# Climate change and biodiversity loss: new territories for financial authorities

Hugues Chenet

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Hugues Chenet. Climate change and biodiversity loss: new territories for financial authorities. Current Opinion in Environmental Sustainability, 2024, 68, pp.101449. 10.1016/j.cosust.2024.101449. hal-04814052

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# Climate change and biodiversity loss: new territories for financial authorities

Hugues Chenet<fnref n="1" />,<fnref n="2" />,<fnref n="3" />

<figure><img src="image_4.png" /></figure>

Climate change became a central issue in 1988 with the creation of the Intergovernmental Panel on Climate Change. Financial authorities only started to take up the subject in 2015. Since then, they have continuously accelerated their endeavour in this regard and have quickly added biodiversity loss to the environmental issues to deal with. Unfortunately, despite the very fast learning curve they follow, financial authorities have taken a path that may not succeed. But moving beyond approaches solely based on a financial risk paradigm and fostering transdisciplinary research to address broad systemic questions at the interface of the natural and socioeconomic worlds, central banks and supervisory authorities could enter a new era, where the impact of their decisions would contribute materially to solve the challenges of our time.

## Addresses

¹ IESEG School of Management, Univ. Lille, CNRS, UMR 9221 - LEM - Lille Economie Management, F- 59000 Lille, France

² Institute for Sustainable Resources, University College London, UK

³ Chair Energy and Prosperity, Fondation du Risque, France

Corresponding author: Chenet, Hugues (h.chenet@ieseg.fr)

**Current Opinion in Environmental Sustainability 2024, 68:101449**

This review comes from a themed issue on **Climate Finance, Risks and Accounting**

Edited by Rosella Carè, Othmar Lehner and Olaf Weber

For complete overview of the section, please refer to the article collection, "Climate Finance, Risks and Accounting"

Available online 9 April 2024

Received: 15 September 2023; Revised: 23 February 2024;

Accepted: 12 March 2024

https://doi.org/10.1016/j.cosust.2024.101449

1877-3435/© 2024 The Author. Published by Elsevier B.V. This is an open access article under the CC BY license (http://creativecommons.org/licenses/by/4.0/).

## Introduction

Finance began to take an interest in the natural environment<fnref n="1" /> relatively recently. In the early 2000s, this interest was focused on some specific financial activities, such as project finance or socially responsible investing.

The main point of view was reputational, trying to avoid or manage either the local impact of financed projects on surrounding communities and nature or the broader controversial activities of invested or client firms. Then came a major turning point around COP21 and the Paris Agreement in 2015, when finance and capital markets became a core issue of the climate change discussion, a first since the creation of the Intergovernmental Panel on Climate Change (IPCC) in 1988 and the adoption of the UN Framework Convention on Climate Change (UNFCCC) in 1992.<fnref n="2" /> Finally, in the last few years, an additional major theme has newly emerged for finance stakeholders and broadened their environmental perspective: the collapse of biodiversity.

In this article, we propose to step back and analyse the current and possible ways forward in this consideration of climate and biodiversity by finance, from the specific perspective of financial authorities,<fnref n="3" /> in articulation with academic research. We adopt a dual frame, highlighting the extent to which they may either contribute to and/or suffer from those environmental changes.

While the subject is blooming, it does not yet benefit from great depth or hindsight in the corpus of academic literature. This is particularly true for the subject of biodiversity, which hardly existed for financial authorities 2–3 years ago.<fnref n="4" /> Lying at the crossroads of fundamental sciences, social sciences, and the governance of public policy, this research topic is fundamentally transdisciplinary. This poses challenges for academic research, on which we conclude.

## Why should there be an interaction between finance, climate, and biodiversity?

Besides making payments, managing personal finances, transforming the maturity of financial flows, and handling risk, the main role of finance at macroscale is certainly to allocate capital to the real economy [1]. From

<footnote n="1">¹ In this paper, the use of 'environment' is for 'natural environment'.</footnote>

<footnote n="2">² The IPCC and the UNFCCC are respectively the science and diplomacy institutional legs created to address climate change.</footnote>

<footnote n="3">³ The financial authorities we address in this paper are central banks and financial supervisors, which can be considered delegated authorities, by opposition to political authorities [18].</footnote>

