THE WORD INFRASTRUCTURE commonly conjures up images of steel and skyscrapers, roads and railways, cranes and concrete… but increasingly it is being applied to a softer, greener landscape as we re-evaluate what we want to prioritise and protect in our living environment.
The UK Infrastructure Bank wants to demonstrate how these definitions can happily inhabit the same space and use its capital to grow the UK’s natural capital market.
Society and the economy depend on natural capital assets and services to function – including the carbon locked up by ecosystems, the provision of clean and reliable water supplies, and the biodiversity that underpins our food security.
Our natural capital is a form of infrastructure, comparable to engineered solutions to problems such as flood risk and greenhouse gas removals. Often underpinning economic growth, it can protect other infrastructure assets as well as delivering wider co-benefits, such as jobs.
However, our base of natural capital assets has been rapidly eroded over recent decades, and urgent investment is needed if the UK is to meet its net-zero targets, adapt to an already changing climate and secure future economic prosperity.
Unlocking potential
These losses have significant implications not only for our enjoyment of the natural world but also for the benefits nature provides to society and the economy. From helping us fight climate change by locking up carbon, to providing clean water, and even the food on our plates, the natural world is an essential form of infrastructure – one we will need more of in future.
At UKIB, we recognise the importance of natural capital to delivering on our mission to tackle climate change and support regional and local economic growth. Nature’s worth to society – that is, the true value of the various goods and services it provides – is not adequately reflected, as so much has no monetary value attached. This has led us, as a society, to underinvest in our natural capital assets.
The Dasgupta Review found that large-scale and widespread investment in nature-based solutions can help address biodiversity loss and significantly contribute to climate change mitigation and adaptation, while delivering wider economic benefits, such as boosting employment.
In response, the UK government has committed to creating a nature-positive future – and the economic and financial decision-making, systems and institutions required to deliver it.
While public funding and philanthropy will remain critical to achieving large-scale landscape recovery, evidence suggests that private sector investment needs to scale up significantly to bridge the financing gap for nature-related outcomes, which is estimated at £56bn over the next 10 years.
The need for an ambitious increase in scale is reflected in the government’s target to mobilise at least £500m of private investment into nature’s recovery every year by 2027 and more than £1bn a year by 2030. Private investment in nature currently stands at around £95m per year, out of a total committed spend on nature of £700m per year.
Market making
While private sector interest in the natural capital market is increasing, most commercial lenders are waiting for the market to further mature before actively participating at scale. A principal barrier to enabling private investment of this kind is a lack of reliable sources of revenue from natural capital.
We have spent the past few months working to understand the dynamics of these emerging markets for natural capital and the role we could play in them. Government, investors, project developers, green groups and many others have lent us their valuable perspectives over this period.
‘Natural capital can protect other infrastructure assets and deliver wider co-benefits’
The picture that has emerged to us so far is of a nascent market, with emerging business models and revenue streams, and a limited number of small projects, often under £1m in size.
This limited pipeline of smaller projects limits the deployment of capital at scale. High transaction costs, the uncertainty and complexity of environmental policy and regulation, data gaps, the absence of universal standards and market infrastructure, and novelty risk also make it difficult for most investors to price and manage the risks of investing in nature.
However, this market is evolving with support from the likes of Defra’s Natural Environment Investment Readiness Fund and NatureScot’s Investment Ready Nature Scotland grant scheme, both of which are working to increase the pipeline of investable projects available to investors.
We are interested in amplifying the benefits of these initiatives – for example, by investing in large-scale natural capital projects as they emerge, or by refinancing groups of promising ongoing projects. While our minimum ticket size for private sector deals is around £25m, we can look at approaches that aggregate projects to get over this hurdle. Our local authority function will lend to local authorities at a preferential rate for high-value and strategic projects of at least £5m.
Furthermore, our view is that investing in diversified portfolios of projects could enable us to reach earlier-stage segments of the market, while managing the risks of doing so.
Although we are keen to deploy across the natural capital market, we have identified three areas of the market that benefit from more established business models, clearer policy drivers and developed market infrastructure: the voluntary carbon market, biodiversity net gain and water services. Initially, we expect to build our expertise and concentrate our efforts in these segments of the market, while remaining open to wider opportunities as they come forward.
Increasing tree planting to sequester carbon and protecting and restoring peatlands to address carbon emissions will also be necessary to achieving the UK’s net-zero target. Markets for the sale of carbon offsets can mobilise private investment towards these objectives. However, carbon offsets should only be used to address residual emissions as part of the journey towards full decarbonisation. We will only invest in high-integrity carbon projects that sell to end-buyers that fulfil this requirement.
