Biodiversity

What Is Biodiversity?

Biodiversity, in a financial context, refers to the variety of life on Earth across all ecosystems, encompassing the diversity within and between species, and the diversity of ecosystems themselves. It is increasingly recognized as a critical component within financial risk management and a significant factor in environmental risk for businesses and investors. The health and stability of natural systems, often referred to as natural capital, directly underpin global economic activity. As such, understanding and addressing biodiversity loss is becoming integral to ESG investing and broader sustainable finance practices.

History and Origin

While the concept of biological diversity has been studied for centuries, its explicit integration into financial discourse is a relatively recent development. For a long time, the economic value of ecosystem services—such as water purification, pollination, and climate regulation—was largely externalized, meaning their costs or benefits were not fully reflected in market prices. However, growing scientific evidence of rapid biodiversity decline and its potential to disrupt global systems has forced financial institutions to take notice.

The recognition of biodiversity loss as a material financial risk began to gain significant traction in the 2010s. Major organizations, including the World Economic Forum (WEF), started highlighting it in their annual global risk reports. For instance, the WEF's 2020 Global Risks Report ranked biodiversity loss and ecosystem collapse among the top five global risks in terms of both likelihood and impact for the coming decade. Thi¹⁰s growing awareness has prompted central banks and financial supervisors to explore how nature-related risks, including those associated with biodiversity loss, could impact financial stability. A significant report published in March 2022 by a group of central bankers, financial supervisors, and academic researchers emphasized that biodiversity loss poses a substantial and under-appreciated threat to financial stability, advocating for central banks to take action.

##⁹ Key Takeaways

• Biodiversity refers to the variety of life on Earth and is crucial for stable ecosystems that provide essential services to the economy.
• Biodiversity loss is increasingly recognized as a significant financial risk, impacting sectors through physical and transition risks.
• Estimates suggest a large portion of global GDP is highly or moderately dependent on nature and its services.
• Addressing biodiversity loss presents both risks for businesses that fail to adapt and opportunities for those investing in nature-positive solutions.
• Central banks and financial regulators are developing frameworks to assess and manage biodiversity-related financial risks.

Interpreting Biodiversity

In a financial context, interpreting biodiversity involves understanding the dependencies and impacts that businesses and investments have on natural ecosystems. It means assessing how a company's operations rely on healthy ecosystem services (e.g., clean water, fertile soil, stable climate) and, conversely, how those operations affect biodiversity (e.g., through pollution, habitat destruction, or resource depletion). This interpretation extends to considering both direct impacts and those within a company's extended supply chain.

Financial institutions are increasingly exploring methodologies to quantify these dependencies and impacts. This involves analyzing portfolio exposures to sectors highly reliant on nature, such as agriculture, forestry, and fisheries, as well as those with significant negative impacts, like mining or certain manufacturing industries. The goal is to translate these ecological considerations into tangible asset valuation and risk metrics, allowing investors and lenders to better understand potential vulnerabilities and opportunities. The Organisation for Economic Co-operation and Development (OECD) notes that while measurements are in their infancy, various metrics and indicators are available to assess these impacts and dependencies within the financial system.

##⁸ Hypothetical Example

Consider a hypothetical publicly traded food production company, "Green Harvest Inc." Green Harvest relies heavily on agricultural outputs, which in turn depend on healthy soil, water availability, and natural pollination—all aspects of biodiversity.

Scenario: A regional decline in pollinator populations, perhaps due to pesticide use or habitat loss, impacts Green Harvest's key ingredient suppliers.

Impact:

1. Increased Costs: Suppliers face reduced yields, leading to higher prices for raw materials like fruits and vegetables for Green Harvest.
2. Supply Chain Disruption: Shortages of certain ingredients could force Green Harvest to seek new, potentially more expensive or less reliable, suppliers. This directly impacts supply chain stability.
3. Reputational Damage: Consumers and investors, increasingly aware of corporate social responsibility, might view Green Harvest negatively if its practices are perceived as contributing to biodiversity loss, potentially affecting sales and brand value.
4. Regulatory Risk: New regulations aimed at protecting pollinators or restricting certain agricultural practices might be introduced, increasing operational costs or limiting sourcing options for Green Harvest.

In this example, the loss of biodiversity translates directly into financial risks for Green Harvest, affecting its profitability, operational continuity, and public perception, underscoring the interconnectedness between ecological health and financial performance.

