Conservation Finance: New Market Opportunities for Investment Banks

Introduction.

The rising demand for conservation finance products, including biodiversity bonds and sustainable investment funds, offers new revenue streams for investment banks. Here, we explore the market potential and strategic benefits for institutions that invest in biodiversity.

As regulatory pressures mount, through frameworks like the Taskforce on Nature-related Financial Disclosures (TNFD) and Taskforce on Climate-related Financial Disclosures (TCFD), and as demand grows for innovative financial products like green bonds and biodiversity bonds, investment banks have a unique opportunity to reshape how capital is deployed for conservation and sustainable growth. This research explores the emerging connection between biodiversity risks and investment banking, delving into the challenges, opportunities, and evolving market for financial products that address this growing concern.

As regulatory pressures mount, through frameworks like the Taskforce on Nature-related Financial Disclosures (TNFD) and Taskforce on Climate-related Financial Disclosures (TCFD), and as demand grows for innovative financial products like green bonds and biodiversity bonds, investment banks have a unique opportunity to reshape how capital is deployed for conservation and sustainable growth. This research explores the emerging connection between biodiversity risks and investment banking, delving into the challenges, opportunities, and evolving market for financial products that address this growing concern.

In the realm of sustainable finance, the conversation has largely revolved around climate change, carbon emissions, and renewable energy. However, a less explored but equally critical issue is biodiversity loss—the degradation of ecosystems and the disappearance of species that support global economic stability. Investment banking, with its pivotal role in capital allocation and financial product innovation, is now facing the challenge of integrating biodiversity risks into its core strategies.

1. What is Biodiversity Risk?

Biodiversity refers to the variety of life on Earth, including ecosystems, species, and genetic diversity. Biodiversity riskrelates to the degradation or loss of ecosystems and species, which can have cascading effects on the economy. For businesses, this risk manifests in disrupted supply chains, reduced raw material availability, increased operational costs, and potential regulatory or legal liabilities.

2. Biodiversity in the ESG Context:

While ESG frameworks often focus on the "E" through climate change and pollution, biodiversity is part of the broader environmental category. The impact of biodiversity on the economy and financial markets is becoming more evident as the natural world degrades. Like climate change, biodiversity loss is now being recognized as a systemic risk.

3. Why Biodiversity Risks Are Less Talked About:

• Complexity: Biodiversity risks are harder to quantify than carbon emissions. The interactions between ecosystems, species, and economic activities are complex, making them difficult to measure and model.
• Awareness Gap: Unlike climate change, which has received significant attention over the years, biodiversity has only recently emerged as a critical issue in financial markets.
• Lack of Standardization: Until recently, no unified reporting standards specifically targeted biodiversity, making it less prominent in sustainability reports and ESG assessments.

4. Key Sectors Affected by Biodiversity Loss:

• Agriculture and Food Production: Biodiversity supports crop pollination, soil fertility, and water cycles. Loss of pollinators like bees can directly impact food supply and increase production costs.
• Pharmaceuticals: Many medications are derived from plants and animals. Loss of biodiversity can limit access to natural resources needed for drug development.
• Forestry: Deforestation and unsustainable logging practices can disrupt ecosystems, affecting industries dependent on timber and paper products.
• Energy and Mining: Projects that disturb biodiversity-rich areas face operational risks, reputational damage, and regulatory hurdles.
• Tourism: Ecotourism relies on healthy ecosystems. Degradation of natural areas can reduce the attractiveness of destinations, leading to economic losses in tourism-reliant regions.

5. Investment Risks Related to Biodiversity Loss:

• Operational Disruptions: Companies relying on natural resources, such as fisheries, agriculture, and forestry, can face operational issues due to biodiversity loss.
• Regulatory and Compliance Risks: Governments are introducing stricter biodiversity protection laws. For instance, the European Union’s Biodiversity Strategy for 2030 includes targets that could influence corporate practices and create new compliance costs.
• Reputation Risk: Companies and financial institutions face reputational damage if they are associated with biodiversity destruction, leading to divestment and consumer backlash.
• Liability Risk: As biodiversity becomes more regulated, companies could face lawsuits for harm to ecosystems, increasing their legal and financial liabilities.

