Mobilising private investment in natural capital: report
This report looks at how to encourage responsible private investment into peatland restoration, including how to overcome barriers to scaling voluntary carbon markets to restore peatland in Scotland.
Section 4: Evidence review
This section reviews existing fund and price floor mechanisms and their associated design features. The aim is to provide insights into how these mechanisms could be applied to inform the structure of the proposed SCF and PFG mechanisms.
Precedent funds
Globally there are a variety of carbon and nature-related funds which are structured to facilitate the flow of private finance into natural capital. These funds set a potential precedent for the proposed SCF.
| Fund |
Description |
Learnings for the SCF |
|---|---|---|
| Livelihoods Carbon Fund[24] (LCF) |
Launched in 2011, the LCF is a project finance vehicle providing upfront financing to project developers to implement large scale agroforestry, rural energy and mangrove restoration projects across Africa, Asia and Latin America. The LCF also looks to support the long-term sustainability of the projects it invests in through funding 10 to 20 years of maintenance costs. Investors in the fund, which include corporates and financial institutions, receive carbon credits in return for their investment. In 2021 the LCF launched its third fund, raising €150M, bringing the total amount raised to €290M. The LCF's ability to attract investment is improved by the fact that it targets funding to projects which not only deliver carbon benefits, but also deliver wider social and environmental benefits for local communities. |
The first LCF has more than 10 years of operating performance and 2 subsequent funds have been launched, evidencing continued interest in carbon credits, from a range of investors and corporates, over the past decade. The fund is using a project finance approach by providing upfront capital to cover development costs and some maintenance costs. A similar model could be suitable for the SCF. |
| Land Degradation Neutrality Fund[25] (LDNF) |
The Land Degradation Neutrality Fund (LDNF) is an investment vehicle which leverages public money to raise private capital for sustainable agriculture, livestock and forestry projects. In addition to carbon sequestration, revenue is generated from the production of sustainable commodities, the creation of green jobs and increasing food and water security. Leveraging the support of the Government of Luxembourg, IDB Invest and the Global Environment Facility (GEF), alongside anchor investments from the European Investment Bank (EIB) and French Development Agency (AfD), projects are sufficiently de-risked to attract a number of institutional investors and insurance companies for the amount of upwards of $100M in the fund. |
The LDNF leverages the participation from a number of public entities to crowd in private capital. The fund invests in a broad range of projects to ensure adequate diversification of risk as well as facilitate the rapid deployment of its capital. |
Precedent benefit sharing mechanisms
The structuring of financing mechanisms ensuring the sharing of benefits of peatland restoration will be essential to obtain the long-term support of local communities. The Scottish Governement, and several stakeholders consulted, indicated a keen interest in options to develop some form of benefit-share scheme to enable the sharing of the benefits with local communities. This is central to the Scottish Government's Interim Principles for Responsible Investment in Natural Capital.
This section explores several mechanisms which have been effectively used in relevant contexts.
Donor Advised Funds (DAFs)
DAFs are flexible philanthropic vehicles that provide attractive tax benefits to donors interested in making gifts to charitable causes. DAFs allow for the donation of funds before specific recipient charities can be identified by the donor. This allows the donor to offset their donation against payable tax.
In the renewable energy sector, DAFs have been established to act as a mechanism to share surplus funds with local communities. In Scotland, this has been achieved through the Community and Renewable Energy Scheme (CARES). For example, the Fallago Environment Fund was established by EDF Renewables and Roxburghe Estates to share the economic benefits of the Fallago Rig windfarm with local communities and visitors to the Scottish Borders.[26] Each year, community and charitable groups can apply for a share of the £200,000 which is available to support local environmental, cultural and education-related projects.
Direct community investments
Direct community investment in restoration projects via crowdfunding platforms, including Triodos and Ethex have been used successfully to build commuity ownership of a range of projects. Crowdfunding campaigns are an alternative to donations that enable communities to realise a financial return as well as have a voice in project governance in exchange for their investment. At the same time, community or retail investors may not be aware of the risks of investing, especially in nascent markets.
