Rational investors avoid ESG-risks

Managing and minimizing environmental, social and governance risks is essential when considering investments in land-use activities.
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Investors tend to be rational, making decisions based on a weighing up of the returns and risks of potential investments. Financial flows to different landscapes will for a large part be governed by the risks associated with each type of investment.

The risks and returns when investing in landscapes may differ from those in many other sectors. By unpacking investment attributes of risks and returns, investors can match their own appetites.

To do so, the traditional PESTE-analysis, applied to landscape sector, can be a useful risk management tool for investors. The modern corporate governance, especially the ESG-approach, brings some new aspects into this consideration.

The traditional PESTE-analysis breaks down categories of risk across political, economic, social, technical and ecological factors[1]. The ESG-factors are matrixlike present in all these layers.

In an analysis of an investment in sustainable land-use activities, a process of managing and reducing risk across the five PESTE layers is essential.

Below shows some of the potential risk pitfalls that investors face when investing in land-use:

  1. political – governance risks
  • regulation, restrictions, sanctions, taxes, subsidies, bureaucracy
  1. economic risks
  • market shock, subcontractors, financing, interest rates, unemployment
  1. social risks
  • reputation, social acceptance, license to operate, consumer behavior
  1. technical/physical risks
  • climate, storm, fire, flood, earthquake, land quality, irrigation, machinery
  1. ecological/biological
  • animals, pests, fungi
  • introduced tree species in planted forests

Land ownership as such can be incorporated into any of these risks as it plays a role in the likelihood for occurrence of these risks and also it has an impact on the potential ways managing the risks (e.g., social risks and accountability).

Policymakers have various tools at their disposal to de-risk land-based activities, one of which includes setting parameters for how land can be used or conserved. Land-use policies – such as property rights, tax deductions and subsidies – can reduce the financial risks of investors to finance sustainable nature-based solutions. Policymakers should focus on long-term policies as signals to investors that they intend to de-risk the financing of the most sustainable nature-based projects.

Dr. Pentti Hyttinen

PenTen Ltd

(The text is based on a report prepared for the Chatham House together with the World Bioeconomy Forum.)

[1] In some sources there is an L at the end standing for legal factors, and in some other sources a C standing for consumer behaviour. On the other hand, legal aspects can be included under political factors and consumer behaviour under social factors.