6. Opportunities for Investment Banks:

Biodiversity risk presents a new dimension of opportunity for investment banks:

• Green Bonds and Sustainability-Linked Bonds: The market for green financial products is expanding beyond carbon-focused products to include biodiversity-linked bonds. These are debt instruments where proceeds are used for projects that restore or protect biodiversity.
• Biodiversity Conservation Funds: Investment banks can create or advise on the creation of investment vehicles that focus on projects like reforestation, sustainable agriculture, or the protection of marine ecosystems.
• Advisory Services for ESG-Linked M&A and IPOs: Biodiversity risk is becoming part of ESG due diligence in M&A and initial public offerings (IPOs). Investment banks that excel in identifying biodiversity risks can provide higher-value advisory services.
• Natural Capital Investment: This is the valuation of natural resources as economic assets, and it’s gaining traction in the financial world. Investment banks can provide innovative financing for projects that aim to maintain or restore ecosystems, such as carbon offsets, water purification, and biodiversity credits.

7. Regulatory Landscape and Frameworks:

Several global initiatives and regulatory frameworks are emerging that focus on biodiversity:

• TNFD (Taskforce on Nature-related Financial Disclosures): Launched in 2022, the TNFD aims to provide companies and investors with a framework to identify and disclose nature-related risks and opportunities. This is similar to the Taskforce on Climate-related Financial Disclosures (TCFD), but focused on biodiversity.
• EU Biodiversity Strategy 2030: Part of the European Green Deal, this strategy sets out a long-term plan to protect nature and reverse ecosystem degradation in Europe. It also includes a plan to integrate biodiversity considerations into corporate governance, which will affect banks and other financial institutions.
• Convention on Biological Diversity (CBD): This international treaty, especially through its Post-2020 Global Biodiversity Framework, emphasizes the role of finance in biodiversity conservation and aims to mobilize capital towards nature-positive investments.

8. Metrics and Tools for Investment Banks:

Measuring biodiversity risk is complex, but investment banks can use emerging tools and metrics:

• Corporate Biodiversity Footprinting: Tools like the ENCORE tool (Exploring Natural Capital Opportunities, Risks, and Exposure) help companies and investors assess the impact of their activities on biodiversity.
• Biodiversity Indicators: Metrics like the Mean Species Abundance (MSA) or Natural Capital Protocol allow financial institutions to incorporate biodiversity into their risk models.
• Scenario Analysis: Banks can apply scenario analysis to evaluate how biodiversity loss might affect sectors or portfolios over time, similar to climate change risk assessments.

9. Recent Trends and Developments:

• Biodiversity Disclosure in Reporting: Financial regulators are increasingly demanding that biodiversity impacts be included in sustainability reporting. CDP (Carbon Disclosure Project), which pioneered environmental reporting, now includes biodiversity in its questionnaire to companies.
• Pressure from Investors: Large institutional investors such as BlackRock and Norges Bank Investment Management are calling for biodiversity risks to be factored into corporate ESG disclosures.
• Biodiversity-related Engagements: Investors are engaging more actively with companies to address biodiversity loss. The Finance for Biodiversity Pledge, signed by over 75 financial institutions, commits them to engaging with companies on biodiversity risks.

10. Challenges for Investment Banks:

• Data Availability: While frameworks like the TNFD are emerging, biodiversity data is still scarce, inconsistent, and difficult to integrate into financial models.
• Lack of Standardization: Unlike carbon, there is no universal unit of biodiversity measurement. The absence of standardized biodiversity metrics complicates risk assessment and disclosure.
• Short-term Financial Pressures: Investment banking traditionally focuses on short- to medium-term financial returns. Biodiversity investments, which often require long-term thinking, may be challenging to integrate into current financial models.
• Valuing Natural Capital: While the concept of natural capital is gaining ground, putting a financial value on ecosystems and biodiversity remains a significant challenge.