<footnote n="4">⁴ The publications we refer to come from different types of sources: peer-reviewed academic literature, documents from central banks and other financial authorities, and publications from international institutions.</footnote>
that perspective, a task for finance in the ecological transition is to allocate funds towards economic activities contributing to sustainability goals [2].<fnref n="5" /> But this positive contributory role of finance — how can finance be useful for ecology [3] — must not conceal its downside related to the negative ecological impact of finance [4]. Indeed, as much as finance can be seen as part of the solution, in allocating funds towards desirable and sustainable economic activities, it is also part of the problem, for having allocated and still allocating funds towards undesirable and detrimental economic activities (e.g. fossil fuels and deforestation) [5,6].

While the narrative and new perspectives on such potential role(s) of finance in relation to environmental sustainability have clearly emerged and grown recently, the more traditional paradigm, based on financial risk and return as the main (if not sole) capital allocation key, still dominates [7–9], despite the coexistence of alternative approaches [10].<fnref n="6" /> This connection between environment and finance is now usually framed through (bio)physical and transition factors of financial risk, illustrating a chain of impact *from* the environment *to* finance (Figure 1). Figure 1 represents this together with the other impact chain described above, *from* finance *to* the environment.

## Why do financial authorities care?

The traditional focus on financial risk mentioned above has been reinforced with the implication of financial authorities, triggered by the pivotal speech ‘*Breaking the Tragedy of the Horizon*’ by Mark Carney, former Governor of the Bank of England and Chairman of the Financial Stability Board, ahead of the COP21 [9,11].

Carney’s 2015 speech is influential in that it clearly sets out the two different aspects that will thereafter frame how financial authorities would justify their role in combating climate change: systemic financial risk and transition financing. As such, it implicitly eludes the other notion: the negative contribution related to financing undesirable GHG-emitting activities (i.e. contributing to a systemic climate risk). Carney also explicitly rules out direct interventions by financial authorities, such as adjusting the capital regime for financial institutions, to rather focus on transparency of information (i.e. disclosure) and evaluation of future financial risk (stress testing). But the impact of this speech and overall narrative centred on the imperative to avoid financial system destabilisation from future climate

change has been tremendous, and literally opened a new chapter of the finance and climate story [9].

This concentration on disclosure of financial risk characterises the importance of financial supervisors in this process, aside the monetary policy role of central banks. The creation of the Network of Central Banks and Financial Supervisors for Greening the Financial System (NGFS) in 2017 substantiates this. It is interesting to note that the ‘greening’ part (‘contribution to the solutions’ in Figure 1), relevant to the role of ‘financing the transition efficiently’ mentioned by Carney and highlighted by the NGFS both in its own name (‘greening the financial system’) and founding statutes as a primary goal (cf. below, bold letters), actually soon became veiled behind the emphasis on financial risk [12].

> “The Network will help to strengthen the global response required to **meet the goals of the Paris agreement** and to enhance the role of the financial system to manage risks and to **mobilize capital for green and low-carbon investments** in the broader context of environmentally sustainable development.” [emphasis added] [13]

The underlying logic behind climate-related financial risk (CRFR) computation as the pivot of financial authorities’ way to the climate emergency can be explained by the primary importance of mathematical model-based risk management in their paradigmatic approach to financial stability [14•–17]. This is particularly true in high-income countries where the financial risk focus rests on the independence of central banks from political authorities, thereby defining a relatively narrow technical mandate (objectified by financial risk) to avoid friction with elected governments and policymakers (‘subjectivated’ by ethics, general and/or individual interest). Such mandates are generally limited to price and financial stability,<fnref n="7" /> while other jurisdictions’ central banks (in particular in developing economies) may have explicit economic development goals, which can include climate and environmental objectives [18•,19•]. Consequently, the attention of financial authorities has been concentrated on attempts to calculate CRFR through climate scenario analysis and climate stress tests, which so far did not lead to significant microprudential nor macroprudential response [14•,20,21].

