Mobilising private investment in natural capital: report

Section 11: Conclusion

The Mobilising Private Investment in Natural Capital project explored the potential role and design of a Scotland Carbon Fund, Price Floor Guarantee and Operating Payments as effective tools to scale peatland restoration across Scotland. Over the course of the project, various design features were tested and refined through engagements with key stakeholders. This iterative co-design process ensured that insights from a wide variety of market actors were effectively captured and used to inform the recommended design of the mechanisms.

The recommendations for the Scotland Carbon Fund, Price Floor Guarantee and Outcome Payment mechanisms, outlined below, will support the scaling up of private investment in Scotland's peatland landscapes and play a significant role addressing a number of the financial and non-financial barriers to peatland restoration, as outlined in Table 18. It is important, however, to recognise that these mechanisms are not a panacea to address every barrier to peatland restoration. It will be important for the Scottish Government to further explore how additional policy mechanisms can be implemented to address other remaining barriers, including those relating to data gaps on peatland condition, harmful subsidies and tax incentives which dis-incentivise peatland restoration and the general lack of awareness of the benefits generated by peatland restoration.

Recommendation for a Scotland Carbon Fund

A SCF, structured as a project finance vehicle with a minimum fund size of £50 million, would enable Scottish Government to leverage sufficient private capital to facilitate the restoration of Scotland's peatlands at scale. In order to support the crowding in of private investors who would otherwise be hesitant to participate in the nascent natural capital market, the fund should include first loss protection, a stamp of approval from Scottish Government and an initial expansion of the investment mandate to cover woodland projects. Through the SCF, the Scottish Government would have strong financial governance over the peatland carbon market, ensuring market activity aligns with the Interim Principles for Responsible Investment in Natural Capital and the need to provide benefits to local communities.

Recommendation for a Price Floor Guarantee

A well-designed PFG offers strong value for money to the Scottish Government and would play a significant role in catalysing private investment into the restoration of Scotland's peatland. Given the PFG is highly flexible, it may be most effective to initially implement a simple PFG and then refine over time as specific activities need to be incentivised. Despite its flexibility, it is important that at its core, the PFG provides index-linked price support for 30+ years in order to provide long term confidence to private investors. When paired with the SCF, these mechanisms could imprint strong governance standards onto the peatland carbon market through facilitating projects aiming to keep PIUs until they vest into PCUs, providing landowners with a long-term revenue stream to cover the lifetime maintenance costs of projects.

Recommendation for Operating Payments

Grant funding through Peatland ACTION should gradually transition from the existing upfront capital grant to an annualised Operating Payment to also support the long-term maintenance costs of peatland restoration projects, with the value of these Operating Payments reflecting the overall project costs. These Operating Payments should be provided for the first 5-20 years of a project to provide optionality to landowners to hold onto PIUs until they begin to vest into PCUs. The provision of Operating Payments will support the development of the evidence base on the costs of peatland restoration and provide confidence to investors and carbon buyers of a minimum level of project establishment and permanence.

Areas for further research and next steps

To build on our proposals, we have outlined specific next steps to support practical implementation. These steps focus on activities that will further build the case for each of the recommended models as proposed in this report.

Scotland Carbon Fund

• Pipeline Mapping and development: SG should conduct further strategic assessments of the peatland resource in Scotland to understand the extent of PC eligibility and the availability of investment ready opportunities. This should identify the near term projects and low hanging fruit for early investment. This will inform work to identify the appropriate scale and mandate of the SCF and how it will invest in aligned opportunities and supply chain businesses.
• Term sheet and fund design: Fund costs should be modelled, and management fees estimated. This will build on the strategic mapping and development, and mandate setting described above. A draft term sheet with key fund characteristics could then be developed.
• First loss guarantee: Assess options to provide first loss capital, including considerations around who should make the contribution and what the conditions of this contribution would be.
• Fund manager: A fund manager should then be selected to undertake fund co-design and testing with potential investors. This will help the Scottish Government's understanding of investors' preferences including expected return, hurdle rate and more.
• Aggregation facilities: Undertake further analysis of options, including an assessment of existing structures which could be leveraged (e.g., LENs, RLUPs) and what skills, capacity and expertise would be required.
• Financing offering to projects: Review the mechanisms through which the SCF might provide capital to projects (such as traditional loan financing, revenue sharing, equity holding etc).
• Insurance mechanisms:Explore how insurance mechanisms could be utilised to mitigate some of the risks specific to peatland restoration projects. Research and engagement with insurance companies would be required to determine their appetite for such products.

Price Floor Guarantee

• Accounting and treatment of long term liabilities: It will be important to engage with the Treasury and/or the Financial Management Directorate (FMD) to understand the viability of funding the PFG. FMD will need to opine on the total value of the guarantee, the amount per auction, the term of the guarantee and the treatment of surpluses. This could be achieved through collaboration with the Woodland Carbon Guarantee to understand how this was initially funded and how the PFG might augment this model. Working with Defra and Treasury, the Scottish Government may also identify an opportunity to expand the guarantee to a UK scale.
• Eligibility and delineation:Further work is required to determine which eligibility criteria are suitable for use by the PFG, and how those projects with desired characteristics are supported through the mechanism. An initial PFG should follow a simple approach, with eligibility criteria refined over time.
• Mechanism design and structuring: Different auction-based mechanisms for a government-backed PFG should be explored further to better understand their suitability for peatland carbon markets in Scotland. The Scottish Government may consider engaging with a specialist consultant, such as the University of Exeter's Land, Economics, Environment and Policy Institute (LEEP) on the final design and implementation of the PFG. SG should also further consider learnings from the Woodland Carbon Guarantee to date.
• Indexation:Further research is needed to understand how indexation of the PFG would affect future liabilities on the Scottish Government. This should be considered alongside accounting for long term liabilities.

Operating Payments

• Peatland ACTION verification: It may be valuable to review previous recipients of Peatland ACTION funding to understand how, and to what extent, sites have been maintained, and at what cost for different project types.
• Market testing: Targeted market research should be carried out on the attractiveness of Operating payments for restored and high-quality peatlands. This should include research into the term and level of payments that is most cost-effective while successfully catalysing action.
• Structuring: Scottish Government and Peatland ACTION will need to work to design a suitable initial offer based on market feedback. This offer may be more generous in the short term to accelerate early uptake, then refined over time.
• Soft launch: The Scottish Government should consider exploring how the OP model could initially be offered alongside the existing offer of full capital grants to provide increased optionality to projects. This could also be tested regionally to explore and refine levels of support.