Will TNFD change the status quo of financial institutions?

Introduction

The Task Force on Nature-related Financial Disclosures (TNFD) aims to bring nature to the forefront of financial decisions.

The framework, launched in 2021, is based upon the widely adopted Task Force on Climate-related Financial Disclosures (TCFD) and is a joint initiative by the Global Canopy, United Nations Development Programme (UNDP), the United Nations Environment Programme Finance Initiative (UNEP FI), and the World Wide Fund for Nature (WWF).

According to the World Economic Forum, USD 44 trillion of global economic output depends on nature for its services and functions. While the agriculture and food and beverages sectors are most exposed, numerous other sectors have been identified as being highly or moderately dependent on nature. However, financial institutions often take the natural environments they operate in for granted, thereby underestimating the risks posed by the loss of natural habitats and biodiversity. The TNFD is a disclosure framework for nature-related risks and opportunities that aims to change the narrative on how financial institutions consider their impacts and dependencies on nature. While the TNFD will be market-led and voluntary, stock exchanges may consider mandatory listing requirements related to nature-related risks. Therefore, reporting in line with the TNFD should be an important consideration for all publicly listed financial institutions.

Implications for financial institutions

TNFD will impact all financial institutions, but the requirements will vary basis the nature of the organization.

Additionally, the TNFD will force new requirements across the investment life cycle. This will include investment analysts considering a company’s nature-based impacts and risks when conducting initial due-diligence, through to fund managers and their engagement with investee companies.

Banks

Banks will be expected to assist in carrying out the TNFD’s mandate of supporting a systemic shift towards nature-positive outcomes. Ensuring financing is in line with the TNFD will be another essential step in retaining leadership in the sustainable finance landscape. Therefore, banks should use nature-related risks and opportunities as part of their investment and lending decision-making. For example, this could include investment analysts and fund managers considering the impact of a potential investment on sensitive ecosystems or contribution to land and water pollution. In extreme situations, banks choosing to ignore nature-related risks may see at-risk companies defaulting on loans. To prevent this from happening, fund managers can begin working with portfolio companies to ensure nature-related risks are incorporated into scenario analysis and their own strategy and risk management processes.

Insurers

Quantifying the material impacts of an ecosystem’s decline makes insurance companies’ actuarial models difficult to design. Much of this difficulty in modeling is due to ecosystems being vulnerable to climate tipping points, where natural environments and climate processes shift drastically and rapidly. An example of this can be seen in the Amazon rainforest, whereby accelerated deforestation leads to hotter and drier conditions in the Amazon and further natural retreat of the rainforest. This will then impose a greater impact on the activities that rely on the natural resources the rainforest supplies and subsequently increases exposure to nature-based risks. Tipping points are being encroached on across the world and are leading to increasingly expensive premiums or complete cessation of insurance for certain businesses. More comprehensive disclosures by companies through the TNFD framework can provide insurance companies with the ability to conduct more informed and targeted underwriting and risk selection.

Asset manager and regulators

Asset managers must integrate analysis of TNFD characteristics into investments to follow industry best practices. The EU Sustainable Finance Disclosure Regulation (SFDR) is concerned with ensuring transparency among financial market participants and preventing greenwashing. While the TNFD has not been explicitly incorporated into this regulation at the time of writing, it should nevertheless be a part of increasing sustainable disclosure among asset managers. Asset managers and regulators need to engage with portfolio companies, which are choosing to not disclose or are especially exposed to nature-based risks and find effective solutions.  

Challenges in implementation

There is currently no commonly agreed goal or policy for nature and biodiversity.

Unlike other climate and sustainability-orientated frameworks that are based on the Paris Agreement and Sustainable Development Goals (SDGs), there is no single policy or target, as yet, to guide organizations on how to build a TNFD strategy.

Secondly, the makeup of nature-related risks and opportunities will lead to the TNFD being inherently more complex than similar disclosure frameworks such as the TCFD. Nature-related issues come in many different forms, with strong geo-locational dependencies and varying levels of materiality across different economic sectors. Moreover, nature-based impacts and risks interact with climate change through the Climate-Nature Nexus and are further shaped by social dimensions and development scenarios, giving rise to complex and interdependent nature-based risks. The first beta version of the TNFD scopes the interdependencies of nature, while future versions will provide financial institutions with the tools to understand and assess complex nature-based risks.

Finally, the wide variety of nature-based risks and subsequent metrics poses a unique challenge for those developing the TNFD. Multiple metrics need defining, which require a range of methodologies for the different nature-based risks and their geo-locational dependencies. This must then be accompanied by comprehensive guidance for companies, so that they can navigate the complexity of nature-based financial risks and produce comprehensive and accurate disclosures.

 Next steps for financial institutions

To prepare for the TNFD, financial institutions can begin by following a number of steps.

Primarily, organizations should confirm their alignment with the TCFD, Sustainability Accounting Standards Board (SASB), Global Reporting Initiative (GRI), and other non-financial reporting frameworks. Such frameworks offer organizations critical experience in non-financial disclosures, data requirements, and the competencies required to conform to these frameworks and generate accurate and detailed disclosures. In addition, financial institutions should start considering the nature-based impacts of their activities, operations, investments, and how they can begin to measure and collect data on their nature-based impacts and risks. This should begin to align with the current recommendations published in first beta release of the TNFD and be augmented as and when future enhancements are made to the TNFD’s recommendations.