- With an estimated $711bn needed by 2030 to reverse biodiversity loss, natural asset companies (NACs) aim to channel money into natural capital.
- NACs are based on a new accounting framework that includes “statements of ecological performance” alongside traditional financial metrics.
- Specialist biodiversity investors question how NACs will accurately price ecosystem services and effect genuine impact.
“If somebody waved a magic wand over the world of natural capital and came up with a credible, scalable and efficient way of gathering up the relevant metrics and reporting on them, they would be pretty wealthy,” says Martin Davies, London-based head of natural capital at Nuveen, a $1.2trn US asset manager.
Wealthy indeed – and much in demand, given that average annual investment of $711bn will be needed to reverse biodiversity loss by 2030, estimated the Paulson Institute in 2020. To put it another way, the $133bn going into ‘nature-based solutions’ will need to at least treble by 2030 and quadruple by 2050, says the UN Environment Programme’s ‘State of Finance for Nature’ report published in May last year (see chart below).
Private sector investment will need to fill much of this vast funding gap. But while there are any number of products offering liquid exposure to net-zero emissions-related investment, such as green bonds, such opportunities are lacking in the natural capital space.
Enter natural asset companies (NACs), a new form of listed vehicle that aims to convert natural assets into financial capital and, in doing so, protect ecosystem services. These are the direct and indirect contributions that ecosystems provide for human well-being and quality of life, such as providing food and water and regulating the climate.
Devised by Washington, DC-based Intrinsic Exchange Group (IEG), the NAC structure will provide quantifiable exposure to these services, says Douglas Eger, IEG chief executive. The most notable of these is probably carbon sequestration, but clean water and healthy soil are other examples. The value of such services has won increasingly widespread recognition in recent years. But quantifying and accounting for them has been notoriously tricky.
Unveiled in September last year, NACs will hold the rights to the ecosystem services produced by natural assets such as forests, marine areas and farmland. These vehicles will be listed on the New York Stock Exchange (NYSE), with the proceeds of their initial public offerings (IPOs) used to manage and, ideally, improve the productivity and ecological benefits of these assets.
NACs raise questions
Seen by investors as a something of a hybrid between special-purpose acquisition companies and real estate investment trusts, NACs have been given a cautious welcome by some, but have also raised questions.
Vicki Benjamin, co-founder and CEO of US biodiversity-focused fund manager Karner Blue Capital, says: “Buying and monetising conservation assets will be fundamentally positive if operators can demonstrate that they will institute sustainable land processes in their asset management protocols.
“The risk lies in their ability to accurately determine the present and terminal value of the cash flows and sell them to investors using an appropriate discount rate,” she adds.
It is not yet clear how NACs will work from an investment standpoint, says Edward Lees, London-based co-head of the environmental strategies group at BNP Paribas Asset Management. “I’d like to see more evidence that the spun-off vehicle is sufficiently well-capitalised to make genuine change and deliver the revenue and earnings that would be worthwhile for investors.”
This is a key point, especially given the sheer amount of capital needed to tackle biodiversity loss. IEG says it hopes to bring to market “hundreds of NACs representing several trillion dollars’ worth of natural assets”. But, initially at least, the flows into NACs are unlikely to be huge, especially from big institutional investors, at least partly because this is a new product with no track record. Eger says family offices have been the most receptive to the concept among investors he has spoken to so far.
Another question mark is that while NACs appear to provide measurable exposure to ecosystem services, in practice that may be easier said than done. Commercial production of nature, biodiversity, water quality and carbon sequestration are all intrinsically linked, says Davies at Nuveen. “I’m not sure you can just pull out the non-food and timber ecosystem service provision of land-based activities, repackage it as a company and trade it.”
There is also the issue of how NACs will ultimately exercise impact on biodiversity. Andrew Niebler, co-founder and managing director of Karner Blue Capital, says: “I think NACs have tremendous potential for bringing investment into the natural areas of the world that desperately need it.
“The question is: can they do so in such a way that they enhance the ability of indigenous people to act as stewards of the land? If NACs don’t incentivise these communities and tap into their skill sets, they are unlikely to be a workable solution over the long term.”
Pricing natural capital
After all, the challenges that NACs set out to solve – how to measure and quantify natural capital and how to monetise such assets – are complex. It’s understandable that some question whether these highly engineered products solve these issues.
One of IEG’s backers, the Inter-American Development Bank (IADB), said in a briefing last year that “at best, natural capital is inefficiently priced, but often it is simply not priced at all”. Yet by some estimates the natural economy could produce as much as $146trn in ecosystem goods and services a year, the IADB report adds.
To address the challenge of pricing ecosystem services, the IEG/NYSE initiative has drawn on the expertise of Robert Herz, former chairman of the Financial Accounting Standards Board (FASB), to develop a natural capital accounting framework to enable investors to measure the value of the ecosystem services generated by NACs.
“Companies’ traditional accounting methodology has failed biodiversity because it has only ever assessed the impact on natural capital of identifiable events,” IEG's Eger says. “This means it is never reported in the main body of a company’s financials until there has been an event like a fire, a flood or oil spill.”
For investors, this is likely to be too late. Hence IEG is proposing a bifurcated financial reporting structure that sets “statements of ecological performance” alongside traditional disclosure based on Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).
These statements are split into three parts. The first measures the value of the ecosystem services recognised by the UN System of Environmental Economic Accounting. The second aims to measure the direct impact of the assets created by these services, such as freshwater, food or fuel. The third – probably the hardest to quantify – is what Eger describes as the "non-use value" of nature.
“Ecologists and environmental scientists believe we are greatly underestimating this intrinsic value, so we are incorporating not just a use value, but also an option value,” he says. One way of looking at this is as a bequeathing value – or the worth of what will be handed to future generations, he adds. “In other words, we’re asking not just what an elephant or coral reef is worth on the basis of what it produces today, but on its intrinsic value.”
Backing from 'big four'
This appears to demand a substantial leap of faith for users of this framework. But feedback from the big four accounting firms has suggested they think it could work, Eger says. That paved the way for a dialogue aimed at securing regulatory approval for NACs.
The proposed rules have yet to be submitted to the US’s Securities and Exchange Commission, but Eger hopes IEG will be ready to submit its IPO filing by late summer or early autumn, with trading starting towards the end of 2022 or early next year.
IEG and the NYSE are already working on close to 100 projects. Some of these have the rights over landscapes measured in millions of acres, Eger says, potentially producing annual ecosystem services valued at several billion dollars.
However, providing enhanced reporting visibility addresses only part of the puzzle presented to investors in biodiversity. No matter how transparently they are audited, accounts themselves provide little, if any, guidance on valuation for investors weighing up an IPO.
The conundrum remains – especially for newcomers to the natural asset capital space, and that is most investors – of how to price an IPO in a virtual vacuum of comparables, benchmarks and other conventional valuation metrics.
IEG is to be applauded for its efforts to resolve this issue, but proving its concept may be a challenge.
