Investing in natural capital has to become the norm

Although our main focus at ep Group is the energy transition, we recognise that climate and energy is only part of the transition we need to make to move towards, and then beyond, sustainability. The issue of biodiversity loss is as important as climate. In 2022 we did some work for Cambridge Conservation Initiative looking at the emerging area of investing in natural capital and in 2024 we are working on a natural capital transaction through Cameron Barney. This piece is a primer on natural capital.

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What is natural capital?

Capital can be defined as a resource used or available for use in the production of goods and services. Typically we think of financial capital when using the term but there are five types of capital:

– Manufactured capital e.g. machinery and buildings
– Financial capital
– Human capital e.g. knowledge and skills
– Social capital e.g. levels of trust and connections amongst people
– Natural capital – the stock of natural ‘resources’ including eco-systems, species, water, soils, minerals, the atmosphere and the oceans, as well as natural processes and functions

Natural capital underpins all other types of capital and our ability to produce actual goods and services.

Natural capital is crucial for our survival because it produces essential ‘ecosystem services’ which can be divided into five categories:

– Provisioning: material outputs from nature such as food, water, timber and energy
– Regulating: indirect benefits generated through regulation of ecosystems such as carbon sequestration, the water cycle and crop production
– Supporting: fundamental ecological processes that support the delivery of other ecosystem services such as nutrient cycling and soil formation
– Cultural: non-material benefits from nature which can be spiritual, aesthetic or recreational.

If the contributions of natural capital were to be valued in the same way as other types of capital, they would be valued at $125 trillion , equivalent to 1.25 x Global GDP in 2022.

Biodiversity, defined as the variety of life, is a critical aspect of natural capital, and one we should be deeply concerned about. According to the WWF Living Planet Report 2022 , between 1970 and 2018 wildlife populations declined 69%, while freshwater species declined by 83% and migratory fish declined by 76%. Almost everywhere we look we see declining wildlife populations and biodiversity. One particularly important part of this is the decline in insect life – sometimes known as ‘insectageddon’. Insects provide ecosystem services valued at between $235 and $577 billion per annum and are absolutely critical for food production as three quarters of the crop types grown by humans require pollination by insects. In the UK ‘wider countryside butterflies’ declined by 46% between 1977 and 2017 while habitat specialists fell by 77%. For those of us old enough to remember the 1970s the famous cartoon that shows a driver with a car windscreen covered in insects in the 1970s, or even the 1990s, and a driver with a car windscreen with no insects in 2020, accurately reflects our experience.

How much capital flows into natural capital and what is needed?

So how much financial capital flows into natural capital and what is needed. UNEP, in 2021, estimated that the flow of funds into natural capital was $133 billion, up from $52 billion in 2010, a 9.85% CAGR. Of this $133 billion only $18 billion was private finance. Deutz et, al. estimate that the financing gap between what was invested and what is needed is between $598 and $894 billion per annum. For comparison purposes the global carbon markets in 2023 were estimated at $949 billion and global investment into the power sector in 2023 was $1,200 billion .

To bridge that gap we need to do two things: reduce the flow of capital into activities that have negative impacts on biodiversity, including reforming harmful subsidies; and scale-up mechanisms to increase private and public capital flows into conservation and regeneration. Areas such as biodiversity offsets, natural infrastructure, green financial products, nature based solutions to carbon emissions, are all expected to grow rapidly.

Growing recognition of the need to invest in natural capital

There is growing recognition amongst financial investors and corporates of the need to increase the flow of capital into protection and restoration of natural capital and biodiversity – becoming ‘nature positive’. This is driven by several factors including:

• growth of ESG investing and ‘green’ or sustainable finance – driven by demand and recognition of the problem
• regulations such as the EU Taxonomy and its national equivalents
• Pillar 3 of the Basel III Accords – disclosure requirements on capital adequacy and operational risks
• disclosure guidelines and increasingly regulations e.g. the Taskforce on Nature Related Disclosures (TNFD).