One example is the Langholm Initiative, which in August 2022 used £2.2 million in proceeds raised from its crowdfunding campaign (using the platform Go Fund Me), along with a contribution from the Scottish Land Fund, to finance the acquisition of 2,415 hectares of land from Bucceulch estates to create a new nature reserve.[27] In another example, Highlands Rewilding sold £7.5m of shares to 50 investors to replicate the rewilding of the Bunloit Estate to other Scottish estates.[28]
Revenue and profit sharing agreements
A revenue or profit share agreement is a benefit sharing agreement that allows for the sharing of revenues/profits between the various stakeholders involved in a project. In this type of agreement, a percentage of the revenues or profits could be allocated to communities.
For instance, one of the models operated by Respira International,[29] a carbon finance business, utilises a profit share model whereby a percentage of profits generated above a hurdle rate (e.g., a specific carbon price) are shared with the project developer and landowner, allowing these stakeholders to benefit from any upside in carbon prices. This type of mechanism could be adapted and expanded to include a profit share agreement with communities.
Conservation dividends
A conservation dividend is another type of benefit sharing agreement that enables a fund to donate a proportion of its returns towards conservation activities, supporting often uneconomical but highly impactful projects, whilst also potentially benefiting from tax relief on their donation.
Working in partnership with Big Society Capital (BSC) and Power to Change (PtC), Finance Earth manages 'Community Owned Renewable Energy' LLP (CORE), a £50m social and environmental impact fund. CORE focuses on the acquisition and restructure of commercial solar projects to allow for long term community ownership. CORE distributes a fixed Community Benefit Payment to community partners each year, with a total of £350,000 donated to date (May 2022). This funding is provided alongside further direct grants from PtC, partially funded through returns generated from CORE.
A combination of the above mechanisms could support the SCF in sharing economic benefits from carbon sales with local communities and other relevant stakeholders. These options are explored in further detail in section 6 of the report detailing the recommended design options for the SCF.
Precedent price floor guarantees
Price floor mechanisms have been used in a variety of environmental contexts. Table 7 provides an overview of a variety of price floor mechanisms which have been successfully implemented in the UK.
| Example |
Description |
Learnings |
|---|---|---|
| Feed-in-Tariff for renewable energy |
A government programme introduced in 2010 designed to promote uptake and financing of renewable energy generation technologies by providing market access and price certainty for energy generated alongside subsidy payments. Guaranteed prices are set centrally at fixed tariff rates (based on technology type), providing revenue for 20 years. |
The Feed-In Tariff was highly effective in supporting investment in Renewable Energy in the UK. The scheme currently supports an installed capacity of 6.43 GWs of generating assets. In part thanks to the scheme, renewable energy assets are able to access finance at very low cost, akin to other established infrastructure assets. The price of renewables decreased rapidly and was hard to effectively predict. This meant that at times administratively set pricing was "too generous" leading to surges in demand. |
| Woodland Carbon Guarantee[30] (England only) |
A £50 million government scheme designed to stimulate woodland creation in England through a guaranteed price for Woodland Carbon Units generated by 2055/56. Projects compete in reverse auctions for price floor agreements, bidding below a maximum (reserve) price determined by the Forestry Commission which runs the scheme. A proportion of each auction's budget is notionally allocated to projects which meet specific criteria and deliver additional positive outcomes. This is achieved through a two-step auction process. These projects are likely to secure a higher reserve price. |
According to the Forestry Commission, Woodland Carbon Guarantee (WCG) auctions have helped stimulate 2,650 hectares of tree planting[31] in England. This sets a precedent for the PFG mechanism to catalyse peatland restoration. Initial applications to the WCG were dominated by farmers and small land landowners, however, as market dynamics are becoming more well understood larger entities have recognised the benefits of the WCG. Given the general similarities between the WCG and the proposed PFG, this newfound understanding of the benefits of the mechanism may increase investor support for the PFG from the outset. Based on the outcomes of early auctions, the Forestry Commission identified that mono-crop, less biodiverse woodlands were over-represented within the pool of successful projects (compared to targets). To address this, in 2021, the WCG shifted from a single auction mechanism to a more nuanced auction structure that allowed projects with certain biodiversity characteristics to access a higher price floor. The use of eligibility and delineation criteria in this was is explored in section 7. |
| EnTrade's Catchment Nutrient Market[32] |
EnTrade operates an online trading platform to buy and sell environmental credits, including nutrient credits. Acting as a broker, EnTrade designs and runs auctions for Wessex Water, a water utility looking to pay upstream farmers to alter their land management practices to improve water quality and in turn reduce operating costs at water treatment works. Farmers bid for the true cost of land use change, with the auction accepting the lowest bids, but pays the amount specified in the highest accepted bid to all accepted bids. This approach is known as a uniform price auction and promotes a more transparent bidding process. |
Through using a uniform price over a pay-as-bid mechanism, Wessex Water were able to purchase greater improvements in water quality and alter land use over a greater area within the same budget. The comparative benefit of each of these mechanisms is explored in detail in section 7. This EnTrade example was the first to demonstrate the benefits of using a uniform price for a payment for ecosystem service. Given its success, the applicability of using a uniform pricing mechanism should be explored when considering a PFG. |
Under each of these structures, price floors have effectively supported market development in slightly different ways. The Woodland Carbon Guarantee (WCC) and EnTrade mechanisms both demonstrate the effectiveness of reverse auctions in setting an efficient price floor. This sets a precedent for how a PFG for peatland carbon could operate. The benefits of this approach, alongside the key risks and challenges of a PFG are explored further in Section 7.
