Gresham House plc                                                                      CAP0042

Written evidence submitted by Gresham House plc

 

Public Inquiry on Private Investment in Nature Recovery

 

Introduction

Gresham House is a specialist alternative asset manager with £8.3bn of assets under management. We provide investors with a range of investment products, across real assets, public equity and private equity. Our investment solutions aim to meet investors’ long-term objectives whilst also positively contributing to society and our environment.

Our corporate purpose is to deliver effective and alternative investment solutions to help clients achieve their financial objectives whilst contributing towards the transition to a more sustainable economy.

At Gresham House, we have been investing in natural capital for many years, seen through our multi-decade track record in Forestry. These assets produce timber which is a provisioning ecosystem service, and contribute to carbon sequestration, a regulating ecosystem service. We are currently expanding our capability to report on the biodiversity within our forests and included initial analysis in our most recent Sustainable Investment Report.

We are also focused on developing new, interlinked solutions across real assets such as forestry and sustainable infrastructure – including carbon forestry, vertical farming, biodiversity net gain credits and habitat banks – as innovative ways to promote the potential transition towards a more sustainable economy through the protection and restoration of nature.

 

Summary

 

 


Responses to inquiry questions

  1. What potential contribution can private capital investment make to measures to secure nature recovery?
  1. It has been estimated that the funding gap to reverse the biodiversity crisis by 2030 is between $599bn to $824bn per year[1]. This is equal to between 0.5% and 0.8% of global GDP[2], hence taking action to reverse the worse effects on nature is entirely possible by combining government incentives and funding with private capital investment.
  2. Governments will play a crucial role to incentivise the creation and scalability of new nature-based markets that attract private capital investment. For example, Gresham House’s investment in Environment Bank Limited, which ‘generate high-integrity Biodiversity (BNG) Units and Biodiversity Credits to ensure the effective implementation of Biodiversity Net Gain legislation and corporate natural capital markets’[3], was successful because of the legally mandated regime for BNG which was created by the Environment Act. Without the legal grounding created by the Environment Act, Gresham House would not have invested in this business as a voluntary requirement to meet biodiversity net gain would not have provided sufficient security of return for investors or market scalability to generate growth.
  3. Gresham House estimates the total potential funding requirement for Environment Bank Ltd will be greater than £1bn over the next five years. The likely market for off-site habitat bank solutions is still nascent but eftec, which has been advising DEFRA on the market, estimates the annual value may be in the region of £270mn per annum in England. Other market commentators have suggested it may be even higher at £400mn+ per annum. This demonstrates the scale of potential nature markets that can attract private capital investment if there is government led incentivisation or policy backing.
  4. In our research with Pensions for Purpose[4] we found that the institutional investors looking to invest in natural capital solutions are doing so to achieve their net zero targets. They view the climate crisis and the nature crisis as interlinked and as such they are seeking investments that target outcomes for both the climate and nature recovery. We have seen an increase in demand for natural climate solutions, such as forestry, from institutional investors as they see it as a way of meeting their own net zero targets.
  5. Forestry assets offer solutions to key sustainability challenges including the production of renewable building materials - timber, sequestration of carbon through the growth of trees, and improved biodiversity through changes in the way land is managed and planted. We have seen an increase in demand for forestry-based solutions from our institutional client base as they start to recognise that forestry assets provide security of return from the sale of timber and the potential to create new return opportunities through the generation of carbon credits and potentially biodiversity-based assets in future.
  6. Forestry management standards in the UK mandate that certain proportions of the land are managed for biodiversity and conservation purposes. It is not currently possible to generate return for investors on the land managed for biodiversity purposes and therefore there is an opportunity for mandatory regimes that may create incentives to further enhance the biodiversity of these parts of forestry assets across the UK which could provide attractive upside in returns for forestry investors and promote an increase in activities that enhance biodiversity.
  7. Currently the main return driver for sustainable productive forestry is the production of timber, however we are also investing in new planting schemes which can generate carbon credits to create additional return drivers for private capital investment. The generation of timber provides investors with security of returns from established ecosystem markets and the potential to generate and sell carbon credits on certain forestry assets gives investors the chance to enhance returns. Private capital investment into forestry can help rapidly scale new planting schemes to meet the 270% expected increase in demand for timber driven by urbanisation, decarbonisation and housing demand[5] and also achieve positive outcomes for nature and the climate.
  8. Currently, only small amounts of capital are being directed to investments that target nature recovery as there is uncertainty in market fundamentals and how they will be impacted by government support in future. A lack in mandatory incentives from policy makers means some nature-based markets are uncertain and can be seen to be too risky for many investors. For example, in discussions with prospective clients, concerns have been raised that many natural capital solutions currently raising private capital investment are heavily reliant on revenue from the sale of voluntary carbon credits. The regulatory basis for voluntary carbon credits is uncertain and it is difficult to determine how the quality of credits issued on these markets are verified and audited. Investors are therefore hesitant to invest in natural capital solutions that are too reliant on voluntary credits as their demand is based on corporate net zero targets that can be changed or reversed – for example Shell has scaled back its climate pledges in 2023 which may reduce its need to purchase carbon credits.
  9. Not many investors are able to accept the higher risk, greater illiquidity and longer-term time horizons inherent within currently available markets that target nature recovery. To address this, we would welcome the ability to develop track record in new nature markets and specific investments in nature, by investing in a blended finance structure. Taking a blended finance approach with newly established nature positive markets will provide a proof of concept that aims to give private capital investment the comfort that investments in these nature positive markets can meet their return/risk profile and achieve positive outcomes for nature.

