Frank Elderson: Nature-related risk: legal implications for central banks, supervisors and financial institutions
Keynote speech by Frank Elderson, Member of the Executive Board of the
ECB and Vice-Chair of the Supervisory Board of the ECB, at the ESCB
Legal Conference 2024Frankfurt am Main, 6 September 2024
As a
lawyer, I am always glad to discuss the novel legal issues affecting
the work of central banks and supervisors.
At last year’s
conference I spoke to you about climate-related litigation and its
impact on the financial sector. [1] This year I want to talk about the
risks that nature degradation poses to the economy and the financial
sector.
As I have said before, assessing nature-related risk
is not some kind of tree-hugging exercise. We are talking about
material financial risks, which – like any other type of risk – must
be assessed, analysed and managed. [2]
Today, I want to focus
on the legal implications of nature-related risk for our central
banking and supervisory work. I will first outline the growing trend
of nature-related litigation. Then I will look at how nature-related
risk should be considered in the context of the mandates of central
banks and supervisors. Nature degradation: risks for the economy and
the financial sector
Scientists worldwide agree that nature has
been declining at an unprecedented rate over the past 50 years. The
Intergovernmental Science-Policy Platform on Biodiversity and
Ecosystem Services (IPBES) already sounded the alarm back in 2019,
shortly before the outbreak of the global pandemic. The IPBES report
even warned us that nature degradation was exacerbating emerging
infectious diseases in wildlife, domestic animals, plants and people.
[3]
The decline of nature is primarily caused by human
activity and is being made worse by climate change. Scientists have
calculated that humanity is using natural resources 1. 7 times faster
than ecosystems can regenerate them – in other words, we are consuming
resources equivalent to 1. 7 planet Earths. [4]
This decline
undermines the planet’s ability to provide ecosystem services, which
are the benefits we obtain from nature to support and sustain our
society and economies. Examples of ecosystem services include food,
drinking water, timber and minerals; protection against natural
hazards, such as floods and landslides; or carbon uptake and storage
by vegetation. [5]
The degradation of nature not only
threatens these ecosystem services, but also increases the risk of us
reaching ecosystem tipping points, i. e. non-linear, self-amplifying
and irreversible changes in ecosystem states that can occur rapidly
and on a large scale. [6] Through these tipping points, we are at risk
of going beyond the Earth’s safe operating space for sustaining life
on the planet. [7]
From the perspective of central banks and
supervisors, the degradation of nature makes our economies, our
companies and our financial institutions increasingly vulnerable.
We cannot ignore these vulnerabilities. Indeed, we need to
deepen our understanding of how nature-related financial risk affects
the economy and the financial system. [8]
Work is progressing
at the ECB: for example, our research has found that 72% of euro area
companies are highly dependent on ecosystem services and would
experience critical economic problems as a result of ecosystem
degradation. [9] Moreover, research by the European Commission has
detailed that several sectors of the European economy – in particular
agriculture, real estate and construction, and healthcare – are
heavily dependent on nature and thus exposed to associated risks.
[10]
Work is also progressing at international level. The
Financial Stability Board recently took stock of supervisory and
regulatory initiatives among its members and established that a
growing number of financial authorities are considering the potential
implications of nature-related risks for the financial sector. [11] In
addition, the Network for Greening the Financial System (NGFS) – a
network of 138 central banks and supervisors from around the world –
had already acknowledged the relevance of nature-related risks for the
mandates of central banks and supervisors back in March 2022. [12] The
NGFS has since developed a conceptual framework offering central banks
and supervisors a common understanding of nature-related financial
risks and a principle-based risk assessment approach. [13]
All
these efforts are improving our ability to quantify the financial
implications of nature degradation. And of course, there are also
important legal implications that we need to start talking about.
Nature-related litigation
The first legal implication is the
rise in nature-related litigation. [14] Litigants are starting to
understand the link between climate change and nature degradation and
are using the legal system to drive policy change.