In Europe, where climate policymaking has been high on the agenda over the last decade, financial authorities have originally struggled to acknowledge that climate change was part of their perimeter and mandates. Over 6 years after the creation of the NGFS, this is now much clearer, due to the strength of the financial risk narrative,

<footnote n="5">⁵ This fits with the concept of ‘financing gap’ towards reaching those climate and biodiversity goals, whether on decarbonisation of the economy or on ecosystem preservation and restoration.</footnote>

<footnote n="6">⁶ For example, cooperative banking, ethical finance, Islamic finance, and sustainable finance.</footnote>

<footnote n="7">⁷ And sometimes to employment, for example, the Fed in the US.</footnote>
<figure><img src="image_5.png" /><figcaption>Figure 1</figcaption></figure>

Schematic links between finance and the environment: positive and negative impact from finance, and financial risk from environmental degradation. By financing and investing in economic activities and financial assets that are tied to the real economy, whether at household, business, or public institution levels, finance can trigger/allow/foster impacts on the environment. For a given issue (e.g. climate change), these impacts can be seen as contributing either to the problem (e.g. emission of more GHG as a consequence of financing new fossil fuel extraction) or to the solution (e.g. emission of less GHG as a consequence of financing new renewable energy capacity). Reciprocally, damages to the environment — or reactions and anticipations to these damages — may impact households, businesses, or public institutions in their economic capacity, thereby affecting their economic and financial performance, and ability to reimburse loans or pay dividends. This constitutes the basics of financial risk.GHS, greenhouse gas.

Source: Chenet (2023) [9].

which has even gained importance by expanding its focus to biodiversity loss beyond climate change as the sole banner for environmental issues. Indeed, the recent recognition by central bankers that the collapse of biodiversity is a source of financial risk leaves no space for financial authorities to ignore it. This quote from the President of the Dutch central bank provides a good illustration:

> "The rapid degradation of nature is threatening ecosystems and the services they provide. Services such as clean water, healthy air, food and materials that are all essential to our economies and our very existence as humans. As central banks and supervisors, we have every reason to be concerned, because it's an illusion to think we can preserve financial stability if this degradation continues. A degradation to which financial institutions under our supervision also contribute through the activities they finance. A degradation that in turn creates risks they need to manage. **Therefore it's squarely within our mandate to address these risks and to use our leverage to bend the curve.** From nature degradation to nature restoration." [emphasis added] [22]

## The current approach and the many fundamental and applied issues it poses

It is also quite recent that this fundamental connection is being investigated by academic research. From the perspective of ‘environmental economics’ and in particular with the renewed inputs and framing of ‘ecological economics’ approaches from the late 1980s, the importance of nature and ecosystem services in the running of our economic systems was duly introduced, although highly debated theoretically [23–26]. Nevertheless, the natural environment continued to be essentially ignored by financial institutions and the financial economics discipline over the last [2-3] decades, and reciprocally, finance kept on being not much touched upon by environmental institutions and sciences [3,4,27,28]. One could have imagined a different outcome, as the financial system progressively took a massive weight in our economies during this period of global financialization, which saw a parallel escalation of global environmental issues.

The new dynamic described in previous sections has been steered essentially by practitioners and ‘field arbitrageurs’ [8] over the last few years, and the academic research did not initially follow such a convergence of both topics and approaches. It is only very recently that
researchers started to approach the issue across tradi-
tional academic disciplines and objects. From that per-
spective, the contribution of ‘systems science’ and
‘Earth system science’ is very useful and opens exciting
outlooks [29•–31]. First, it helps to envision climate and
finance as part of the same systemic issue and then to
‘zoom out’ and reframe that issue as part of a broader
question concerning the embeddedness of the economy
and finance in nature.

Regarding a systemic tool like that of finance, this ‘natu-
rally’ conduces to consider systemic climate change as just
one of the many nature-related systemic processes and
issues that we must address. Others, such as biodiversity
loss, changes and impacts related to water, land use, or
novel entities [29•,32], are to be considered similarly.

This is how, shortly after climate change, the subject of
the loss of biodiversity was approached by financial au-
thorities [33•–40]. But this positive step towards a more
complete approach suffers from two main flaws:

- It followed a similar path than for climate: anchored
into a financial risk narrative [41–43];

- It failed so far to address the issue systemwise and
sticked to a siloed approach [44•,45].