 

 

  1. How can investment best be aligned with environmental benefits, so as to achieve or surpass the Government’s targets for nature recovery?
  1. Currently only a small fraction of capital markets are designed to achieve nature positive outcomes and those that are focused on nature recovery tend to be based in voluntary commitments from corporates e.g. voluntary carbon credits and reef credits.
  2. Through the implementation of mandatory reporting and mitigation strategies, market participants should be encouraged/required to reduce their negative impacts on nature, such that the funding gap for nature does not continue to increase. Waiting for market participants to avoid negative outcomes for nature or restore nature on a voluntary basis will be too late for the 2030 target set by the UK Government.
  3. Increasing private capital investment in nature recovery is critical, but it will not be sufficient to outpace the damage caused to nature by current economic activities. Introducing mandatory regimes in sectors that create the greatest damage to nature, such as fossil fuels and mining, should be prioritised to prevent further damage to nature and create new nature recovery markets that attract private capital investment. For example, by recognising that the construction industry can negatively impact nature, the Environment Act is a good example of how the government has incentivised positive outcomes for nature in England, whilst continuing to meet other commitments, such as infrastructure development and house building.
  4. To secure nature recovery, current market activities need to better assess and understand the dependencies they have on nature, in line with the requirements of the Taskforce for Nature Related Financial Disclosures. We would therefore advocate that the Government impose a requirement for market participants to produce TNFD reports alongside or integrated into their TCFD reports.
  5. Once market participants understand how their economic activities impact nature and how they depend on nature to generate revenues, they must apply a mitigation hierarchy to avoid damage to nature, reduce their impact on nature and then take action to restore nature, which may include the requirement to purchase biodiversity credits or other solutions that aim to restore or regenerate nature.
  6. The challenge for private investment into nature is that taking action to avoid, reduce and restore nature are currently mostly required on a voluntary basis by market participants. Voluntary markets, such as those for carbon, can be difficult for investors to gain confidence in at scale as demand is based in voluntary commitments and the associated funding could be withdrawn. This creates uncertainty and risk that not all investors can accept.
  7. Hence the creation of new markets that target nature recovery need to be based in government compliance requirements, such as that created by the Environment Act. Mandatory requirements are critical to securing private investment into measures that restore nature. As previously mentioned, without the legal requirements imposed by the Environment Act, Gresham House would not have invested in the Environment Bank Limited. This is a clear example of mandatory legislation creating the certainty needed by private sector investors to deploy capital into nature-based projects that target nature protection and restoration. 
  8. Sustainable productive forestry is a good example of an asset that can be managed to create and restore nature when mandatory requirements are in place. Across our forestry assets, in line with UK forestry standards, we are required to manage a certain proportion of our forestry assets for biodiversity purposes. Whilst we have found that multiple species live in our forests (see paragraph 18), the active management of this proportion of our forests to create positive outcomes for nature is generally quite high level and no set targets are imposed to deliver positive outcomes for nature, other than hectares managed. We cannot currently generate biodiversity linked credits on this land due to additionality rules, but the opportunity to deliver this value for nature is inextricably linked to the growth and harvesting of timber from the adjacent sustainable productive forestry. The creation of credits or incentives that aim to further enhance biodiversity for forests, by enabling more on-the-ground management actions by woodland managers and ecologists to promote biodiversity, or that allowed for a more diverse, less productive mix of tree species, would enable our forests to focus less on the production of timber for revenues to support investor return requirements and instead support greater improvement in biodiversity and other ecosystem services.
  9. Sustainable productive forests are often portrayed as “green deserts” or habitats supporting no biodiversity. Whilst we recognise that productive forests have different characteristics in terms of biodiversity from native woodlands, they are still habitats to many plant and animal species. We conducted an exercise in early spring using water samples which provide a snapshot of species that have recently been present. 49 species of birds, mammals and amphibians were identified, painting a picture of a variety of animals using the woodland. This complements the 44 species identified across all properties in 2022 by the Woodland Manager Questionnaire.

