Analysis: With the world’s nations reaching a historic agreement to preserve global biodiversity at COP15 in Montreal, attention is inevitably turning to how businesses can uphold the commitment to protect 30 per cent of the planet’s land and sea.

Financing biodiversity projects has long been a sticking point for institutions. The International Finance Corporation describes a “lack of guidance in the market on criteria for projects eligible for this kind of financing”, resulting in a “gap” between investors’ ambitions and biodiversity-centric outcomes.

But biodiversity has captured the attention of fixed income investors, with linked instruments and biodiversity-labelled bond issuances. For pension schemes, the mainstreaming of the nascent market comes as strategies shift to be on course with long-term net zero ambitions.

Creating strategies
“We believe that biodiversity is an important consideration when creating sustainable investment strategies and [protecting it] will help us to meet our climate targets, including our longer-term target of being net zero, without offsets, by 2040,” says Fiona Smith, investment proposition manager at Smart Pension.

The master trust made its first green bond investment through Mirova’s global green bond fund in December.

She notes that biodiversity is becoming “more prominent” in the green bond space because of the area’s links to other issues, such as climate change and deforestation, are becoming more widely recognised.

Nikko Asset Management green bond specialist Thomas Archer notes that most existing green bond issuance has been towards building the infrastructure needed to help mitigate and adapt to the effects of climate change.

“As it stands, nearly 20 per cent of green bonds outstanding make some form of reference to biodiversity,” Archer says – a figure that he anticipates will increase as issuances accelerate.

From the perspective of an asset manager, Archer says there is an evident need to be “pursuing a path of investing in biodiversity projects” through green bond holdings.

“Outside of reducing carbon emissions and the energy transition, investment in nature, forestry and water will be the next largest contributor to our effort to meet our global climate targets,” he says.

Biodiversity barriers
Despite a growing sentiment around biodiversity-linked products, the practicalities of investing in such bonds still present roadblocks to potential investors, says Federated Hermes head of investment Eoin Murray.

He notes that biodiversity is regarded as a “far more complex matter than climate change”, in part because it is more difficult to value the associated risks.

“A number of different, competing metrics have been suggested for the measurement of seeking biodiversity improvement, from carrying capacity estimation through biodiversity intactness to threat reduction or rewilding credits,” Murray says.

The challenge of bolstering the biodiversity-linked data universe is being addressed by the Taskforce on Nature-related Financial Disclosures, but, much like other disclosure and reporting frameworks, it is contending with the challenges of intricacy and scale.

“Measuring nature and biodiversity loss is complex,” notes Cardano co-head of sustainability Will Martindale. “On its own, an aggregated portfolio-level metric is not particularly useful, as it depends on sector and geography.

“A ton of greenhouse gas, whether emitted in the UK or Indonesia, has the same atmospheric effect,” he continues.

“But an acre of land in the UK will have very different environmental characteristics to Indonesia.”

The improvement in data quality will provide further credibility and assurance for institutional investors, but Archer notes that biodiversity projects tend to be smaller in size and have a much longer-term focus, and therefore “cannot necessarily be implemented straightaway and take time to mature”.

As such, he says it is “critical to plan for adequate support within the investment community” to enable capacity development.

Global opportunity
In general terms, the income offered by green bonds will be an attractive feature for pension schemes alongside their capacity for liability matching, with sustainability-linked products allowing pension schemes to hedge interest rate risk across liabilities while investing in a range of sustainable projects, notes Murray.

“Unfortunately, the size of the market remains small, with liquidity and accessibility potentially fraught with difficulty. The complexity of biodiversity-targeted instruments might also raise concerns over vulnerability to misuse and greenwashing,” he says.

But the impact and magnitude of COP15’s pledges are yet to fully materialise. Alongside COP27’s pledge to support vulnerable countries, attention is shifting to what the future of the biodiversity-linked green bond market may look like.

One indicator is the emergence of sovereign sustainability-linked bonds, with Chile and Uruguay the first countries to issue these products.

“More countries are likely to follow suit in 2023, into what is a rapidly growing market,” says Murray, as more nations pivot to meet the targets of the Global Biodiversity Framework.

At present, emerging markets “lack sufficient expertise” to gain access to institutional flows of capital, says Archer. He argues that for emerging market issuers to benefit from institutional investors, they should be “creative in their approach” to choosing relevant biodiversity projects.”

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