To provide a more accurate connection between biodiversity risks and investment banking, it is essential to focus on how this emerging issue influences financial institutions’ strategies, risks, and product offerings. Here’s how key elements like green bonds, TNFD, TCFD, and biodiversity bonds are integrated into the investment banking ecosystem:

1. Investment Banking’s Role in Biodiversity Risks

Investment banks play a critical role in the allocation of capital, risk management, and advisory services, which are all being increasingly influenced by biodiversity concerns. As biodiversity risks become more prominent, they affect key investment banking functions, such as:

• Mergers and Acquisitions (M&A): When conducting due diligence, investment banks now need to consider biodiversity-related liabilities. Companies that rely on natural resources or operate in environmentally sensitive areas might face higher future costs or regulatory risks, influencing their valuation and deal attractiveness.
• Underwriting and Initial Public Offerings (IPOs): Companies that are not managing biodiversity risks could face future reputational or operational challenges, making them less attractive to investors. Investment banks must now evaluate biodiversity risk alongside traditional financial risks when advising on capital raises.
• Risk Management: Just as climate risks are being integrated into financial models, biodiversity risks are becoming a part of investment banks’ risk frameworks. These risks can affect credit assessments, especially for sectors dependent on natural resources.

2. Green Bonds and Biodiversity Bonds

Green bonds are debt instruments designed to raise capital for environmental projects. Traditionally focused on climate change mitigation and renewable energy, green bonds are increasingly being used to finance projects aimed at protecting biodiversity. Examples of biodiversity-related projects that can be financed through green bonds include:

• Forest Conservation: Protecting forests, which are critical to biodiversity, can be financed through green bonds. Such projects contribute to carbon sequestration and biodiversity protection, creating a dual environmental benefit.
• Marine and Coastal Ecosystem Restoration: Investment banks can structure green bonds to fund the restoration of marine ecosystems like coral reefs, which are vital for biodiversity and act as natural coastal defenses.

Biodiversity Bonds: A newer development, biodiversity bonds (a subset of green bonds), are financial instruments whose proceeds are used explicitly for biodiversity conservation and restoration projects. Investment banks can issue biodiversity bonds to help clients raise funds for initiatives like ecosystem restoration, reforestation, and the protection of endangered species.

• Example: In 2020, the World Bank issued a Wildlife Conservation Bond to finance the protection of black rhinos in South Africa. These bonds provide returns linked to the success of conservation efforts, illustrating how financial products are evolving to address biodiversity.

3. TNFD (Taskforce on Nature-related Financial Disclosures)

The Taskforce on Nature-related Financial Disclosures (TNFD), launched in 2022, aims to help financial institutions assess and disclose biodiversity-related risks. It mirrors the Taskforce on Climate-related Financial Disclosures (TCFD), but its focus is on nature and biodiversity.

Role of TNFD in Investment Banking:

• Risk Identification and Reporting: TNFD provides a framework for identifying and reporting nature-related risks, helping investment banks assess how biodiversity loss could affect their portfolios. It encourages transparency and consistent reporting across industries, enabling investment banks to better integrate biodiversity into their risk management frameworks.
• Scenario Analysis: Investment banks can use TNFD’s guidelines to run scenario analyses, evaluating how different biodiversity outcomes (e.g., deforestation, loss of pollinators, or water scarcity) might impact the industries they finance.
• Advisory Services: As companies are required to disclose more nature-related risks under TNFD, investment banks have an opportunity to expand advisory services. They can help clients understand and mitigate biodiversity risks through ESG-linked advisory for M&A, debt issuance, and equity capital markets.

4. TCFD (Taskforce on Climate-related Financial Disclosures)

While the TCFD primarily focuses on climate risks, it has set a precedent for how investment banks should approach biodiversity risks. Many of the methodologies developed for climate risk disclosure are now being adapted for biodiversity through TNFD.

