Biodiversity risk and finance

Measures of biodiversity risk

In this paper, Giglio et al. explore the effects of physical and regulatory risks related to biodiversity loss on economic activity and asset values. The authors provide a systematic way to measure aggregate biodiversity risk so that it can be studied quantitatively with the analytical tools of finance.
The first measure is a biodiversity news index that analyzes articles in the New York Times (NYT). To identify articles related to biodiversity loss, they develop a dictionary and classify the sentiment of these articles, through the use of the Bidirectional Encoder Representations from Transformers, or BERT, a standard model from the natural language processing literature which assigns each sentence a positive, negative, or neutral sentiment score. This information is aggregated to compute a daily “NYT-Biodiversity News Index”.
The second measure of biodiversity risk exposures, available at the firm level is based upon:

• Firms’ 10-K statements. The authors use  textual analysis of firms’ 10-K statements to identify discussions of biodiversity-related risks.
• The opinions elicited in their survey of financial professionals, and academics on biodiversity loss. The authors received a total of 668 survey responses.
• The portfolio holdings of four biodiversity related funds.

The authors then form equity portfolios of industries sorted by their biodiversity risk exposures. The portfolios hold long positions in industries with low biodiversity risk exposures and short positions in industries with high biodiversity risk exposures. They test whether biodiversity risk is priced, by examining whether the return of these biodiversity-risk-sorted portfolios covaries with the aggregate biodiversity news index.
The authors find:

Exposures to biodiversity risk vary substantially across industries in a way that is economically sensible and distinct from exposures to climate risk. We find evidence that biodiversity risks already affect equity prices: returns of portfolios that are sorted on our measures of biodiversity risk exposure covary positively with innovations in aggregate biodiversity risk. However, our survey indicates that market participants do not perceive the current pricing of biodiversity risks in equity markets to be adequate.

Biodiversity Risk
Authors: Stefano Giglio, Theresa Kuchler, Johannes Stroebel, Xuran Zeng
From: Yale SOM, NYU Stern

How policy-related news influences investors’ perception of firms’ biodiversity footprint

The Kunming Declaration of 2021 and the Montreal Agreement of 2022 are the most recent globally coordinated steps toward protecting biodiversity. In this paper, Garel et. al attempt to establish a link between biodiversity and finance by introducing to the finance literature a science-based measure, the corporate biodiversity footprint (CBF), and exploring whether investors price this footprint. The CBF, developed by Iceberg Data Lab (IDL), measures the potential negative change in Mean Species Abundance (MSA) due to a firm’s activities, and its is expressed in terms of square kilometers of “artificialized” or “denaturated” land. It aggregates the biodiversity loss caused by a firm’s annual activities related to land use, greenhouse gas (GHG) emissions, water pollution, and air pollution. The authors use a data set that includes the universe of listed firms for which CBF data are available from IDL over the years 2018-2021. It consists of 2,106 firms from 34 countries.
The CBF metric correlates with whether firms have been targeted by the investor coalition Nature Action 100, which released in June 2023 a list of 100 firms to engage with in order to tackle biodiversity and nature loss. Garel et al. use textual analysis to find that biodiversity terms are mentioned in only 5.1% of their sample firms’ earnings conference calls, a percentage consistent with Giglio et al. (2023) above. They conducted an event study to examine whether and how investors revised their valuations of large-CBF stocks around the Kunming Declaration.

The authors provide empirical evidence that investors’ perception of firms’ biodiversity footprint is influenced by policy-related news and that high-CBF firms experienced a negative price reaction following the Kunming Declaration. This suggests that investors do care about biodiversity and react to policy developments that signal increased attention to biodiversity-related risks.

Do Investors Care About Biodiversity?
Authors: Alexandre Garel, Arthur Romec, Zacharias Sautner
From: Audencia Business School, Toulouse Business School, University of Zurich, Swiss Finance Institute