Climate capital

2024 is shaping up to be a momentous year for biodiversity finance.

Bonds incorporating biodiversity loss prevention and nature protection objectives account for almost a third of total ESG labelled debt issued so far this year, up from just 3 per cent in 2015.

At this pace, annual issuance of such debt could come close to USD300 billion by the end of 2024, a record.

The surge is no aberration.

A rapidly developing policy and regulatory framework now requires countries and companies to do more to protect nature and plug an estimated USD700 billion a year gap in biodiversity finance.https://www.nature.org/en-us/what-we-do/our-insights/perspectives/closing-nature-finance-gap-cbd/

For a growing number of investors, meanwhile, biodiversity restoration is seen as a potentially more cost-effective way to tackle global warming and meet net zero goals.

As credit ratings agency Fitch reports in a recent study, nature-positive portfolios are growing in popularity.

There is, then, every reason to believe that biodiversity bonds will account for an ever larger share of the USD6.5 trillion ESG bond universe.IIF

Gaining prominence

Sovereigns and supranational institutions have been spearheading the development of biodiversity-related capital. Borrowers such as the European Union and the World Bank were among the first to issue such debt. Together, they account for around two thirds of all biodiversity-related ESG debt issuance to date, according to the Institute of International Finance (see Fig. 1).

But corporate borrowers are beginning to enter the fray. The shift comes in response to the implementation of a growing number of nature-related company regulations and reporting standards, all of which geared to force firms to consider biodiversity protection as part of their net zero planning.  

Two types of corporate biodiversity bond have been in the ascendancy.

The first is the Use of Proceeds (UOP) bond, through which the money raised is earmarked for specified sustainability projects. Interestingly, issuance of such bonds has grown in the past few years while sales of other types of ESG debt has flagged amid fears of a lack of transparency. 

Among the most popular UOP nature bonds have been those that fund terrestrial and aquatic biodiversity conservation objectives – both recognised as an eligible UOP category by the International Capital Markets Association. These represent some 16 per cent of all new biodiversity bonds issued in 2023, up from 5 per cent in 2020, according to Fitch.The ICMA’s Green Bond Principles, Sustainable Fitch

Among the issuers coming to market is Chilean pulp and paper company CMPC. It issued bonds with UOPs in sustainable forest and water management and restoration of native forests.

Finnish forestry company Stora Enso, meanwhile, issued a number of green bonds with UOPs earmarked for sustainable forest and water management as well as pollution control among others.

China has also been an active participant in this market. The Bank of China recently issued two biodiversity bonds with net proceeds allocated to biodiversity conservation projects as well as environmentally sustainable management of living natural resources and land use projects – another eligible UOP – in mainland China. 

The second type of biodiversity bond popular among corporate issuers is the sustainability-linked bond (SLB). The distinguishing feature of SLBs is that they include a mechanism through which their terms and conditions – such as the interest rate or coupons – change depending on the company’s ability to meet its specific performance objectives within the pre-defined time frame.

Brazilian pulp and paper company Klabin offers an interesting case study. It recently sold a SLB with sustainable performance targets linked to its nature and biodiversity related goals, with the final maturity of 2030 with 2025 as the trigger for the pricing of the next interest rate.

The company's 2030 goals include:

• Reintroduce two species that are proven to be extinct in a certain habitat and promote the population reinforcement of four more threatened species. Coupon payment increases by 6.25 basis points if the target is not met.
• Water consumption equal to or below 3.68m3 per ton of production, representing reduction of 16.7 per cent over 2018. Upward coupon readjustments of 12.5 basis points if the target is not met.

EM: biodiversity hotspots

Corporate biodiversity bonds have proved popular among issuers based in emerging markets. They have accounted for nearly two-thirds of all biodiversity-related corporate bonds issues. 

Asian-based borrowers are becoming more active in the market, accounting for nearly 20 per cent of all newly-issued bonds. That is nearly as much as the combined amount issued by borrowers based in the US and the euro zone.Barclays Research

Emerging market corporate borrowers look likely to make greater use of biodiversity bonds.

This is because the population in these countries, which are home to the world’s most diverse ecosystems, are more heavily dependent on nature for their wellbeing and prosperity - be it through agriculture, fisheries and tourism. According to estimates from BloombergNEF, all of the top 20 funding priorities for global biodiversity protection are located in emerging markets.

They’re also keen to finance nature-based solutions – considered effective from a cost point of view too – for climate adaptation as emerging countries brace themselves for the effect of global warming.

Nature risk and premium

Growing investor demand for biodiversity bonds may also reflect favourable financial performance of the asset class.

The IIF noted that the median return of biodiversity fixed income funds stood at just over 10 per cent, outpacing conventional peers, which it calculates delivered 6.7 per cent last year.

The analysis chimes with a growing body of academic research which has uncovered the existence of a “biodiversity risk premium” in the fixed income market.For more, see https://am.pictet/en/us/global-articles/2023/expertise/esg/corporate-impact-on-biodiversity

One study which analysed credit risk term structure of infrastructure companies found that companies which manage biodiversity risks had up to 93 basis points better relative long-term financing conditions those that do not.Hoepner, A. et al, The Impact of Biodiversity, Water, Pollution on the CDS Term Structure https://ssrn.com/abstract=4351633 What is more, the results show the difference was greater over longer lending periods – the slope showing one to 10 years was steeper than that for one to five years.

The CDS curve, the researchers concluded, indicates that investors perceive those risks as long-term issues in an industry especially vulnerable to a triple planetary crisis of climate change, biodiversity loss and pollution.

Biodiversity: becoming material

Biodiversity has yet to become a mainstream investment in the green bond market, with some 8 per cent of the total raised in the market directly funding nature protection efforts, compared with over 50 per cent in renewable energy infrastructure.Cumulative volume USD 2010-2019, IRENA

The use and setting of biodiversity performance targets has significant room to improve as the current framework makes it difficult to quantify and monitor biodiversity gain or loss accurately. Bodies like the Taskforce on Nature-related Financial Disclosures (TNFD) and the Finance for Biodiversity Foundation are working with the scientists to refine data monitoring and collection processes.

A more standardised biodiversity finance architecture should help investors ramp up their capital commitments for companies with nature restoration projects.

It could be a matter of time before nature-related bonds followed the same path of climate to become a standard environmental feature in the global sustainable fixed income market.