Bridging the finance gap for Nature
“[…] just as diversity within a portfolio of financial assets reduces risk and uncertainty, so biodiversity increases Nature’s resilience to shocks, and thereby reduces risk to the ecosystem services on which we rely […]”
As for every investment case, the starting point is a specific Ecosystem project which needs to be financed. Therefore, the development at sufficient scale of high-integrity ecosystem projects is the necessary condition for the growth of a dynamic investment market covering a wide portfolio of different geographical regions, kinds of ecosystem and types of initiative.
Different categories of action need to be financed, ranging from restoration (e.g., reforestation) and preservation / conservation (e.g., coastal damage prevention) to sustainable management of productive landscapes and seascapes (e.g., agriculture/forestry/fishery/human settlements).
The core of projects should generate gains for Nature, but they may also deliver other benefits related to ecosystem services, for example on climate, health, water resource, or livelihoods.
Each project category may need to apply different indicators for measuring Nature’s improvements or avoided losses. For example, actions focused on the preservation of ecosystems usually require physical indicators based on appropriately selected reference sites. Instead, in the case of a restoration initiative, indicators need to demonstrate improvement (or accelerated improvement) on the same site over a certain timespan.
“To cover the largest possible range of actions that can contribute to the restoration, preservation, and sustainable use of ecosystems, […] the scope […] should be as large as possible […] However, it does not seem possible to cover the entire diversity of geographies, ecosystems and initiatives in a single impact quantification approach, therefore our goal is to develop a general framework which allows the integration of context-specific methodologies.”
Organization for Biodiversity Certificates (OBC), (2022), Towards biodiversity certificates: proposal for a methodological framework, p. 11)
The development of ecosystem projects suitable for professional investors requires an approach that addresses some critical issues for mobilising investments.
Directing capital to projects that are expected to provide ecosystem benefits inevitably requires an evaluation of hoped-for environmental rewards in monetary terms.
When making the business case for investing in an ecosystem/biodiversity project, an anthropocentric approach to Nature is inevitably needed and, indeed, establishes the methodological starting point of environmental economics. Nevertheless, evaluating an environmental project in economic terms is only an instrumental approach which doesn’t imply the denial of the intrinsic value of Nature.
Natural Capital is the key concept used in environmental economics, as it transforms Nature (or parts of Nature) into valuable assets based on an anthropocentric approach to Nature, given that they deliver beneficial ecosystem services to people.
Accordingly, investors have developed various methodological approaches for estimating the monetary value of the environmental good that is likely to derive from each financial investment.
Typically, investors, according to specific pre-defined targets of a minimum environmental return on investment, will carry out an evaluation – for each type of project – of issues such as relevance and scale, targeted environmental outcomes, the economic value of these outcomes for society, and the risks and terminal value of each project. Finally, based on these evaluations, Investors will then calculate the environmental return on the investment.
Project developers therefore need to understand and define well these issues in order that the Nature outcomes (net gains) of their planned actions can be easily and properly assessed and quantified. Investors will then face the challenge of defining the economic value and, subsequently, the financial performance of a proposed ecosystem project.
Finally, it is widely accepted that an acceleration of investments in Nature by institutional funds will depend on ongoing and increased harmonisation of data and standards by internationally recognised reporting institutions.
“If we are able to show […] that biodiversity is of the utmost value to humanity, and that because we are embedded in Nature, gradual biological extinction will hasten our own extinction, then for purely anthropocentric reasons we would wish to preserve and promote it […] Therein lies the advantage of a limited point of view.”
“Impact investing—directing capital to ventures that are expected to yield […] environmental benefits as well as profits—provides investors with a way to “do well by doing good.” […] Now the Rise Fund and the Bridgespan Group have developed what they call the impact multiple of money (IMM) to demonstrate the value of putting impact underwriting on the same footing as financial underwriting”.