Building on
their successes in the field of climate litigation,[15] litigants are
taking court cases to address the biodiversity crisis, protect carbon
sinks, limit deforestation and loss of ocean habitats, and prevent
ecosystem degradation. [16]
In July of this year the NGFS
published a report on this new trend to raise awareness among
financial institutions, central banks and supervisors. [17] The report
highlighted that while nature-related litigation is still in its
infancy, the number of cases is expected to grow rapidly.
The
report reiterated that litigation can affect financial institutions,
not only where they are directly challenged, but also indirectly, when
their counterparties, or the states in which they operate, are subject
to such claims. [18]
The report identified two key categories
of nature-related litigation as well as two key drivers. Categories of
nature-related litigation
In terms of categories of litigation,
most nature-related cases are being brought against states and public
entities, using arguments based on fundamental rights. [19] This is
not surprising given how effective such arguments have been in climate
litigation.
Interestingly, however, corporates and banks, too,
are already being directly targeted in nature-related litigation. This
contrasts to the trends we saw under climate litigation, where cases
against the private sector were much slower to start.
First,
this may be because climate litigation has offered a blueprint for
action for litigants who are seeking innovative ways to protect
nature. Second, it may be because nature-related litigation can
identify a closer causal connection between the impact of economic
activities on local ecosystems and people. It is often easier to
pinpoint the damage and attribute responsibility to specific actors.
Thanks to new legislation, it is also becoming easier to hold
multinational companies liable for harm occurring in remote parts of
their global supply chains. And we can even see that litigants are
already challenging banks that are alleged to finance such companies.
[20]
Indeed, we can observe a close nexus between corporate
litigation and legislation. Litigants are already relying on new
corporate sustainability due diligence legislation,[21] on tort law,
anti-money laundering laws[22] and shareholder rights to bring nature-
related claims. The number of such cases is likely to grow as further
legislation – such as the EU Directive on corporate sustainability due
diligence and the EU Deforestation Regulation – enters into force.
Drivers of nature-related litigation
Looking now at the drivers
behind the trend in nature-related litigation, the first is that
scientists – and litigants – are developing a much better
understanding of the climate-nature nexus. Protecting nature is
crucial to mitigating climate change and vice versa. The climate
crisis deepens the nature crisis, thus diminishing nature’s ability to
mitigate what the UN Secretary General has called “the era of global
boiling”. [23] The scientific consensus on this point may help
litigants to strengthen their cases. [24]
The second driver is
that courts are taking, as a given, the findings of climate and
environmental science, in the same manner as any other area of
technical expertise. Court assessments and rulings are taking into
account advanced scientific concepts and sources. We saw this quite
clearly in the recent ruling of the European Court of Human Rights, in
the case brought by a group of Swiss grandmothers. [25] There, the
Court based its ruling on the IPCC reports, and took it as a matter of
fact that climate change exists, that it poses a serious threat to
human rights, and that states are aware and capable of doing something
about it. Moreover, the Court held that states have a positive
obligation to act, regardless of whether their individual contribution
might be a “drop in the ocean” in terms of its ability to affect
climate change. [26] Relevance of nature degradation for the mandates
of central banks and supervisors
This leads me to the next key
legal implication of the nature crisis: how will it affect the
mandates of central banks and supervisors?
It goes without
saying that addressing the nature crisis is primarily up to
governments and legislators. However, as I mentioned at the outset,
central banks and supervisors also need to consider the nature crisis
as a source of risk to the economy, financial system and the
individual banks they supervise. Nature-related risk and banking
supervision
A very clear example of this is the way banking
supervision is looking at nature-related risks. Back in 2020, the
ECB’s guide on supervisory expectations for the risk management of
climate-related and environmental[27] (C&E;) risks already highlighted
the need for banks to identify, measure and – most importantly –
manage nature-related risks, such as water stress and pollution. [28]
We have been actively following up with banks regarding these
supervisory expectations since then. [29] The first interim deadline
fell due in March 2023, when banks were expected to have in place a
sound and comprehensive materiality assessment of both climate and
nature risks. Since then, we have issued binding supervisory decisions
against 28 banks that failed to meet this first interim deadline –
with the possibility of imposing periodic penalty payments in the 22
most relevant cases, if the banks don’t remedy this shortcoming in
time.