Why invest in natural capital?

Why should institutions invest in natural capital? There are four main reasons:

– risk management; including: physical risk, litigation risk, transition risk and systemic risk
– market opportunity: there is a large opportunity to deploy capital at scale
– regulations such as the EU Taxonomy and national equivalents
– ESG drivers

The barriers

Despite the need and the interest in investing in natural capital there are many barriers. Surveys of investors have identified the following barriers:

• Terminology: there is no common language between project developers and the finance sector
• Multiple, diverse stakeholders: including the private sector, the public sector, NGOs, and local communities – many of which have very different view points and objectives
• Lack of awareness: failure to understand he consequences of insufficiently valuing natural capital
• Measurement tools and metrics: investors want quantifiable, standardized information
• Mindset: natural capital lies outside normal investment concerns and is seen as complex
• Valuation: no framework and legislation, and quantification of tangible value is difficult
• Stock vs. flow: natural capital is not reflected as a capital stock, but rather a flow of resources
• Cash-flow implications: evidence is lacking on how natural capital impacts on cash flows
• Timing / short-termism: conflict between short-term investment horizons and long-term nature of biodiversity projects
• Reporting: trustees and asset owners require visibility and frequency in reporting
• Policy: policy makers not currently designating value for natural capital
• Diversified global firms: natural capital risks are considered small relative to overall business activities
• Performance criteria: consequences for mismanaging natural capital are sufficiently minor as not be a disincentive, at least in the short-term
• Corporate strategy: natural capital is not linked to corporate strategy
• Perceived costs: perception that sustainability related activities are a cost and not profitable
• Diversified portfolio requirements: institutional investors obliged to take all attractive investment opportunities despite their impact on natural capital
• Lack of opportunities: a lack of credible investment targets rather than a lack of capital. Developing projects requires multiple stakeholders coming together and is complex, lengthy and expensive.
  

These key barriers can be boiled down to:

– Risks – real and perceived
– Development time and complexity
– Lack of capacity in project development as well as in project evaluation and underwriting
– Lack of standardization.

The issue of standardization is fundamental – investors like standardisation but by its very nature it is hard to standardise nature and biodiversity!

Of course, as well as specific ‘natural capital’ or biodiversity projects, we need to ensure that every-day, ‘normal’, projects address biodiversity issues. For example, we should not be funding solar farms when we can design solar farms that increase bio-diversity. Every project, whatever its core purpose, should be evaluated for its impact on biodiversity and measures incorporate to improve it.

Multiple financial instruments

There are multiple types of financial instrument for natural capital including:

– Carbon markets
– ‘Carbon +’ (i.e. incorporating biodiversity criteria into carbon markets)
– Reducing Emissions from Deforestation and Forest Degradation (REDD)
– Biodiversity offsets
– Specific species bonds e.g. Rhino Bonds
– Green Bonds

Multiple standards

Another issue is that there are multiple evolving standards and metrics for measuring biodiversity including:

– Biodiversity Metric 3.0
– Global Biodiversity Score (GBS)
– Biodiversity Footprint for Financials (BFFI)
– Species threat abatement and recovery metric (STAR)
– Net Environmental Contribution (NEC)
– ENCORE

There are several initiatives underway to standardize or align different measurement systems. Biodiversity data is location specific & unique to the asset, and therefore it is inherently difficult to aggregate data.

It seems that we are at a turning point in investing in natural capital. Research from 2024 suggested that over half of UK investors were looking at natural capital investments.

Some examples of natural capital investing

Mirova’s Sustainable Ocean Fund (SOF)
A public-private partnership with Conservation International and the Environmental Defense Fund (EDF), the SOF is dedicated to implementing ocean-friendly practices in developing countries and small island states. Projects include supporting fisheries to maintain sustainable levels of marine fish stocks, providing financial incentives for low-impact aquaculture, responsible seafood supply chains, and wastewater management. The SOF has pledges from EIB, AXA, IADB, and Caprock Group. USAID has committed a $50m risk-sharing guarantee to attract further investment into the fund. The SOF is expected to deploy $100m with USAID support and closed in early 2022 at $132m in capital commitments.

