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Biodiversity: introduction
Pricing it in, warts and all
Ouida Taaffe introduces this special series of articles on biodiversity and how it relates to financial services by explaining why it is important for markets to price nature risks
The cane toad is “a large, warty, poisonous amphibian native to South and Central America”. Cane toads are also a major ecological problem across northern Australia, where they have no natural predators, poison native species and eat almost any insect – apart from the crop pests they were introduced in 1935 to tackle. And they’re not the only troublesome invasive species that Australia faces. The fire ant, also from South America, has “the potential to threaten the survival and abundance of native fauna, particularly invertebrate species”, the Australian government says. It adds: “[But] potential impacts of the fire ant in Australia are essentially unknown.”
Financial services firms are about to come under pressure to do much more to protect biodiversity
You might be wondering why Financial World is writing about some of the textbook examples of a lack of understanding of ecosystems. It’s because, as the final recommendations of the Taskforce on Nature-Related Financial Disclosures noted in September this year: “Our society, economies and financial systems are embedded in nature, not external to it.” From the point of view of financial services, our reliance on nature is a critical risk that markets ought to price in but currently ignore.
A paper from the Banque de France on biodiversity loss and financial stability highlights that “the global rate of species extinction is now tens to hundreds of times higher than the average rate over the past 10m years. This could affect terrestrial biogeochemical processes in a non-linear and irreversible manner” – which clearly has implications for more than the number of toads.
For a long time, it was assumed that human activities could not really change the workings of nature. When the last passenger pigeon (Martha) died in Cincinnati Zoo in the US in 1914, many people believed that wild flocks of the birds had survived somewhere. Their loss was unthinkable. After all, in the mid-nineteenth century there were still many hundreds of millions of passenger pigeons.
But now it’s clear that humans can affect not only what seemed like indestructible species but also how the planet functions – and in dangerous and unexpected ways. Climate change is the most obvious problem. The EU’s Copernicus Climate Change Service reported that the average global surface air temperature in September this year was 16.38°C, an “unprecedented temperature anomaly”, and 0.5°C above the previous record in 2020. In Europe, it was the warmest September on record – 2.51°C higher than the 1991-2020 average, and 1.1°C higher than September 2020.
But despite the increasing urgency of tackling climate change and biodiversity loss, we are, in many respects, still refusing to respond to the fact that human economic choices can have permanent negative consequences for large and complex natural systems, including the integrity of the planetary ecosystem as a whole.
It’s still largely business as usual. For example, the Leonardo Centre on Business for Society, in partnership with HSBC, recently reported on ‘The Evolution of Corporate Behaviour to Tackle Biodiversity Challenges’. It looked at 651,880 sustainability reports of more than 6,000 publicly traded companies between 2000 and 2021 and found that just 6% dealt with biodiversity. And the biodiversity they paid attention to wasn’t very biodiverse. The overwhelming focus was on life on land, although oceans are of central importance to the planet. Which sector was most active? Utilities led the charge, with 16% having a biodiversity initiative within their overall sustainability goals.
But financial services firms are about to come under pressure to do much more to protect and enhance biodiversity. The Kunming-Montréal Global Biodiversity Framework was adopted at the COP 15 climate conference at the end of last year. It aims to protect 30% of the planet’s land, oceans, coastal areas and inland waters by 2030 and it requires that all financial flows should be aligned with its targets by that date.
Regulators are gearing up to intervene to give such frameworks teeth. In September this year, the Network for the Greening of the Financial System (NGFS), which brings together 127 central banks as members and 20 other organisations, including the Bank for International Settlements and The Basel Committee on Banking Supervision, as ‘observers’, brought out a beta version of a framework for nature-related financial risks. The NGFS framework “seeks to create a common science-based understanding of, and language for, these nature-related financial risks among NGFS members”.
The NGFS makes clear that this will be tricky work and it wants an “integrated approach” that also looks at climate. One pressing reason for that is, as it points out, climate change mitigation can itself be a source of nature risk. Examples are poorly planned tree planting and destroying natural areas to build solar power installations.
There are no genuinely sustainable companies. ESG has to become much more sophisticated
In the UK, firms are already working on biodiversity ahead of the regulatory push. In July 2023, the Green Finance Institute announced a new UK Financial Institutions for Nature Group (G-FIN). Its work will include providing input on government aims, including the development of ‘high-integrity domestic nature markets’ and a green taxonomy. The initial 20 members include Barclays, British Business Bank, Lloyds Banking Group, NatWest Group and the UK Infrastructure Bank.
The UK is also expected to introduce disclosure requirements based on those of the International Sustainability Standards Board, which will be incorporating the TNFD framework.
But although regulation will be necessary, it is unlikely to be sufficient. Arguably, markets need to reconsider radically how they price what risk. For example, the record wildfires in Canada in the summer, which made the air in New York an orange soup of particulates, didn’t have an impact on the Canadian covered bond market because “the wildfires have not been located in heavily populated areas and have not caused a great deal of property damage to date”.
Factors such as an increase in the cost of timber may even make existing Canadian houses look more valuable. Such a siloed approach should cause some head scratching. For example, the health costs of the blaze over one week in one Canadian province alone were estimated to be $1.28bn.
What will it take to change the way the market prices risks? The answer is a lot of effort and new thinking. In this issue of Financial World, economist Dieter Helm points out that, “the reality when it comes to ESG [environmental, social and corporate governance] is that there are no genuinely sustainable companies, full stop. The next phase of ESG has to become much more sophisticated.”
The good news is that a change in approach has started. Sarah Butcher reports on how banks are now building teams to assess biodiversity and natural capital risk and bring new skills to the traditional banking background. Clarisse Simonek outlines why investment institutions are responding to ‘unhedgeable risk’ with strategies that try to enhance the stability of the financial system as a whole, and Emmanuel Monnier examines some of the benefits that a regard for biodiversity can have at the business level, using French vineyards as an example.
Meanwhile, Andy Davis asks how the markets view financial instruments that aim to support biodiversity gains. He outlines, too, the UK’s ambitious Biodiversity Net Gain scheme. Separately, when it comes to less obviously finance-related issues, such as the soil microbiome, there are some interesting projects under way, Beth Brearley reports.
It’s not all roses though. George Graham, in his look at the response of pension funds, reminds us that it took years for the funds to include a consideration of climate risk. Nature-related risks are more complex and have no single benchmark. Chris Newlands interviewed some asset managers who have signed the Finance for Biodiversity Pledge about what they’re doing and why. For them, collaboration and learning are among the main goals.
What about the sort of big, practical, projects that hit the headlines, such as rewilding? Natasha de Terán looks at the situation in Wales and finds that, while rewilding is essential, it is also hyper-local and highly charged. Many farmers in Wales are far from wealthy and rewilding projects need to have an incentive for them as well as investors.
All in all, as Paul Wallace reports from his interview with Sir Partha Dasgupta on the economics of biodiversity, the need for the financial sector to fully price in the value of the natural world will mean economists and ecologists have to start to learn from one another. That is likely to mean many interesting changes in financial services – perhaps even the acceptance that there are some things we need to value that we should not try to put a price on.
Ouida Taaffe
Ouida Taaffe is the Editor of Financial World
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Biodiversity