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'Biodiversity risk will become material by 2024'

By Wynne Lawrence, Clyde & Co

Biodiversity loss will lead to write-downs and write-offs in affected business lines, increasing claims and rising premiums, hitting multiple classes of insurance including directors' and officers' and financial lines

The requirement to protect biodiversity and respond to the associated natural capital reporting and compliance standards is set to become the next environmental, social and corporate governance (ESG) challenge for global businesses, raising significant liability and litigation risks.

Businesses will see new physical, regulatory, market and reputational risks – all of which are compounded by the hyper-connectivity of global value chains. The consequences of not managing these risks will play out in terms of inability to attract finance, do deals, and ultimately, in damage to market value.

Insurers will face scrutiny of biodiversity risks and of the impact of their underwriting and investments. Biodiversity loss will lead to write-downs and write-offs in affected business lines, increasing claims and rising premiums.

Value chains translate biodiversity liability risk across jurisdictions, and new due diligence standards are raising corporate standards of care to prevent and mitigate biodiversity harms. 

 

Timetable for change 

Wide-ranging value chain due diligence standards of care are coming to the fore, and will be in place in many jurisdictions by 2024. At the same time, new standards in nature-related risk reporting will be embedded into mainstream corporate reporting standards.

A global framework for nature-related disclosures (through the Taskforce on Nature-related Financial Disclosures (TNFD)) is being trialled this year. Following the climate disclosures trajectory (through the Taskforce on Climate-related Financial Disclosures), investor pressure will likely lead to greater adoption, with mandatory reporting regimes to follow.

Further action will take place at the Convention on Biodiversity’s COP15 in Kunming, China later this year where countries are expected to agree to “30x30” targets for biodiversity – to preserve and protect 30% of land and sea by 2030. Concerted policy action on biodiversity will increase law and regulation in this area.

Like the climate, the biosphere is a planetary boundary we endanger at our peril. The economy is wholly dependent on a healthy biosphere and there are many initiatives to translate that structural material risk into corporate decision-making

In the EU, the proposed Directive on Corporate Sustainability Due Diligence is expected to be adopted later this year and will require companies with significant turnover in the EU to understand whether value chain activities are having an adverse impact on biodiversity, as well as other environmental harms and human rights abuses. These duties will extend to any part of a value chain where there is an “established business relationship”, not just direct suppliers.

Building on similar mandatory Human Rights and Environmental Due Diligence (“mHREDD”) legislation in France and Germany, the directive will require companies to take action to prevent, mitigate or end adverse impacts.

The directive will create a civil liability regime, and national administrative authorities will be empowered to levy fines for non-compliance. As with other far-reaching EU legislation, like the General Data Protection Regulation (GDPR), the effects will be transmitted through value chains to corporates globally. EU member states will have two years to implement the directive, with harmonisation expected by 2024.

 

Climate change 

In many ways, climate change wrote the playbook here. Like the climate, the biosphere is a planetary boundary we endanger at our peril. The economy is wholly dependent on a healthy biosphere and there are many initiatives to translate that structural material risk into corporate decision-making.

There are ever-rising standards of care for biodiversity risk assessment, monitoring and disclosure. At the same time, courts are increasingly willing to look beyond corporate structure at group companies and value chain partners.

We have already seen the first cases brought under existing mandatory due diligence standards in France. And courts in the UK, Netherlands and Canada have found parent companies can be responsible at law for the actions of their foreign subsidiaries. These developments will raise the bar for responsible business conduct in the biosphere.

Companies that fail to understand their reliance on ecosystem services (or those of their supply chain partners) or that fail to anticipate the scale of the transition to a sustainable economy will find themselves exposed to liability risk. 

Businesses will need to stay nimble and anticipate incoming investor and regulatory pressures, as well as rapidly changing procurement priorities for value chain partners.

Inadequate planning or management around the physical risks of biodiversity loss can affect companies directly reliant on ecosystem services, such as food and agriculture. But it can also harm companies in diverse lines of business, as biodiversity risks are embedded in every value chain, including real estate, aviation, and electronics. Through increased regulation and investor scrutiny, companies will need to understand their biodiversity dependencies and impacts.

 

Due diligence failures

Following guidance from the Organisation for Economic Cooperation and Development, companies will be required to: embed responsible business conduct into policies and management systems; identify and assess adverse impacts in operations, supply chains and business relationships; cease, prevent or mitigate adverse impacts; track implementation and results; communicate how impacts are addressed; and provide for or co-operate in remediation of negative impacts when appropriate.

There will be increased liability risks for companies that do not exercise sustainability due diligence.

Nature has been providing its ecosystem services free of charge with economic models not properly accounting for nature’s contributions to people and planet, or for the true costs of pollution and environmental degradation. As a result of ignoring the importance of the natural world and our impact upon it, we are now facing a biodiversity crisis that will reverberate across society and economies.

The evidence is clear that if not properly managed biodiversity risk has the potential to impact multiple classes of insurance including directors’ and officers’ (D&O) and financial lines. 

 

Wynne Lawrence is a senior associate at Clyde & Co

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