Innovative approaches can help finance sector respond to nature loss

A group of researchers have published new methods to help the financial sector recognise the importance of nature to economic and financial stability.

Introducing a special issue of journal Ecological Economics, Professor Ben Groom from the University of Exeter Business School said the financial sector largely fails to consider the economic and financial risks posed by biodiversity loss.

Assets including equities, bonds, loans, and other financial instruments he said are vulnerable to ecological disruptions that undermine the long-term viability of the underlying economic activities.

He explained that biodiversity risks to finance can be both physical – eg from degraded ecosystems reducing returns in sectors such as agriculture and tourism – and transition risks, as firms have to adjust their operations in response to policy.

The flow of capital can also exacerbate biodiversity loss, whether directly (eg financing deforestation-linked infrastructure) or indirectly (eg insurance underwriting for extractive industries such as oil and gas producers).

But despite this two-way relationship, biodiversity remains marginal in financial decision-making, which reflects structural barriers such as the difficulty of monetizing ecosystem services, the public goods nature of biodiversity as well as misaligned fiduciary incentives.

“We’re questioning whether current market practices — while often aligned with fiduciary responsibilities such as those defined under Section 172 of the UK Companies Act—are sufficient to address the scale of biodiversity-related risks and calling for innovative approaches that recognize nature’s critical role in underpinning economic and financial stability and human well-being,” said Professor Groom, Dragon Capital Chair in Biodiversity Economics.

In a series of research papers, Professor Groom joined influential financial and environmental economists and sustainable finance experts in critically examining how financial markets measure, price, disclose and manage biodiversity risks.

A study led by Exeter’s Dr Wei Xin alongside co-authors Professor Groom, Dr Lewis Grant and Professor Chendi Zhang, found that ESG ratings for biodiversity make little difference to investment decisions, financial performance or nature-related risk management.

From analysis of a large ESG dataset spanning 2013-2020, their study revealed that biodiversity ratings for firms are mostly unrelated to a firm’s characteristics (except size), do not predict stock returns and have no effect on profitability, risk or valuation.

Their analysis found that biodiversity ratings are generally ignored by investors and analysts, and as they stand are failing to advance biodiversity and nature recovery goals.

Dr Xin, a Lecturer in Finance from the University of Exeter Business School, said: “The current metrics of biodiversity in the market are not of a high quality, which may overlook key information in evaluating the biodiversity performance of firms.

“It is necessary to develop high-quality biodiversity tools to enable the financial sector (investors, analysts, fund managers and other market participants) to allocate capital more effectively and internalise external costs. Although the biodiversity ratings performance does not affect a firm’s future stock return, it is in principle costless for investors who have a concern about biodiversity to move their investments to those firms that are more friendly to biodiversity.”

But another article in the special issue provides evidence that biodiversity risk may indeed be partially priced in financial markets, with the authors explaining that these contrasting findings underline both the importance of biodiversity in determining financial risks and returns, as well as the ongoing challenges in measuring these risks.

“This diversity of perspectives highlights the value of opening up debate, and the need for more innovative approaches to capture how nature-related risks affect investment and economic outcomes,” said Professor Groom.

Other studies in the series include a new approach to mapping the investments of financial portfolios on ecosystem services, which finds that 42% of investment in French financial portfolios is tied to sectors with high risk of biodiversity loss.

One study introduces a breakthrough approach to evaluating the plausibility of nature loss scenarios, providing a structured framework for decision-makers navigating complex and uncertain futures, and while another reveals a fragmented landscape of biodiversity reporting among European financial institutions – with only a handful of firms articulating clear biodiversity or nature strategies.

Biodiversity and Finance: Risk, Disclosure and Double Materiality is a special issue of Ecological Economics, which includes the study Noisy biodiversity: The impact of ESG biodiversity ratings on asset prices.