Chapter 2

The connection between biodiversity and systemic financial risks

Garry Peterson and Megan Meacham 

Economic activity is unweaving the web of life. Finance is a major force directing this economic activity.  This chapter explains how biodiversity sustains economics and finance, and how losses of biodiversity threaten the viability and stability of economic activities. The chapter also explores current activities from biodiversity science, economics and regulation that are being advanced to address these risks.

The Essential Role of Biodiversity in Finance

Finance, economies, and human societies are all embedded within the biosphere (Folke et. al., 2016; Dasgupta, 2019). The living world is the ultimate source of human well-being. However, sustainability researchers recognize that the increase in scale, connectivity and speed of the global economy is reshaping the biosphere, and its capacity to reliably support humanity (IPBES, 2019; Nystrom et. al., 2018).  The planetary boundaries framework focuses on defining safe limits to these modifications (Rockström et. al., 2009) and recently there have been attempts to define just limits (Rockström et. al., 2023).  

Figure 1. The economy and society as embedded within the biosphere, as intertwined parts of the planet. The biosphere serves as the foundation upon which prosperity and development ultimately rest.  From Folke et. al. (2016). Creative commons figure. 

International science policy assessments have documented how human existence and quality of life depend on nature in increasing detail.  The Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES) described how nature plays a critical role in providing food, energy, medicines and a variety of materials fundamental for people’s physical well-being, social support, and cultural identity.  Ecosystems contribute to fundamental functions like pollination, carbon sequestration, water purification, and climate regulation. These ecosystem services have monetary value and are vital for various industries, including agriculture, pharmaceuticals, and tourism (TEEB, 2010). Genetic diversity, an essential component of biodiversity, is crucial for agriculture and medicine, playing a pivotal role in the creation of resilient and high-yielding crops, as well as in drug development (Heywood, 1995).  Marine and terrestrial ecosystems are the key sinks for human caused carbon emissions, and currently store about 60% of human caused emissions (Rockstrom et. al., 2021). 

Biodiversity loss is changing nature by reducing the supply of ecosystem services, reducing the resilience of ecosystems, and reducing the ability of nature to adapt to change. Biodiversity loss undermines key aspects of human wellbeing: food security, water quality, health, and security. By reducing the productivity of agricultural systems, biodiversity loss reduces access to food for millions of people who depend on crops and livestock for their livelihoods. By impairing the ability of ecosystems to provide clean water, biodiversity loss reduces access to safe drinking water for billions of people who rely on natural sources. By creating new opportunities for zoonotic spread of disease, biodiversity loss makes people more vulnerable to infection by exposing them to novel pathogens and vectors. By destabilizing ecosystems and making them more variable and more likely to experience regime shifts, biodiversity loss reduces the predictability and stability of the services that ecosystems provide. Furthermore, by making ecosystems less resilient to extreme weather events, such as floods, droughts, and wildfires, biodiversity loss increases the risk of disasters that can destroy homes, infrastructure, and livelihoods. 

The benefits that nature provides people are fundamentally irreplaceable (Dasgupta, 2019).  Technology and infrastructure can enhance and replace some of the benefits that people receive from nature, but most of them are more expensive than maintaining nature, incur high future costs, and fail to provide multiple co-benefits. For example, the storm surge and coastal protection can be provided by seawalls and dikes, rather than mangroves. However, technology and infrastructure are also costly, often difficult to maintain, and do not provide other ecological benefits such as spawning habitat, carbon sinks. Nature’s ecological and evolutionary processes maintain these capacities in the living world and provide nature and people with the capacity to adapt to future changes in the living and non-living world.

Finance’s Impact on Biodiversity and Systemic Financial Risks

The financial sector steers economic activity by providing investment, loans, and insurance. The financial system could be funding the restoration and revival of biodiversity, but it currently does not. Instead, it promotes the expansion of activities that are simplifying ecosystems and driving the loss of biodiversity (IPBES, 2019).  Not only are many of these activities bad investments, but these activities can also produce new types of risks and shocks (Dasgupta, 2019). Understanding both the direct and systemic economics risks arising from biodiversity loss becomes crucial for economic resilience and sustainable development.

