Financial markets price all kinds of risks. But there’s one they ignore: how nature loss affects governments’ ability to pay their debts. Sovereign debt is the world’s largest asset class, yet economies suffer from the loss of forests, fisheries, pollinators and fresh water.
However, credit ratings barely take this into account. That blind spot skews how creditworthiness is assessed and disregards a growing risk to financial stability. Markets may be mispricing as much as USD 83 trillion of sovereign debt.
And this is why rating agencies, regulators and governments should build nature-related risks into how they judge a country’s overall creditworthiness.
More than half of global GDP (around USD 44 trillion) depends moderately or highly on nature and services derived from it. In the euro area, around 75 % of bank lending goes to companies that depend heavily on at least one ecosystem service. European banks are already exposed, regardless of whether they price it in.
There are physical effects too. Over USD 1 trillion of annual GDP in Europe, China and the US is reliant on rainfall generated by forests. Nature loss is a systemic financial risk and one that doesn’t respect national borders.
A risk without a price
So, why don’t markets price it? Partly because the work to do it has barely begun. Nature is the least advanced sustainability risk assessed by the UN’s Environment Programme Finance Initiative. For credit risk, 17.9 % reported that physical nature risk isn’t even minimally integrated into their models, with 28.6 % saying the same for transition risk.
The European Central Bank (ECB) says banks’ capacity to stress-test nature-related risks is still at an early stage. At national level, the gap is even wider. None of the three leading credit rating agencies factor nature loss into how they rate governments.
Businesses, meanwhile, are moving faster. The number of companies and financial institutions committed to disclosing their nature-related risks under the Taskforce on Nature-related Financial Disclosures framework reached 700 this year, holding some USD 22 trillion in assets. Most are early in their journey, assessing their impacts and dependencies rather than pricing them. Yet the lesson is clear: if only the front-runners act while the risk is systemic, the market will still misprice nature-related risk.
Putting a number on nature-blind ratings
A recent study shows what pricing this risk would look like in practice by building nature into a sovereign credit model and scenario-testing it across 23 countries. It looked at how ecological decline would feed through to financial indicators like sovereign credit ratings, the probability of default and the cost of borrowing.
Under a ‘business as usual’ scenario, where nature continues to degrade at the current rate, global GDP in 2030 will be around USD 75 billion lower than it would otherwise be. Under a partial ecosystem collapse scenario, global GDP will fall by USD 2 trillion each year. Sovereign credit ratings will also fall.
Even under the ‘business as usual scenario’, Indonesia, Bangladesh, India and China already face downgrades. Under a partial ecosystem collapse, they face even steeper falls, while China’s probability of default would triple. Across the 23 countries, governments would face an additional USD 162 billion in interest each year, with India and China particularly exposed.
The significance of these findings lies in their method. Nature-related risk can be rigorously measured and integrated into sovereign credit assessment, using the same indicators that markets and regulators already rely on. The barrier isn’t technical. These methods can be applied today, giving rating agencies, regulators and investors a workable starting point.
Pricing nature both ways
Those countries facing the steepest downgrades are among the world’s poorest and most biodiverse, and many already borrow at far higher rates than wealthier economies. Simply pricing nature risk into their ratings would then penalise them twice – for the ecological damage they suffer from, and again through higher borrowing costs when acting to prevent it.
This also clashes with a shared commitment. Under the Kunming-Montreal Global Biodiversity Framework, most nations agreed to combat nature loss and recognise shared responsibility, with developed countries pledging to raise financial flows to developing ones.
Nature loss erodes productive capacity and public revenues, raising the chance of default and the cost of borrowing. By the same logic, conservation and restoration reduces a country’s vulnerability to future shocks due to increased macroeconomic and fiscal stability, and a sounder economy commands cheaper credit.
Protecting nature isn’t a cost to be absorbed. A country actively rebuilding its natural capital is lowering its risk exposure and improving its creditworthiness, and national assessments should price this accordingly.
The tools exist – the mandate doesn’t
Everything needed to identify, assess and price nature-related risk already exists and can be translated into terms that markets understand. What’s missing isn’t the capability to price risk but the obligation to price it. It depends on data, which depends on disclosure, which in turn should be mandatory and enforced.
The EU’s simplification directives have scaled back nature-related reporting while the International Sustainability Standards Board opted not to develop a standalone biodiversity standard. Even where reporting is mandatory, it’s still incomplete, especially for the sectors most directly affected by nature.
Without data, markets can’t see – let alone price – the exposure these firms carry. Meanwhile, governments continue to spend around USD 2.6 trillion a year on subsidies that degrade the natural ecosystems their economies depend on.
None of this is beyond fixing. During the June Environment Council, ministers acknowledged that nature loss is a direct threat to national competitiveness and economic resilience. Turning that recognition into action will take several actors and processes moving together, as no one can deliver it alone. Rating agencies, supported by supervisory authorities, should build nature-related risks – and the conservation efforts that reduce them – into their sovereign methodologies, a shift their supervisor, the European Securities and Markets Authority, can actively encourage. The ECB should also incorporate nature into its stress testing and determine which collateral would be needed should nature-related risk be priced in.
The European Commission should ensure that corporate disclosure continues to capture material nature-related risks, keeping such information easily available and comparable. Alongside this, national governments should incorporate nature-related risk into their own financial and economic decisions.
Investing in nature now will significantly reduce future risk exposure. The alternative is to keep mispricing a risk we know how to measure. The continued loss of nature will only carry a heavier cost.
The question is whether governments and markets pay now to prevent it… or far more to mitigate it later.
