COP16: Nature, Biodiversity Key in Finance

Climate change is already posing a serious risk to the financial sector. The flood disaster in the German state of North Rhine-Westphalia in 2021 caused insured damage of almost 9 billion euros, stated NU.nl. The total damage was a lot higher, an estimated 33 billion. Hence, not all inhabitants and businesses were insured against water damage to, for example, their homes, businesses and cars.

The effects of biodiversity loss are also gaining recognition and taking hold in the financial sector. For example, a Mexican government agency insured a coral reef off the coast of Quintana Roo with a Swiss insurer. The rationale: the coral reef provides ecosystem services. The reef attracts fish and is therefore a source of income for local fishermen. It also provides diving tourism and acts as coastal protection, reducing the risk of flooding during hurricanes. When a hurricane passed through in 2020 and damaged the coral, the agency received 800,000 dollars to restore the coral reef.

These provide illustrative examples of loss related to climate change and biodiversity for financial institutions. However, is it also possible to value the ecosystem services that support, for example, the agricultural sector in different countries? This is something financial institutions are increasingly looking into. WUR is also conducting research into this. In the public-private project 'Biodiversity Related Risks and Opportunities to the Financial Sector', Wageningen economists and environmental scientists are working together with banks, insurers, financial advisory organisations and investors to develop a state-of-the-art methodology for assessment of biodiversity related risks and opportunities.

EU's Corporate Sustainability Reporting Directive

There is a great need for ecological knowledge and valuation of nature in the private sector, to fulfil the need to be transparent and comply with mandatory and voluntary reporting requirements, say Florence Arke and Pieter van Dusseldorp of Deloitte, one of the partners in the project. Biodiversity is part of the EU's Corporate Sustainability Reporting Directive (CSRD). This legally obliges 50,000 large European companies to report their performance in the areas of climate change, pollution, water management, biodiversity and the circular economy, next to social and governance topics. One of its objectives in the long run is to remove harmful practices from corporate activities and direct them towards activities that enhance biodiversity.

'Many of the larger clients we work for are working on their CSRD implementation', the Deloitte employees say. Deloitte wants to help clients understand the relationship their business activities have with nature and identify the important dependencies, impacts, risks and opportunities (DIROs) and to report on these issues. 'This allows clients to better manage their nature-related DIROs, focusing increasingly on positive impact and opportunities as well as regenerative relationships.'

In order to achieve this, the financial institutions need to, in many cases, check with their clients whether and how they have a dependency or an impact on nature and biodiversity. How are the companies performing now and what objectives do they have to improve nature and biodiversity? And how can they transparently communicate all of this to corporate stakeholders? To do this, they need baseline studies of the current situation and methodologies to determine how they can achieve these goals. Van Dusseldorp compares the CSRD with the actions taken by banks to prevent money laundering; in both cases they need a lot of information from their customers.

Deloitte, with 40 other organizations, supported developing the Taskforce on Nature-related Financial Disclosures, in which around four hundred financial institutions exchange knowledge on nature-related dependencies, impacts, risks and opportunities. Arke explains that one of the first goals of this taskforce was to define the concepts of nature, which can be a completely new topic in some industries. From there, further guidance on, for instance, risk management was developed.

Measuring biodiversity loss

The risks that nature degradation and biodiversity loss pose to the financial sector are much more difficult to measure than climate change, says insurance company Allianz, another partner of WUR in the project. With climate change, local emissions have global consequences; every ton of CO2 contributes to global warming. The consequences of biodiversity loss are usually local and not perfectly substitutable - a forest in one place is different from another. 'This leads to a very heterogeneous map of biodiversity loss and resulting risks and opportunities', the insurer said. Which complicates assessment.

Many studies investigating the economic impact of biodiversity loss focus on "exposure'', or the total market value of products and services that depend on biodiversity. This way you can reach huge values in exposure. 'This approach ignores the fact that economic activities can often be continued, albeit at a lower level, through more expensive alternatives', says Markus Zimmer of Allianz. 'Our research measures the actual economic impact of biodiversity loss, taking into account lower production levels and higher costs.'