 

 

c)      What measures are necessary to (a) establish and (b) maintain the high-integrity markets in ecosystem services which are expected to attract private investment? What confidence do investors currently have in the UK’s arrangements for these markets?

  1. As mentioned above, mandatory requirements to firstly assess and report on the impacts and dependencies a company has on nature using the TNFD, followed by mandatory requirements to minimise the negative impacts and create positive outcomes for nature, using a mitigation hierarchy.
  2. This is critical to the continued growth of UK GDP as one company may be having a negative impact on an ecosystem service upon which another company relies to generate revenues or protect value.
  3. There also needs to be development of measurement methodologies that can be used to assess value across all relevant ecosystem services, whereby value is understood as both the existing ecosystem services provided as well as enhancement to ecosystem services. Frameworks that measure each ecosystem service in isolation, e.g. biodiversity, will be more resource intensive and ultimately reduce returns for private investors.
  4. A joined-up approach to setting a measurement methodology is required across the UK and Ireland. Methodologies to measure biodiversity are currently diverging across England, Scotland and Wales which is prohibitive and resource intensive for market participants if adopted.
  5. New markets and incentives are needed to generate value for investors to create and protect ecosystem services beyond carbon and biodiversity – e.g. soil nutrients, water purification and water storage (drought protection), enhancements to existing infrastructure (reduce water losses).
  6. Carbon sequestration is an ecosystem service that is currently traded on voluntary (and compliance) carbon credit markets. In the work we did with Pension for Purpose, ‘several asset owners outlined how carbon credits are important because some natural capital investment products do not offer the hurdle of return, they are looking for from their private market portfolios. Including these credits could help achieve a better return if carbon markets and prices evolve in the future as expected.’[6] However, the volatility of the market remains a concern as does the ability to verify the quality of credits asset owner capital is being used to create.
  7. For this reason, we do not currently offer forestry funds to clients that rely only on the generation and sale of carbon credits. Instead, we combine one ecosystem service, timber production and sale, with another, the sequestration of carbon which can be monetised through carbon credits. The production of timber ensures a base level of returns from established timber markets providing investors with a security of return and a lengthy track record, while the sale of carbon credits creates the opportunity to boost returns through the application of another, albeit less established and less mature, nature market.
  8. The carbon credit markets desperately need more consistency in the way they are verified. We have found that because there is such concern in the market about the quality of carbon credits being sold, that carbon credit rating providers, separate from verification bodies, are needed by those purchasing credits to avoid getting caught by greenwashing issues.
  9. In terms of investor confidence, we have found that the understanding of nature markets is still nascent for most market participants, including asset managers and investors. Training is required across capital markets to enhance understanding of how private capital investment can benefit nature and achieve returns for investors. We have run several workshops and teach-ins for our clients and other market participants on the value of off-site habitat banks and how it is possible to generate returns from the creation and long-term protection of biodiversity. We have also spoken at conferences about the topic of natural capital and the importance of agreeing the outcomes an asset owner or investor wants to have on nature before investing in natural capital solutions.
  10. Gresham House, alongside Pensions for Purpose, found that the main barriers for UK asset owners to invest in natural capital include risk tolerance, little asset management track record, illiquidity, high asset management fees, minimal nature-related data, lack of specialist knowledge and lack of understanding of financial drivers. Asset owners need comfort across many of these factors to provide private capital investment into nature markets that secure nature recovery. In additions, markets based in voluntary commitments are seen to be riskier for investors and therefore solutions targeting nature recovery cannot rely solely on revenues from the sales of certain credit-based solutions.
  11. Investments that generate credits to meet mandatory requirements, e.g. biodiversity net gain credits and compliance carbon credits, are a more attractive solution due to increased security of demand, scalability and a regulatory basis. However it is still preferable for many asset owners to invest in a portfolio of natural capital investments that utilise different types of nature markets and do not rely solely on one type of nature market.
  12. Our experience has revealed that the stability of the regulatory / policy environment, and alignment with international market policies, are essential for market confidence in voluntary nature markets. For example, the UK market for voluntary carbon credits through afforestation has been subject to multiple changes in policy in recent years, mostly surrounding financial ‘additionality’, which has significantly raised the risk profile of investments in afforestation for UK investors. This is likely to severely restrict the investment into afforestation at the scale required to contribute meaningfully to the UK’s targets for climate mitigation, thus also hindering the contribution to other ecosystem co-benefits such as biodiversity and woodland linked ecosystem services, as well as socio-economic benefits from rural employment.

