How Do We Get Emerging Economies to Invest More in Large-Scale Nature-Based Solutions?
This article is published in collaboration with Arup.
Nature provides huge value to our society and economy. Because its preservation and restoration are paramount to addressing the climate emergency, governments have set the course for significant levels of investment in the decades ahead. But the scale of the task is immense.
Biodiversity continues to decline at alarming rates while levels of carbon dioxide are still rising. COP26 in Glasgow welcomed nature to the table, recognizing the interlinked global crises of climate change and biodiversity loss. The Glasgow Leaders’ Declaration on Forests and Land Use saw 145 nations commit to significantly increase finance and investment to halt and reverse forest loss by 2030.
Nature-based solutions, aiming to protect ecosystems such as forests, agricultural land, peatlands, mangroves and oceans while addressing societal and economic challenges, are widely accepted as the way forward.
Governments are unable to fund all the interventions that are needed, however. This is particularly true in cities and metropolitan areas, which produce more than 70% of global carbon emissions—and is of even greater concern in emerging economies.
Blended finance, the strategic use of development finance to mobilize additional finance toward sustainable development in emerging countries, has long been seen as the key to unlock innovative projects and demonstrate the value of nature as an infrastructure class. However, despite significant interest from investors, nature-based solution projects delivered by blended finance in cities are still thin on the ground. But there is much we can do to change this.
Perceiving the value
While vehicles such as bonds, equities, and real assets have been used in this space, the impacts of nature-based solutions are often unclear to investors, or difficult to quantify and validate. Return is perceived as low, with long payback periods, and project sizes have been relatively small. The median transaction size of nature-based solutions is estimated at around $9.3 million, making the effort to structure transactions hard to justify given their higher risks.
There are some successful examples, however.
Under the DC Water project, in the District of Columbia, a bond funded the construction of green infrastructure such as green rooftops and landscaped water retention areas to capture stormwater runoff. The nature-mimicking green infrastructure avoided some of the cost to DC Water of providing water to consumers through gray infrastructure such as additional water pipes. A portion of the cost savings made by the project’s beneficiaries, deriving for example from reduced stormwater damage to coastal businesses by investing in natural systems that protect coastlines, was used to provide a return to investors. If the project produces stormwater runoff reduction greater than 41% of the measured baseline, DC Water will make a one-time additional outcome payment to investors of $3.3 million.
In emerging economies, it is particularly hard to attract private finance for urban investments, as the risks are compounded by political and sovereign risks. The public and private sectors must work together to promote the standout examples of nature-based solutions providing robust returns while delivering on nature outcomes.
Some promising developments include debt swaps—where a portion of a country’s external debt is relieved in exchange for domestic investments in the conservation of biodiversity or mitigation, adaptation or resilience to climate change. The Nature Conservatory lent funds to Belize to buy back $553 million of the country’s debt at a discounted price, reducing it by 10% of gross domestic product. By allowing Belize to repurchase and retire existing external and commercial debt, the loan created significant annual cash flow and established an endowment fund for conservation activities that generate revenue. Belize agreed to spend about $4 million a year on marine conservation until 2041. It will double its blue economy project investments including marking protection parks—spanning coral reefs, mangroves, and the sea grasses where fish spawn—from 15.9% of its oceans to 30% by 2026.
The potential for Development Finance Institutions to mobilize private capital through blended finance is significant, given their experience and expertise in arranging top-tier equity and loan investments in emerging countries, coupled with their higher risk tolerance, they can play a key role in making nature-based schemes attractive for private investors.
Driving investment, accelerating solutions
Although cities provide fertile ground for investment in nature-based solutions, very little blended finance is currently being directed to urban projects in emerging markets. In order to move from individual, small-scale projects to large investments, it is essential that all stakeholders have a role to play.
Multilateral development banks and the public sector need to identify a more systematic way of identifying projects and collaborating with a wider range of stakeholders. A systems approach that builds upon and integrates effective sectoral actions can be highly effective in assisting cities identify and reveal opportunities that will generate investment return.
When multilateral development banks provide technical assistance facilities and concessional finance in support of nature-based solutions, their offerings often focus on training civil servants and strengthening project pipelines. While these are important issues to address, they are not sufficient to systematically identify nature-based solutions.
Multilateral development banks need to focus on strengthening city systems to deliver more bankable projects. This includes working closely with cities on how to plan for the future, design decision-making frameworks, set up institutional structures and governance, collaborate with stakeholders, and invite community participation. Thinking about green corridor networks, increasing green spaces, developing natural flood mechanisms—and how they are all connected in a systematic way—can help enhance the value proposition of nature-based solutions and attract more private finance.
By better understanding who can benefit from nature-based solutions in a city ecosystem, including financial beneficiaries ranging from insurers to asset owners, it will be easier to build partnerships and generate robust financial returns. Rather than focusing on individual infrastructure sectors, for example restoration of a single wetland, projects need to incorporate an approach that supports integration between multiple angles to make the most of cross-sectoral opportunities and create synergies through a city’s natural assets. Adopting a portfolio-based approach where gray infrastructure can be replaced with green elements would unveil new sources of revenue and boost investment appeal.
How do you measure success?
Cities are fertile ground for nature-related projects: they consume 78% of the world’s energy, produce more than 60% of greenhouse gas emissions, and half of the world’s population lives in urban areas. Expanding green spaces in cities and nurturing natural systems that provide water, food, and clean air would not just keep residents healthy and reduce the impacts of climate change but also boost the local economy.
Significant barriers prevent the rapid upscaling of regional biodiversity-linked investments. They include unsatisfactory policy and regulatory frameworks, inadequate finance instruments, underdeveloped accounting frameworks, a lack of standardized data and measurements, and missing institutional design and coordination. As a result, nature-related projects in cities are typically funded by government bodies with limited blended finance. By clearing the path for would-be investors, clarifying which metrics and data will govern future investment, and strengthening the business case for it, cities can take a leadership role in attracting private finance.
Some nature-based solution sectors with well-established and widely understood verification providers, such as the forest carbon market, are growing rapidly. Other sectors, however, struggle to flourish as a result of bespoke verification models to validate impact. The public sector can encourage increased investment into urban nature-based solutions by providing floor prices, offering guarantees, and hosting auctions for the sale of ecosystem services.
Encouraging and shaping new market behavior is always hard to predict. But at the level of individual projects, there is much that can be done to accelerate much-needed investment. First, more collaboration is necessary between governments, developers, and investors around innovative project design that delivers higher-integrity benefits and more robust revenues from nature-based solutions compared with gray infrastructure.
More action must come from governments to develop a clear structure for the metrics and data that will govern future investments, including metrics on outcomes and the frameworks required to manage nature-based solutions over time. Finally, multilateral development banks must adopt an enhanced risk-taking strategy through the use of debt swaps or political risk insurance to attract much larger amounts of private finance.
Luke Thompson is a senior member of the City Economics team at Arup in London. Luke has over 15 years of experience working as an economist specializing in economic development and infrastructure investment advisory. He has worked with a range of clients including national governments, UN agencies, and multilateral development banks.
This story was first published by Arup on 28 November 2022.
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