Addy C. et al, (2019), Calculating the Value of Impact Investing, HBR, 2019, Summary, (p. 1)
“By developing and promoting the adoption of a standardized reporting framework, the TNFD (Taskforce on Nature-related Financial Disclosures) encourages financial institutions and companies to assess, manage, and report on their impacts on nature […] Similarly, the Global Reporting Initiative (GRI) has introduced […] an update to its previous biodiversity standard, to improve transparency in supply chain operations and their impacts on biodiversity.”
CBD (Convention on Biological Diversity), Advisory Committee on Resource Mobilization, Exploration study of the current biodiversity finance landscape (2024), p 46
Environmental economics values Natural Capital by using accounting or shadow prices, conceptualised as the sum of the market price of a natural item and the externality associated with its production and consumption.
In practice, the feasibility of this very logical approach is limited by several issues. First, many natural items are not priced by the market and therefore market prices are often missing, as is usually the case for all global commons (sea water, soil, air and biodiversity). In all these cases, therefore, the whole effort is dedicated to estimating the value of the externalities indirectly or directly caused by humans.
Second, often the value of externalities cannot be objectively measured but is the result of complex evaluation processes that ideally incorporates all the main sources of Nature’s (biodiversity’s) value: 1) direct contribution to human existence and health; 2) provision of Nature’s goods and services on which we depend (use value); 3) source of enjoyment (amenity value); 4) Nature’s very existence and intrinsic value.
Given these measurement problems, natural capital items have been valued by environmental economists using a practical approach which analyses specific ecosystems (e.g., forests and fisheries), species and natural resources (e.g., seas and rivers).
This research work by environmental economists and social scientists is often drawn on by investors to estimate an environmental project’s impact potential.
“Holcim Spain […] has developed a methodology for the study and valuation of ecosystem services for the restoration and rehabilitation of quarries […] It is a tailormade approach, based on combining BIRS (Biodiversity Indicator and Reporting System, developed by IUCN) and the LBI (Long-Term Biodiversity Index, developed jointly with WWF) with a monetisation of ecosystem services […] Now, the quarry has become an experimental ground for ecological restoration.”
(Lammerant, Johan (2021), Business and Natural Capital Accounting Case Study. Quarry restoration by Holcim, Spain. UN Statistics Division, Dept of Economic and Social Affairs, NY, p.10)
The environmental and financial credibility of an Ecosystem project depends on satisfying the criteria of additionality, permanence (durability) and non-leakage.
First, an Ecosystem project should only reach the status of an Investment case if it can demonstrate that its positive outcomes would not have been achieved without the implementation of the project itself. Second, the project needs to demonstrate the sustainability of its positive outcome for Nature over a significant timespan. Finally, the implementation of the project should not lead to negative actions/effects for Nature, if while addressing positive results in one specific site, negative effects will merely ‘leak’ to another neighbouring site with a reduction or potential cancellation of the overall net gain for Nature.
“Biodiversity credits should only be awarded to project interventions where biodiversity outcomes are additional to those that otherwise would occur without the project intervention and revenue from the monetization of the biodiversity credits. Projects seeking to issue biodiversity credits must quantitatively and qualitatively demonstrate that the positive biodiversity outcomes would not be achieved without the project and anticipated biodiversity credit revenues […]”
Biodiversity Credit Alliance (2024). Definition of a Biodiversity Credit (p. 12)
“Part of […] implementing biodiversity targets is the establishment of robust measurement, reporting and verification (MRV) processes across the full bank value chain. […] Establishing KPIs and targets that are easy to measure, report and verify against and provide robust internal guidance […] (as well as risk, compliance and legal) are key enablers for scaling flows of capital […]”
An Ecosystem initiative is financially attractive to an Investor thanks also to its efficiency and therefore to its overall cost burden (operational, management and transaction costs).
Within the management costs of an Ecosystem project, a critical role is played by measurement, reporting and verification (MRV) costs.
Ecosystem improvements need to be measured using different indicators and KPIs, all providing clear evidence of positive impacts having been delivered over a sufficiently meaningful timespan compared to a baseline benchmark scenario.
