Financing Biodiversity - Paia Consulting

Biodiversity, which refers to the variety of life within an ecosystem, is crucial for the flourishing of all life on earth. We frequently draw upon nature for inspiration or new substances based on the characteristics of plants and animals. Diversity in genetic material also strengthens the resilience of the population against emerging threats of disease or climate change. The removal of certain organisms could have an unintended effect on the populations of other species that people depend on.

However, biodiversity is in danger of being neglected while climate change receives more attention. For instance, carbon offset programmes to mitigate climate change often involves the reforestation of a single species of trees[i], which is unable to provide the ecological functions of a forest ecosystem with many different species of trees. Human activities, such as the expanding demand for agricultural land, also continue to threaten natural habitats.

The need to balance climate change mitigation, human activity and biodiversity preservation is known as the triple challenge[ii]. Improvements or deteriorations to any of these three aspects can reverberate across to the others. It is therefore necessary to pay attention to the issues plaguing each of the three aspects.

In a series of articles, the Paia team will discuss the implications of biodiversity protection and loss for the private sector. This article will present an overview of biodiversity financing, while the second will lay out a potential framework with which the value of biodiversity can be better accounted for. The third article will cover means in which biodiversity can be viewed as an asset to promote conservation. Together, our articles will demonstrate why businesses today must consider the value of biodiversity alongside other ESG concerns.

The complexity of putting a dollar value on nature

Markets for climate financing have developed rapidly over the past few decades. While there is still a long road to go, there are liquid markets in many regions for the trading of carbon credits. The global Carbon Trade Exchange, the Shanghai Environment & Energy Exchange in China and Singapore’s upcoming Climate Impact X exchange are but some examples. The same cannot be said for markets in biodiversity, where financing solutions that seek to mitigate the impact of human development are scant. However, to ensure that efforts to improve biodiversity are self-sustaining and not dependent on continuous activism, such solutions are vital.

In this article, we will lay out:

1) Why biodiversity financing is more complex than carbon financing

2) Current solutions in biodiversity financing

3) Potential pitfalls in designing these financial instruments

Why is biodiversity financing more complex than climate financing?

Although the issues of climate change and biodiversity are very much intertwined, the complexity of linking financial instruments to biodiversity benchmarks is greater than for its climate change counterparts.

Firstly, the impact on biodiversity from human activities is often non-linear and unpredictable. Unlike climate change which can be modelled based on the level of carbon emissions, the interconnectedness of ecosystems often leads to cascading effects when their equilibriums are disturbed. The loss of certain species can lead to unpredictable, yet devastating consequences. Financing structures often need a quantified metric with which they can base the expected rate of return upon. It is hence also difficult to price in the negative externalities generated by firms. An inability to set the value of biodiversity in quantified terms hence hinders the development of financing solutions.

Secondly, biodiversity impact is more difficult to trade from one area to another, and similar offset programmes cannot be applied to seek out arbitrage across large distances. As the removal of organisms from one ecosystem will have implications on other species that depend on them, damage is highly localized and cannot be compensated for by interventions in another area. Thus, unlike carbon emissions, biodiversity impact cannot be as easily mitigated through the application of the Coase Theorem[iii]. The Coase Theorem refers to the concept that efficient outcomes can be achieved through bargaining to reflect the true value of property rights. Carbon permits find a pareto efficient outcome through the trade of allowances to emit, made possible since the generation of 1kg of CO₂ in, for example, the United Kingdom can be offset by the removal of 1kg of CO₂ in, for example, China. This brings down the overall opportunity cost of reducing emissions. The highly localized nature of biodiversity impact does not allow for a similar system.

Current Solutions

Efforts to protect biodiversity in a self-sustaining way have sprung up. These complement regulatory action that require constant enforcement, such as poaching and logging bans.

Some areas of conservation apply the Coase Theorem to mitigate the impact of human activity on conservation. For example, farmers can be compensated for livestock loss from wild predators, preventing the farmers from retaliating. Compensation can be drawn from the tourism revenue generated by these predators, forming a self-sustaining loop. However, such schemes are often supplanted by assistance from the government or NGOs, indicating that the value of tourism is insufficient to support the costs of conservation.

In another example, the preservation of fisheries is now often facilitated by Individual Transfer Quotas (ITQs)[iv], which cap the number of fish that can be captured and allow fishermen to trade these ITQs. Hunting permits work in the same way, auctioning off the right to hunt a limited number of animals.

Other solutions combine carbon and biodiversity. Also, Australia’s Carbon + Biodiversity Pilot[v] rewards farmers who improve both climate and biodiversity performance. Under the pilot programme, farmers who plant native trees will receive payments for biodiversity outcomes, which adds on to payments from carbon abatement projects

Potential Pitfalls

While commendable for slowing the decline in biodiversity, these measures are often reliant on enforcement against illicit behaviour.

The solution involves the design of financial instruments that reframe biodiversity as an asset to the owners of the land, instead of a nice-to-have. An asset is a financial instrument that is expected to bring economic benefit. To place a value on biodiversity and pave the way for quantified incentives in its conservation, methods to determine the present value of the cash flows from biodiversity have to be constructed. This metaphor can be extended to the way in which assets are depreciated through use over time as well as impaired from improper use; the benefits brought about by biodiversity declines as resources are extracted and careless treatment leads to an unnecessary decline in value.

The Dasgupta Review[vi], a report commissioned by the UK government on the economics of biodiversity, suggests that nature be regarded as a portfolio of assets that has thus far been “mismanaged”. He advocates that the full impact of human activity should be demonstrated by the agglomeration of not only human and produced capital, but also natural capital Dasgupta also cautions against solely using a pricing strategy to resolve the tragedy of the commons issue, since the difficulty in determining nature’s value creates barriers against developing an optimal price. The tendency to underestimate the value of nature could hence give rise to overconsumption deemed efficient. In addition, having a price tag attached to the exploitation of nature could then remove the psychological barriers of people to do so, much in the same way that parents tend to be later in picking up their kids if a small fine is imposed[vii]. Finally, a system that seeks to allocate resources requires a robust system of property rights which may deprive indigenous communities of resouces they have traditionally relied on. The initial allocation of property rights may also strike some as being unfair, especially to those who believe that nature is a part of the commons and unowned by humanity. Yet, property rights are necessary for such a system because only property owners have an incentive to defend against exploitation, negating the Tragedy of the Commons.

Nonetheless, while it is important to realise that any pricing strategy would potentially undervalue the true contribution of nature to humanity, it is vital to start somewhere. These schemes can be tweaked and improved incrementally so that they tend towards a reflection of the true value of nature.

Biodiversity financing is complex, and current solutions have their pitfalls – but it has never been more essential for businesses to keep in view. In the next article, we will cover how businesses can consider the impact of such schemes and the conservation of biodiversity in general on their operations.