TCFD’s Influence on Biodiversity:

• Financial Impact of Biodiversity: Investment banks have learned from TCFD how to evaluate the financial impact of non-traditional risks (e.g., climate change). This experience is now being applied to biodiversity, where banks assess how ecosystem degradation can affect the financial performance of companies they invest in.
• Metrics and Targets: Just as TCFD pushed for companies to set clear climate-related targets, investment banks are now encouraging clients to set biodiversity-related goals. These could include commitments to reforestation, reducing reliance on natural resources, or protecting endangered species.
• Cross-Sector Impact: TCFD helped show how climate risks cut across sectors (e.g., energy, manufacturing, and agriculture), and this is equally true for biodiversity risks. Investment banks are using similar cross-sector analyses to evaluate the impacts of biodiversity loss on portfolios.

5. Biodiversity Bonds as a Financial Innovation

Biodiversity bonds are designed to channel capital into projects that restore or protect natural ecosystems. These bonds are structured in a way that links their financial performance to specific biodiversity outcomes, offering investors both a financial return and an environmental impact.

• Biodiversity-Linked Outcomes: Investors in biodiversity bonds might receive returns tied to the success of specific conservation efforts, such as forest restoration or species recovery. This creates a new revenue stream for investment banks while aligning finance with biodiversity goals.
• Investment Opportunities: The market for biodiversity bonds is still in its infancy, but it is expected to grow as investors look for more ESG-aligned products. Investment banks have an opportunity to structure and market these products, helping clients access capital for nature-positive projects.

6. The Growing Market for Biodiversity Financial Products

As biodiversity risks gain prominence, investment banks are developing new financial products that align with conservation goals:

• Biodiversity Index Funds: These are equity funds that invest in companies with strong biodiversity practices. Investment banks can create or manage such funds, offering investors an opportunity to align their portfolios with biodiversity objectives.
• Conservation Finance: Investment banks can tap into the $300-400 billion annual market opportunity in conservation finance by structuring products like biodiversity credits, sustainable agriculture funds, or water preservation initiatives.

7. Challenges and Opportunities for Investment Banks

Challenges:

• Lack of Standardized Data: Unlike carbon emissions, biodiversity data is harder to quantify and standardize. Investment banks face challenges in integrating biodiversity risks into financial models due to a lack of clear metrics and benchmarks.
• Time Horizons: Biodiversity investments often have longer-term payoffs, which may not align with the shorter-term profit goals of some financial institutions.

Opportunities:

• ESG Advisory Expansion: With increasing regulatory pressure and investor demand for biodiversity-focused products, investment banks have the chance to expand their ESG advisory services, helping clients navigate biodiversity risk and align with global frameworks like TNFD.
• Innovative Financial Products: The development of biodiversity bonds, green bonds, and sustainability-linked financial instruments offers investment banks new avenues for growth and differentiation in a competitive market.

8. Real-World Example: HSBC and Biodiversity

In 2022, HSBC partnered with Pollination, a climate change advisory firm, to launch a natural capital fund aimed at investing in nature-based solutions. This fund targets projects that enhance biodiversity, such as sustainable forestry and regenerative agriculture. Such initiatives highlight how investment banks are aligning with the growing biodiversity agenda.

Conclusion:

Biodiversity is an emerging frontier in the ESG landscape, increasingly relevant to investment banking due to the growing regulatory, operational, and reputational risks it presents. While often overshadowed by climate change, biodiversity loss is a systemic risk with the potential to disrupt financial markets and economic systems. Investment banks can mitigate these risks and capitalize on opportunities by integrating biodiversity considerations into their risk assessments, product offerings, and advisory services.

As biodiversity risks become more prominent, banks that take a proactive approach will position themselves ahead of competitors, offering innovative financial solutions and building resilience against future environmental challenges.

Biodiversity is increasingly recognized as a material risk in financial markets, similar to climate change. Investment banks are now tasked with integrating biodiversity risks into their traditional operations, from underwriting and M&A advisory to the structuring of innovative financial products like biodiversity bonds. By leveraging frameworks such as TNFD and TCFD, investment banks can better assess, disclose, and mitigate these risks while also tapping into new revenue streams through biodiversity-linked financial products.

The rising demand for green bonds, biodiversity bonds, and nature-positive investments presents an opportunity for banks to drive positive environmental impact while enhancing their ESG credentials and growing market share in sustainable finance.