In this way, Allianz and WUR calculated the macroeconomic value of pollinating insects in an earlier study. Some findings: A 20% loss of pollination activity would reduce U.S. agricultural production by 1.3%. This translates to an estimated loss of 28 billion dollar annually. A complete loss of pollination would reduce agricultural production in Britain by 2%, and in Belgium by 7.9%. To limit the loss of pollination services, the study identified seven agricultural measures. Some of these were relatively cheap, such as a precision farming dashboard; others were more expensive, such as the use of nematodes instead of insecticides. In certain countries, the study concluded that investing in insect protection measures paid off when considering their potential to reduce economic losses caused by pollination services.

This study measured the direct disruption of production processes due to the decrease in pollination. But there is another risk: transition risks. Degradation of natural ecosystems may lead to sudden changes in regulation, technologies or consumer preferences. Companies may need to adapt to new regulations, pay taxes, set emission ceilings or take recovery measures. Zimmer: 'Although these measures may be costly in the short term, they can lead to cost reductions through managing risk and ensuring financial sector stability. However, there is little research on the transition costs associated with biodiversity loss.'

Valuing ecosystem services

Wageningen ecologist Arnold van Vliet will help to broaden the pollination study to a whole range of other ecosystem services. 'Calculating the financial impact of biodiversity loss is new, challenging and necessary and I am familiar with it. We do a lot of research into this in the Earth Systems and Global Change group at Wageningen University. I am also a board member of the Foundation for Sustainable Development, an NGO that focuses, among other things, on valuing ecosystem services in the world. To this end, we are developing the Ecosystem Services Valuation Database, a free database filled with thousands of studies that have calculated what nature provides society.' His role in the project is to determine how biodiversity worldwide will change in the coming decades and what consequences that could have for various ecosystem services. The results then feed into the economic MAGNET model that is being developed by Wageningen Economic Research.

MAGNET is a global general equilibrium model, explains developer Willem-Jan van Zeist. 'The governing principle in these models is that demand equals supply at certain prices, so if a demand for, for example, coffee or bananas increases, the market will respond with more supply. More machines, land and labor are needed and so a new equilibrium is created. MAGNET can explore new situations by solving a complex system of economic equations that give insight in where the responses in demand and growth in production will take place.'

'We have also added climate, biodiversity and land use', says Van Zeist. 'We can now say: we are going to protect this piece of land for biodiversity. Then there are fewer land use options. To indicate the effects, we also need to indicate how much land on earth can still be used for agriculture, and where. This data creates a new balance between demand and supply, with new prices.'

The Wageningen researchers are now further developing the model with specialists of their project partners. They will, among others, draw on the ENCORE classification system, which has identified 21 crucial ecosystem services that connect biodiversity with the economy. One of those ecosystem services is pollination, another is soil quality.

Understanding the role of soil quality

'Soils are a crucial ecosystem service; they sequester carbon and help to regulate the climate', says Markus Zimmer of Allianz. 'Pricing carbon, for instance through biodiversity offsets, can generate revenues through sequestration and is therefore essential for financing activities that improve soil quality.' Allianz estimates that, at a social cost of carbon of 132 euros per ton of CO2 equivalent, investments in soil quality would ultimately create carbon sequestration worth 18.3 trillion US dollar, or 1.1 times the size of the European economy. 'Investments in sustainable soil management are often very cost-effective and offer significant socio-economic benefits', Zimmer concludes.

The participants in the project readily admit that this market-oriented approach has its limitations. 'The true impact of biodiversity on human well-being is poorly understood and not reflected in GDP figures,' says Zimmer. MAGNET Developer Van Zeist says, 'I have a healthy distrust of our model. It is a fairly traditional growth model; we do not work with alternative economic paradigms in the project.'

Yet there are already good examples of nature investments by private institutions. For example, there are investment programs in which small-scale farmers invest in cocoa and coffee cultivation in an agroforestry setting while restoring rainforests so they can provide more ecosystem services. Deloitte also knows an example of a company that grows coral for reef restoration. Hotels along the coast invest in this company, for example through hotel guests who can indicate at check-in whether they want to contribute to coral restoration. Tourism can, therefore, also contribute to biodiversity recovery.