Agriculture Capital
Agriculture Capital is a regenerative agriculture and food investment firm that currently manages two investment funds. The Funds invest in permanent cropland and synergistic midstream assets to create a vertically integrated enterprise that grows, packs and markets high-value produce. Through an owner-operator model, the Funds employ a value-added approach to farm and food operations, focused on regenerative farm practices and the processing and sale of that produce as a means of enhancing returns. Agricultural Capital applies its regenerative agriculture model to farms, marketing, packing and nursery companies. The total portfolio covers 20,000 acres and produces table grapes, citrus, blueberries and tree nuts across California, Oregon, Washington and Australia. It has consistently reduced water and energy use, increased soil health and increased wild pollinators by a factor of 9x.

The AGRI3 Fund
The AGRI3 Fund was created by UNEP and Rabobank, together with partner IDH and supported by FMO, the Dutch development bank. It aims to catalyze private investment into forest protection and sustainable agriculture with the aim of unlocking at least $1 billion in finance towards deforestation-free, sustainable agriculture and land use. The Fund provides de-risking financial instruments and grants for technical assistance for food value chain actors, and particularly farmers.
The fund targets $150m to allow an exposure of up to $300m. It is an evergreen fund with an open architecture allowing future partnerships with commercial banks beyond Rabobank. IDH manages the AGRI3 Technical Assistance Fund which provides reimbursable grants to projects at pre- and post-investment stages to improve project quality and strengthen environmental and social impacts.
The fund has closed transactions including:

– Forest protection and renovation of degraded pastureland in Mato Grosso. $5m, 10 year project covering >2,500 hectare forest protection and replanting, and renovation of 1,200 hectare of renovation of degraded pasture land
– Sustainable pepper farming in the Chongquing region. $10m, 3 year project.
– Sustainable production of citrus fruit and sugarcane in Brazil. 10 year loan $20m from Rabobank.

Rhino bonds
Rhino bonds were issued by the World Bank in 2022 and were the world’s first wildlife conservation bond. The total issued was $150 million as five year bonds and the returns were outcomes based related to net growth in Black Rhino population. The outcomes were independently measured and the project was supported by grant funding from the Global Environmental Facility. Purchasers of the bonds included:

– Nuveen (lead)
– AllianceBernstein
– ASN Impact Investors
– BlueBay Asset Management
– Mackenizie Investments
– HNWs.

Overall population of black rhinos has increased.

Phyla

Phyla Uses high yielding Pomgania tree to restore degraded land and produce biomass, seedcake and oil which can be used to produce multiple products including synthetic aviation fuel (SAF). It aims to regenerate one million hectares of degraded land by 2030 and has projects and partnerships in multiple countries. Cameron Barney are advising Phyla.

Conclusions

The decline in natural capital is as life threatening as the worst scenarios for climate change. We have to arrest the decline in natural capital, restore it and ultimately regenerate it. This can be done by applying private financial capital – often blended with public capital, and there are now enough examples of how this can be done.

Natural capital is an emerging asset class but there are still many barriers including: development complexity; lack of clarity on revenue models; lack of understanding & know-how; lack of standardisation & competing standards. Natural capital investing shares some characteristics with infrastructure – in that it is long-term and large-scale. As well as investing in projects surrounding natural capital there is a burgeoning private equity opportunity of ‘natural capital tech’ or ‘agri-tech’ or ‘bio-diversity tech’ including: sensors; data; drones, DNA sampling, AI applied to measuring and regenerating natural capital.

Investing in natural capital, and ensuring projects of all type are nature positive, has to become the norm rather than the exception.