 

  1. What contribution will data from the Natural Capital and Ecosystem Assessment (NCEA) programme make to the objective measurement of changes in environmental outcomes?
  1. The NCEA could be a way for private investors to identify and allocate investment if they want to use a place-based approach to impact investment. This information may ensure that capital is directed to the aspects of nature in greatest need of recovery or to the locations where the most value can be created from enhancement activities. 
  2. The data from NCEA could address concerns over ‘additionality’ of nature-focused investment by identifying the aspects of nature in greatest need of restorative action, thus prioritising the appropriate source of funding.
  3. Private investors may also use the information to identify regions that may generate additional revenues in future from nature recovery, however this still relies on government incentives to put a price on nature and its recovery through various initiatives as discussed above.

 

 

  1. How can the proposed UK Green Taxonomy support high-quality investments which deliver genuine benefits to nature? What financial disclosures should the taxonomy require?
  1. If a similar ‘do no significant harm’ criteria to the EU taxonomy is adopted then:
      1. The Green Taxonomy should include specific criteria for each economic activity to demonstrate that the economic activity meets baseline minimum standards in terms of impact on nature as measured by impact on all forms of nature (soil, air, water, animals, plants), based on rigorous scientific and ecological research. Specific metrics should be selected per activity type. We recommend that the baseline reflects the current state of ecological value and intactness of land/soil/water/air for each activity, to allow for improvement from a lower state to a realistic end-point and to not preclude activity other than those which can be restored to “pristine” habitats .
      2. The DNSH criteria should include as a requirement for each activity identified as having high ecological value, or a high risk of causing biodiversity loss, to have a biodiversity/environmental action plan in place. I.e., an environmentally sustainable activity has fully assessed its impact on nature, potentially in collaboration with an ecological expert, and has a medium to long-term plan to avoid/reduce/enhance its impact on nature.
      3. As mentioned above there should be clear quantitative baseline standards and an action to target overall maintenance or enhancement against the baseline over time. This might mean applying the Defra Biodiversity Metric Tool for English assets (and the roll out of equivalent tools for Scotland, Wales and Northern Ireland). This approach should also allow for qualitative demonstrations of enhancement for circumstances in which specific metrics are not appropriate.
  2. For Substantial Contribution Criteria for biodiversity
  1. Economic activities that contribute to enhanced biodiversity should align with pre-existing and globally supported targets – the Kunming Biodiversity Framework (and UK goals – Biodiversity 2020 plan) would be the most obvious
  2. The EU Taxonomy categories of activities deemed aligned to the protection and enhancement of biodiversity should be expanded to other activities that contribute materially to nature of which there are many, including forestry conservation and restoration, sustainable forestry management, regenerative or sustainable agriculture
  3. Assets should follow and demonstrate the Mitigation hierarchy approach and be clear on the aim of the activity (i.e., does the activity aim to reduce negative impacts, or is it to actively improve a specific ecological state?)
  1. Financial disclosure requirements should include:
      1. the % of assets with an environmental action plan
      2. a quantitative target for nature-positive change over time (BNG unit increase, increased native broadleaves hectares, for example). This should be in addition to a carbon/climate target.
      3. absolute nature impact (per point ii) per $m invested.

