Fireside chat with Isabel Milligan,
Head of Nature Assets at Great Yellow
- Isabel Milligan, Head of Nature Assets at Great Yellow
Back to main blog pageELJ: Izzie, it’s great to have you here. I’d like to kick off by asking you: What is 'natural capital'?
IM: The groundbreaking Dasgupta Review, published in 2019, was the first of its kind to identify the failure of accounting techniques to capture the value of natural capital. The publication defined natural capital as being all of the ecosystem services performed by nature that absorb carbon, prevent soil erosion, create habitats for wildlife and pollinators, and create other direct benefits to humanity – from recreation to clean air.
ELJ: Does natural capital cover all natural resources?
IM: Yes. The simplest way to explain it is as a way of quantifying the ecosystem services that underpin our existence. Much like the way that can extract crude oil, refine it and sell it at an agreed market value, units of natural capital such as carbon and natural flood management can also be quantified and traded. Whilst there are ongoing debates as to the ‘true cost’ or value of natural capital, having an ascribed value enables translation of the ecological and social benefits of these underpinning ecosystem services onto corporate balance sheets, and into a language that the private sector can understand. Given that the stewardship of natural capital requires capital funding (amongst other types of funding), most people understand the need for putting a financial value on natural capital as a way of compensating nature’s custodians and incentivising sustainable, regenerative management of nature’s assets.
ELJ: Could you give a real-life example of how this would work?
IM: I’ll give a variety to illustrate the benefits provided across different ecosystems.
Let’s start with Nutrient Neutrality: Nutrient Neutrality is a compliance scheme which is based on the ecosystem service of ‘nutrient mitigation’ produced by river habitat, for instance wetlands creation, restoration and management. It was introduced to reduce the impact of pollution into UK river catchments caused by increased nutrient load from new housing developments in the form of nitrates and phosphates. The mitigating benefits delivered by land managers are ascribed a unitary value - in a sense turning it into ‘natural capital’ - which developers can purchase in the form of credits to offset or mitigate their impact.
If we extend this river catchment scale example, there are additional co-benefits that can be sold on voluntary markets. For example, if native woodland is planted along a river catchment, this not only supports the aforementioned nutrient mitigation, but also produces quantifiable natural capital in the form of woodland carbon; the creation of new habitats also increases biodiversity; and the more complex root systems help to retain water in the soil thereby slowing the flow rate and providing natural flood management benefits. There is also the more established voluntary carbon market at play here. Currently, in the UK the sale of natural capital in the form of carbon units is regulated by the Woodland Carbon Code whereby sequestration rates (emissions of carbon removed from the atmosphere) are calculated, market value ascribed, and units sold by project developers to offtakers, such as corporate entities as part of their net zero strategy.
Referring again to the Woodland Carbon Code gives a good example of how returns work. Pending Issuance Units (PIUs) for carbon are essentially a promise for a certain amount of carbon that will be sequestered over a specific period and allow for funding to be allocated ‘up front’ and support project development. For instance, if I plant tree species X, I know from existing data that it will take Y number of years for that tree species to grow and I have a good estimate of how much carbon it will sequester over its lifecycle and at what stages. Using existing carbon pricing and carbon curves, I can inform an investor that it will take Z number of years for that carbon to become a verified unit. At that point, the PIU will turn into a Woodland Carbon Unit (WCU), which means it has fulfilled its purpose and can be retired. The PIU provides the funding to plant and manage the tree so that it produces the carbon it is forecasted to. Once it becomes a WCU, it can then be used to offset or report against a company’s emissions.
ELJ: You’ve mentioned some important co-benefits. Could you expand on this idea of benefits that natural capital can deliver?
IM: It's important to understand who's involved in the flow of natural capital creation and associated benefits. If we take the natural flood management element of the example just mentioned, we can see how the benefits impact different stakeholder groups. For example, communities living at the bottom of a river catchment will benefit from the flood mitigation generated by the new woodland habitat creation. But beyond that, there are also benefits to companies operating within the landscape, such as infrastructure. If a railway track is at risk of flooding due to increasingly severe weather events, then the co-benefit of natural flood management will help to manage the risk posed to that company’s asset. This is obviously within a UK context - elsewhere, indigenous peoples are very important to consider with prior informed consent on any project development, and to ensure the appropriate benefit sharing mechanisms are in place. But I work in the UK geography, and am speaking from my own experience.