By ignoring, as mentioned above, the impact of financial
activities on nature,<fnref n="8" /> the financial risk focus has the
advantage in the first place to legitimise the action of
financial authorities without challenging their current
mandates, but it also suffers from a question of feasi-
bility [42]. Today, most of the ‘biodiversity endeavour’
of financial authorities and associated stakeholders, in
the academia, international institutions, and civil society,
concentrates on the assessment of exposures of financial
portfolios to biodiversity loss. This notion of ‘exposure’
has the advantage of being directly linked to the un-
derlying economic activities that may depend on and/or
impact biodiversity. But ultimately translating such an
exposure to biodiversity loss into quantitative figures of
financial risk at financial institution and financial system
levels — similar to what is attempted for climate with
scenario analysis [46] — is not assured. Computing such
types of environment-related financial risk is indeed
highly intricate, and ultimately questions whether it is

an achievable quest in the presence of radical un-
certainty.<fnref n="9" />

Moreover, even if those computation ventures were
theoretically and practically possible, approaching bio-
diversity loss (or climate change) in an isolated manner
entails likely misestimates, by missing the complex
feedback and compound effects driven by interactions at
the system level [44•,45], which may conduct to mini-
mising the interpretation of consequent results and
making inappropriate decisions. Beyond financial issues,
this question of interactions, synergies, and trade-offs is
becoming central at the interface between Earth system
science and policymaking, particularly after the COVID-
19 turmoil reshuffled the cards [52–57]. Considering a
broad, long-term, and systemwise perspective is cer-
tainly a sensible way forward, especially at a time when
complexity and global interconnectedness are every day
more blatant.<fnref n="10" />

How to move beyond a paradigm driven by
the calculation of financial risk?

We have seen above that the usual ‘computational’ route of
financial risk management is a potential dead end, in par-
ticular, because of the heroic calculation it would require.
However, this does not dismiss the necessity to consider
the climate systemic risk from the perspective of the fi-
nancial system. Instead of solely attempting to ‘manage’
the financial risk when it becomes material, an alternative
way consists of rather ‘preventing’ it ahead of its occur-
rence. Such an *ex ante* mitigation of the risk instead of a
‘syn’-adaptation can be seen as a precautionary approach,
as introduced by Refs. [14•,44•,47]. Acting in a precau-
tionary way to mitigate the environment-related financial
risk corresponds in the first place to alleviate the source of
the risk, that is, fighting environmental degradation itself.
That is genuinely the sense of the ‘greening the financial
system’ role that, as detailed above, nevertheless tends to
be veiled behind the objective of financial risk manage-
ment. But we see with this notion of financial risk en-
dogeneity [58•] — that is, the financial system contributes
to generating the financial risk it tries to circumvent — that
both roles/objectives are somehow equivalent. Mobilising
the power and tools of financial authorities to mobilising
capital for the ecological transition (including by de-mo-
bilising the capital allocated to deleterious economic ac-
tivities) will undoubtedly decrease the financial risks the
financial system is exposed to.

A number of tools have been analysed in the literature

<footnote n="8">⁸ NB: this does not mean that the impact of finance on nature is completely neglected by financial authorities, as it is in fact increas- ingly mentioned by reports (e.g. [33•]) and speeches (e.g. “A de- gradation to which financial institutions under our supervision also contribute through the activities they finance.” [22]), but when it is, it is still often considered only as for the endogenous financial risk it ultimately constructs [29•,35•,47] — as highlighted in the full quote from [22] — and not for itself (cf. the notion of ‘intrinsic value of nature’) nor for the risks it could build for other stakeholders beside financial ones.</footnote>

<footnote n="9">⁹ Radical uncertainty is especially characterised at large space and time scales — for example, global level, 2100 horizon — due to the incommensurable degree of complexity and multiplicity of possible futures that have to be scenarized in such modelling exercises [42,44•,47–51•].</footnote>

<footnote n="10">¹⁰ Cf. the notion of global megatrend [66,67].</footnote>
that can be employed to contribute to this dual goal, in the form of either monetary or prudential instruments (see e.g. [59,60] for recent reviews and references therein).<fnref n="11" /> Prudential tools, whether micro (e.g. sustainability risk weight in capital requirements) or macro (e.g. countercyclical buffers), are by nature designed to manage financial stability issues, while monetary instruments such as collateral frameworks or asset purchase programmes are more fit with the dynamics of capital mobilisation.

