Ragini Gupta, CLB Student Fellow—LLM (Environmental Law and Policy, ’23)

In Part I of this post, I provided an overview of some of the legal issues arising from loss of genetic diversity and biodiversity. In this post, I will consider the securities law aspects in some more detail.

New regulatory frameworks on biodiversity-related disclosures may be on the way

Climate related disclosures have attracted considerable attention in recent years. Biodiversity disclosures have attracted comparatively less, though this might change when the Task Force on Nature-related Financial Disclosures (“TNFD”) releases its final recommendations later this year. Another key development is the adoption of the Kunming – Montreal Global Biodiversity Framework (“KMGBF”). Target 15 of the KMGBF calls upon countries to “take legal, administrative and policy measures to encourage and enable business, and in particular to ensure that large and transnational companies and financial institutions” monitor, assess disclose their risks, dependencies, and impacts on biodiversity. (Note: the USA is not a party to the Convention on Biological Diversity). Though the KMGBF is not legally binding, there may be enhanced requirements for biodiversity-related disclosures in the future.

What about existing regulations?

However, do existing regulations require disclosure of biodiversity related risks in certain circumstances? Regulation S-K lays down disclosure requirements for various SEC filings by listed entities. Some of the Items in Regulation S-K may in certain situations be relevant for risks from biodiversity loss.

Item 101 (“Description of business”)

Item 101 requires disclosure of “material effects that compliance with governmental regulations may have” on “capital expenditures, earnings and competitive position” including “estimated capital expenditure for environmental control facilities.” An example of biodiversity regulations that may impact capital expenditures and earnings are Biodiversity Net Gain (BNG) laws, as will become effective in the  U.K. from November 2023. The U.K.’s BNG law requires developers to avoid loss of habitat on development sites, and if this is not possible, to create habitat either on-site or off-site, or as a last resort, buy statutory credits from the government. Costs from such regulations could impact capital expenditures and earnings. Another example of laws affecting earnings is the phase-out of subsidies and incentives harmful for biodiversity as contemplated under Target 18 of the KMGBF. (The KMGBF is not binding; still countries will have to show progress towards implementation through national biodiversity action plans and national reports.)[1] Of course, Item 101 refers to existing regulations and would apply only when these regulations are passed.

Item 105 (“Risk factors”)

Item 105 requires a disclosure of “material factors that make investment in the registrant or offering speculative or risky.[2]” Presentation of risk factors that could apply to any registrant or offering is discouraged, but to the extent generic risk factors are presented, they would have to be disclosed at the end of the risk factor section under the caption ‘General Risk Factors[3].’

Since the regulations discourage presenting generic risk factors, this would not require simply disclosing risks to the economy from biodiversity loss, but those specific to the registrant’s business. Legal, political and scientific developments related to biodiversity could create various risks, which, if material, may need to be disclosed. Some examples of such risks are:

• Decreased consumer demand for certain products (e.g., consumer pledges to boycott restaurants serving bluefin tuna, an overfished species.
• Reputational risks, if a business causes or is linked to contributing to biodiversity loss; (e.g., in some cases, reputation of institutions can be damaged if linked to financing palm oil companies
• Bans on products (e.g., the EU Parliament has approved a deforestation law that would ban imports into the EU of coffee, soy and other commodities if linked to destruction of forests.)

Item 303 (“Management’s discussion and analysis (MD & A) of financial condition and results of operations”)

Item 303 requires discussion, among other things, of “any known trend or any known demands, commitments or uncertainties that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way.[4]” In addition, known material trends in the registrant’s capital resources and reasonably likely material changes in the mix and relative cost of these resources have to be described.[5] Also, known trends or uncertainties that are reasonably likely to materially affect net sales, revenues or income from continuing operations are to be described.[6] MD & A must focus on material events and uncertainties known to management as “reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future operating condition.”[7] Item 303 may require that registrants disclose whether any legislation related to biodiversity is reasonably likely to affect its financial condition.[8] Examples of such legislations are those discussed above with respect to Item 101. Registrants may also have to consider and disclose the impact of international agreements on biodiversity on their business (if material.)[9]

New or pending laws are not the only relevant trend or uncertainty here. Coral reefs have declined by over half since the 1950s. The total economic value of coral reef services for the U.S. (including fisheries, tourism and coastal protection) is over USD 3.4 billion each year. Biodiversity losses could thus have direct implications for businesses that depend on these services. Another example is declines in coffee – 60% of wild species of coffee are at risk of extinction, posing risks to businesses. Declines in productivity in coffee plantations have had economic consequences earlier – the coffee leaf rust epidemic in 2011-12 in Latin America and Central America caused more than USD 3.2 billion in damage.

