November 4, 2022

Global Biodiversity: A Stable Ecosystem Yields Stable Economics

The U.N. General Assembly unveiled a 10-point plan on financing biodiversity, showing how reversing biodiversity loss helps stop the spread of poverty.

Reported by Dusty Hagedorn

The global decline of biodiversity poses fundamental risks to food and water security, weakens economies, increases instability, heightens the risk of conflict, and degrades the beauty of the natural world.

While risks are appreciated in both finance and in natural studies, the assessment of natural risks, applied to its financial repercussions is an emerging area of research and discussion in asset management.

Biodiversity is a measure of variation and variability at the genetic, species and ecosystem level. Biodiversity investing concerns also include environmental issues around deforestation, desertification, and the protection of the natural water .

One of the reasons biodiversity preservation is so important societally and financially is the rainforest, which is the most biodiverse ecosystem in the world. According to the World Health Organization, 25% of global modern medicinal drugs stem from rainforest flora.

The U.N. General Assembly has unveiled a 10-point plan on financing biodiversity, In the plan, it writes, “we recognize that we face several interrelated environmental crises including climate change, biodiversity loss, desertification, and pollution. We therefore commit to ensuring coherent and mutually reinforcing financing across each of these issues.”

The U.N. Principles for Responsible Investment in a September 2020 paper called “biodiversity loss a systemic risk” for investors.

“More than half of the world’s gross domestic product, some $44 trillion, is moderately or highly dependent on nature and its services – such as the provision of food, fiber and fuel – and the unprecedented loss of biodiversity places this value at risk,” the UNPRI paper states. “It is critical that institutional investors take action to halt the loss of biodiversity.”

The paper recommended that investors, “allocate capital to sectors or business models which are avoiding and reducing biodiversity loss and increase opportunities for positive outcomes on the ground, including restoration; engage investees on reducing negative biodiversity outcomes and design stewardship approaches to deliver positive biodiversity outcomes; [and] engage policy makers on reforming incentives, including subsidies, to activities that drive biodiversity loss.” As environment, social and governance principles grow from a qualitative framework of ideas to quantitative measurement of human capital and carbon outputs, it has become clear that economic stability intertwines with the preservation of nature, says the U.N.

Whereas many would think that climate is the environment, when discussing the needed protections, climate is only one aspect.

Blaine Townsend, executive vice president and director of sustainable, responsible and impact investing at Bailard, a values-driven wealth and investment management firm in the San Francisco Bay area, said “our future economies will hugely rely on biodiversity to succeed, nature is a feed stock of all industries. Economies rely on these natural feed stocks, and early adopters to protect the feed stocks will beneficiaries over the long run.”

To enable biodiversity protections and restoration efforts, both public and private sector entities will have to team to help finance efforts, according to the U.N.

Over half of global GDP depends on well-functioning ecosystems services and biodiversity and 103 institutions, banks, asset managers and insurers, recognize this, signing a calling for a global biodiversity framework and the scaling-up of capital flows towards projects which provide positive ecosystem outcomes.

Plans to stimulate financing and redirect cash flows, include developing biodiversity finance plans at the national level, and removing government subsidies from industries that cause harm to nature are two of the main components of the U.N.’s guidance.

The U.N. plan emphasizes that private sector businesses must stay “resilient, climate-neutral, nature-positive and less polluting,” while remaining vigilant to assess and disclose their nature-related risks and dependencies and set quantitative targets to reduce negative impacts.

The expectation levied upon financial institutions is that multilateral development banks and international financial institutions that have not done so already should make a biodiversity pledge.

According to Townsend, “private capital takes much of the burden currently. There could be incredible economic opportunities which line up with protecting biodiversity, like alternative types of protein, forest regeneration, and higher utilization of agriculture and farming. Private capital can afford to be more patient and take greater risk, and thus really reap a reward in financing early biodiversity efforts. The companies that invest and become early adopters and find solutions to environmental degradation will outperform their peers.”

Though Townsend sees a role for public markets and big financial firms to contribute to biodiversity funding efforts via the securitization process, “there are a lot of participants in the capital markets which could help securitize these offerings to make them more attractive to investors. We have seen on a smaller scale the success of the Calvert community investment note.”

The Calvert Community Note is a fixed-income security that finances organizations creating positive social and environmental impact in communities around the world. The Note is widely available to U.S. retail and institutional investors in one-, three-, five- or 10-year maturities.

One common way of financing and securitizing biodiversity efforts is using green bonds. These fixed income issuances are instruments that specifically earmark funds for climate and environmental projects. The bonds usually are asset-linked, and are backed by the issuing entities balance sheet, carrying the same rating as the issuer.

