The nature of risk − speech by Sarah Breeden

Given at Ethical Finance Global 2022: ESG in a Volatile World – Profit, Purpose, or Politics?
Published on 06 September 2022
Sarah Breeden speaks about nature-related financial risks, exploring the potential financial risks arising from the physical and transition impacts of nature loss. Sarah also discusses the need for collaboration between real economy regulators, financial regulators and industry, to address these risks.



Nature underpins everything that we as humans do: from the water we drink; to the air that we breathe; and the creatures and plants that sustain us. However, the world’s leading scientists are concerned that nature is witnessing a global decline that is unprecedented, accelerating, and largely caused by human activity.footnote [1]

This global decline can be seen in the UK, where the ONS estimates that the value of the UK’s natural capital stock declined by 10% between 2010-2018.footnote [2] Here in Scotland, over 80% of peatlands are now deemed to be degraded.footnote [3] 

There’s no denying this is a pressing issue, and one that governments and society should make every effort to address.footnote [4] In fact, the Chancellor’s March 2021 FPC remit and recommendations letter asked the FPC to consider the relevance of environmental risks beyond climate change to its primary objectivefootnote [5]. The question for me, as a central banker and financial regulator, is what should my specific role be in this space – what action can and should the Bank of England be taking?

Asking such a question about an environmental issue is not a novel experience for us. We asked this very question in 2015 when first considering climate change. With climate – and now with nature – we look to our statutory objectives (most obviously for financial stability and the safety and soundness of firms) and our Remit to determine the appropriate response.

What I want to do today is unpack our current thinking on this important topic. I will look to explore the nature of these risks [excuse the pun] – to consider both their link to financial losses and potential materiality, and whether they exhibit traits that are sufficiently distinct from those captured in our existing regime to suggest bespoke action might be warranted. These may sound like simple questions. However, unpicking the answers involves a level of complexity that is unusual even for the Central Banking world.

Financial risks from nature loss and degradation

The first step in our analysis has been to determine whether nature loss and degradation gives rise to financial risks.

We are fortunate here as we have been able to utilise the pioneering work of others: the [2021] Dasgupta Reviewfootnote [6]; analytical work from central banking peers, including the Dutchfootnote [7] and Frenchfootnote [8] central banks; the more holistic analysis from the Network for Greening the Financial System (NGFS)footnote [9]; and the work being done by the Task Force for Nature-related Financial Disclosures (TNFD).footnote [10]

We have also been able to draw from our work on climate-related financial risks, where some parallels exist. For example nature-related financial risks share many of the characteristics that make climate risks hard to assess: non-linear, far-reaching, and subject to tipping points and spillovers.

Some nature risks are arguably more reversible than climate risks. But they also present novel and challenging traits:

  • Broad and varied in scope: Nature risks come from an immensely broad and varied range of sources, with numerous interdependencies.footnote [11] This means there isn’t a single metric to measure the condition of natural assets (like temperature for climate), and there are countless transmission channels through which financial risk might arise.
  • More localised: Compared to climate change, nature loss and degradation is more often a local not global issue.footnote [12] Nature risks are likely to be more material in economies that are more directly dependent on natural assets and their services. For example, Costa Rica’s tourism industry – which generated nearly 11% of GDP in 2019 – relies on its natural assets.footnote [13] Nevertheless, globally interconnected supply chains can cause local nature risks to spillover to other countries and regions.
  • Lack of policy clarity: And there is no ‘net zero’ for nature. There has been increased talk of an end goal being a ‘nature positive’ economy.footnote [14] But without a clear definition of what that comprises, it is hard to quantify the risks from a transition to it.

So, what we have is an immensely complex set of risks that we need to understand better.

We, and our peers, have sought to do this by looking at the risks in a methodical way. That is helped by adopting the physical and transition risk lenses that are used in climate. Let me explore each in turn.

Physical nature-related risks

Nature-related physical risks are a direct result of a dependency on naturefootnote [15]. A decline in natural assets - such as air, water, land, minerals and species - impacts financial institutions through indirect transmission channels.

Any change in the quality or quantity of natural assets first hits real economy companies who depend on the ‘ecosystem services’ those assets provide.footnote [16] This can feed through to financial institutions that finance, insure or invest in those companies.footnote [17]

The scale of the impact is hard to estimate. Using the ENCORE database, internal Bank of England analysis found that over half [52%] of UK GDP and nearly three-quarters [72%] of the stock of UK lending exhibits dependence on ecosystem services – levels that might suggest elevated vulnerabilities.

But dependence on ecosystem services is somewhat abstract. Let’s dive into a specific channel of risk to make it more tangible – the provision of freshwater.

Water provision is a growing global issue – with demand expected to be 40% greater than supply by 2030.footnote [18]

As well as having an acute humanitarian impact, a lack of access to freshwater could disrupt economic activities, resulting in declines in asset or collateral values, or lower profitability for real economy companies dependent on water directly or through their supply chain. Financial firms exposed to these companies could see heightened financial risk as a result, materialising as credit, market or liquidity risks.

