Biodiversity in the Digital Age Part 1

As societies recognise the urgent need to address the accelerating loss of species and habitats, the use of market mechanisms such as biodiversity credits as a potential solution is gaining traction. This was reinforced through the outcomes of COP15 (the 15th Conference of Parties to the UN Convention on Biological Diversity held in Montreal 2022), with biodiversity credit markets being identified in Target 19 of the Kunming-Montreal Global Biodiversity Framework (GBF) as an important mechanism for driving private sector finance towards nature protection and restoration.

At their simplest biodiversity credit markets are systems where conservation projects generate tradable units representing positive impacts on biodiversity. Their aim is to address the significant gap that exists in financing for biodiversity by encouraging private investment in nature protection and restoration while facilitating sustainable development practices. The thought is that by aligning economic incentives with conservation objectives, markets can become an additional mechanism by which a primary goal of biodiversity protection and restoration can be achieved.

Although there have been some initial projects and explorations into biodiversity credit markets and a number of publications to provide guidance on their governance and design (for example here, here and here), the concept remains nascent. As such the potential for biodiversity markets to achieve their primary goal of biodiversity protection and restoration at scale remains untested.

In creating and supporting a robust supply of credible and impactful conservation projects, biodiversity credit markets need to be designed and implemented so that any unintended negative social or environmental outcomes associated with their function are avoided.

While there is undoubtedly potential for negative outcomes to occur on the supply side of the market (the generation of credits), with the most notable being potential misrepresentation of biodiversity gain [1], it is arguably within the demand side of the market (the purchasing of credits) where hidden risks reside.

The reason for this is that it is the demand side of the market that is responsible for introducing finance and liquidity into the system[2], with which comes an expectation of return for participants, whether that be direct and financial or indirect and other (e.g. enhanced reputation). Therefore, clearly understanding the nature of that return, and determining whether it results in an extra-market impact on nature, is essential to ensuring that the primary goal of a biodiversity credit market (i.e. biodiversity protection and restoration) is maintained.

Before going deeper into the demand side of a biodiversity market it is important to clarify the difference between biodiversity offsets and biodiversity credits, as the distinction leads to a foundational requirement for biodiversity credit markets.

Biodiversity credits and offsets can often be conflated due to their shared focus on the value of biodiversity, a common use of metrics to quantify and verify changes in biodiversity, and the fact that both address ecological harm through some form of investment in conservation or restoration projects. However, the distinction between the two instruments lies in their focus and ultimately their end use by the purchasing party.

Biodiversity offsets are a conservation strategy used to compensate for the unavoidable negative impacts of development projects on biodiversity and ecosystems. The goal of offsets is to achieve a “no net loss” or even a “net gain” of biodiversity as a result of the development. Biodiversity offsets are often subject to regulatory frameworks and guidelines to ensure that they are designed and implemented effectively. This includes ensuring that the mitigation hierarchy is properly applied and that offsets are only being used as a last resort to achieve equivalent or greater conservation outcomes.

Biodiversity credits are units representing some quantity of maintenance or improvement of biodiversity and are increasingly being adopted as a financial instrument to facilitate investment in biodiversity conservation and restoration. Credits are generated by conservation or restoration projects that measurably maintain and improve biodiversity, such as increasing species diversity or restoring habitats. Once created these credits are purchased by market participants who value biodiversity and/or are interested in generating a financial return.

A fundamental distinction therefore exists between the two in that an offset is a licence for buyers to compensate for a known and direct impact on biodiversity, while a credit is not tied directly to any development or predicated on any associated impact occurring. Given that the primary goal of a biodiversity credit market is to scale biodiversity protection and restoration, the impact associated with biodiversity offsets, which equates to an actual loss of biodiversity at a specified location, makes them unsuitable for inclusion. Therefore, a foundational requirement for an effective biodiversity credit market is that the demand side operates in isolation to any biodiversity offset scheme.