Investing in Biodiversity

Lars Erik Mangset, head of sustainable finance at Grieg Investor, a Norwegian independent investment consultant, shared that investing in biodiversity often occurs in the venture capital and private equity sectors.

“We note the emergence of funds that have fully or partly biodiversity [as their] focus,” Mangset says. “Examples can be funds that invest in companies that change their practices to reduce deforestation, funds that promote companies with more sustainable agriculture practice in low-income countries, or funds with a more technology approach to biodiversity.”

According to Mangset, “some of funds we have seen in the VC/PE space have blended finance structures that at least lowers risks, but from what we have seen at the moment, the risk-return profile has been less attractive compared with other funds. “Compared with climate-focused funds, the commercial drivers around biodiversity are perhaps not as clear or as strong, but that might change in the future depending on the introduction of more EU-taxonomies and perhaps also regulatory intervention.”

In general, the share of green bonds featuring biodiversity under their use of proceeds is low. However, biodiversity as a use of proceeds could rise, particularly if COP 15 – the U.N. Biodiversity Conference that convenes in December – results in a ramping-up of policy ambition by policymakers.

Marco Lambertini, director general of the World Wildlife Fund International, wrote in the WFF Living Planet Report 2022, on the rise of biodiversity efforts, “just as the global goal of ‘net-zero emissions by 2050’ is disrupting the energy sector so that it shifts towards renewables, ‘nature positive by 2030’ will disrupt the sectors that are drivers of nature loss – agriculture, fishing, forestry, infrastructure, and extractives – driving innovation and acceleration towards sustainable production and consumption behaviors.”

Townsend said climate and biodiversity “are not different issues but are often discussed as if they are. Previously in COP, [the U.N.] had isolated climate earlier on as a focus, on what mechanisms in the market exist and how to measure it. Though the nature aspect will be much more of focus,” in reference to COP 15.

Latin America has been a leader in financing biodiversity. In recent months, the region pioneered the development of green financial products and instruments related to biodiversity.

In Colombia, financial regulators have adopted a taxonomy to classify sustainable activities for ESG investors that place emphasis on nature-positive land use and biodiversity. The country is also working on national standards for use of proceed bonds, which will include more detailed guidance on biodiversity.

Further in South America, earlier this year Uruguay published a sovereign sustainability-linked bond framework, making it only the second sovereign nation, after Chile, to make concrete plans to issue SLBs.

The framework includes maintenance of the country’s rainforest area as a key performance indicator and includes a coupon step-up/step-down mechanism linked to forest preservation.

SLBs are one of the fastest-growing segments of the sustainable bond market. It is feasible that these constructs in South America could foreshadow developments elsewhere, notably in other biodiverse emerging markets in Asia and Africa.

Grieg’s Mangset says that he expects the green bond and SLB market to grow with respect to their biodiversity focus. SLB issuances should push innovation in the future, said Mangset.

“It will likely not only focus on projects or activities that seek to restore nature, but I think we will also see products with a focus on developing technologies that are able to de-couple economic value creation from biodiversity destruction, such as finding ways to produce food in the oceans with lower biodiversity footprint,” he said.

Disclosure Standards

The EU is leading in the efforts to homogenize reporting and disclosure standards in the biodiversity and climate spaces.

The European Financial Reporting Advisory Group proposed standards last year for the EU’s Corporate Sustainability Reporting Directive, which required detailed disclosures relating to biodiversity, ecosystems, pollution, and natural resources.

“The regulators in the EU have been ahead of market participants in setting down ground rules, whereas in the U.S. market, participants have been ahead of regulators,” said Townsend.

In the U.S., the Harvard Management Company, which manages the $53 billion Harvard University endowment, more than doubled the amount of capital it deployed to climate solutions in 2021. And at of the end of fiscal year 2021 the allocation to climate solutions approached 1% of total assets.

At a global level, the Taskforce on Nature-related Financial Disclosures is developing a third iteration of its draft framework, with a final version due in September 2023. Although a voluntary standard, it could play a significant role in influencing voluntary and mandatory reporting regimes, potentially leading to greater standardization of nature and biodiversity-related risk metrics. The TNFD suggests, “an integrated approach to climate- and nature-related risks, scaling up finance for nature-based solutions.”

Countries that have signed up for the U.N. General Assembly’s 10-point plan include France, the U.K., Gabon, Ecuador, Maldives, Nicaragua, Netherlands, Denmark, Colombia, Germany, Belgium, Norway, Luxembourg, Canada, and the Czech Republic.