TheCityUK CAP0010
TheCityUK response to the Environmental Audit Committee’s call for evidence on the role of natural capital in the green economy
About TheCityUK
TheCityUK is the industry-led body representing UK-based financial and related professional services. We champion and support the success of the ecosystem, and thereby our members, promoting policies in the UK, across Europe and internationally that drive competitiveness, support job creation and enable long-term economic growth. The industry contributes over 12% of the UK’s total economic output and employs nearly 2.5 million people, with two thirds of these jobs outside London, across the country’s regions and nations. It is the UK’s largest net exporting industry and generates a trade surplus exceeding that of all other net exporting industries combined. It is also the largest taxpayer and makes a real difference to people in their daily lives, helping them save for the future, buy a home, invest in a business, and protect and manage risk.
Executive Summary
Government Commitments
Our industry supports this enquiry, the role of natural capital in the green economy, and proposals to increase investment to support nature’s recovery.
But we suggest government continues to deliver on its pre-existing commitments which include the 10 Point Plan for financing biodiversity[1], commitments to clean up UK supply chains to protect forests[2], the Dasgupta Review and the economics of biodiversity[3], the Environmental improvement plan[4], commitments made following COP15 particularly the global biodiversity framework[5], and commitments made following COP26[6] and COP27[7].
Incentivising and Aligning Investment
The process to commercialise the protection of natural capital is in its infancy. The only examples currently in the market are nature swaps, rhino bonds and blue bonds. These can be complicated
and expensive to investors. Some financial services providers are already developing approaches to make natural capital investments commercially viable. For example, HSBC has a longstanding focus on the issue of deforestation[8], and Triodos Bank crowdfunded over £2 million to open the world’s first rewilding centre near Loch Ness, Scotland[9]. Across our industry there is acknowledgement that working with nature finance can be slow. The process from conceptualising a potential investment opportunity to deploying the money is long. The structuring of deals can be complex, and time delay often contributes to deals collapsing. Whilst private capital investment can help due to speed of deployment, many companies still struggle owing to a lack of frameworks to deploy capital.
A key challenge that needs to be overcome to channel more private investment into natural capital is helping investors have confidence in the returns on their investment. Further work is needed on this. There are further challenges for securing private sector investment, including many companies lacking appropriate access to government and multilateral organisations.
The current lack of detailed and reliable information and data about many nature-based investment opportunities puts them outside the risk appetite of many investors. Also, some natural capital deals are too low value to be commercially attractive. There is a need for a commercial or government vehicle to scale these projects to ensure the quality, efficiency, and sustainability of projects to make them commercially viable.
Another challenge to stimulating investment is that investors do not trust the current standards that measure the likely return on an investment in natural capital, and there is a lack of relevant ‘key performance indicator’ (KPI) frameworks. There is also no current market framework for any type of trading or liquidity in nature investments, and the secondary market does not have the ability to do due diligence on nature capital investments. The market needs time to mature, and credible industry frameworks to emerge, which will allow investors to understand the market and invest with confidence.
There is a lack of clarity around the risks involved in natural capital investments. Many investments are in developing countries. Investment opportunities in developing countries carry inherent risks, including issues around corruption and a low trust in data from these geographies. Many of the investment opportunities are also not at the investor grade (investor grade meaning investment opportunities that hold a relatively low risk of default).
There are huge data challenges to incentivising investment in nature capital. Establishing reliable and accurate data to inform nature investing is inherently more complex than in other sustainability investment areas like carbon. Even high integrity nature-based projects may find their methodologies challenged owing to a lack of trusted nature-related data. Distrust around ‘greenwashing’ is a symptom of this complexity. Because of this, principles-based European Sustainability Reporting Standards (ESRS) have been established, including a materiality assessment to help companies most exposed to nature risks begin to work out there their nature dependencies and risks lie. To build investor confidence, government should provide an external reference point for what good biodiversity data looks like. This could be aided by establishing a stronger feedback loop between government and the private sector. Government can help further by providing some level of financing such as blended finance, to de-risk nature investments. Targeted and proportionate subsidies could also help.
Despite being hard to commoditise within our financial system, nature and biodiversity financing are huge opportunities, particularly for developing countries. Many are ‘megadiverse’ because they harbour the majority of the earth’s species and a high number of endemic species. The opportunity to foster sustainable development investment for nature-positive outcomes is huge.
To facilitate this, government must provide clarity on a green taxonomy in its autumn consultation. Specifically, it should provide timescales for delivery of ‘technical screen criteria’ for the nature-related objectives in the UK Green Taxonomy, and clarify the criteria it will use to decide whether to make reporting against the UK Green Taxonomy mandatory. Over time we also want to see a simpler nature taxonomy, across both natural capital and biodiversity, to help investors understand what each project is promising. There should also be a centralised registry of projects and nature credits.
Some additional steps government should take to incentivise investment in this area include integrating nature into existing research and development (R&D) funding models. This would help develop relevant technologies and nature-related solutions alongside new funding models[10]. Government should also bring the private sector into the policy making process at an earlier stage.
Natural Capital Markets
Natural capital markets are following the same path as carbon credit markets but developing at a much faster rate. It is a new and complex area in need of expertise across science, finance, innovation and MRV (monitoring, reporting & verification) to enable market development and allow the sector to scale[11]. When building markets to protect natural capital, proper value needs to be attached to said capital. Currently no value is attached, which means natural capital is not considered in company decision making. The Taskforce on Nature-Related Financial Disclosures (TNFD) recommendations will help businesses to assess risks, opportunities, and nature dependencies.