 

 

  1. How can the operation of natural capital markets ensure genuine net gains for nature? How do such markets address the risk of ‘greenwashing’ of investments and the offsetting of natural recovery in the UK against environmental degradation elsewhere?
  1. A credible assessment for all assets sold as ‘natural capital’ should be completed measuring both the positive and negative impacts the asset has on nature.
  2. To do this, a standard must be developed, alongside ecological experts, that allows natural capital assets to assess and report the impacts on all relevant ecosystems. The development of standards ensures that all market participants are reporting against a consistent methodology which helps investors to make comparisons across different natural capital assets.
  3. It should be a mandated requirement for any assets claiming to contribute to nature recovery to report against this standard and get a baseline measurement completed prior to any enhancement works carried out to restore nature. The incremental changes in nature need to be captured accurately to avoid greenwashing and overemphasis of outcomes.
  4. Care should be given to avoid attempting to summarise the contributions a natural capital asset is making to nature, either positive or negative, in a few simple metrics. Reporting the impacts on nature are not straightforward, so while standards are needed, these standards should avoid trying to be too clever to aggregate different nature outcomes into too few metrics. Qualitative information will likely be needed to support any quantitative data provided.
  5. Consideration should be given to how reporting against standards will be audited and how regularly. By requiring audits, regularly or periodically, will encourage better practice and provide evidence for investors that the intended outcomes for nature are being achieved. For example, Forestry activities that align with the EU Taxonomy must have third party audits carried out every 2 and 10 years to verify that Substantial Contribution Criteria and Do No Significant Harm criteria are met.
  6. In addition, Environmental Impact Assessments should be reviewed to ensure the requirements are in line with the UK’s nature recovery targets. 
  7. This is however a challenging topic and with the development of certain types of infrastructure, such as wind and solar, can result in conflicts arising between climate outcomes and nature protection/recovery. For example, our experience of aligning our international forestry fund with EU taxonomy requirements has resulted in numerous debates about whether the biodiversity requirements of the Do No Significant Harm criteria can be upheld whilst also maximising carbon sequestration of the forests to support our clients’ desire of meet their own net zero standards. Standards are yet to clearly address this potential conflict, which highlights the importance for nature and climate policies to be developed in tandem.
  8. Incentives need to be established to create the basis for nature-based markets that direct capital into solutions that reduce the impact they have on nature as well as contribute to initiatives that restore nature. This might come in the form of nature linked bonds that offer preferential terms if certain outcomes for nature are achieved or payments for the delivery of various ecosystem services such as water purification or flood defences that enhance or protect revenues of other sections such as utilities and insurance companies, respectively.
  9. The potential for greenwashing remains, for example over emphasising positive outcomes to secure a lower cost of capital or to secure payment for ecosystem services beyond what was created. Therefore, this approach also requires a robust methodology for measuring nature initially and monitoring this over time.
  10. Developing market drivers that incentivise positive action, rather than trying to offset damage or loss, will encourage companies to create positive benefits as they can create additional or new revenue flows. Requirements to generate a ‘net gain’ of any unavoidable damage or loss to nature should be in place, such as that required under the Environment Act. A similar net gain requirement could be applied to carbon markets, requiring that more than one carbon credit has to be purchased for each tonne of carbon dioxide equivalent emitted.
  11. Finally, it is essential that mechanisms are in place to prevent double or triple counting of outcomes. There is clearly a potential for multiple market participants, including the government, to claim the positive impact on nature recovery for one project. With regards to BNG units it may be possible that the buyer of the unit will claim the net gain to nature within their reporting, as could the seller or funder of the BNG unit and then this net gain to nature could also be claimed within government natural capital accounting. This is also a reality within carbon credit markets where those that generate carbon credits report the carbon avoidance/reduction/sequestration they have produced through their projects (e.g. Gresham House generating carbon credits from new planting in the UK); the purchaser of the carbon credit on the voluntary market will also claim the equivalent carbon figure to reduce their total emissions; and then if the assets that generated carbon credits are owned within an investment fund then the asset owner may also claim the carbon figure to explain to their stakeholders the contribution they are making to deliver net zero. This is ability to count the outcomes on nature recovery and carbon multiple times needs to be carefully addressed and prevented within reporting methodologies.

