Originally published by Yale Environment Review.
Financial institutions like banks historically have played a critical role in the face of global challenges, from restructuring industry after World War II to the financing of the industrial revolutions. A new study argues that banks can play a similar role in helping society transition to a low-carbon footprint model.
A range of “ecosystem services” play a vital role in making human society and economy function. Nature provides society with food, timber, clean water, livable climates, regulation of disease, recreation opportunities, and products. For example, nature-based products account for an estimated 42 percent of the world’s top-selling pharmaceutical drug sales, according to KPMG, one of the big four global auditing firms. And this is just one example of how much the economy depends on the services of nature.
A recent paper in the journal Responsible Investment Banking provides a landscape analysis of the history and evolution of financial tools that use the concept of ecosystem services to champion conservation and responsible business practices.
The authors are researchers from Conservation International (CI), a well-established non-profit organization that has taken the lead in developing innovative financial mechanisms and partnerships to conserve ecosystems around the world. The growing movement in sustainable consumption and efficient supply chains, as well as high-risk areas such as raw material sourcing to sustainable production practices, is a profitable investment opportunity for banks, they write. This analysis is based on the thesis that the protection of ecosystem services lie at the heart of a healthy and sustainable society that supports economic growth at scale and that investment banks can play an important role.
The authors conduct a literature survey of financial tools that have been used in the past to promote conservation. And they provide case studies of Conservation International’s implementation of such tools. “Debt-for-nature” swaps — financial transactions in which a portion of a government’s or private sector entity’s foreign debt is forgiven in exchange for local investments in environmental conservation measures — were one of the earliest of such tools that arose in the 1980s in recognition of biodiversity hotspots around the world.
In many cases these hotspots were found in the same countries that had high levels of financial debt. Another mechanism, known as “conservation trust funds” (CTFs), on the other hand, provides sustainable financing for long-term management costs for a country’s Protected Area (PA) system. In this scenario, banks play the role of an asset manager for CTFs. Today green bonds are gaining popularity as a new investment vehicle to promote key areas of concern such as climate change, natural resource depletion, and biodiversity loss/pollution.
Given the potential of these tools, the authors highlight three key areas where financial innovation can take place today: (1) risk avoidance (2) market development and (3) public-private partnerships. Obvious as it may sound, mitigating both climate risks and reputational risk is a growing priority for banks because of increasing client awareness on the impacts of fossil fuel industries on the environment. The fact that 77 financial institutions are building social and environmental safeguards into a larger number of their loans and products signals the direction the industry is moving.
These financial institutions are part of the Equator Principles Association, a network of financial institutions that follow the Equator Principles, a risk management framework for determining, assessing, and managing environmental and social risks in project finance. The authors also point out the growing impact investment marketplace, particularly the Payment for Ecosystem Service (PES) schemes, which provide an opportunity for mainstream banks to be the facilitator between the buyer (i.e. ecosystem service user) and the seller (i.e. ecosystem service provider). Finally, highlighting the impact of public-private partnerships (PPP), the authors highlight the partnership between the State of Connecticut and the Connecticut Green Bank, a partnership that facilitates the financing of residential use of renewable energy.
The authors conclude that a great deal of education, coordination, and alignment is required between banks searching for funding options and projects looking for funds. There is enough capital in the world to support these projects but industry has been slow to catch up.
The authors suggest four approaches: (1) deploying unused capital, for example dormant accounts into a revolving fund to support projects financed through PES schemes, (2) developing the market by educating financial intermediaries, business incubators and accelerators about the opportunities of investing in ecosystem services, (3) developing new financial products like the Forest Bond, and (4) developing an enabling environment by investing in local capacity building, business development and monitoring as key components of any investment product.
Ultimately, the authors conclude, investment banks can be one of the strongest allies for the conservation community in shaping the future of ecosystem services and the society.