Integrating biodiversity into fixed income portfolios

When we look specifically at fixed income, we see important reasons why investors should begin to integrate biodiversity into their decision making.

First, biodiversity loss presents risks that could impact the performance of fixed income portfolios. As with climate change, the starting point is to understand the risks in play, divided into two components. They may be physical risks from biodiversity loss and ecosystem degradation, or transition risks linked to global efforts to tackle the problem, which include increasing liability risks.

We expect that companies which do not proactively address these risks, and which fail to adopt more sustainable nature-positive business models, could face higher costs or lower revenues, therefore reducing their ability to repay debt in the future.

Nature-related physical risks

The dramatic degradation of biodiversity and of natural resources has created and will continue to create significant pressures on issuer supply chains and manufacturing processes. This in turn may lead to a loss of revenue or reduced profitability, ultimately impairing the ability of an issuer to repay its debt. Examples of this could include increased flood risks due to soil and flora reductions, difficulties sourcing raw materials, reduced suitability of land for crop cultivation, or costs incurred from forced relocations of manufacturing bases.

For instance, the nuclear sector and the paper industry are among sectors responsible for large-scale water withdrawal, and often have their operations positioned close to water sources. Over time water availability may become a real operational risk for these industries. Many new nuclear facilities are built close to the sea, but existing inland sites will likely face water stress risks at some level.

Nature-related transition risks 

Consumers are becoming more aware of the dangers of biodiversity loss and could shift their spending habits to products and services least associated with having negative impacts on nature. The shift could be more acute in the face of controversial events where a boycott of a company's products occurs across a wide consumer base. In addition, issuers could face further risks from evolving regulation, technological breakthroughs, market changes, and litigation.

A good example of liability-related transition risks is the case of US litigation around perfluoroalkyl and polyfluoroalkyl substances (PFAS)-a large complex set of synthetic chemicals used in consumer goods. This litigation has given rise to new regulatory measures in both the US and European Union with a potential ban targeting these so-called 'forever chemicals'. Another recent example would be the introduction of taxes on plastic packaging in some countries, like the UK, seeking to encourage intensive plastic users to adapt the company's business model.

In our view, interactions between different categories of naturerelated risks, in particular cascading interactions of physical and transition risks, could eventually lead to a nature-related systemic risk with consequences for global economies around the world.