We note the first nature deal completed by the UK Infrastructure Bank [12]. The project aims to capture carbon through peatland restoration and consider ways to demonstrate improved biodiversity and apply these learnings to other projects. But many in our industry are still unfamiliar with the term ‘natural capital markets’ and the chain of knowledge around natural capital markets is not sufficiently established: from funding, to creating natural capital benefit, to documenting natural benefit, to the buy side benefits. These are not linked together or well understood. This makes it difficult to attract private investment. Further education is needed. One solution to increase awareness of the area is to tie biodiversity to private companies’ risk and performance reporting. Companies see value in carbon because they must report on it. The same should be true for biodiversity. Further thinking is also needed on how to outline the benefits of biodiversity to investors.
The lasting negative impact of greenwashing has carried over into natural capital markets. As a result of greenwashing there is an overarching lack of trust in the levels of stringency associated with information and data about environmental investment opportunities. This feeds into a lack of demand on the buy side, which is needed for functioning capital markets. Tax incentives could be a solution to stimulate demand and push the market in the right direction.
The scaling of investment in natural capital markets can be supported by establishing high integrity nature credit markets. The UK is a pioneer in the development of nature credit markets, a key driver for mobilising private finance. The government’s Biodiversity Net Gain (BNG) policy is one of the world’s first mandatory markets for biodiversity credits requiring developers to avoid habitat loss in their operations[13]. The recently published Nature Markets Framework outlines priorities for the development of high-integrity markets[14]. These build on the UK’s reputation as an early leader in developing voluntary carbon markets to support woodland creation and peatland restoration[15]. Nature-based carbon credits can enable investment by creating units to be bought and sold. The credits are delivered by nature restoration projects and can ensure those who benefit from nature pay a fair price for the service nature provides. Nature credit markets can incentivise farmers and landowners to protect and restore nature and reward efficient monitoring, reporting and verification[16]. However, if these credits are cheap and inappropriately assessed regarding their nature value, it is easy to see them being misused. For example, developers could destroy ancient woodland, natural capital rich in biodiversity, in exchange for a fallow meadow site, which offers low biodiversity and could be returned to agricultural use in a few years’ time.
Government should also support R&D that creates the technologies and services needed to scale investment in nature, alongside supporting the green jobs markets to ensure the UK workforce has the quality and quantity of expertise needed to deliver these technologies and services[17].
International Standards
The International Sustainability Standards Board (ISSB) is considering how companies should report on the material impact of biodiversity loss. The UK will likely base its standards on the example set by the ISSB and the upcoming Taskforce on Nature-related Financial Disclosures (TFND) where appropriate[18]. The release of the TNFD recommendations in September 2023 is a landmark moment in driving financing for nature and biodiversity. They will be a critical tool in allowing firms to understand nature-related risks and opportunities. After the release, the government should provide clarity on how the recommendations will be incorporated into UK policy and legislation.
The government should also endorse the ISSB standards, and should consider introducing regulatory requirements as part of sustainability disclosure requirements (SDR). In the interim, government should encourage business to voluntarily align their reporting with the TNFD Framework, while the ISSB continues to develop its nature-specific standard. There is concern that to meet all government requirements, the ISSB standards may become increasingly complicated, which may increase the risk of greenwashing. To avoid this, government should focus on creating a few, simple standards that are interoperable across borders. Government should also consider how it can incentivise private sector environmental protection ahead of these reporting standards being formally introduced. To ask private companies to disclose nature-related risks via the TNFD (under the SDR without a supervisory framework in place) risks generating an incoherent policy approach.
The UK should aim for its regulation to serve as a model for other countries incorporating nature into their regulatory frameworks. This would help position the UK as a leading centre for nature finance[19].
September 2023
[1] The 10 Point Plan for financing biodiversity - GOV.UK (www.gov.uk)
[2] Government sets out plans to clean up the UK’s supply chains to help protect forests - GOV.UK (www.gov.uk)
[3] Final Report - The Economics of Biodiversity: The Dasgupta Review - GOV.UK (www.gov.uk)
[4] Environmental Improvement Plan 2023 - GOV.UK (www.gov.uk)
[5] New deal to protect nature agreed at COP15 - GOV.UK (www.gov.uk)
[6] COP26 - GOV.UK (www.gov.uk)
[7] UK announces major new package of climate support at COP27 - GOV.UK (www.gov.uk)
[8] Forestry and agricultural commodities | HSBC Holdings plc
[9] World’s first rewilding centre opens in Scotland (triodos.co.uk)
[10] A Global centre for nature finance (theglobalcity.uk)
[11] A Global centre for nature finance (theglobalcity.uk)
[12]At the forefront: Pioneering new approaches in Scotland’s emerging natural capital markets | UK Infrastructure Bank (ukib.org.uk)
[13] Understanding biodiversity net gain - GOV.UK (www.gov.uk)
[14] Nature markets - GOV.UK (www.gov.uk)
[15] A Global centre for nature finance (theglobalcity.uk)
[16]A Global centre for nature finance (theglobalcity.uk)
[17] A Global centre for nature finance (theglobalcity.uk)