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The Increasing Risk of Neglecting Environment in Financial Markets

It’s not just about saving the whales, or hugging a tree, but also about making a robust case for the value of the environment and the benefits that ecosystems provide, said Dipak Patel, the head of climate finance and innovation in the SA Presidential Climate Commission, at COP28.

Speaking on Monday during a panel discussion hosted by Oppenheimer Generations Research and Conservation at the SA Pavilion, entitled “The Increasing Risk of Neglecting Environment in Financial Markets”, he was critical of businesses whose business model was based on damaging and plundering natural resources. “There are specific sectors that have come to rely on their profitability on natural resources, from continued mining and burning coal to overfishing of our oceans and chemical pollution of rivers. A starting point would be to identify those culprits.”

The other panellists were Odirilwe Selomane, a senior lecturer at the University of Pretoria, researching ecosystem services, socio-ecological systems, sustainable development indicators and ecological economics, and Olivia Adhiambo, the climate policy director of Wildlife Works in Kenya.

Fellow panellist Odirilwe Selomane stressed that “when we talk about the environment we’re talking about both climate change and biodiversity loss, and a recent report from IPCC on climate change made a strong case for why these two should be considered together rather than separately.”

He said biodiversity has a crucial role to play in climate adaptation and mitigation, as emphasised by the Global Biodiversity Framework. However, goals agreed to as part of the Kumning Montreal Protocol will, like those agreed under the UNFCCC and other climate change fora, require increased financing and investment. He noted that already overstretched governments provide 87% of the funding that goes to climate change mitigation and adaptation, and that includes trying to halt biodiversity loss. To tackle the problem required the private sector to take responsibility for biodiversity for their own self-interest, because ecosystem services underpin their own continued business survival.

The top four global risks identified in the 2023 World Economic Forum Global Risks Report are all related to concerns about climate change and biodiversity loss.

The OECD identifies seven different types of biodiversity related risks for businesses:

  1. Ecological risks: linked to resource dependency on nature, often affect operations.
  2. Liability risks: might include lawsuits as a response to malpractices and others.
  3. Regulatory risks: may include restrictions on land and other resource use.
  4. Reputational risks: coming from shareholders, consumers, and other stakeholders.
  5. Market risks: emerging from changing consumer preferences.
  6. Financial risks: linked to higher insurance premiums, or risk from capital safety.
  7. Materiality risks: biodiversity loss resulting in material loss for businesses.

Selomane said that “the conventional wisdom is that in business, investors can get higher returns by taking on more risk through diversification. Risks emerging from climate and biodiversity loss on the other hand are less well understood, and present different kinds of challenges. This is because it is not clear how, where, and when (not whether ,because they will have an impact) these risks will affect economic activity. As such, the way of dealing with these risks has largely focused on securing the reputational risks (because of limited information on operational, and other risks), through mechanisms such as social impact funds and others. “

He told the panel that investment risk due to climate change depends on the sector, but in agriculture, for example, the impact of climate change is clear and so investment will get riskier. In the insurance sector, environmental damage leads to an increase in claims, and so underwriting insurance becomes a risk.

“Other risks come from inputs into the sector. For example businesses using water as an input will be vulnerable to catchments drying up”, and when drawing up their business models they needed to incorporate biodiversity preservation.

To deal with risks public sector funding “is not enough”, said Selomane. “So to bring the private sector in would be to close the funding gap, but also to reduce nature-negative investing.”

Patel emphasised the existential threat to human existence. “Global warming is no longer a theoretical concept, thanks to the work of literally thousands of scientists under the IPCC have done. All the crises we face, interrelated as they are, are human-induced. We can’t run away from the fact that we have a particular global order that has seen the depletion of all natural resources, as well as an acceleration of pollutants, greenhouse gases and CO2 into the atmosphere.

“At the heart of this is not the continued wellbeing of the planet, but the preservation of our planetary boundaries, within which human existence is made possible.”

He said that biodiversity preservation is not just the preserve of environmentalists. “There is acceptance that saving the whale alone is not going to work. Hugging a tree in your individual right is not going to work. “

He added however that multi national companies had to be held responsible “not only for their historical pollutions and emissions but also in a quantifiable way for what they continue to produce either as pollutants or greenhouse gases or in the worst case scenario industries that continue to plunder nature because their business models rely on such plunder.”