Given that the demand side of a biodiversity credit market isn’t compensating for any direct impacts on nature, motivation for market participants largely aligns with facilitating proactive measures that support the protection, restoration and maintenance of critical ecological features and functions. For the purposes of this article I have identified this form of demand as ‘foundational’ as the value for participants is derived directly from the creation or maintenance of biodiversity assets (i.e. physical and tangible improvements). Some examples of this type of demand include:

Maintenance or improvement of a biodiversity asset from which economic value is derived: for example tourism operators protecting a coral reef, or the concept of ‘in-setting’ where companies focus on improving biodiversity within their own operations or supply chains

Companies seeking to avoid long term downstream costs associated with the degradation of ecosystems and/or the loss of access to natural resources: for example insurance companies using nature based solutions to reduce flood risk, or manufacturers restoring catchments to maintain access to clean water; and

Investors seeking to promote economic activity through biodiversity protection and restoration activities: for example, governments, but also impact investors considering both biodiversity and social returns.

It is also worth noting that voluntary purchases by either a business or an individual, driven by altruistic motivations, can also represent a form of foundational demand. However, given that this type of activity is often charitable and entered into with no expectations for any return in any form, participation may be better defined as constituting a donation rather than an investment, and perhaps the instrument better classified as a credit scheme rather than a market per se.

For participants who make up the foundational demand, biodiversity credit markets are there to deliver a product (the protection, restoration and maintenance of biodiversity), with that product giving them a greater opportunity to continue to generate revenue and profit, or minimise the risk of economic losses, over the longer term.

Given their underlying motivations, these participants are more likely to be prioritising meaningful conservation efforts over financial returns or symbolic gestures that lack substance.

For a biodiversity credit market to build sufficient momentum to drive the proliferation of biodiversity conservation and restoration projects that generate high quality credits, participants must be able to buy and sell credits easily. Assuming a well-designed and highly functional market, the size of the market should correlate strongly with the scale of positive biodiversity impact that is achieved. This direct relationship between the size of the market and the scale of impact highlights one of the primary motivations for growing biodiversity credit markets.

At a functional level there are also additional strong motivators for scale.

Essentially, larger scale markets attract more participants, leading to more diversified conservation projects and allowing for resources to be allocated more efficiently.

With foundational demand offering a basis of support for biodiversity credit markets the question remains whether the total volume of support from foundational demand can be activated quickly enough and at a large enough scale to drive meaningful change in biodiversity protection and restoration efforts. If not then demand may remain weak, with the market then not able to generate enough funds to achieve the critical mass required to result in substantial conservation outcomes. Hence finding and accommodating additional sources of demand for biodiversity credit markets may be required.

Beyond foundational demand, additional demand for biodiversity credit markets is generally associated with two key motivators: the ability to generate a financial return and the ability to enhance and promote sustainability credentials. Details of each of these options are outlined below.

1) Financial assets and secondary trading

One method of increasing the demand side of the market is through the creation of financial assets and investment products open to secondary trading. As an example, a financial product for secondary trading in a biodiversity credit market could be a Biodiversity Credit Exchange-Traded Fund (ETF), created to track a specific index of biodiversity credits. The value of this ETF would be determined by the overall performance of the underlying biodiversity credits with shares in the ETF made available for purchase on the open market. Financial products such as this, and the facilitation of secondary trading, offer a means of enhancing the liquidity of biodiversity credits, making for a more flexible and dynamic market in which it is easier for buyers and sellers to transact.

A potential downside of secondary markets, however, is that they can attract speculative behaviour with participants motivated to buy and sell credits for financial gain without any genuine concern or connection to the underlying conservation outcomes. Although that is how secondary markets operate, by bringing liquidity that allows for markets to scale without direct investment in asset creation, this impacts on the public perception of credibility for a biodiversity credit market.

