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ESG Focus: Takeaways From Biodiversity COP15

ESG Focus | Dec 22 2022

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:

ESG focus: Biodiversity COP outcomes

World leaders met in Egypt to formalise the first steps in progressing the biodiversity agenda, resulting in big subsidy cuts to “harmful” industries, and a an imperative for investors to start revising their strategies.

-Key outcomes from COP15
-Industries in the headlights
-Europe cracks down – bans expected in 2023
-Biodiversity credit markets about to step up
-Australia is one of the megadiverse, with a mega role

By Sarah Mills

The Conference of Parties (COP15) United Nations Biodiversity Conference closed this week.

“No Planet, No Business” was the mantra and all up, the COP announced four overarching goals and 23 targets, which have been well publicised.

They include the following big-ticket, more immediately impactful commitments:

-To protect and restore at least 30% of the Earth’s land and water by 2030, although what that entails and the immediate implications for investors is unclear 

-To reduce harmful subsidies by -US$500bn a year by 2030

-The mobilisation of US$200bn a year in domestic and international biodiversity-related funding from all sources by 2030

-To reduce to near zero the loss of areas of high biodiversity significance

-At least 30% of degraded terrestrial, inland water, and coastal and marine ecosystems are restored by 2030. Rich nations will pay $30bn a year by 2030 (not much and at the current rate of inflation even less by 2030 but it’s a start) to poorer nations through a new fund managed by the Global Environment Facility

-Large and transnational companies and financial institutions will be required to monitor, assess and transparently disclose risks, dependencies and impacts on biodiversity through their operations and supply and value chains

-The monetary and non-monetary benefits from the utilisation of genetic resources and digital sequence information on genetic resources, and of traditional knowledge associated with genetic resources are shared equitably and fairly with indigenous communities

Lesser commitments included:

-A species extinction target 
-To prioritise the removal of invasive species in sensitive areas
-Stronger regulation of plastics
-Mangrove restoration
-A nod to the circular economy

Bloomberg estimates US$700bn a year will be needed to plug the financing gap for the protection of natural systems.

Given climate change is considered a subset of biodiversity, it will be interesting to see how issuers decide to target these separate bond markets going forward.

Industries in the headlights

The -$500bn reduction in harmful subsidies is likely to be one of the most impactful commitment for global markets in the near to medium term.

Those most likely to be affected (not including the usual fossil-fuel producing culprits) include:

-Agriculture – particularly beef, dairy, soybean, palm oil, rubber, coffee, chocolate
-Logging, forestry and downstream markets such as furniture
-Polluting industries
-Plastic pollution – consumables, recycling, virgin fossil fuel plastic

Grants for land-usage converting peatland to agriculture are likely to be withdrawn, and susbsidies for roads and development into richly biodiverse areas are also likely to be target.

Natural Asset Companies are also likely to come into focus, according to Morgan Stanley.

These companies are aimed at monetising ecosystem services such as carbon sequestration and water filtration, although at this stage the analyst says the class is unproven and scalability unclear but may offer a niche asset.

At this stage, Morgan Stanley says natural asset companies fall under the classification of impact investment, and the analyst sees a potential future as an incentive to landowners to bolster systems within their jurisdiction to enhance their ESG credentials.

Global Developments In December To Hit Markets in 2023

The European Union was extremely busy on the biodiversity legislation front in December.

The EU agreed to strengthen and broaden its carbon market, endorsing the Green Deal Strategy, and extending emissions trading to heating, road transport and shipping.

The EU also committed to accelerate the pace at which companies are obliged to reduce pollution and this should have implications for steelmakers, building materials companies and power producers.

The EU also agreed a law to ban the import of products linked to deforestation. 

The law is enforceable within 20 days of its formal acceptance (it is yet to be ratified by the European Council and Parliament), expected some time next year, according to the BBC.

Once legislated, operator and traders will have 18 month to comply, and smaller companies 24 months. 

This was an interesting development given many observers had been expecting a tariff similar to the carbon border adjustment mechanism rather than an outright ban.

The World Bank estimates the law will also cut global carbon emissions by -31.9m metric tonnes.

Credit Markets Starting To Trickle

COP15 agreed to mobilise at lease $200bn a year in domestic and international biodiversity-related funding from all sources.

This pales in comparison to Reuters' estimation that debt-for nature deals will require US$1trn in external finance by the 2030, and suggests more such commitments may be forthcoming in future COPs.

Morgan Stanley expects innovation in labelled bonds and biodiversity offsets and credit markets are likely to be encouraged.

Bloomberg lists debt-for-nature swaps, bio-credits, natural capital funds and biodiversity offset schemes as some of the more common debt instruments.

Morgan Stanley adds blue (ocean) bonds and Rhino bonds to the list.

At the moment, the market is tiny, totalling about $1bn a year, a figure dwarfed by the trillion-dollar vanilla credit markets, and not much is expected in the first half of this decade.

Morgan Stanley expects growth to be hampered by sovereign prioritisation of climate goals in the near term, but it does note Ecuador is expected to issue a “Galapagos” bond, targeted at conserving biodiversity in the area, to be announced in 2023 at the earliest (although Reuters suggests the deal is likely to be wrapped up in weeks).

Reuters expects Ecuador’s likely $800m debt-for-nature swap could result in a sharp cut to serial defaulter Ecuador’s debt burden.

The agency says this would make it the biggest such deal struck to date.

But Reuters also expects Sri Lanka may trump this with at $1bn nature-related bond.

Belize clinched a $553m swap in 2021 to protect the world’s second-largest coral reef, slicing its debt by more than -10% of GDP.

The risks are high with such swaps, reports Reuters, noting that bondholders either lose money or ground in the event of a country default.

Australia Has A Job Ahead Of It

Australia, like most southern hemisphere nations that still boast true biodiversity will be expected to do some heavy lifting on the biodiversity front.

Australia is classed as one of 17 “megadiverse” countries, which combined constitute more than 70% of the planet’s biodiversity, but our record on extinction and ecosystems is among the world’s worst.

It is unlikely that Australia will receive any assistance from northern hemisphere pockets, unlike its poorer southern-hemisphere counterparties.

The biodiversity thematic is more likely to manifest through the country’s credit markets, mining, logging and tourism industries and legislation.

The government may be in a position to issue biodiversity bonds, although nothing is likely in the near term, with the responsibility likely to be born by the corporate sector in the near to medium term.

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