Sergey mazhuga, Unsplash

Nature-related financial risks gain urgency in emerging markets

Insight / 12 Nov 2020

Financial institutions in Colombia, Peru and South Africa are beginning to tackle nature-related risks, exemplifying a trend across emerging markets

Risks linked to nature loss are rising up the finance sector agenda across emerging markets. According to a recent Swiss Re report, 40 percent of South Africa is now classified as having fragile ecosystems. Zero percent of the country’s ecosystems are considered fully intact. In contrast, Peru and Colombia have the highest share of preserved nature globally, with respectively 55 percent and 45 percent of ecosystems left undisturbed. But despite these vast differences, they all face nature-related economic and financial risks: on a scale where 1 implies the highest global dependency on ecosystem services and 0 signifies no dependence, Swiss Re estimates that South Africa’s GDP has a 0.40 dependence on ecosystem services, rising to 0.54 in Colombia and as much as 0.63 in Peru. Nature is foundational for their sustainable development.

From climate and water to nature

Financial institutions in emerging markets are increasingly seeing nature loss as an urgent risk. This week, a group of financial institutions from Colombia, Peru and South Africa came together in two virtual capacity building sessions to learn about the financial risks linked to nature loss. Hosted by the NCFA, a joint initiative by Global Canopy and UNEP FI, in collaboration with UNEP-WCMC, the training covered how financial institutions can map their nature-related risk exposure using the ENCORE tool.

This year’s Global Risk Report from the World Economic Forum was particularly instrumental in placing nature on the finance sector agenda: for the first time, all the top five risks in terms of likelihood were environmental. Biodiversity loss was listed as one of the main risks.

Overall, emerging and developing markets are typically even more exposed to nature-related risks than developed economies. Using ENCORE data, Swiss Re estimates that Kenya, Vietnam, Pakistan, India and Indonesia have the highest share of GDP dependence on ecosystem services, while Luxembourg, the UK, Malta, Cyprus and the US have the lowest share of GDP reliant on nature; though even for this group of developed economies, the dependence is significant. Peru, Colombia and South Africa’s dependencies on nature hover between the two extremes.

Emerging markets are highly dependent on ecosystem services

“The narrative around nature is changing,” Thomas van Viegen explains. “In emerging markets, we’ve had this view that we have so much nature we don’t have to worry about losing some of it. But now financial institutions recognise that’s no longer the case. Agricultural expansion in particular is driving a really rapid change in our landscapes.”

Integrating nature in strategic decision making

Many financial institutions in emerging markets already include nature-related considerations to a certain extent. Nature is commonly approached from a compliance perspective, as financial institutions assess whether individual transactions adhere to environmental regulations or not. But leading financial institutions now recognise this approach is too narrow. Regulatory compliance is not sufficient to protect their investments against nature-related risks.

To gain an accurate picture of their risks, financial institutions have to consider the cumulative nature-related risks across a whole portfolio. At the individual transaction level, risk may look minimal, but the picture could be different when looking across all their transactions. For example, the South African financial services company Sanlam considers water scarcity a risk to their agricultural insurance portfolio as a whole: droughts can lead to crop failures, which means Sanlam risks having to make higher payouts. To understand and mitigate that water risk, Sanlam has been collaborating with WWF for the past 12 years. The partnership has involved concrete projects to improve water quality and develop a water risk tool.

The ENCORE tool maps impacts and dependencies on ecosystem services across 68 industries and 157 sub-industries, which financial institutions can then use to undertake company and project level analysis. Only once they have that information can they take informed, strategic action on nature. Financial institutions across Colombia, Peru and South Africa are already using ENCORE to map their risks. Based on pilots with banks across these three emerging markets, the NCFA has published a step-by-step guide for natural capital risk assessments that can assist other banks in following suit.

Watch this space for upcoming updates of the ENCORE tool: New functionalities are launching this month and next year a new biodiversity module will help financial institutions understand alignment with global biodiversity goals.

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Image: Sergey Mazhuga, Unsplash

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