Finance for Biodiversity: Nature loss will take a heavy toll on sovereign borrowers

Ecological destruction can drive downgrades, debt crises and soaring borrowing costs.

Biodiversity and nature-related risks can have significant impacts on sovereign credit ratings, default probability and the cost of capital, a new paper warns.

Published on Thursday by Finance for Biodiversity, Nature Loss and Sovereign Credit Ratings modelled the effect of nature loss on the creditworthiness and borrowing costs for 26 sovereigns – covering more than $66 trillion in sovereign debt – under multiple scenarios.

Japan, Mexico, Canada, the US, South Africa, Madagascar, Brazil, Colombia, India, China and Malaysia were among those surveyed.

The researchers, led by the University of Cambridge, hailed from the universities of East Anglia, Sheffield Hallam, and SOAS University of London.

Under the most severe scenario – “partial nature collapse”, which would see continued degradation leading to ecological tipping points (ie ecosystems collapse) – the ratings impact would be in many cases “significant and substantial”.

“More than half (58 percent) of the sovereigns included in the sample would face a downgrade of one notch or more. Those downgrades would in turn trigger between [$28 billion]-£53 billion in additional costs of annual interest payments borne by these downgraded governments,” the report claimed.

In particular, the researchers noted that China and Malaysia would be hardest hit, with rating downgrades of more than six notches in the partial collapse scenario.

The report also flagged that under this scenario the creditworthiness of lower-rated sovereigns in emerging and developing countries would be most directly affected, in comparison with highly rated sovereigns, where “the estimated rating changes are generally small and within the margins of error”.

Due to the particular countries in the sample and specific ecosystem services analysed, however, the report admits the results provide only a partial estimate of the effects of nature loss on sovereign debt markets.

Looking ahead, several calls to action were issued – for example, that credit rating agencies should use scientific research to integrate nature loss into credit ratings to provide a more accurate picture of nations’ credit risk. “Omitting this may ultimately undermine market stability, bankrupt governments, and severely impact households,” the report said.

EC targets nature restoration

In related news, on Wednesday, the European Commission adopted a proposal for a Nature Restoration Law to repair the 80 percent of European habitats that are in poor condition, and to bring back nature to all ecosystems.

Under the proposal, legally binding targets for nature restoration in different ecosystems would apply to every member state, complementing existing laws. The aim is to cover at least 20 percent of the EU’s land and sea areas by 2030 with nature restoration measures, and eventually extend these to all ecosystems in need of restoration by 2050.

The Commission also proposed to reduce the use and risk of chemical pesticides by 50 percent by 2030.

Responding to the announcement, Adam Kanzer, head of stewardship Americas at BNP Paribas Asset Management, told Responsible Investor: “Nature loss is a key systemic risk that touches every aspect of our lives. Nature’s contributions to our economies have been overlooked and dramatically undervalued. We therefore welcome the European Commission’s focus on nature and look forward to reviewing the details. We are pleased to see the broad scope of the plan and, in particular, the attention paid to pesticide use, an area that has been a recent focus of our corporate engagements.”