Banks were also expected to meet a second interim
deadline in December 2023, and by the end of this year, we expect all
banks under our supervision to be fully aligned with all our
supervisory expectations on the sound management of C&E; risks.
In that respect, nature degradation is already integrated in
ECB supervisory work as a risk driver that banks are expected to
manage. Rather than considering nature-related risk as a standalone
category of risk, we see it as a driver for each traditional type of
risk reflected in the Capital Requirements Directive, from credit
risk, reputational and operational risk including legal risk, to
market and liquidity risk. Nature-related risk and monetary policy
We must also properly consider nature-related risk in the
context of our monetary policy mandate.
First, the nature
crisis could have direct implications for price stability – the
primary objective of the ECB. One of the papers presented at the
annual ECB Forum on Central Banking in Sintra, Portugal, in July shows
how loss of biodiversity can cause losses to economic output while at
the same time decreasing the resilience of output to future
biodiversity losses. [30]
As part of its Climate and Nature
Plan 2024-2025, the ECB is conducting further work on the risk posed
to the economy by nature loss and degradation. [31] This will inform
our understanding of risks to price stability and financial stability.
Second, it is clear from the Treaties that the ECB must take
into account the EU’s policies to address nature degradation when
carrying out its mandate. [32] There are two key legal bases for this:
the ECB’s secondary objective in Article 127(1), second sentence, and
the transversal Treaty provisions of Articles 11 and 7 of the Treaty
on the Functioning of the European Union (TFEU).
The ECB’s
secondary objective states that, without prejudice to price stability,
the ECB shall support the general economic policies in the EU, with a
view to contributing to the objectives of the EU. These objectives
include “the sustainable development of Europe” and “a high level of
protection and improvement of the quality of the environment”. It is
irrefutable that the EU’s climate policy constitutes part of the
general economic policies in the EU. As reiterated in the European
Climate Law, the transition to net zero affects every aspect of
economic life, in all sectors. Thus, to the extent that nature
protection directly contributes to climate crisis mitigation and
adaptation – which it often does – the ECB must support the EU’s
efforts in this field. In this context it is notable that the EU
adopted the groundbreaking Nature Restoration Law earlier this
year[33] and signed up to the Kunming-Montreal Global Biodiversity
Framework (the “Paris Agreement for nature”) in 2022[34] – significant
developments that could be invoked to argue that nature protection,
just like climate policy, constitutes an independent general economic
policy. As lawyers, we need to watch this space.
Beyond the
secondary objective, the ECB has to comply with two key transversal
principles of the Treaties. Article 11 of the TFEU provides that the
EU’s environmental protection requirements must be “integrated into
the definition and implementation of the Union's policies and
activities”. [35] This imposes an obligation on the ECB to take into
account the EU’s policies to protect nature when shaping its own
policies and performing its tasks. In addition, under Article 7 of the
TFEU, the activities and policies of the ECB need to be consistent
with EU law – including EU law on nature and biodiversity.
This does not mean economists should start counting ants in
Aragon, butterflies in Bavaria or worms in Wallonia. Instead,
economists must develop means to transpose insights from nature
science into variables of economic interest like growth, inflation and
financial risks.
In developing tools for policy analysis of
nature-related risks, the growing availability of data from
sustainability disclosures will make it easier for central banks to
identify how they need to incorporate nature into their work. Recently
adopted legislation, in particular the sustainable finance
framework[36], creates an entire “ecosystem” of EU legislation that
makes the link between nature degradation, the economy and the
financial sector – and thus central banks and supervisors – clear and
apparent. It leaves us in no doubt that we have the duty and the tools
at our disposal to take nature-related risk into account when we
exercise our mandate. Conclusion
Let me conclude.
The
economy and the financial sector are vulnerable to nature-related
risks. This vulnerability is all the more relevant given the
importance of nature in mitigating and adapting to climate change.
Time is running out to prepare for the materialisation of
nature-related risks. We need to be ready for the impact of these
risks, just like we are for climate-related risks – or indeed for any
other risk driver.
For that reason, we need to properly
consider the legal implications of nature-related risks for the
financial sector, and for the mandates of central banks and
supervisors.
Thank you for your attention.