 

 

  1. What role can the UK’s financial markets play in developing the flow of international capital into the development of the UK’s natural capital?
  1. The UK can demonstrate best practice in terms of setting standards to monitor and measure the outcomes on nature’s recovery of private capital investments. By doing so, the UK will lead by example and demonstrate to other countries that by valuing nature as a form of capital it can be restored to protect existing industries (e.g. forestry returns are reliant on the health of nature and our climate) and generate returns for investors. In addition, the provision of this data in a consistent, comparable manner should give investors comfort that the reported outcomes are credible.
  2. By mandating the implementation of TNFD, an international standard, (in a similar way to how the UK mandated reporting against the TCFD), the UK will secure itself as a leader within nature reporting and demonstrate that nature recovery is a critical part of UK capital market activities. It will also provide data for private capital investors which can be used to inform asset allocation decisions, manage nature related risks, and identify opportunities in natural capital.
  3. The UK can also create new nature markets to offer new investment opportunities for international investors which they cannot access within their region. This will help to scale these markets faster than relying on UK based investors only. The BNG credit market is a good example of an investment opportunity available in the UK which is lacking in other regions globally.
  4. For international investors to gain confidence to invest in UK natural capital assets or markets, it will be crucial that there is clarity on the policies or incentives that create the market opportunities. It is unlikely that international investors will be prepared to take on risks of unproven nature markets that do not have stable underlying market drivers or a mandatory regime underlying the market. In addition, the government should lead by example and invest in these new markets to establish a proof of concept.
  5. Encouraging international investment in markets that aim to restore and regenerate nature across the UK will scale nature markets but will also enhance the resilience of numerous sectors that depend on nature for their revenue creation or risk management. Therefore it is an imperative that markets that restore and regenerate nature are based in mandatory requirements as the outcomes of scaling these solutions will have positive indirect effects on the UK’s wider economic activity, including agriculture.

 

 

  1. What role does the UK have in establishing international standards for natural capital investments, alongside other jurisdictions and financial centres?
  1. The UK’s role should start by mandating the application of the existing international standard for nature reporting, the TNFD. In discussions with asset owners, we have found a consensus that frameworks will drive investor interest in natural capital, much like the TCFD did for climate. The mandatory requirement for market participants to report against and apply the TNFD will hopefully encourage more thoughtful conversations on how nature risks and opportunities can be managed across an investment portfolio. Pensions for Purpose found that until there is regulation to consider nature as a risk within investment decisions, asset owner focus will remain on climate risk alone.
  2. Developing international standards for measuring and reporting natural capital consistently, with the ability to make appropriate comparisons is an extremely difficult task. The nature in one country will differ significantly from that in another and yet international standards will require parallels to be drawn to accurately report on global natural capital investments. The UK should be included in the development of these standards to ensure the natural capital within our country is appropriately represented and therefore the value in UK natural capital investment is recognised.
  3. The UK is already demonstrating leadership in certain natural capital markets, such as the implementation of the Environment Act. Sharing knowledge on the merits of this approach will be crucial to scaling the biodiversity net gain credit markets globally.

 

 

 

September 2023

 

[1] The Biodiversity Finance Institute

[2] Assuming global GDP was c. $100tr in 2020 as reported by The World Bank

[3] Environment Bank Limited

[4] Natural capital and biodiversity – where are UK asset owners on their journey? | Pensions For Purpose

[5] Market forecasts completed by Gresham House.

[6] Impact Lens, Pensions for Purpose - Natural capital & biodiversity – where are UK asset owners on their journey?