start with a massive caveat:

I don't know and I am probably wrong…

… but I am independent and can ask in public the simple questions that need asking but might be too embarrassing for someone employed by a big investment firm to ask.

… especially if it helps to progress understanding of the issues amongst the sustainable investment industry more broadly.

However, I should clarify a few things up-front:

• I'm not (as will be evident) an expert on banking.?Rather, I am an equity investment analyst looking to understand whether banks (that issue equity or listed debt) may have exposure to agriculture and the sustainability issues involved with this
• I have no experience of nor opinion to offer on private equity or direct investments into - for example - farmland or timber.
• I always aim to establish a 'clear line of sight' between sustainability issues and the key drivers of target businesses; I focus primarily on establishing financial and investment materiality but also recognize the role of 'engagement' where materiality may not be significant.?(I am sceptical of engagement on issues that are of minimal direct materiality as this runs the risk of undermining the practice of investor engagement in other important issues)
• In this work, I am addressing biodiversity and biotic natural capital (BNC) directly (rather than trying to identify second order effects such as (for example), "fossil fuel companies exacerbate climate change and climate change threatens biodiversity, so "fossil fuel companies should be considered as direct contributors to biodiversity loss"

So, the hypotheses below are issued with a loud request to anybody out there who can correct mistaken assumptions and provide evidence / data to help me fill in gaps.

How is agricultural activity financed?

My starting assumptions are that:

• Agriculture appears to be largely funded through private ownership and bank lending with (I strongly suspect) influential support provided through specialist financing of crops and machinery and specialist insurance.
• Some banks will have loan books that are significantly exposed to agriculture
• Some (many?) of these banks will have a specialist agri-focus - indeed there is a possibility that the banking of agriculture is relatively concentrated
• Many of these banks will be mutually-/co-op- or state-owned or have strong agri-heritage
• However, banks that issue equity of listed debt will also have some exposure

Is the exposure of listed banks / listed-debt issuing banks likely to be 'financially-material'?

It goes without saying (I hope) that it is recognised that preserving biodiversity and biotic natural capital is massively important to all of us and to human existence as a whole (… and that it is something we really shouldn't be messing with).?By extension, knock-on effects that undermine humanity's survival, clearly make 'financial-materiality' both significant but also a moot point.

I will address systemic issues later in the post.?For now, however, I will focus on the direct exposure of banks.

It seems likely that we can get a proxy for the share of agriculture on a diversified bank's loan book from the contribution that agriculture makes to the GDP of any country in which they are active.

Aaaargh!?It's not very big in any countries where banks that equity or fixed income investors might invest in are active.

Of course, we should add to this figure the supplier or customer businesses that depend on agriculture.

However, even if these increase the exposure by an order of magnitude, it's going to be hard to make a case for relevance based on financial-materiality to banks' balance sheets.

Does 'exposure' have to be directly financially material for investors to engage?

There are four perspectives here:

• One perspective holds that investors should only engage companies on sustainability issues when a clear line of sight can be established between the sustainability factor in question and one of the key value drivers of a business.?(To do otherwise damages the credibility of the 'engagement' request and - more worryingly - undermines the whole concept of investor engagement for other investors and other issues)
• The other perspective argues that with ownership investors acquire a moral responsibility to engage on all environmental, social, economic and ethical issues that a given holding may influence
• The third and fourth split between these two extremes and argue that investors should only engage on 'systemic risk issues' or should engage selectively.

To see a rough state of current industry thinking on this point see poll and thread here: (When) should investors 'engage' companies on sustainability issues that DO NOT HAVE direct financial or investment materiality?

If no direct materiality can be established can / should investors engage?

Well, direct exposure of the balance sheet might be the wrong way to look at this issue (but I have an equity investor's brain, so that's what I inevitably do first).

Instead, one might argue that if the biodiversity of a country is being compromised (which all are in different ways), then there is a moral responsibility on all enablers of that compromising activity to intervene - led by governments (where such leadership is possible) who should set in train actions that causes the most appropriate actors to intervene to bring about the most efficient mitigation).