Model investors
We consider the woodland carbon market to be most ready for investment. Some areas of this sector are already fully commercial, such as where timber revenue forms a significant portion of a project’s business model.
We see a role for UKIB in scaling more nascent sections of the woodland carbon market, including projects delivering significant social and environmental co-benefits. Such projects typically face increased barriers to implement at scale, including higher development costs and longer payback periods, but can also attract a price premium for their carbon.
We are interested in investing in business models that help capture this additional value by overcoming barriers to commercial implementation at scale. This could include diversified hybrid models that combine more established income streams, such as revenue from timber and carbon, with more novel revenue streams from natural capital.
Peatland carbon could present significant opportunities for achieving restoration at scale. We intend to build our understanding of this market and our potential role over time. This will include identifying opportunities for early investment in peatland projects – for example, via diversified funds.
Mandatory biodiversity net gain will be introduced in England from November 2023, with the aim of securing positive outcomes for biodiversity, improving the planning process for developers, and creating better places for local communities.
Regulation
A key determinant of success for the biodiversity market will be the design of underpinning policy and regulation. While the Environment Act sets the framework for biodiversity net gain, full details on its implementation are still being provided through secondary legislation, policy and guidance. We will maintain an active interest in the development of biodiversity net-gain policy, including the role of private finance in bringing forward supply, offering advice to government where appropriate.
Difficulty in projecting the future structure of the biodiversity market is an important barrier to private investment. Uncertainties include demand for offsite habitat creation and the price of biodiversity units. We will monitor the early development of the market and consider where it may be appropriate for UKIB to step in and take additional risk to bring forward necessary supply. Voluntary markets for biodiversity gain may also provide a route for investment.
‘Water companies are trialling the application of green infrastructure, such as constructed wetlands, that reduce carbon emissions’
Local authorities will play an important role in overseeing the delivery of biodiversity net gain, and some are applying this requirement ahead of statute. We will engage with these early adopters to better understand market dynamics and the lessons learned to date. Where opportunities emerge, we will look to invest in projects that address scarcity of supply within local planning authority areas. We are also interested in whether UKIB can play a role in raising the skills and capacity of authorities seeking to deliver biodiversity net-gain projects.
Water resources are at the forefront of climate resilience – and a unique challenge.
Defra’s 25-year environment plan signals a fundamental shift to driving environmental improvements in England through a natural capital approach. This is reflected in the department’s recent statement of strategic priorities for the 2024 Price Review (PR24), which calls on Ofwat to increase the use of nature-based solutions by water companies.
Defra expects these solutions to be delivered as a matter of preference, where risks are understood, controlled and proportionate to potential benefits. Nature-based solutions are perceived as riskier than traditional engineered solutions to raw water protection, wastewater treatment and flood mitigation, and are likely to require patient capital to support their rollout at scale.
Water companies are trialling the application of green infrastructure, such as constructed wetlands, that reduce carbon emissions and provide wider environmental and social benefits. We are aware that, unlike asset-based solutions, nature-based solutions must be funded from operating expenditure within each regulatory price cycle.
Flooding risk
But this creates additional financial risk through revenue uncertainty and presents a barrier to the wider implementation of these measures. We are keen to consider investment opportunities that help mitigate this financial risk within the current regulatory framework.
Across the UK, catchment-based approaches will also be necessary to tackle the complex and cross-sector issues affecting the water sector, including diffuse pollution and flooding. The design of catchment-based approaches is often bespoke, which can limit easy access to private finance. To overcome this barrier and support scale, we are particularly interested in developing and investing in financial models that are transferable across catchments.
To secure the long-term supply of land needed for nature-based solutions, landowners, rural communities and wider stakeholders will need confidence in natural capital markets and their ability to generate value for them fairly and over the long term.
This includes considering the balance between food production and the delivery of environmental targets. We are committed to encouraging responsible private investment in natural capital markets, and intend to build on existing initiatives, such as the Scottish Government’s Interim Principles for Responsible Investment in Natural Capital.
Recognising that the pipeline of natural capital investible projects will be limited at this early stage, UKIB intends to focus on creating pathways for future private investment by demonstrating the soundness and replicability of emerging business models. Its efforts and investments will be directed towards high-integrity markets for natural capital, capable of generating and evidencing clear gains for the climate, environment and society. It intends to work collaboratively with policymakers, project developers, investors, landowners and others to deliver this ambition.
Investment in natural capital can play an important role in delivering our urgent mission to help tackle climate change and boost regional and local growth.
Read more at www.ukib.org.uk/natural-capital
Kate McGavin and Helen Williams are directors of strategy and policy at UK Infrastructure Bank
