The theme of this year’s Earth Day, celebrated on 22 April, invites us to ‘Invest in Our Planet’. Doing so requires rethinking how we manage economic development and recalibrating how we direct flows in the financial system, writes Danae Kyriakopoulou.
|This article is part of a series by LSE's Grantham Research Institute on Climate Change & the Environment (visit website).|
Nature’s high risks and returns
The interdependencies between people, planet and profit are becoming increasingly evident and well-documented: we are embedded in nature, not external to it. More than half of global GDP is highly or moderately dependent on nature and its services, and around two-thirds of food crops rely at least partly on animal pollination. Degradation of the oceans and marine ecosystems risks costing the global economy around $8.4tn over the next 15 years. The financial sector is not immune either: nature degradation is an endogenous financial stability risk. Indicatively, research in 2021 by the Banque de France, the French central bank, concluded that 42 per cent of the securities portfolio of French financial institutions is highly or very highly dependent on one or more ecosystem services. Similar studies for the Netherlands, Malaysia and Brazil have found even stronger dependencies.
These services are now in a state of emergency. The world has already lost 83 per cent of wild mammals and half of all plants; human activity has significantly altered three-quarters of ice-free land and two-thirds of marine environments. Nearly one million species of plants and animals are threatened with extinction in the coming decades at a rate tens to hundreds of times faster – and accelerating – than in the past 10 million years. The risks to the economy and the financial system are commensurately large, especially in climate-vulnerable countries: the World Bank estimates that low-income and lower-middle-income countries could lose over 10 per cent of their GDP annually by 2030 even in a conservative scenario of only partial ecosystem collapse without biophysical feedback effects.
Putting risks aside, even if we were not trying to solve the existential crisis that is presented by non-substitutable ecosystem collapse, preserving nature and biodiversity makes economic and financial sense in its own right: it has been calculated that $10tn of GDP and 395m jobs could be unlocked by 2030 by transforming the three economic systems responsible for 80 per cent of nature loss (food, land and ocean use; infrastructure and the built environment; and energy and extractives). While getting there will require a significant finance push, the opportunities in the form of future savings mean this is an investment, not a cost.
Dual crisis: nature and climate
Ecosystem collapse is closely interlinked with climate change: the nature and climate crises are reinforcing one another, eroding the very foundations on which our collective wellbeing depends. The Intergovernmental Panel on Climate Change (IPCC) has repeatedly warned that investing in our planet, particularly its ecosystems, is critical if we are to meet the 1.5°C climate target of the Paris Agreement.
The links run both ways: the natural world is significant to climate change mitigation and adaptation, while climate change drives nature loss.
“To break this vicious cycle and restore resilience and productivity, climate and nature goals must be coordinated.”
Our oceans and forests serve as natural carbon sinks and are responsible for absorbing 60 per cent of the world’s global anthropogenic emissions. Mangroves, sea grasses and corals provide protection for humans and wildlife from both the causes and effects of climate change. For example, coastal mangroves store three to five times more carbon than rainforests, and are multiple times cheaper than flood-protection infrastructure such as breakwaters. At the same time, the increased frequency, intensity and geographical spread of climate-related disruption is degrading ecosystems and eroding nature’s capacity to mitigate climate change. For example, droughts may result in wetlands releasing significant levels of greenhouse gases, while the melting of the Arctic permafrost can also lead to rising emissions.
To break this vicious cycle and restore resilience and productivity, climate and nature goals must be coordinated. At the policy level, this requires harmonising climate goals (such as Nationally Determined Contributions and National Adaptation Plans) with National Biodiversity Strategies and Action Plans. It requires governments moving on from the siloed approach that designates the environment to a single ministry and fails to reflect the systemic risk that nature loss poses to economic development. At the financial system level, it requires managing climate- and nature-related risks in relation to one another.
Finance for biodiversity
The financing needs for delivering the net-zero transition and managing climate- and nature-related risks and opportunities can be broadly grouped into three categories:
- First, investments with defined revenues attached, that can be largely met through private finance. This includes much of the climate mitigation agenda, which represents the lion’s share of investment needs – particularly energy, which has benefitted from the falling costs of renewables.
- Second, investments with no current revenues but high future savings, where concessional and innovative financial solutions are needed. This includes investments in natural capital, but also in adaptation and resilience.
- Third, finance for areas where there are no revenues and few savings, but which are necessary for the transition to be seen as fair and hence politically viable, such as addressing loss and damage and the social costs of the just transition.
