Irene Espinosa Cantellano: Moving beyond climate - the relevance of
biodiversity loss for the financial system
Keynote (pre-recorded) by Ms Irene Espinosa Cantellano, Deputy Governor of the Bank
of Mexico, at a one-day conference organised by the Netherlands Bank (Eurosystem)
and the OMFIF's Sustainable Policy Institute, Amsterdam, 29 September 2022.
* * *
Good afternoon. Welcome to the second part of the conference, where we will discuss
how financial institutions can integrate biodiversity into their portfolios and scale up their
investments.
As a member of the Governing Board of Banco de Mexico, an institution that is a
founding member of the NGFS, it is an honor to open this panel with a few words to set
the stage for the conversation.
The panel's central theme is the role of private finance in guiding financial flows towards
biodiversity preservation, specifically in emerging economies.
As a backdrop, it is helpful to keep in mind that preserving biodiversity is a goal that can
be much more challenging than combating climate change. There are several reasons,
but let me highlight a few:
First, biodiversity is a multidimensional phenomenon that encompasses biological
resources, ecosystems, and habitats, which are difficult to classify, measure, and
compare. Indeed, there is no common language about biodiversity, and the
concept can have different meanings for different people.
Second, damage to biodiversity is often irreversible and can affect -and be
affected- by climate change. This interaction should be considered in policy
design and when assessing the costs and benefits of Nationally Determined
Contributions under the Paris agreement. However, doing it is not straightforward.
Moreover, this is a powerful reason for calling to action.
Third, since biodiversity is a "public good" and markets and nationalaccounts
generally do not put a price on the value of its services, whichare estimated to be
significantly higher than global GDP, overexploitationand degradation are
pervasive problems. In addition, companies,governments, and investors are
generally not aware. They do not incorporate into their decisions the
dependencies and impacts of their activities on biodiversity, which often are local
in nature.
And finally, investing in biodiversity preservation and restoration generates a
positive externality that, under the status quo, does not pay off companies or
investors. Their benefits are for all and are delivered through time. ¿How can
these dependencies and impacts be internalized in companies' and financial
institutions' decision-making processes?
Markets have been operating as if there is an unlimited supply of ecosystem services. It
has passed the time to realize that natural capital or the "Earth's infrastructure" is
limited and rapidly decreasing and that this is critical for the survival of society, not only
for the economy. Thus, developing innovative solutions in financial markets that include
biodiversity preservation and restoration in capital allocation decisions is of the utmost
importance, and this conference is a great opportunity to have a broad discussion.
What is the importance of biodiversity for the financial system and the role of private
capital in preserving biodiversity?
We need to transit from climate change to biodiversity loss
Some progress has been made in recent years to integrate physical and transition risks
related to climate change into the risk analysis frameworks of financial institutions.
Behind such progress is considerable scientific and academic work.
Fortunately, analysis and assessment of biodiversity risks and opportunities by financial
systems can benefit from the physical and transition risk discussion in climate change:
a) From the biodiversity perspective, physical risks capture the potential for reductions
in the quantity and quality of ecosystem services. They can affect the ability of
businesses to access credit and repay debt.
b) On the other hand, transition risks related to biodiversity loss reflect changes in
consumer, investor, and political preferences for practices that seek to prevent
biodiversity loss and the existence of more environmentally friendly technologies.
It is essential that, as has already happened with climate change, the private sector, the
scientific community, and academia collaborate in developing methodologies and tools.
In this regard, the recently created TNFD representsa promising concrete response.
Furthermore, biodiversity loss caused by deforestation is a crucial element contributing
to GHG emissions that exacerbate climate change risks and may cause irreversible
tipping points.
The importance of biodiversity in EM's
The issue of biodiversity takes on particular relevance when we talk about emerging
economies. These economies traditionally base their economic development to a
greater extent on primary activities that involve the intensive exploitation of natural
resources.
The intensive exploitation of natural resources, in its turn, degrades biodiversity. At the
same time, emerging market economies could have the fewest human and financial
capital resources available to move towards sustainable development, despite
possessing the most significant amount of natural capital that can be preserved and
restored.
Developing and emerging markets face additional challenges, because losing
biodiversity and natural capital makes countries poorer and less resilient.
This vicious cycle is where the importance of directing capital flows towards projects in
emerging economies, where the potential benefits may be more significant, both
environmentally and financially, must be evaluated. Here is where the capital is most
needed. Investments are enormous, but the returns are even higher.
Recent estimates from the World Economic Forum suggest that a sustainable transition
in the primary sectors (food, land and ocean use, infrastructure, construction, energy,
and extractives) would require a capital investment of some 2.7 trillion dollars annually.
This investment could generate around 10 trillion dollars in annual business
opportunities and 400 million jobs by 2030.
Investing in preserving biodiversity, especially in emerging economies, may yield great
returns for the world.
The case of Mexico, one of the most biologically megadiverse countries in the world,
could be used as an example. It occupies the fourth place in the group of 17
megadiverse countries hosting 70% of the globally known species. Unfortunately, it is
threatened by climate change and deforestation in agriculture and livestock extension.
Air, ocean, and soil pollution, unsustainable fisheries, and the pressures of unorganized
and unplanned urbanization also have their toll on biodiversity. These problems are
acute not only in Mexico but in other emerging markets and low-income countries, like
Brazil, Colombia, Peru, and Venezuela, to mention a few in Latin America.