Nature loss does not only increase the likelihood of extreme events which impact society, it also reduces the capacity of nature and society to cope with and respond to these shocks.  While it is difficult to estimate the exact size of economic losses which will result from an eroded natural environment, it is not difficult to estimate some possibilities. For example, nature loss is increasing the risk of zoonotic diseases. The emergence of a disease with greater impacts than the COVID pandemic could disrupt global supply chains, as well as reduce consumer and business activity. The economic toll of the COVID-19 pandemic for the U.S. economy is estimated to reach US$14 trillion by the end of 2023 (Walmsley et al 2023). These shocks could lead to banking, debt, and currency crises, and the interconnectivity of global financial networks could amplify the effects, transmitting risk from vulnerable areas to other areas. For example, US$4.3 billion was spent preventing and treating malaria in 2016 (Haakenstad et al 2019). More locally, conversion of natural ecosystems, and in particular the loss of wetlands in urban watersheds could lead to severe urban flooding, leading to substantial property and infrastructure damage, as well as business interruptions. If such losses overwhelm local insurance mechanisms, the financial consequences of such an event could trigger sectoral, local, and national crises, particularly in the banking and debt sectors, highlighting the vulnerability of urban infrastructure to ecological changes and the systemic risks posed to financial institutions that finance and insure such assets.

Many types of economic development are based on subsidies which promote activities that decrease the public benefits from nature (Barbier et. al., 2022). For example, the World Bank recently estimated that continued land clearing in Brazil could cost the country US$317 billion annually.  While public economic benefits from ecological conservation are estimated to be seven times as valuable as the economic benefits from agriculture, logging, and mining (Hanusch, 2023), the beneficiaries from these activities are different.

Furthermore, the destabilization of ecosystems can produce novel types of shocks or risks for economic actors and the financial system. For example, agriculture is a major sector in Brazil’s economy and a key driver of Amazonian deforestation. Amazonian deforestation appears to be reducing rainfall and water availability in ways that are threatening agriculture, water for cities and hydroelectric power generation (Keys et. al., 2019a; Leite-Filho, 2021), thus resulting in new material financial risks (see Chapter 6).  By destabilizing the biosphere, economic activity can produce new types of so called “Anthropocene risks” that in turn destabilize economic activity but are difficult to forecast and quantify (Keys et. al., 2019b; Rising et. al., 2022). This vulnerability can trigger cascading effects through the economy, leading to widespread instability, affecting businesses, markets, and livelihoods (Henderson, 2021).

Realization of the adverse impacts of biodiversity loss has led to the emergence of sustainable investment movements. There is increasing understanding of the need for both greening finance, to reduce harm, and financing green, to strategically invest in solutions that enhance biodiversity (World Bank, 2020). Reducing harm involves minimizing detrimental impacts on biodiversity, acknowledging its foundational role in ecosystem services. Financing green entails investing in innovative approaches that align with nature-positive production of goods and services, ultimately contributing to halting and reversing nature loss (Locke et al., 2020).

Going Forward

The recent Kunming-Montreal Global Biodiversity Framework (GBF) was established as a key step towards stopping biodiversity loss. This framework encompasses 23 global targets to be completed by 2030, with the ultimate goal of living in harmony with nature by 2050. Among these targets, the “30X30” agreement, aiming to protect 30% of land and seas, is a significant step in addressing the main driver of biodiversity loss—land-use change (CBD, 2020).  The framework emphasizes the need to shift incentives in global finance and business towards nature-positive actions. It also highlights the importance of considering the perspectives and interests of Indigenous peoples and local communities, promoting a pluralistic approach to biodiversity conservation (IPBES, 2019).  Achieving the targets outlined in the GBF is a monumental challenge to the status-quo, and while political awareness and international cooperation around nature are historically high, the resources being committed to this goal are still far too low (Deutz et. al., 2020).

The Dasgupta Review (Dasgupta, 2019) suggests that businesses and financial institutions should be required to disclose their dependence and impact on nature.  The aim of this increased transparency allows investors and shareholders to assess the nature-related risks in their portfolios, as well as consumers and regulators to assess the activities of companies and investors.  There is substantial progress towards this goal. The GBF includes target 15, which requires governments to ensure that large and transnational companies disclose “their risks, dependencies and impacts on biodiversity”. There is a wider variety of initiatives in Europe, the US, and Japan to track corporate impact, along with the recommendations from the Taskforce on Nature-Related Financial Disclosures that can be expected to continue to develop and be implemented in some form.

Achieving all of these goals will require substantial change in how the world operates and this will require not only biodiversity science, but new accounting systems, regulations and business practices. Creating effective standards will require collaboration between all these fields to implement, monitor, and evaluate, as well as development of new operating practices and standards over time. Striking a balance that promotes sustainable financial practices and nurtures biodiversity is a shared responsibility, requiring collective efforts from stakeholders across sectors. 

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