Practical Applications

Biodiversity considerations are becoming increasingly relevant across various areas of finance and investing:

• Investment Screening and Due Diligence: Investors are integrating biodiversity criteria into their screening processes for potential investments. This involves assessing a company's reliance on and impact on natural ecosystems, identifying associated environmental risk and opportunities. This helps inform investment strategy.
• Risk Management Frameworks: Financial institutions are working to incorporate biodiversity-related risks (both physical and transition risks) into their overall risk management frameworks, similar to how climate change risks are being addressed. The Financial Stability Board (FSB) published a stocktake in July 2024 detailing how member financial authorities are identifying and assessing nature-related financial risks.
• ⁷Product Development: The financial sector is developing new products, such as sustainability-linked bonds or green bonds, that specifically finance projects with positive biodiversity outcomes or incentivize companies to improve their biodiversity footprint.
• Stewardship and Engagement: Investors are engaging with companies to encourage better practices related to biodiversity protection and restoration, pushing for greater transparency and improved governance around nature-related issues.
• Policy and Regulation: Central banks and financial supervisors globally are increasingly examining how biodiversity loss could pose a systemic risk to financial stability. Organizations like the UN Environment Programme Finance Initiative (UNEP FI) are actively collaborating with foundations to provide guidance for financial institutions on setting robust, science-based targets for biodiversity. The W⁶orld Economic Forum estimates that protecting nature and increasing biodiversity could generate business opportunities worth $10 trillion annually and create nearly 400 million new jobs.

L⁵imitations and Criticisms

While the importance of integrating biodiversity into financial analysis is growing, there are several limitations and criticisms:

• Data Gaps and Measurement Challenges: Quantifying biodiversity impacts and dependencies in financial terms remains complex. Unlike carbon emissions, which have relatively standardized metrics, biodiversity impacts are often localized, diverse, and harder to aggregate. This makes it challenging for portfolio management to accurately assess exposure. Some authorities have noted data and modeling challenges as reasons for not yet prioritizing this area.
• ⁴Lack of Standardized Frameworks: Although efforts are underway by bodies like the Taskforce on Nature-related Financial Disclosures (TNFD), widely accepted and standardized reporting frameworks for biodiversity are still emerging. This can lead to inconsistent disclosures and make comparisons difficult for investors focused on social responsibility.
• Complexity of Interdependencies: Ecosystems are highly complex, with intricate interdependencies. Isolating the financial impact of a specific biodiversity loss event from other environmental or economic factors can be difficult.
• Long-Term vs. Short-Term Focus: The benefits of biodiversity conservation often materialize over longer time horizons, while financial markets typically prioritize short-term returns. This mismatch can hinder significant capital allocation towards nature-positive solutions.
• Greenwashing Concerns: As biodiversity finance gains prominence, there is a risk of "greenwashing," where companies or funds may overstate their positive impact on biodiversity without genuinely transformative actions. Robust verification and transparency are crucial to mitigate this risk.

Biodiversity vs. Climate Change

While often discussed together as interconnected environmental challenges, biodiversity and climate change represent distinct yet mutually reinforcing concepts within finance.

• Climate Change primarily refers to long-term shifts in temperatures and weather patterns, largely driven by human activities, especially the emission of greenhouse gases. In finance, this translates into risks related to carbon emissions, transition to a low-carbon economy, and physical risks from extreme weather events. Financial responses often focus on decarbonization, renewable energy investments, and climate risk disclosure.
• Biodiversity, conversely, refers to the variety of life on Earth. Biodiversity loss is driven by multiple factors beyond climate change, including habitat destruction, pollution, overexploitation of resources, and invasive species. From ³a financial perspective, biodiversity risks involve the degradation of natural capital and ecosystem services that underpin economic activity, such as pollination for agriculture or water filtration. Financial responses involve assessing dependencies on nature, reducing negative impacts, and investing in nature-positive solutions like ecosystem restoration.

The two are interconnected: climate change is a significant driver of biodiversity loss, and healthy ecosystems can help mitigate climate change (e.g., forests absorbing carbon). However, addressing one without the other provides an incomplete picture of environmental and financial risk. Central banks, for instance, are increasingly extending their focus from climate change to the broader challenges posed by environment-related risks, specifically including biodiversity loss.

F²AQs

What is the financial significance of biodiversity loss?

Biodiversity loss poses significant financial risks by degrading the natural assets and ecosystem services that the global economy depends on. This can lead to disruptions in supply chains, increased operational costs, reduced asset values, and systemic risks to financial stability. It can also create regulatory and reputational risks for businesses.

How do businesses depend on biodiversity?

Businesses depend on biodiversity in numerous ways, often indirectly through ecosystem services. Examples include access to raw materials (e.g., timber, fish, agricultural products), clean water for manufacturing, natural pest control for crops, and climate regulation, which impacts physical assets and operations.

What is "nature-positive" finance?

"Nature-positive" finance refers to financial activities, investments, and strategies that aim to halt and reverse the loss of biodiversity and the degradation of ecosystems, leading to a net gain for nature. This involves directing capital towards solutions that conserve, restore, and sustainably manage natural resources, aligning with sustainable finance principles.

Are central banks concerned about biodiversity?

Yes, central banks and financial supervisors are increasingly concerned about biodiversity loss. They recognize it as a potential source of financial risk and a threat to financial stability. Many are developing frameworks and research to understand how nature degradation impacts the economy and the financial system, and how to integrate these considerations into their mandates.¹