Patel said it is necessary to “balance-sheet risks”. “There are specific sectors that have come to rely on their profitability on natural resources, from continued mining and burning coal to overfishing of our oceans and chemical pollution of rivers. A starting point would be to identify those culprits.

“Given the threats we face, we all have to come to the party. We have only recently come to understand what the individual balance-sheet implications are of highly emitting industries (sectors as well as individual companies) that have an outsized impact. We are now starting to count the costs of doing business as usual.

“The first port of call for biodiversity extension, preservation and rehabilitation must be in the transitional plans for businesses in the frontline (of climate damage), causing biodiversity loss and the extraction of other materials.”

Patel said the SA Reserve Bank “has done some interesting work in this regard. Through the presidential authority that regulates banks they are finding that we’ve failed to count not only the historical costs associated with the profits that get generated from commercial balance sheets, but that these are at risk if they don’t start factoring in what the future costs associated with those risks are.

“We must mainstream the conversation from being good to the environment to getting people to understand that in all of our business operating models, in our existing income statements, in our collective balance sheets, is sitting a huge risk which no one has been able to quantify.

“We should start small, as we do with just energy transition projects. It sits outside the parameters that the financial system understands. We must begin advocacy. Yes, continuing to cry to save the whales, but more importantly advocacy that becomes smarter, that becomes much more tailored and pinpointed, to identify where the risk spots are, where the financial crises might sit and where their source is, and beginning to persuade them that they need to start fundamentally change the way in which they operate and pay attention to externalities.”

Selomane added “we are not interested in biodiversity for its own sake”, because it provides a range of ecological services, in tangible objects in households, but also in provisioning of for example water, and also in climate regulation.” These services flow into businesses, into households, into national balance sheets.

Olivia Adhiambo said ”the conversation is about how the financial sector is driving environmental solutions, as opposed to being a driver of environmental degradation”. She said her company “is focused on forest conservation and we use market-based solutions to enhance forest conservation. One of the tools we use is REDD+ (Reducing emissions from deforestation and forest degradation). It has transformed communities. It tries to understand the drivers of deforestation. Communities directly depend on forests for their daily livelihoods. Whether we want to admit it or not communities will always harvest resources from forest and any other natural resource for that matter.

“REDD+ works to understand the drivers of deforestation and uses that baseline to create change. So if the main driver is charcoal production, are there alternative sources of energy that communities can rely on? If the main driver is harvesting forestry products for economic use, are there alternative economic resources? Then you look at communal needs: education, health, water etc. Companies like Wildlife Works invest in those and then monitor changes in deforestation. Once communities start seeing benefits outside forests, the pressure on the forest reduces and we calculate the carbon stock that has been stored and we trade that in the carbon market.”

Patel said “we’re very good at projecting in a way that absorbs future costs at a future time, whereas issues related to ecosystem services like catchment investment upfront that preserves water rather than wastes it is very important. But we’re not very good at making a convincing case for what the savings down the line would mean to the rand investment today.

“The value chain through which we have learned to be wasteful needs to be revisited and we need to redefine the way in which we count the costs of investments that are made today with respect to the future benefits.

“We need to locate our economic and market opportunities in the context of the environment that we live in. South Africa is water scarce so it makes absolute sense to focus on that. Another focus should be the rehabilitation of spent mining areas, in particular coal mining areas of Mpumalanga. We need to conceptualise alternative value chains that emerged in the brown economy.”

Patel added that “we’re also talking about biodiversity in terms of what a country’s natural endowment might be. In South Africa we have preservation areas that are relatively well maintained but there needs to be better utilisation of them, whether they be the national parks, or diving spots off the east coast, and start finding ways in which to articulate as well as package new environmentally based economic opportunities, for jobs, for livelihoods, and bring the nexus closer together between people development and the preservation of our natural resources.”

Watch a recording of the discussion here

 

Yves Vanderhaeghen is a member of the Oppenheimer Generations Research and Conservation delegation to COP28. He writes for Jive Media Africa, science communication partner for OGRC.

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Yves Vanderhaeghen

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