Financing Biodiversity with SLBs

Standard financial securities have not proven to be effective tools to  attain sufficient private capital for biodiversity protection. How to finance a reversal in biodiversity deterioration remains a challenge. Based on ongoing work, we propose a theoretical model of Biodiversity-related Sustainability-Linked Bonds (BrSLBs) as an innovative financing instrument for biodiversity conservation and restoration. We first derive a pricing model where the Key Performance Indicator (KPI) is related to contrasting biodiversity loss and nature deterioration. Specifically, our pricing formula, which is based on multivariate digital options, accounts both for the KPI provision and default risk. We then investigate a few relevant questions about these financial instruments, for example, the existence of a “bio-sustainium,” the interaction between sustainability performance and issuer’s credit risk and the optimal design of these contracts. Our work extends some previous results of ours and contributes to the understanding and expansion of biodiversity finance. Although biodiversity-related bonds still represent a niche segment of the universe of sustainable finance, there is growing interest in nature preservation from sustainability-focused investors and demand for financing from issuers with nature-related strategies and targets.  Despite this, biodiversity finance instruments are still few. In our paper we examine under which circumstances  SLBs may represent an alternative to use-of-proceeds bonds, allowing for more versatility in the use of proceeds and alleviating the concern for greenwashing.  Our paper discusses the main KPIs with a biodiversity focus and develops a comprehensive pricing model with the structure of real-world BrSLBs in view.  We study the role of several variables and risk factors in price formation and in appeal to issuers and investors. In particular, we show how the dependence structure between credit risk and environmental performance has a material impact on the bio-sustainium. Our results are linked to the challenging problem of an optimal design of these outcome-contingent financial instruments and the fine tuning of the bond characteristics aimed at attracting investors and bond issuers.