As monitoring technologies, such as remote and proximity sensors, advance and scale up, their increasing integration with new data processing capacities (e.g., AI), can help deliver reliable evidence of positive Ecosystem results at ever lower costs.
Furthermore, the widespread application of DLT (distributed ledger technology) and blockchain technology by field operators for registering changes in the field can lower transaction costs while providing investors with robust measurement, reporting and third-party verification outcomes.
On the other hand, transaction costs (writing and executing contracts) of an Ecosystem project also often need to be contained. In fact, given the limited size and value of a single project, these costs are usually too high to make it financially attractive to Investors.
This is particularly true for projects designed for the emission of biocredits. In this case, while the roll out and digitisation of DLT can reduce transaction and registration costs and new more accurate monitoring and data integration technologies can increase the trustworthiness and transparency of MRV, only a more active liquid biocredit market will convince large investors to step in.
“[…] Numerous payment-for-ecosystem-service models and conservation schemes are utilising distributed ledger technology (DLT) […] Integration and digitisation of DLT can assist in lowering transaction costs and maintaining the simplicity of a biocredit scheme […] One challenge of ecosystem markets is the high cost of meeting both biodiversity and financial criteria, including the monitoring and verification that is required to do so.”
Ducros, A and Steele, P (2022) Biocredits to finance nature and people: emerging lessons. IIED, London, (p. 12-13)
Biodiversity certificates or ‘biocredits’ can be attractive tradable financial assets for institutional investors (demand side), delivering consistent net positive biodiversity outcomes at scale, although until now, the value of biodiversity credits issued on the voluntary market has lagged far behind the value of biodiversity offsets used by companies for compliance purposes.
Demand is, above all, based on a strong supply of projects with a convincing business plan for increasing biodiversity over a given timespan in a predefined geographical area. Therefore, the role of project developers plays a key role in building the biocredit market.
Nevertheless, as true for the success of any voluntary environmental finance scheme, also for the development of a strong demand for biocredits, governments are required to be key enablers of a robustly regulated market by exerting a pro-active role as opinion and policy makers.
As a starting point, for a biocredit market to work efficiently and at scale, buyers and sellers of credits need a shared definition of a unit of biodiversity (a key requirement for institutional investors). However, since – compared to units of measurement for the carbon-credit markets – biodiversity is complex and habitat specific, environmental economists are struggling to define a standardised unit together with scientists that can quantify its improvement or avoided loss across different geographies.
Valuable work is being done to find a reliable definition of such a unit with some metrics measuring Mean Species Abundance (MSA) while others aggregate different biodiversity variables to create a single index such as the Biodiversity Index Assessment Method (BIAM) that uses a consensus of scientific experts to measure improvements in biodiversity outcomes.
A simple and accurate definition of this unit is also essential to allow effective third-party verification of biodiversity positive outcomes and therefore the necessary transparency and credibility of this new financial instrument.
“[…] unlike biodiversity offsets, biodiversity credits allow companies to support nature-positive action, funding long-term conservation and restoration of nature, a higher order contribution than simply offsetting negative impact. This concept is gaining momentum and attracting more focus within environmental finance discussions.”
Convention on Biological Diversity (CBD), Advisory Committee on Resource Mobilization, Exploration study of the current biodiversity finance landscape (2024), p 47
“[…] biocredits are far from being a purely market-driven intervention. Government will be required to enable policy to regulate and facilitate the market according to clear and simple rules in an efficient, transparent way that promotes biological integrity […]”
Porras I. & Steele P., Making the market work for nature, How biocredits can protect biodiversity and reduce poverty, IIED Issue Paper (2020), p. 23.
“Building an indicator that looks at ecosystems as a whole […] suitable for field measurement is a challenging task […] the diversity of ecosystems, their complexity and their non-substitutability make it […] difficult to combine them into a single value system […] it may be possible to develop a single unit approach […] to adequately catalyze the preservation and restoration of ecosystems, by directing funding towards actions […] identified as priorities for biodiversity.”
Organization for Biodiversity Certificates (OBC), Towards biodiversity certificates: proposal for a methodological framework(2022), p. 9.