So what could this mean in practice? Analysis in this space remains light, but:

  • The World Bank estimates water scarcity could impact GDP by up to 6% by 2050 in some regions, such as the Middle East and the Sahel in Africa, as it affects agriculture, health, and incomes.footnote [19]
  • And HSBC modelled a disruption to water supply in East Asiafootnote [20] that led to steel companies’ turnover falling by 25% and a significant downgrade of credit ratings.

At first glance these figures might suggest the absence of freshwater could have potentially material implications for financial risks within financial institutions exposed to these companies. But this is the gross risk – to understand the likelihood of feed-through to financial firms, we also need to understand mitigating actions that might net this off.

As ever, this is complex. In the UK, the water regulatorsfootnote [21] are tasked with securing the long-term resilience of the water supply. In times of stress, they can reduce pressures by transferring water between regionsfootnote [22], introducing restrictions on water usefootnote [23] (such as those we are seeing this summer), or undertaking desalinationfootnote [24]. This would of course dampen the impact on companies and consequently the risks to the financial sector.

But that is the UK, which has a developed water infrastructure. The situation in other countries might be different. And we also need to consider how individual companies might respond too.

This example helps to show how physical nature-based changes can give rise to financial risks. But this is just one risk - there are a myriad other sources – from air pollution to food provision to flood regulation - each impacted by the actions of real economy regulators and individual companies. This is an unprecedentedly complex area to asses.

Transition nature-related risks

The other bucket of risks are transition risks – which stem from changes in policies, technology, or consumer sentiment that aim to reduce or reverse nature loss.footnote [25] And so it follows that companies that negatively impact nature are more likely to be exposed to these risks.

In theory, this is similar to the climate risk framework. However in practice, defining transition risks for nature is much more challenging, because we have neither a single ‘net zero for nature’ measurement metric, nor a global commitment to deliver it.

Efforts to agree international nature goals are growing and an important milestone will be the UN’s biodiversity conference (COP15) later this year. Nevertheless, although we lack a comprehensive global policy framework for nature loss, we are increasingly seeing more narrow policy measures that give some indication of potential risks.

For example, the UK Government has proposed to make it illegal for large corporates to use commodities associated with deforestation.footnote [26] This would likely increase input costs for those companies exposed to deforestation, with implications for supply chain operations, asset values and location of activities.

These changes would be expected to impact the financial sector. The materiality of these impacts is hard to determine. But some analysis exists, such as Make My Money Matter’s estimate that £306bn of UK pensions are invested in companies linked to deforestation.footnote [27] This is expected to remain a challenge whilst poor visibility over supply chains and related exposures persists – an observation that we highlighted as important for risk assessment in our recent climate scenario exercise (the CBES).footnote [28]

Next steps in measuring nature-related financial risks

What we can take from this analysis of physical and transition risks is that a link between nature loss and financial risk can be demonstrated. However, it is clear that there are significant challenges in identifying and sizing nature-related financial risks.

Understanding the materiality of these risks is a key part of the jigsaw. And the work of the TNFD will be essential to progress here. To improve our understanding, the Bank is engaging with DEFRA and partners to better size the potential UK financial exposures from nature loss and degradation. We will look to share the results next year.

The Bank’s role in responding to nature-related financial risks

Let me now turn to another key consideration: whether nature loss and degradation exhibits traits that are sufficiently distinct from those covered in our existing regime to suggest a need for bespoke action. This is a more conceptual question and one that the Bank grappled with for climate risks back in 2015.

I like to characterise climate change as two tragedies – a tragedy of the commons and a tragedy of the horizon.

In a tragedy of the commons it is difficult or costly to exclude users from common resources which are overused as a result. The typical policy response is property rights or supply management, responsibility for which sits with real economy regulators and government.

Those real economy policy responses can create financial risks for corporates and households and so financial firms. But assuming there is good sight of policy and disclosure of the potential exposure to those risks, the existing financial regulatory regime should naturally capture them. On this basis, there would be nothing extra for the financial regulators to do, beyond checking that material risks are being captured, as they would do with any other emerging risk.

The position is however different for a tragedy of the horizon. Here, actions today create future financial risks that fall outside of normal planning horizons. In this case, specific intervention from financial regulators is warranted – to stretch firms’ horizons and so ensure they are considering the long-term financial interests of the firm, including how their decisions today affect their future financial risks. That has been an important factor underpinning financial regulators’ interventions on climatefootnote [29].

To help judge the appropriate role for the Bank in respect of nature, therefore, we need to explore whether nature loss and degradation represents a tragedy of the horizon, a tragedy of the commons, or both.

Obviously nature loss and climate change are inherently interlinked.footnote [30] Some of the factors - such as deforestation - that increase climate risks also negatively impact nature. Nature therefore has a critical role in the climate challenge, in mitigating physical risks using nature based solutions and in acting as a carbon sinkfootnote [31]. The financial regulators’ response to climate risks should therefore include nature’s role in the climate challenge.