Policy context
The Scottish Government has taken a proactive approach to climate action and natural capital restoration. This leadership has resulted in the formulation of a multitude of new policies, consultations and other commitments across a broad range of sectors to support their aims.
The SCF and PFG must be designed with these in mind. Through ensuring these policies inform the design and structure of the SCF and PFG, these mechanisms can support the delivery of the Scottish Government's aims. Existing and forthcoming policies therefore played a critical role in the formulation of our recommendations for the SCF and PFG. Those of particular focus are explored in more detail in Table 8.
| Policy |
Date published |
Implications on proposed SCF and PFG |
|---|---|---|
| Climate Change Plan Update[33] |
2020 |
Twin commitments of achieving net-zero by 2045 and reducing biodiversity loss by 2030 – accelerating peatland restoration beyond existing target of 25,000ha/year through effectively leveraging private finance will support these commitments. The Climate Change Update Plan includes a commitment to increase the woodland carbon market by 50% by 2050. As such, it could be possible to broaden the mandate of the SCF to fund a certain number of woodland carbon projects. The Policy includes a commitment to increase peatland restoration contractor/delivery jobs. The SCF could also provide finance to support the upskilling of people to become contractors, whether that is direct funding or through benefit sharing mechanisms. |
| National Strategy for Economic Transition (NSET)[34] |
2022 |
A key action of NSET is to "Establish a values-led, high-integrity market for responsible private investment in natural capital…" by 2032. It is therefore important for Scottish Government to be able to use the proposed SCF and PFG to enact financial governance over the peatland carbon market. NSET has a strong focus on ensuring a Just Transition and that local communities are empowered and benefit from investment in natural capital. In order to ensure alignment, the SCF and PFG should be structured to include benefit sharing mechanisms so that monetary and non-monetary benefits are shared with local communities |
| Land Reform Bill consultation paper[35] |
2022 |
Proposals for Scottish Government's forthcoming Land Reform Bill look to address some of the barriers to peatland restoration which cannot be addressed through financing mechanisms alone, from regulating the transfer of large-scale landholdings to pushing large landowners to support nature restoration efforts. |
| Scotland's Biodiversity Strategy consultation[36] |
2022 |
The Scottish Government's forthcoming Biodiversity Strategy aims to drive the transformation in the way Scotland's natural resources are managed to support biodiversity. A key focus of the consultation is on ensuring that public investment leverages and works alongside increasing levels of responsible private investment in a values-led high integrity natural capital market as well as ensuring Just Transition principles are embedded in all investment in nature recovery. The SCF and PFG could therefore play a key role in realising this strategy. |
To support the delivery of the NSET's natural capital markets commitments, Scottish Government published a set of Interim Principles for Responsible Investment in Natural Capital in 2022. The six Interim Principles set out the Government's ambitions and expectations for a values-led, high-integrity market for responsible private investment in natural capital across Scotland. The Interim Principles lay a strong foundation for the implementation of a SCF and PFG, and provide a useful guide as to how these mechanisms should be designed and structured. An overview of how each of the six Interim Principles have guided the design of these mechanisms in provided in Annex C.
Contact
Email: peter.phillips@gov.scot
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