With an increasingly sceptical populus and increased scrutiny of the financial mechanics and beneficiaries within the adjacent carbon offset market, there could be considerable negative perception for a biodiversity credit market where trading in the financialised layer generates substantial returns that are abstracted from the biodiversity outcomes that are or need to be achieved.

Moreover, the financial activity of secondary trading can also lead to greater commoditisation of the underlying asset, that being a process to standardise biodiversity credits driven by a focus on price competition rather than differentiation based on the unique qualities of the credits. Commoditisation is desirable for markets in which the underlying asset is largely homogenous, such as carbon credits, as it generally leads to cost-effective production across the market. However, for non-homogenous assets such as biodiversity, where the implementation is local and the cost of production greatly variable depending upon the management actions required, commoditisation can result in negative outcomes. Specifically, commoditisation can lead to a reduction in pricing power for suppliers (the ones actually undertaking on-ground activities to protect and conserve biodiversity), potentially resulting in poor quality outcomes (cost constrained) or project locations contingent on production price rather than need.

Furthermore, it is questionable whether the path towards greater commoditisation is a desirable outcome for biodiversity credits. Although commoditisation can lead to convenience for the financial participants in a biodiversity credit market (particularly for larger investors and secondary traders who are restricted by the terms of their mandate to invest), the requirements for commoditisation such as homogeneity of the asset and standardisation of the metrics representing that asset, can result in a disservice to the variability, context and complexity of biodiversity. Notwithstanding that the foundational demand for biodiversity credits is within niche and specialised markets where participants value conservation outcomes (sometimes specific to their operations) rather than the convenience of a generalised commodity. And whilst price considerations and efficiencies remain front of mind for these participants, the integrity in the delivery of the product, that is the protection, restoration and maintenance of biodiversity, remains their primary objective.

Given this is the case it could be argued that a foundational level a more desirable biodiversity credit market is one in which there is preference towards maintaining the complexity of nature (i.e. material integrity in the outcome) rather than promoting a more simplified interpretation as preferred by secondary traders.

2) Reputational rewards

There is a portion of the market that will seek to be involved in biodiversity credit markets to enhance their reputation or sustainability credentials. This could be driven by a companies’ commitments around Environmental, Social, and Governance (ESG) or a desire to demonstrate their commitment to sustainability and environmental stewardship via Corporate Social Responsibility (CSR). Although genuinely invested organisations with an intrinsic desire for participation exist, in most cases organisations are influenced by external stakeholders, including investors, financial institutions offering access to capital and consumers demanding sustainable and ethical products. For the most part these parties are also invested in seeing substantial outcomes being achieved rather than tokenistic gestures.

Tokenistic gestures, or worse, greenwashing, are risks associated with using biodiversity credits to support reputational enhancement. Greenwashing occurs when organisations falsely present themselves as environmentally responsible or sustainable without making genuine efforts to address real environmental concerns within their own operations and supply chains.

In this circumstance an organisation uses their association with biodiversity credits, and more specifically the outcomes (biodiversity) achieved by participants (brands) in the supply side of the market, to enhance their own brand reputation whilst ignoring or disregarding their own known, unknown, direct and/or indirect impacts on nature.

For this reason companies seeking to participate in biodiversity credit markets should not only be considering adherence and disclosure with respect to their regulatory commitments, but also ensure that there is a clear distinction for any offsets requirements they have, so as to avoid any potential conflation or confusion. Moreover, across-the-board transparency for participants is essential for instilling credibility in a biodiversity credit market, a process assisted through the use of standards such as the SBTN’s science-based targets for nature for assessing nature and biodiversity footprints and the Taskforce on Nature-related Financial Disclosures (TNFD) for defining and disclosing nature related impacts, risks and dependencies. These measures are important to ensure that the ‘ledger’ with which an organisation is entering into a biodiversity credit market is disclosed and clear, so that the public can understand whether participation is genuine or rather driven by a desire for some form of de-facto offsetting.