NGFS Publishes Landmark Reports on Nature-Related Financial Risks and Litigation Trends
The Network for Greening the Financial System (NGFS) recently took major initiative in dealing with nature-related financial risks by issuing two landmark reports meant to guide central banks and financial supervisors in their moves. This growing realization is about the realization of the fact of how environmental degradation affects financial stability. The reports also come with timely insight and practical guidance on how to manage emerging risks associated with these environmental degradations.
It outlines, at a conceptual level, the NGFS blueprint for central bank and supervisor implementations, along with those of financial institutions, to identify, assess, and manage the risks associated with the loss of biodiversity and ecosystems’ degradation. From September 2023, the framework has already been in the Beta phase but has received a warm welcome from the global financial community. This version now brings all those insights together to be able to offer a guide that makes sense for stakeholders looking to integrate nature-related risks into their strategies.
A New Framework for Nature-Related Risks
The Conceptual Framework is a set of common language and practical tools to further equip financial institutions better to respond to nature-related risks within their decision-making processes. It includes cases that are illustrative of the application of the framework in reality—some ecosystems, like forests and freshwater bodies, and how they might cause financial risks through supply chain disruption, asset value reduction, and increased regulatory pressure, among others.
“The first report shows real-world examples of how to apply our conceptual framework for nature-based risks. This will give us very valuable insights as supervisors start to take action,” said Sabine Mauderer, Chair of the NGFS. According to Mauderer, this quotation underscores the increasing need to encourage central banks and financial regulators to go beyond discussing, in a theoretical way, what action to take in order to cope with risks.
The framework offers actionable advice for several critical areas, including identifying relevant sources of data and measuring exposure to nature-related risks, and it operationalizes the inclusion of these risks into stress testing and scenario analysis. It also provides practical suggestions on stakeholder engagement with governments and the private sector in building resilience in the financial system.
Managing the Growing Threat of Nature-Related Litigation
The second report points to an ever-emerging trend with potentially very large implications for financial institutions: nature-related litigation. New risks are increasingly emerging for the financial sector as legal action against environmental damage, including biodiversity loss, deforestation, and pollution, accelerates. Drawing parallels, the report indicates how the rising tide of climate-related litigation has already started to change how financial institutions approach environmental risk management.
The head of the NGFS Experts’ Network on Legal Issues, Chiara Zilioli, also took the trend as noteworthy, outlining it through her expression of the “growing tendency of strategic nature-related litigation, which is becoming increasingly relevant for the financial system. The purpose of this report is to raise awareness on nature-related litigation within central banks and supervisors, and even within individual financial institutions.
The comments by Zilioli point to increasing and material legal risks that financial institutions should take into account. Several significant areas in the report indicate where nature-related case law is expected to be prominent: cases on actual or likely loss of biodiversity, degradation of ecosystems, and breaches of environmental laws. This trend is likely to gain greater strength as governments and civil society groups increasingly turn to the courts to enforce accountability of business corporations and financial institutions to account for their environmental impact.
Moreover, natural environment-related litigation may boundlessly spread to take in financial costs, reputation damage, administrative penalties, as well as an asset devaluation profile. A financial institution may then ignore these risks at its own peril because the losses emanating from legal liabilities and possibly reduced market confidence, amongst other ways, would eventually translate to financial losses. To that effect, the NGFS encourages the actions of central banks and supervisors to proactively consider the integration of legal risk considerations in their risk management framework.
This includes the integration of nature-related risks into financial stability.
Clear message from the NGFS: Nature-related risks can no longer be overlooked by financial institutions. With environmental degradation hastening and escalating legal pressure, such risks are bound to escalate to feature as a cornerstone in discussions of financial stability. The two reports reflect a broader effort underway from the NGFS to mainstream environmental risks in financial regulation and supervision in a global drive to advance sustainable finance.
Emmanuelle Assouan, Co-chair of the NGFS Taskforce on Biodiversity Loss, noted the practical usefulness of the Conceptual Framework as follows: “The new developments included in this final version… provide a convincing demonstration that immediate action to start assessing these risks is both possible for central banks and supervisors and useful to their missions.
Advanced Nature- and Climate-Related Risk Integration: The comments of Assouan point toward a need to hurry in integrating nature-related risks into our financial decision-making. This, when combined with examples that are actionable, means NGFS reports can be used by financial institutions to be out in front of acting on emerging risks in a time-constrained way and effectively contribute to building a more resilient global financial system.
The Road Ahead: Challenges and Opportunities
The reports published by the NGFS represent an important landmark on the way to mainstreaming supervisory practices in relation to nature-related risks in the financial sector. However, the road ahead is not entirely free from challenges: the most significant ones being represented by the huge data gaps, methodological uncertainties, and the complex and complicated nature of risks. However, the NGFS work will form a good basis for passing through these barriers and further the agenda of sustainable finance.
This has clear implications for financial institutions: nature-related risks are no longer things that can be ignored. Supported by guidance provided by the NGFS, surely central banks and financial supervisors will be in the forefront of the vanguard in developing a resilient financial system amidst the growing harsh environment. Nature-based risk integration is critical for the support of long-run financial stability within the financial sector as it continues to evolve in this new reality.
These reports underscore the need for urgent action and set the scene for a new era in financial regulation—one that truly understands the interplay of nature with the global economy. The NGFS has defined the path; now it is up to the financial institutions to follow it.