The further the move away from the ‘bankability frontier’ towards less revenue-clear projects and jurisdictions where the cost of capital is higher (but financing needs tend to be greater), the more innovative and concessional financing needs to become.
Closing the nature and biodiversity finance gaps requires an estimated $598–824bn per year by 2030 and $4.1tn by 2050. This equates to less than 1 per cent of global GDP. Part of it can be sourced from freeing harmful subsidies that are damaging ecosystems both directly and indirectly through creating disincentives for climate change mitigation. These include fossil fuel, agriculture and other subsidies at a magnitude of around $800bn globally, a large share of which is estimated to hurt nature.
“The further the move away from the ‘bankability frontier’ … the more innovative and concessional financing needs to become.”
The reform of harmful subsidies can and should be complemented by a strong finance push of innovative instruments. The fixed income market has demonstrated some successes with nature-related bonds, including in the market for blue bonds (such as the world’s first sovereign blue bond issued by the government of the Seychelles to support sustainable marine and fisheries projects, and more recently Barbados) and wildlife conservation bonds (such as the World Bank’s $150m ‘Rhino Bond’, which aims to protect South Africa’s population of black rhinos).
For low- and middle-income climate-vulnerable economies that are fiscally constrained because of significant debt burdens, debt-for-nature swaps have proven an effective way to address nature risks and raise revenue for conservation. Such swaps have converted around $500m of debt into $230m of conservation finance over the past six years, according to some estimates. Belize is a case in point, with a $553m swap to protect the world’s second-largest coral reef that reduced debt by more than 10 per cent of GDP.
Building on the breakthroughs of carbon offsets, nature-based and biodiversity offsets traded in voluntary carbon markets can act as an additional channel for shifting financial flows towards nature, provided they are truly reserved for cases where genuine emission reductions cannot be carried out and that other integrity standards are followed. Other proposals include directly paying those ‘stewarding’ natural resources, in a model inspired by the fees earned by asset managers in the private financial sector (for example a 2 per cent fee paid to the government of Brazil to stop deforestation in the Amazon).
Realigning the financial system
It is not enough to direct finance towards investments in conservation, restoration and sustainable resource use: we also need to align the financial system so that it directs flows from activities that degrade nature to ones that protect and enhance it. Here, the work of finance ministries, regulators, central banks and supervisors will be critical, as well as the efforts by standard-setting bodies and ratings agencies to transform the wider information architecture around nature-related risks and opportunities. The Global Biodiversity Framework agreed at COP15 in Montreal last December can help provide an impetus for action, with many hailing it as a “Paris moment for nature”.
“…the critical links across economic development, climate change and nature and biodiversity … are now well-understood by both scientists and economists.”
Central banks in particular are well-placed to extend existing frameworks for collaboration and action under the Network for Greening the Financial System (NGFS), from climate-related assessments to nature-related ones, given distinct similarities across the two (notwithstanding important differences, too). In the case of nature, as explored by the newly-created Biodiversity Loss and Nature-related Risks Taskforce (NGFS), there is significant scope to integrate nature and biodiversity loss considerations into existing policy frameworks, including microprudential policies and disclosure requirements, as well as macroprudential assessments and scenario analysis.
A supportive nature information architecture is an important prerequisite for turning these opportunities into action, both when it comes to financial policy, regulation and supervision, and regarding the decisions within the financial sector itself. The intention by the International Sustainability Standards Board (ISSB) to explore nature and biodiversity standards as one of its next areas of focus, and to align with the work of the Task Force on Nature-related Financial Disclosures (TNFD), is significant in this regard.
No Planet B
Nature has always served as an inspiration and resource to human civilisation, a critical input to our progress and development. So much is at stake as we celebrate Earth Day for the fifty-third year this weekend, not least because of the critical links across economic development, climate change and nature and biodiversity that are now well-understood by both scientists and economists.
COP15 provided the policy signal. Now it is time for the financial system to look at this long-awaited north star and accelerate the shift to ‘Invest in Our Planet’. Not only is it existentially essential and intangibly valuable, but it will also help move humanity onto a better path, one defined by greater food and water security, reduced risk of zoonotic diseases and pandemics, and more fruitful and productive ecosystems.
* The author wishes to thank Charlotte Gardes-Landolfini for her comments on an earlier draft.
- This blog post represents the views of its author(s), not the position of LSE Business Review or the London School of Economics.
- Featured image by USGS on Unsplash
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