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Why repairing nature isn’t just a job for finance quants

Financial engineers are busy developing models and products to put a price on natural capital and help address biodiversity loss, but it is hard to scale up such complex and niche structures, argue experts. Others say such arguments are missing the point.

By Virginia Furness

Signs of life: The nature finance market is struggling to gain traction. (Photo by vencavolrab via iStock)
  • Quantitative analysts engineer and implement complex models to price and trade securities, but such structures are not suitable for scaling nature finance, say market participants. 
  • Structures such as the ‘rhino bond’ issued last month are too niche to attract the estimated $4.1trn needed to address biodiversity loss, say experts, and would require standardised data and key performance indicators linked to financial returns.  
  • The head of NatureVest says data will not be enough to measure positive impact on nature, and investors must accept uncertainty, as some pin their hopes on the forthcoming Taskforce on Nature-related Financial Disclosures. 

It took a team of scientists, financiers, conservationists and non-government organisations six years to structure and price the world’s first ‘rhino bond’, a nature finance deal linking coupon payments to the rise or fall of South Africa’s rhinoceros population.  

Thanks to the perseverance of the deal’s architects, some R152m ($10m) of private investment will now be paid to two South African protected conservation areas – Addo Elephant National Park and Great Fish River Nature Reserve – to increase the number of black rhinos, an endangered species. 

Supporters say it is an important step in linking biodiversity and financial outcomes. “This is how you improve the market,” says Fabrizio Palmucci, senior adviser at the London-based Climate Bonds Initiative. “There’s now a methodology for the measurement of rhinos. That’s how you start to have a benchmark. But is it scalable? I’m not sure.” 

The deal’s small size and heavily structured design means it will not appeal to the market masses, say experts – despite claims by the deal arrangers that it brings impact finance to the mainstream.  

“It’s always important for there to be these smaller innovative transactions – currently, the mainstream capital markets don’t tend to focus these bespoke, artisan-type deals,” confirms Abyd Karmali, managing director, ESG advisory at Bank of America. “To get the large flows of capital, the opportunities structured need to be benchmark size.” 

Niche plays

That leaves the UN-estimated $4.1trn in extra financing needed by 2050 to address biodiversity loss and land degradation a long way off. Tackling such issues may be key to helping slow or reverse some of the impacts of climate change, but it remains a niche play in the financial markets; private funding accounts for a small chunk of the $133bn of investment in this area annually (see chart below). 

Specialist investment platforms such as Nuveen Natural Capital – launched in February – are springing up, while financiers are working to create investment opportunities like the rhino bond, as well as blue bonds and other equity-based products, but such nature finance offerings remain scarce. 

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Large-scale investment in nature and biodiversity would require standardised data and key performance indicators (KPIs) that can be linked to financial returns, experts argue, and this appears a long way off.  

“The market only scales if things can be put in a box, and nature can’t be put in a box,” says the London-based head of ESG debt capital markets (DCM) at a large international investment bank on condition of anonymity. “The way [investments] scale is if they become commoditised and standardised; the more you structure something, the more difficult it is to attract capital.”  

However, financiers have typically found ways of pricing and boxing up things that might have been considered unsuitable for such treatment – and in some cases should arguably not have been structured in the first place. CDO-squared, anyone?

Still, nature finance solutions remain largely confined to academia so far, the DCM head says. Calculating high conservation value (HCV) is an approach first set forward by the international non-profit Forest Stewardship Council for forest assets, while London-based NatureMetrics is working to value nature on a more empirical basis through DNA identification. From this empirical basis, future cash flows can then be calculated. “If you can’t do that, you can’t engage the capital markets,” he adds.   

Metrics needed

Without metrics there is nothing to measure or monetise, agrees Cédric Merle, head of the centre of expertise and innovation for the green and sustainable hub at Natixis Corporate & Investment Banking. Metrics such as Mean Species Abundance – a measure of the intactness of local biodiversity – and other relevant KPIs “are not really applicable to corporates and businesses”, he adds.  

As the long gestation period of the rhino bond shows, nature cannot be easily captured on a spreadsheet, making it almost impossible for money managers to apply traditional risk-return investment strategies.  

The rhino bond development team had originally set out to raise the financing through a traditional social impact bond – an outcomes-based model where the investor’s entire capital is at risk, says Oliver Withers, who had led the project at the Zoological Society of London before joining Credit Suisse as biodiversity lead in May last year.  

But the instability of the local rhino population meant that investors were only willing to put a much smaller portion of their capital at risk, Withers says. The animal’s population growth could be as high as 12% a year but equally, thanks to poaching and biological constraints, theoretically the whole population and thus principal investment could be wiped out. Hence only the coupon is tied to the rhino population growth rate.  

The team also needed to secure grant money from the UN-supported Global Environment Facility (GEF) to cover the coupon payment, as the rhino project would not generate enough financial revenues on its own to cover the cost. The GEF provides funding to assist developing countries in meeting the objectives of international environmental conventions.

No silver bullet

While the deal’s architects say the rhino bond is both replicable and scalable, they do not claim it will be a silver bullet for all conservation efforts, Withers notes. “It would be fantastic if we could value nature holistically, so that capital could be allocated more efficiently in order to address the conservation funding gap. 

“It’s an instrument designed to work for the most important conservation areas with the best management teams with demonstrable track records,” Withers adds. “It talks to the idea of systems change. If we can start deploying capital more effectively in the conservation sector, we can achieve a bigger bang for our buck.” 

But while many see more and better data as key to the expansion of nature finance, Charlotte Kaiser, New York-based managing director overseeing NatureVest, the impact investing arm of The Nature Conservancy, says heavy engineering and a laser focus on data collection are not the answer.   

The rhino bond is a good example of why, she says. “We cannot spend six years structuring every transaction that supports conservation. 

“We will never get the scale and pace [of nature-focused investment] we need if people remain obsessed with data,” Kaiser adds. “My hope is that as we see more and more of the impact of climate change and damage to biodiversity, people will start to have more instinct for this analysis in a more holistic way and less obsession with financial metrics. 

“Investors are looking for a clear outcome – that is what appeals to people about the rhino product,” she says. They must “get comfortable with uncertainty. [We need to] get directionally close enough and be comfortable with the good not the perfect.” 

Nature finance: looking to TNFD

Many in the industry are pinning their hopes on the Taskforce on Nature-related Financial Disclosures (TNFD), which is under industry consultation and due to be released in the third quarter of 2023.  

Encouraging companies to disclose and think about their impact on nature and how nature affects their business models will become a powerful tool, says Gavin Templeton, a partner at Pollination, a specialist climate change investment and advisory firm.  

Just as the TCFD (the Task Force on Climate-related Financial Disclosures, launched in 2015) has catalysed the carbon markets, he says he expects the TNFD to do something similar for biodiversity markets, such as drive the adoption of biodiversity offsets.   

Kaiser adds: “You can never perfectly analyse risk, but even asking the question [in relation to biodiversity] is something a huge number of investors aren’t doing,” Kaiser says. “As we’ve seen with TCFD and companies’ disclosure, [such data] will never be as good as a liquidity ratio, but it will force them to think about a systems-level change, and that is important.” 

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