Natural capital is the next horizon for green investors
This post is by Guy Thompson, managing director of EnTrade, an online marketplace in ecosystem services. He was director of Green Alliance, 2004-06.
Last week, the FTSE re-labelled oil and gas as non-renewable energy and the National Trust renounced its fossil fuel shares, just as the government launched its Green Finance Strategy at the City’s third Green Finance Summit. Whether this chain of events was serendipity or a rare masterstroke by Number 10 communications, the message to the financial sector is clear: the future is low carbon.
The strategy makes a strong case for harnessing the power of our financial system and London as a financial hub in the fight against climate change. This commercial firepower is urgently needed to unlock innovation, R&D, data analytics and investment in clean growth.
Yet it doesn’t say much about how finance can help to achieve wider environmental goals. More than 100 green bonds have been listed on the Stock Exchange, but how green are they? Look, for example, at current investment trends in climate mitigation: whilst land use accounts for 24 per cent of global greenhouse gas emissions (compared to 25 per cent from the power sector), it has attracted investment in less than five per cent of green bonds (the vast majority in forestry). This is in spite of the range of additional ecosystem services offered by land-based interventions, such as clean water, healthy soils, thriving wildlife and vibrant landscapes. As Professor Dieter Helm rightly asserts in his recent book Green and prosperous land: a blueprint for rescuing the British countryside: “It doesn’t have to be like this”.
Policy can unlock green investment
The strategy highlights the need to unlock new revenue streams for wider environmental benefits. Policy can play an important role here. When I was working on low carbon solutions at Green Alliance in the mid-noughties, the conventional wisdom was that renewable energy could only be a bit part player in our energy mix, but its capacity has now overtaken that of fossil fuels in the UK for the first time. Green Alliance led the way on making the case for government interventions which helped to bring about this transformation, like the Renewables Obligation and the Renewable Heat Incentive.
How do we use this experience in the power sector to speed up the flow of private investment into enhancing natural capital? Here are my five lessons from the low carbon journey so far:
1. Smart regulation drives efficient markets
Robust regulation provides common trading standards and the impetus for participation, as the EU Emissions Trading Scheme has demonstrated. To create real markets (as opposed to voluntary markets, which will not attract third party investment), the regulatory bar needs to be set at an ambitious level and based on outcomes rather than prescriptive inputs.
2. Simple statutory targets and metrics help
The government’s commitment to biodiversity net gain will remove many barriers to investment in natural capital. But it shouldn’t stop there. We need to get to net gain for all the goals in the 25 year environment plan, as quickly as possible. A simple, asset-based set of metrics aligned to the ten goals in the 25 year plan would establish a natural capital asset baseline. Metrics can then evolve as the market establishes
3. The government can pump prime the market
Government mechanisms and levers can help to create tradable markets in natural capital. For example, the 25 year plan committed to an Environmental Impact Fund: we need this soon to support new entrants and nascent markets.
4. Make space for innovation
With farm support shifting to public funding for public goods under the Environmental Land Management System (ELMs), the UK government is set to become the biggest procurer of ecosystem services in the world. However, this new system must not only work for farmers, it must also convince the Treasury to release its purse strings to the tune of the £3 billion currently given in support under the Common Agricultural Policy. Encouraging more private investment means creating and scaling up local private markets in conjunction with publicly funded schemes like ELMs, much as Green Alliance and the National Trust have advocated under their concept of a Natural Infrastructure Scheme. Whilst publicly funded schemes will be critical to correct market failures, the government needs to make space for innovation in the market too. Undeliverable top-down mega schemes can crowd out innovation just as new nuclear diverted policy attention from distributed energy solutions in the years before the Climate Change Act.
5. Accredit brokers
Green Alliance recommended, in its recent report on spending on water and the environment, that the government would build confidence by accrediting brokers and market mechanisms like EnTrade. We can help to support markets by verifying environmental outcomes to investors, reducing transaction costs and stacking revenues and benefits on behalf of funders. The government can further support verification by establishing accreditation schemes, like the Woodland Carbon Code, to increase confidence in environmental markets. Government codes can help to set the rules and avoid the questions around the additionality and permanence of measures, problems that dogged the credibility of some of the early carbon offset schemes under the Clean Development Mechanism.
With political momentum already behind a new Environment Bill and related measures, these policy interventions would help to drive down the cost of capital and increase liquidity in emerging natural capital markets. It would lead to more investible propositions and better environmental outcomes. Investment of this kind would really put the green into ‘green finance’.