Unlocking Landscape Change - Building A Bridge Between The Environment And Finance
As published on North Star Transition on 27 Oct 2022
https://www.northstartransition.org/insights/unlocking-landscape-change
How can we fund the transformation of landscapes? Jenny Scott reports back from a meeting North Star Transition co-hosted on behalf of Anglian Water with financial institutions and policy-makers on the challenges and opportunities of funding landscapes at scale.
Anglian Water, a water company in the East of England, has recently announced plans for a new reservoir in the Cambridgeshire Fens, one of two to be built in the area, the first anywhere in the UK for over 40 years. With the reservoir as an anchor, Anglian has been collaborating with a number of organisations to build a common approach on enabling the longer-term social, economic and environmental benefits for the region, under the label Future Fens Integrated Adaptation (FFIA).
At the invitation of Anglian Water, North Star Transition, in collaboration with Mott MacDonald, an engineering consultancy, brought together local policy makers with experts on the environment and institutional investors, in order to explore the challenges and opportunities of funding landscapes at scale. While these investors have a long track record of financing major hard infrastructure projects – like reservoirs – there are no precedents for investing in landscapes at the system level – what we are calling ‘soft’ infrastructure.
Brendan Bromwich, a leading water expert at Mott MacDonald, provided some insight on the nature of the additional value that could be created in the landscape:
Carbon – a global good
Biodiversity, environment and flooding – local impact, global offsets
Agriculture – potential shift to higher value system
Social and economic – co-benefits of landscape interventions
River flows – enhanced by reservoirs
Brendan assessed the benefits of these landscape interventions at £6.3bn of value, against a potential cost of £1.3bn.
Jyoti Banerjee, co-founder of North Star Transition, outlined the challenges in enabling such nature-based financing to be realised. The financial system is not currently configured to easily fund multiple, interdependent ecosystem services across a landscape. As a result, those services tend not to be delivered, hampering the change that is needed in the face of our climate and biodiversity crises. This will ultimately impoverish businesses, communities and society as a whole.
This mismatch exists for a number of reasons, including:
Scale: projects that deliver ecosystem services tend to be small and piecemeal, failing to attract the interest of large financial institutions. Yet, a large number of participants are needed for systemic change projects – a problem for financial institutions to engage with.
Risk / return: There are multiple sources of debt and equity (asset classes) and each often has their own risk profile and expectation of return.
Timeframes: there is a mismatch over the timeframe in which private finance expects a return, and when the benefits from ecosystem services accrue
The discussion unearthed a number of insights, including:
The challenge of moving away from the convention that those directly benefiting are the ones directly paying investors’ returns. How can we accommodate the fact the client (paying the investor) could be different from the beneficiary (the commons)? For example, while there is a nascent carbon market, there isn’t a comparative one for peat restoration or biodiversity yet both have benefits for the commons.
Similarly, there are system benefits delivered by aggregation across a landscape, that would be complex to measure and price. For example, wetland restoration is good for carbon and biodiversity but could also make more land available for productive light industry. Improved soils could sequester more carbon and also retain more water, reducing the risk of flooding and returning more land to high value arable farming. How can those benefits be aggregated, each with their different risk/return, scale of funding and investment horizons, and each often interdependent with their interaction impacting their efficacy?
Investors felt the majority of funding must be investment grade; so anchoring the soft infrastructure spend on nature-based solutions to the hard infrastructure investment of the reservoir offers the best hope for attracting private funding. It comes down to the degree of revenue volatility investors can tolerate – if the wider hard infrastructure project makes up the vast majority of the investment, that leaves a smaller proportion as volatile, which investors felt becomes more doable.
On a related point, there was agreement that a blended finance approach could catalyse action, where public or philanthropic funding de risks the investment, thus crowding in private funding. This points to an important role for government in either covering the first losses, or front-funding those actions which are for “the common good” or where the private beneficiaries cannot act collectively.
Investors asked if there was a smoothing mechanism that could be employed to make the returns more palatable, perhaps over years rather than months. That would help with, for example, bouts of extreme weather that may impact returns in particular years.
A related point and a future challenge identified was the need for clarity from the regulator as to the risk weights, etc, that would need to assigned to future benefit streams from landscape transformation. Would those benefit streams have to be known with certainty up front?
Participants identified different layers of benefits; first order could be monetary/revenue streams, second order could offer credits (carbon, biodiversity?) with third order benefits couched in terms of insurance against future risk of adverse climate impact.
There was seen to be a need to identify the financial and non-financial investable opportunities and create a common language around them, a taxonomy to facilitate a blended finance approach where, say, local authorities invest for the non-financial return and asset managers for the financial.
Some from the finance side explored ideas around how to take into account rising asset/land values, not just revenue streams. For example, the value of land may increase thanks to peat restoration or flood control or better soil – indeed this may be the larger part of the return. Understanding that would be important as it would also affect how the finance is structured – increasing the value of the underlying assets could open up longer term guarantees.
Carbon markets provide an interesting backdrop in this discussion. They are not mature and suffer from a “Wild West” syndrome. Yet, private operators have continued to participate in such markets, even without much intervention by way of regulation. Perhaps, biodiversity credits will also benefit from such market pressures, as finance looks for new ways to engage with opportunities relating to nature and its restoration.
Finally, the group discussed possible next steps, including the key challenge in such a wide landscape transformation project of bringing together the multiple actors on the ground into a single forum. North Star Transition’s work in the Wales Transition Lab provided a helpful example of how to meld together the contrasting (and even conflicting) participants in a landscape on an equal footing.
Given the timelines for building the reservoirs – they are due to come onstream in the mid 2030s – even though the models for landscape finance are not in place just now, they are likely to be developed well before the reservoirs are built. Therefore, we must not miss the opportunity to open up the doors to landscape finance as an additional investment on top of the reservoir investment.
Jenny Scott, Partner, Apella Advisors. This article appeared on NST on 27 Oct 2022.
https://www.northstartransition.org/insights/unlocking-landscape-change