What is less clear to me at this stage is whether the Bank has a role in responding to those nature risks that are not directly connected to climate risks. Put another way, are there other aspects of nature loss and degradation that give rise to irreversible future risks that need to be addressed by financial regulatory action today? I think there’s more analysis to be done here.

Of course what is clear cut is that nature loss and degradation represents a tragedy of the commons, giving rise to real life issues now, that governments and real economy regulators are addressing. And so alongside their critical work to improve management of climate risks, financial firms will also need to monitor how environmental regulations develop.

As Emma Howard-Boyd stressed in her final speech as Chair of the Environment Agency, “…Environmental regulation work[s] in lockstep with financial regulation and economic regulation… drive change”.footnote [32] In this way, finance can be a force for good.


Let me conclude.

The Bank’s early work suggests that nature loss can lead to financial risks. But more work is required to help us determine their materiality to the financial system and the extent to which they are not already captured in our regime.

We have previously highlighted the critical role of financial regulators in helping address the tragedy of the horizon - ensuring firms consider now how actions today can affect future financial risks. And it is clear that the interlinkages between nature and climate change mean that nature loss and degradation can represent such a tragedy. However, the extent to which this tragedy extends beyond areas linked to climate is an area where further work is needed.

Looking forward, through our collaborative efforts with DEFRA and partners, the NGFS, and the TNFD, we aim to build a clearer picture of the nature-related financial risks facing the UK. And alongside this, we will seek to clarify if and where nature loss and degradation can give rise to material financial risks that are not already being addressed in the regulatory regime.

Addressing nature loss and degradation is important to all of us on the planet. In the round, this work will allow us to determine the nature of these risks and so enable the Bank – and the financial system - to play its part in the collective response to this critical challenge.

The views expressed here are not necessarily those of the Financial Policy Committee. I am grateful to Cassandra Archer, Jennifer Bell and Chris Faint for their assistance in drafting these remarks. I would also like to thank Thomas Viegas, Christopher Ford, Vasilisa Starodubtseva, Timothy Rawlings and Sam Woods for their helpful comments.

  1. More detail on the broader issue of nature loss can be found in IPBES (2019), Global assessment report on biodiversity and ecosystem services of the Intergovernmental science policy platform on biodiversity and ecosystem services

  2. ONS Natural Capital Accounts (2019)

  3. Scotland soils, peatland restoration

  4. For example, see World Economic Forum (2020), Nature Risk Rising: Why the crisis engulfing nature matters for business and the economy

  5. See for example Bank of England (2021),Remit and recommendations for the Financial Policy Committee – March 2021

  6. Dasgupta (2021), Final report - The Economics of Biodiversity: The Dasgupta Review

  7. DNB (2020), Indebted to nature: Exploring biodiversity risks for the Dutch financial sector

  8. Svartzman et al. (2021), Working Paper no.826 Banque de France: A “Silent Spring” for the Financial System? Exploring Biodiversity-Related Financial Risks in France

  9. NGFS-INSPIRE (2022): Central banking and supervision in the biosphere

  10. TNFD – Taskforce on Nature-related Financial Disclosures

  11. IPBES (2019), Global assessment report on biodiversity and ecosystem services of the Intergovernmental science policy platform on biodiversity and ecosystem services

  12. Svartzman et al (2021), Working Paper no.826 Banque de France: A “Silent Spring” for the Financial System? Exploring Biodiversity-Related Financial Risks in France

  13. Statista, Travel and tourism as percentage of gross domestic product in Costa Rica from 2019 to 2021

  14. World Economic Forum (2021): What is nature positive and why is it key to our future?

  15. TNFD (2022) (Beta v0.1):Nature-related risk & opportunity management and disclosure framework

  16. TNFD (2022): LEAP nature risk assessment process

  17. DNB (2020), Indebted to nature: Exploring biodiversity risks for the Dutch financial sector

  18. UNEP press release (2016): “half the world to face severe water stress by 2030 unless water use ‘decoupled’…”

  19. World Bank (2016), High and Dry: climate change, water and the economy

  20. University of Cambridge Institute for Sustainable Leadership and HSBC (2022), Nature related financial risk: use case (impact of water curtailment on the credit rating of heavy industry companies in East Asia)

  21. The water regulators are Ofwat for England and Wales and Water Industry Commission for Scotland

  22. Ofwat (2019), A rapid response to boost water resources

  23. Ofwat, conserving water (drought)

  24. Thames Water (2022), Drought Plan

  25. TNFD, 2022: LEAP nature risk assessment process

  26. Defra consultation (2021-2022), Implementing due-diligence on forest risk commodities

  27. Make Money Matter (2022), Cutting deforestation from our pensions (final report)

  28. Bank of England (2022), Results of the 2021 Climate Biennial Exploratory Scenario (CBES)

  29. See for example Bank of England SS319 (2019), Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change

  30. IPCC (2022), Climate Change 2022: Impacts, adaptation and vulnerability

  31. World Economic Forum (2021), “New report shows biodiversity key to fighting climate change”

  32. Emma Howard Boyd's final speech as Chair of the Environment Agency (2022), Return to the unfrozen moment