If so, we could look at three potential 'enablers' of damage done by companies / 'enforcers' of reparation by companies:

• Governments - who can make laws, regulations and create fiscal incentives addressing company exposure
• Other stakeholders (Customers / civil society / employees etc)
• Financiers (and Financial Regulators)

Self-evidently, there is an important role for the first two.?But what about those in our category of interest?

If we assume that biodiversity loss is:

• a classic 'tragedy of the commons' (that affects everyone but no-one in particular) and
• that the most likely route to it becoming manifest as a financial factor is as a systemic risk (to the whole food chain) and that
• it is serious

(These all seem pretty safe assumptions)

Then, we have to ask:

• Who might act?
• What might their justification be for action?
• Who might they target for action?
• What impact might this have on the targets?
• Could the value of such actions impact the value of investments?

"Never let a good crisis go to waste" - central bank awareness of systemic risk

Arguably the credit crunch of 2008 was exacerbated by banks having over-focused on their financial responsibilities (to shareholders) at the expense of their wider economic responsibilities (to support a functioning and structured economy).?(Arguably, anyone that uses the initialism 'ESG' over 'EESG' commits the same crime by conflating the different financial and economic responsibilities of businesses).

Since this lapse, central banks and banking regulators have been more active in mitigating 'too big to fail' and appear to be extending this line of protection against systemic risk thinking to 'climate change' and steadily on to 'biodiversity'.

(While I think the concept of 'universal ownership' is nonsensical, I am more sympathetic to the concept of 'oligopolistic lendership'.?If there's an environmental/social problem in a country that is caused by business in a country and market share amongst banks is concentrated, it's reasonable to assume that the banking sector holds one of the keys to resolving it.?"Woooah, Mike.?That imposes an awful lot of responsibility on banks".?"Yes, fictional respondent.?It certainly does.?But banks also get a whole load of special privileges that are not accorded to other businesses.?This is part of the deal.?They get special treatment; they are set special expectations.?Think of it as an extended 'licence to operate'".

An answer - finally!

@Jerome Tagger, you asked a simple 8 word question.?It has already taken me 1,503 words to fail to answer it … so, bearing in mind all of the considerations above, my answer, finally, is:

• Yes, investors should pay attention to the biotic natural capital and biodiversity exposure of banks
• But not because it is likely to have a direct impact on their balance sheet … rather because their action / inaction will reasonably bring them into the crosshairs of banking regulators
• … and investors in banks should be interested in anything that sees banks becoming more / less regulated
• … and they should get interested now because the shape of regulatory travel is becoming clear and it could (and certainly needs to) move faster than banks will be able to build systems

So, specific questions that - if I were an investor in banking stocks - would be asking are:

• How exposed is your balance sheet to the food / agri sector?
• If this number isn't given, what is your market share (in the SME/business banking market … which is the closest proxy I can think of for the agri sector) in markets where national biotic natural capital / biodiversity loss is most significant?
• Do you lend to facilitate any activities of particular concern around BNC and biodiversity? (e.g. neonicotinoids, palm oil etc)
• How could you evidence to central banks and banking regulators (when they come knocking) that you are actively using your banking relationships with clients to prevent further biodiversity loss?
• How could you evidence to central banks and banking regulators (when they come knocking) that you are actively using your banking relationships with clients to promote regenerative agriculture?

And now a couple of questions for you and others …

Do you agree??Where is my thinking flawed?

(It will be flawed as I am far from being an expert in the space and sadly don't get to be an investment analyst myself any more so can't devote the level of research time that I would like to these questions.)

As above, I see my role in this debate as being to ask the simple questions and propose simple-seeming solutions.

Your role, dear sustainable investment on LinkedIn community, is to point out (politely and with evidence wherever possible) where I am wrong.

So, we all learn ??