ELJ: What is the market for natural capital investment?
IM: Again, referring back to the woodland planting given earlier in this article helps to explain where investment comes in. Investors play a key role in providing the necessary up-front, capex funding required to set up the woodland planting project - think of spades, fences, saplings, and so forth. The natural capital revenue generated in the form of woodland carbon is where the investor will get their return from. Beyond this type of investment, if the aforementioned railway company funds projects delivering natural flood management benefits, their returns come in the form of protecting their assets and therefore their company revenue; it’s a win-win.
This is in relation to voluntary markets, but there are also compliance mechanisms at play in the UK too, like Nutrient Neutrality schemes. Biodiversity Net Gain (BGN) is another example of a compliance mechanism, where the impact of a housing development on local habitats is quantified, and the required number of BNG units to produce a minimum ten percent biodiversity uplift is calculated. This market is highly localised, because Defra requires that in the first instance biodiversity uplift must be at least attempted within the boundaries of development. Where this isn’t possible, developers can purchase credits from the local authority as approved within their planning application, and failing that, they must purchase statutory credits from the Government. In the latter instance, the developer is essentially ‘investing’ in the biodiversity uplift generated by Government-regulated projects.
ELJ: Tell more more about what else exists, beyond compliance markets?
IM: BNG and nutrient neutrality are two compliance mechanisms. But as already discussed there are voluntary mechanisms for woodland, and peat under the Woodland Carbon Code (WCC) and the Peatland Carbon Code (PCC) which are two of the most established voluntary UK markets. In other words, those which have no mandated requirement for actors to participate. In the case of the WCC and PCC, Pending Issuance Units (PIUs) and Woodland Carbon Units (WCUs) or Peatland Carbon Units (PCUs) are the the form of natural capital returns generated from projects under these schemes. There are a number of other voluntary market mechanisms and codes being created, such as the UK Saltmarsh Code and Soil Carbon Code, but these are much less developed. Generally speaking, it is expected that these voluntary markets will pave the way for compliance markets but it is essential that governments create appropriate legislation for this kind of regulation to occur.
ELJ: You’ve mentioned BNG and Nutrient Neutrality in the context of the natural capital market in the UK. How do these translate into opportunities for buyers and suppliers in the UK?
IM: BNG provides a great framework for wider voluntary biodiversity restoration in the UK, but the state of the market currently is that supply outstrips demand. The nutrient schemes and BNG schemes are small right now and as such, the growth of UK compliance markets is slower than anticipated. However, opportunities for buyers and suppliers will most likely increase as, for example, when the government pushes to meet housing targets (progress against targets was being held up as a result of constraints placed on development by Nutrient Neutrality and BNG legislation). As has already been mentioned, the WCC and PCC are the most established voluntary markets in the UK at the moment, but as European reporting mandates increasingly encourage corporate entities to understand how their supply chains rely on nature and what the associated risks and opportunities for restoration and regeneration look like, it is likely that we will see growth in these markets too.
ELJ: Is the UK not one of the most nature-depleted countries in the world? What can we do to improve the situation?
IM: Yes, it’s true that the UK is one of the most nature-depleted nations - ranking 228th out of the 240 countries in the Biodiversity Intactness Index. But, it’s important that we don’t take a defeatist attitude and note that we have everything we need to address the issue. From a financial perspective, the UK, particularly London, has some of the deepest ‘capital pockets’ in the world. We are also a centre for innovation when it comes to natural capital accounting, technology for data monitoring, reporting and verification (MRV). In this sense, we have already got to grips with the scale of our domestic nature crisis and the resources (amount of capital) required to address it.
With a new Government in place, what we need now is innovation and strong signalling of support for both compliance and voluntary markets if we’re going to unlock this capital and leverage it to meet legally binding national and global targets to reverse biodiversity loss and achieve net zero emissions.