The demand on ecosystems by the current level of economic activity is not sustainable.
It compromises current and future generations' health and living conditions, entailing
unknown economic and financial risks. Preserving and restoring natural capital is
essential to mitigate these risks. About 50% of the world's GDP depends directly or
indirectly on nature. Furthermore, according to the Living Planet Index, Biodiversity has
been declining rapidly, and worldwide we have lost about 70% of the biodiversity
measured since 1970.
There are many isolated projects, but not as big as what the world needs to stop the
decline of natural capital, and this is where the private financial sector can help.
The premise that we must stop developing to protect nature is not correct. There are
many examples of how society can make these two objectives compatible. Sustainable
fisheries and sustainable forestmanagement are some examples. We can innovate with
financial instruments, funds, and other investment vehicles that combine sustainable
risk capital with commercial aspects, reaching high returns with particular attention to
climate change, conservation, and sustainable management.
To do so, the financial system needs more granular information and greater clarity of
the opportunity cost of ecosystem services. While this is a formidable task, we must
remember that the stakes are incredibly high.
But the big question is: How to finance biodiversity?
Biodiversity poses significant risks and opportunities to sustainable development goals,
the economy, and the financial system, especially in emerging market economies.
Thus, there are significant challenges for financial regulators and supervisors that
include:
bridging the data gaps,
supporting the assessment of the value of ecosystem services in different
industries,
creating the skills and capacities to analyze biodiversity risks,
supporting the development of innovative solutions to finance conservation and
restoration of biodiversity, and
building the necessary financial architecture for efficiently mobilizing capital and
investments that contribute to global biodiversity conservation.
There is much to do, and I hope this conference will help us understand how we can
move forward.
* * *
Now let me refer to the challenge of building markets. One of the roles of the private
sector, with the support of public and academic sectors, is to develop analysis tools and
platforms that contribute to an efficient decision-making process on projects and areas
in which the capital oriented to conservation of biodiversity will be directed.
These tools include well-defined metrics, indicators, standards, appropriate disclosure
practices, and financial institutions' access to information concerning biodiversity,
ecosystem, and environmental services.
This task is more challenging. It requires additional efforts, given that the loss of
diversity lacks of specific metric or objective as clear as in the case of climate change.
Elements such as metric tons of CO2 equivalent or a numerical objective for the
increase in global temperature in climate change are absent in biodiversity loss.
Financial innovation is another key element. It is imperative that emerging market
economies and less developed economies have access and tap international capital
markets to protect and restore forests and coasts. In Mexico, we believe we have an
opportunity to do it. For instance, capital markets are supporting mangrove protection
and restoration. These ecosystems provide many services, including carbon capture,
sustaining life on the coast, and avoiding flooding from hurricanes.
Another example is the parametric insurance scheme in the Mexican Caribbean, which
has supported the restoration of coral reefs from the destruction caused by hurricanes
over the last few years. In addition to their beauty and tourism value, coral reefs protect
communities at the shore as they reduce the size of waves.
Now let me move to highlighting transparency and incentives in
preserving biodiversity.
The increasing public scrutiny of corporate investments is a powerful incentive for the
private sector to align their business decisions, as they may face reputational risk. On
the other hand, financial institutions may be expose to lending or investments that
negatively impact biodiversity. Therefore, as governments implement appropriate
policies, change societal expectations, and transform market expectations, financial
institutions may face transition risks due to misaligned corporate objectives.
Our framework for the climate field also talks about biodiversity. Therefore, we see an
opportunity to manage climate and biodiversity-related risks under an integrated
approach.
Thus, the priority is to build a system of accounts, an analytical framework, and a
system of metrics and indicators, both qualitative and quantitative, that help reveal
nature's contribution to society. It must show the benefits of achieving an orderly and
fast transition towards a green economy that considers both climate change and the
maintenance and recovery of ecosystems in terms of biodiversity while taking
advantage of investment opportunities.
In other words, the purpose is to promote a sustainable investment strategy and make it
clear that it is a win-win strategy in which the benefits exceed current and future costs,
considering the counterfactual of not acting in a timely and decisive manner.
A relevant question that needs to be addressed is how to create impact investment
opportunities in areas where externalities have led to profound environmental
degradation. The task of the public sector is to provide the economy and the financial
sector with regulatory bases and align the incentives to achieve the goal of greening the
financial system.
However, this purpose cannot be achieved without the participation of the private sector
through long-term initiatives that identify and internalize environmental, social, and
governance standards as a priority in their business models and that are aware of the
need for restoration and conservation of our ecosystems.
One more challenge is that often biodiversity is identified as a local and complex aspect
that, however, it must be addressed in a globally systemic way. For this reason, the
participation of all economic agents is crucial to achieving positive results.
While climate change has been discussed for decades in the policy arena, biodiversity
loss seems to be in an infant state. We are learning, and biodiversity is "the new kid in
town." We all are responsible for recognizing that biodiversity is not only a challenge
and a risk beyond climate change but also represents an opportunity for the financial
sector, the economy, and society.
Thank you!
The keynote was pre-recorded on Thursday 22 September 2020 at 9:00 A.M. Mexico
City time.