The use of prudential instruments has mainly been blocked so far by the nonconclusive quantitative approaches deemed to calibrate any such response. Acknowledging the limitations of these justifies adopting a precautionary approach instead, which would allow unleashing the use of both the prudential and monetary toolbox, thus overcoming both the risk calculation flaws and the narrow-mandate obstacle at the same time. Of course, opening such new possibilities does not mean the implementation would be straightforward.

The extent to which financial authorities can use their monetary policy power to feed the transition financing axis, beyond financial risk management, is indeed far from clear and consensual but is rapidly evolving.

Making use of monetary policy for climate purpose is undeniably a sensitive topic. If some central bankers explicitly discard it for largely overpassing their mandates (cf. the US Fed),<fnref n="12" /> the community is now opening the way for such possibilities [61,62].<fnref n="13" /> While this seemed totally infeasible three years ago, some central banks have started to implement new monetary frameworks for climate-related purposes, even in high-income countries. Thanks to their secondary mandate to support the economic policies of their jurisdiction, the Bank of England and the European Central Bank could open the way to, for example, carbon-tilted collateral and corporate bond purchase frameworks. Even without any such secondary mandate, and thereby implicitly adopting a kind of precautionary approach, the Bank of Japan issued a zero-interest green financing scheme, recognising that not supporting the net-zero transition would be against its

price and financial stability mandate. This involvement of central banks beyond the market neutrality principle [63–65] involves renewed coordination between political and delegated authorities [57], notably to address or arbitrage the trade-offs arising from the conjugation of multiple policy objectives together. Other countries (e.g. Brazil and China), thanks to the explicit economic development mandate of their financial authorities, benefit from a more straightforward coordination context and began earlier to mobilise their monetary policy for the purpose of greening their economy.

## Conclusions and challenges for research

We have seen that financial authorities have made an outstanding acceleration in considering climate change and biodiversity in their perimeter, in less than a decade. But besides the incontestable success of such a turning point — with central banks and financial supervisors being certainly the last such type of key institutions to join the climate change discussion (but to some extent a relatively early one on biodiversity loss) — a couple of fundamental flaws weaken the prospect of a possible positive impact in the short term.

Ways forward include the imperative for financial authorities to approach the ecologic emergency beyond a sole financial risk issue. This is nevertheless not straightforward and relies on the necessity to fundamentally question the expectations societies collectively have on the role(s) of the financial system in the desired transition to a net-zero and nature-positive future. One cannot just simply expect the financial system to suddenly turn into a for-purpose tool; hence, this fundamental shift away from a pure financial risk paradigm needs to be planned and governed properly, which raises paramount questions of social organisation, politics, and democratic debates.

It is also a challenge for associated scientific research, which must embrace the topic beyond siloes, with transdisciplinarity and systemic approaches to address a diverse set of complex, uncertain, and yet existential objects. Earth and Finance are indeed two particularly intricate and multidimensional systems, which in our present case need to be treated simultaneously. This undoubtedly opens up new research challenges that will have to combine a variety of academic disciplines and scientific approaches, capable of coalescing elements as contrasting as the physical laws ruling the climate and the animal spirits governing human behaviour.

## Data Availability

No data were used for the research described in the article.

<footnote n="11">¹¹ The “INSPIRE Toolbox of policy tools available to central banks and financial supervisors” [68] actually details a third category (‘other policies’) beyond monetary and prudential tools. Other instruments, such as credit policy by the central bank, can be seen to overlap both monetary and macroprudential policies [69].</footnote>

<footnote n="12">¹² Cf. US Fed Chair J.H. Powell: “We are not, and will not be, a ‘climate policymaker’” [70].</footnote>

<footnote n="13">¹³ The most recent leap on the matter is the French President Macron advocacy for a dual interest rate for green/brown assets. https://www.lemonde.fr/en/opinion/article/2023/12/29/emmanuel-macron-our-strategy-must-be-to-speed-up-the-ecological-transition-as-well-as-the-fight-against-poverty_6384821_23.html</footnote>
# Declaration of Competing Interest

The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

# Acknowledgements

The author acknowledges the support of the Chair Energy and Prosperity, under the aegis of the Fondation du Risque.

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This paper proposes a first analysis of the interactions between climate change and biodiversity loss at financial authorities level, insisting on the pernicious consequences of considering both in silos.

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