Finding Nature Finance Opportunities that are Hiding in Plain Sight

Mainstream nature requires identifying and repurposing existing financial mechanisms, just like any evolutionary process. Focusing on the dollar value of funding needed to meet nature goals gets in the way. Rather, understanding the pathways available to firms and local governments for managed risks and reframing the nature finance as a risk management problem can help identify existing, but perhaps hidden, nature-related financing opportunities.

Nature loss poses risks for organizations seeking to maintain a flow of services. Firms have pathways to manage risks. Firms can use market-based or self-insurance mechanisms; diversification of suppliers and customer base; and technological substitution. These approaches reduce dependency on nature and enhance firms’ adaptabilities to manage environmental disruptions without directly engaging with nature. Firms are expected to choose these options when they are least cost.

Beyond insurance and diversification, firms can engage in activity-based risk management. When firms can establish control and exclude others, e.g. through privatizing of natural resources, then firms may do so. Imperfect controllability points firms towards legal engagement to increase controllability and excludability of others. When those options fail or are expensive, firms engage in complex conservation efforts, but those may have large transaction costs, e.g., payments for ecosystem services. 

Insurance occupies a unique position because insurance is primary tool for firms to manage nature-linked risks. Nature may influence existing swap products or new swaps could be developed. Insures may use payments to pursue nature conservation initiatives to lower aggregate risk of the strike conditions emerging.

Local governments (municipalities) primarily connect to financial markets through municipal bonds, creating indirect exposure to nature-related risks. Municipalities have limited insurance options, and because they are geographically fixed, have fewer spatial diversification options. Full controllability creates governance issues. Thus, local governments are on the frontlines of managing nature-linked risk. An emerging literature suggests that their securities reflect how they manage these nature-linked risks. These investible securities may create a pathway for nature investment.   

Rather than starting with nature, starting with risk management, with an eye to nature, may uncover readymade nature investment opportunities.