There is currently a £50 billion funding gap that private investment has a crucial role in closing by deploying large amounts of capital through different mechanisms, such as equity and debt. That’s the way to improve the situation, which is where organisations like Great Yellow come in! On the demand side, we are regulated by the FCA to raise equity and to facilitate transactions of large scale investment into nature restoration. By creating standardised commercial and financial structures, contractual agreements, and investment vehicles, we are aiming to develop standardised - and crucially, verified - nature and carbon market infrastructure which has the potential to support global efforts in this space.
On the supply side, we work with schemes such as Defra’s Landscape Recovery and Leveraging Investment in Natural Capital (LINC) that support aggregation of the smaller-scale projects which would otherwise fall short of the larger-ticket requirements for investment. This is key from both a financial and ecological perspective as - using BNG as an example - you might only need 20 acres to access those markets, but this wouldn’t appeal to an investor. So by working on projects up to tens of thousands of hectares which convey landscape scale ecosystem restoration and community benefit, we’re helping to make nature restoration a more attractive proposition to an investor.
ELJ: You’ve discussed infrastructure companies funding these nature-based solutions - at least, in an ideal world. Who else is investing in natural capital?
IM: In an ideal world, anyone who is starting to map out assets and dependencies on nature! It gets very nuanced very quickly, but generally speaking, legislation reporting requirements which are backed by the likes of the Science Based Targets Network (SBTi) are driving understanding around dependencies on nature – take CSRD in Europe, or the TNFD. These reporting frameworks are asking businesses to identify and then measure dependencies and impact on nature, in the same way that they’re being required through TCFD to report on their carbon emissions. By mapping all of this, they get an understanding of where their supply chains are exposed to environmental risks, as well as the opportunities within their supply chain.
ELJ: So if a company wants to invest in natural capital, what investment mechanisms are most popular?
IM: Until recently, much of the investment into nature restoration came from philanthropy because non-profit organisations like the Wildlife Trusts, WWF and the RSPB, had been taking the lead on everything to do with conservation. But in the last few years, private finance has scaled up its involvement. Depending on the requirement of capital and agreements on return quantum and timeframes, this could be in the form of equity or debt, but we’re also seeing pension funds beginning to act in this space too. At a global level, debt-for-nature swaps are beginning to happen, and green bonds are being traded between countries. In short, there are lots of different financial mechanisms, and market operators are becoming increasingly creative in how they’re creating and applying them.
ELJ: If private finance is increasing, how can natural capital create long-term financial returns?
IM: Good question! The theory is there, but as these are emerging markets, the confidence to act isn't quite matching the appetite. Investors are used to faster, higher return rates than those generated by the slower growth of ecosystem services and natural capital such as woodland carbon. In the absence of established markets - particularly secondary markets - investors are hesitant to move into the voluntary space.
There are a suite of natural capital assets available, it is possible to create a very diverse portfolio, encompassing a wide variety of assets such as peatland, water quality and biodiversity. While the issue of funding and stacking can be discussed in another conversation, it is important to note that the increasing types of natural capital assets help diversify portfolios and reduce risk. Since these assets function in different ways and progress at different rates, they can generate returns over a longer period.
ELJ: What’s the link between natural capital and climate change?
IM: This is an important question, and points towards the vital importance of tackling the nexus of climate change and nature - not either one in silo from the other, Because put simply, ou cannot solve one without addressing the other. Historically we have treated nature and climate as separate issues, but this is changing, which is why the government is increasingly being called upon to produce clearer policies around stacking and bundling credits in a holistic way. And it’s also why the value of carbon is changing as methodologies increasingly take into account the associated nature co-benefits that come with creating ‘carbon+’ or more premium carbon.
The associated co-benefits of carbon credits will drive the value of carbon on the market, and in turn generate the necessary high-integrity and equitable impact. But when it comes to investment and true-cost accounting, demonstrating the additionality— and avoiding double counting amongst other pitfalls—becomes difficult because the carbon and biodiversity values are so interlinked. For various reasons, co-benefits need to be disaggregated at both the natural capital supply and demand end of the spectrum to encourage engagement with these markets. In so far as this engagement is what is funding the net zero and nature positive actions of governments and investors, all the way through to supply chain managers, land stewards and custodians of nature, it is crucial that we accelerate the creation of policy that supports growth of investment in natural capital to create regenerative - not extractive - economies that address climate breakdown and biodiversity loss.