Where a trend, event or uncertainty is unknown (including the passing of a new legislation related to biodiversity), the management must make a two-step analysis[10]: (1) Whether the known trend, demand, commitment, event or uncertainty is likely to come to fruition (if the management determines that the event is not reasonably likely to occur, no disclosure is required. (2) If the management cannot make that determination, it must evaluate the consequences of the known trend, event or uncertainty, assuming it comes to fruition. Disclosure would be required unless the management determines that material effect on the registrant’s financial condition is not reasonably likely.

Determining whether a particular biodiversity related risk would have a material effect on a business’s financial condition is highly fact intensive and potentially complex. However, tools and methodologies for this purpose are emerging. The World Wildlife Fund’s Biodiversity Risk Filter launched earlier this year is an online tool intended to help businesses and financial institutions assess biodiversity related risks. UNEP and S&P Global also recently announced the launch of the Nature Risk Profile, a methodology for identifying and quantifying nature related exposure.

These are only some of the possible ways in which disclosures of biodiversity risks may be required under existing laws.

 

References

1. TNFD Releases fourth and final beta framework global (28 March 2023), https://tnfd.global/news/tnfd-releases-fourth-final-beta-framework-v0-4/
2. Kunming-Montreal Global biodiversity framework (18 December 2022), https://www.cbd.int/doc/c/e6d3/cd1d/daf663719a03902a9b116c34/cop-15-l-25-en.pdf
3. Department for Environment, Food & Rural Affairs, Biodiversity net gain, Gov.UK (21 February 2023), https://www.gov.uk/government/collections/biodiversity-net-gain
4. Jeremy Hance, Thousands pledge to boycott restaurants serving bluefin tuna, Mongabay (1 December 2010), https://news.mongabay.com/2010/12/thousands-pledge-to-boycott-restaurants-serving-bluefin-tuna/
5. Biodiversity Degradation: 3 Risks for Finance, OAFD (29 October 2021), https://www.afd.fr/en/actualites/biodiversity-degradation-3-risks-finance
6. Kate Abnett, EU lawmakers back ban on goods linked to deforestation, Reuters ( 19 April 2023), https://www.reuters.com/markets/europe/eu-parliament-approves-law-banning-imports-deforestation-linked-goods-2023-04-19/
7. James Ashworth, Over half of coral reef cover across the world has been lost since 1950, National History Museum ( 26 September 2021), https://www.nhm.ac.uk/discover/news/2021/september/over-half-of-coral-reef-cover-lost-since-1950.html#:~:text=Coral%20reefs%20have%20declined%20by,the%20half%20century%20from%201957.
8. Luke Brander & Pieter van Beukering, The Total Economic Value of U.S. Coral Reefs: A Review of the Literature (NOAA, February 2013), https://www.ncei.noaa.gov/data/oceans/coris/library/NOAA/CRCP/other/other_crcp_publications/TEV_US_Coral_Reefs_Literature_Review_2013.pdf
9. Adam Moolna, Coffee: 60% of wild species are at risk of extinction due to climate change, The Conversation ( 17 January 2019), https://theconversation.com/coffee-60-of-wild-species-are-at-risk-of-extinction-due-to-climate-change-109982
10. Brian Wallheimer, COVID’s next casualty could be your cup of coffee, edu – Agriculture News (28 June 2021), https://www.purdue.edu/newsroom/releases/2021/Q2/covids-next-casualty-could-be-your-cup-of-coffee.html
11. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Interpretive Rule) (1989), https://www.sec.gov/rules/interp/33-6835.htm
12. WWF’s new Biodiversity Risk filter helps companies tackle nature-related risks, WWF (16 January 2023), https://wwf.panda.org/wwf_news/?7438966/WWFs-new-Biodiversity-Risk-Filter-helps-companies-tackle-nature-related-risks
13.  UNEP and S&P Global Sustainable1 launch new nature risk profile methodology, UNEP.org (17 January 2023), https://www.unep.org/news-and-stories/press-release/unep-and-sp-global-sustainable1-launch-new-nature-risk-profile

[1] See Section J, Responsibility and Transparency, Kunmig Montreal Global Biodiversity Framework

[2] 17 CFR 229.105(a)

[3] Id.

[4] 17 CFR 229.303(b)(1)(i)

[5] 17 CFR 229.303(b)(1)(ii)(B)

[6] 17 CFR 229.303(b)(2)(ii)

[7] Instructions to Item 303

[8] See Commission Guidance on Disclosure Related to Climate Change (2010), https://www.sec.gov/rules/interp/2010/33-9106.pdf.; Management’s Discussion and Analysis of Financial Condition and Results of Operations (Interpretive Rule) (1989), https://www.sec.gov/rules/interp/33-6835.htm  Here, this logic has been extended to biodiversity

[9] See Commission Guidance on Disclosure Related to Climate Change (2010), https://www.sec.gov/rules/interp/2010/33-9106.pdf

[10] Management’s Discussion and Analysis of Financial Condition and Results of Operations (Interpretive Rule) (1989), https://www.sec.gov/rules/interp/33-6835.htm