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What the new biodiversity credit rating tells us about the future

Author: ICAEW Insights

Published: 05 Jul 2022

Sharp declines in animal and plant species are threatening financial ruin for 26 countries, according to nature-focused sovereign debt study.

Losses of animal and plant species are poised to trigger major sovereign downgrades in the coming years, with 26 countries showing signs of concern, according to pioneering research from the University of Cambridge.

Pooling their skills at the university’s Bennett Institute for Public Policy, a team of economists has modelled the world’s first biodiversity-adjusted sovereign credit rating.

Its debut report forecasts downgrades among the 26 nations in question that would raise annual global interest payments on sovereign debt by up to $53bn per year, leaving many developing nations at significant risk of default – in effect, bankruptcy.

Steep drop

Bennett’s rating model builds on last year’s World Bank report The Economic Case for Nature: a first-of-its-kind effort to identify the macroeconomic consequences of declines in biodiversity.

Focusing on a collapse in select ‘natural services’ – namely, wild pollination, timber supplies and the provision of food from marine fisheries – the report showed that, in 2030, nature loss could lead to a total drop in global GDP of $2.7trn.

In the Bennett team’s analysis, if the world sees a ‘partial ecosystems collapse’ in those three service areas, then more than half of the nations in the study group would face downgrades – with India falling by four notches on the 20-notch scale and China plummeting by six.

Other nations that would face four-notch downgrades include Bangladesh and Indonesia – which would also be saddled with billions of dollars in interest payments.

A dozen of the study countries would increase their bankruptcy risk by more than 10%, most dramatically Bangladesh (41%), Ethiopia (38%) and India (29%). Meanwhile, six – including Pakistan and Madagascar – would be more likely than not to default if hit by a sudden ecosystem collapse.

Holy Grail

The Bennett team notes that, at present, ‘difficult to quantify’ financial risks examined at rating agencies such as Moody’s and S&P typically revolve around geopolitical events, while largely ignoring the economic consequences of ecological degradation.

In addition, the economists stress, their modelling should be considered ‘cautious’ as it focuses only on the three service areas chosen for the World Bank report. In its totality, they point out, nature loss also degrades everything from human health to farmable soil.

For that reason, they say, fully quantifying the financial risks from national losses of biodiversity is widely regarded as the “Holy Grail of environmental finance”.

Sheffield Hallam University Senior Lecturer and Bennett study co-author Dr Matt Burke says: “Economies reliant on ecosystems face a choice: pay now, by investing in nature, or pay later through higher borrowing costs and spiralling debt.

“The ‘pay now’ option generates long-term returns for people, business and nature. The ‘pay later’ option has significant downside risks, with little or no upside.”

ICAEW Climate Change Executive Sarah Reay said: “There are cascading risks posed by climate change and biodiversity loss that are difficult to predict and manage. Research such as this can help public financers consider the short-, medium- and long-term risks associated with nature loss.”

“In parallel with environmental degradation, nature loss has serious socioeconomic ramifications for all nations across the globe,” Reay added. “The challenge is to invest significantly now in restoring biodiversity, to ensure we can minimise the risk of large-scale ecosystem failure and related economic crises in the future.”

Find out more about the role of accountants in embracing sustainability at ICAEW’s dedicated hub

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