Global | Publication | July 2023
With the current rate of nature loss, recognizing and addressing the nature crisis is now critical. Whilst government and public sector initiatives play a significant role in addressing the challenge, the scale of the threat will require the mobilization of private capital. With the significant potential for market creation and fund engagement, private finance may meaningfully support the management, restoration, and preservation of Africa’s natural resources.
The concept of ‘natural capital’ refers to the world’s stock of natural resources and ecosystems that together, yield economic, social and environmental benefits. It encompasses the earth’s natural assets of forests, rivers, oceans, soil, air, living organisms and geology, and has been viewed by many as a blind spot across global economies, with its potential often overlooked. In recent years however, there has been a growing recognition of the importance of the natural environment. The opportunities provided by natural capital, with nature emerging as an independent asset class, has created a shift in the investment landscape. Investment in natural capital is about attributing economic value to the preservation and restoration of the natural environment by recognizing the pivotal role nature plays in supporting both our economy and society, and the financial benefits that can accrue from natural capital.
Although private finance has, and is, playing a significant role in addressing the climate crisis, it has mostly overlooked the second key global environmental challenge: the nature crisis. The nature crisis refers to the rapid loss of biodiversity and the degradation and fragmentation of ecosystems worldwide. This crisis not only threatens the survival of numerous plant and animal species, but also puts the critical services that ecosystems provide, such as pollination, water purification, carbon sequestration and natural pest control at risk. Although public financing has been active in addressing this challenge, private capital is now essential for the preservation of global biodiversity. The UN Environment Programme estimates that total financing will, at a minimum, need to double to $384bn a year by 2025 to meet biodiversity goals. Investors are beginning to recognize the economic rationale for such investment, with the World Economic Forum estimating that nature and biodiversity protection could generate $10tn annually in business opportunities.
COP15 brought to light the potential of natural capital through the adoption of the Kunming-Montreal Global Biodiversity Framework1 on Biological Diversity, which established both short-term and long-term targets to promote conservation and sustainable use of biodiversity. The African Development Bank (AfDB) however, recently further highlighted Africa’s potential for nature-based investing in a flagship report on the African Economic Outlook for 2023, setting out private investment opportunities in Africa’s natural capital.
Africa hosts a quarter of global biodiversity and, according to the AfDB, natural capital accounts for between 30 percent and 50 percent of the total wealth of African countries. At the same time, the balance sheets of African governments are under pressure and therefore, public sector funding of conservation is being squeezed.
Various initiatives are coming into play to support private investment in natural capital in Africa. A key example is the African Natural Capital Alliance (ANCA), a body of financial and governmental institutions working to ensure African policymakers and regulators better integrate nature into their decision-making. The ANCA acts as a key advocacy group, with a focus on promoting the Task Force for Natural Finance Disclosure framework2 and the region’s adherence to it. The ANCA works with financial institutions to encourage structured feedback and input into nature-related frameworks and standards to ensure they align with the needs and realities of African jurisdictions. The ANCA’s key focus is on long-term biodiversity policy development and best practice sharing among financial institutions.
The Natural Capital for African Development Finance (NC4-ADF) is also driving scaled natural capital investment in Africa. NC4-ADF is a joint initiative led by the AfDB and the Green Growth Knowledge Partnership with a focus on applying natural capital approaches to infrastructure projects in Africa, pushing multilateral development banks in Africa to support nature capital initiatives, integrating natural capital into sovereign credit ratings, and raising capacity for natural capital accounting in finance and infrastructure decision-making.
Investment in natural capital in Africa can take various forms. Although investment has traditionally been directed towards the natural resources derived from nature-based projects, the associated ecosystem services and benefits that natural assets provide to humans can also be harnessed and monetized. These include benefits such as carbon sequestration, biodiversity, pollination, water and air purification and soil protection.
Whilst forestry, agriculture, mining and marine-based projects across Africa have established markets and revenue streams (primarily through income derived from natural resource extraction), the nature asset class and related biodiversity enhancement has the potential to generate financial returns through unconventional and untapped sources of revenue.
Conservation and ecotourism, for instance, present avenues for investment in, and returns from, responsible tourism and recreation activities, as well as community-based conservation initiatives. Sustainable agriculture practices, such as agroforestry, organic farming and precision agriculture presents an additional opportunity for nature-based investment. Improvements to food security and soil health, and the reduction in agriculture’s environmental footprint and water consumption, supports the adoption of more sustainable agricultural models resulting in greater market value and higher revenues. Investments in these practices can help unlock Africa's agricultural productivity whilst preserving valuable ecosystems.
The liquidity profile and investment time horizon should be considered. Many natural capital projects can have 15-20-year terms, with some regenerative projects exceeding 40 years. Such projects are therefore particularly attractive for long-term investors with net-zero and biodiversity-related objectives. The value of the financed land must be revalued, with all ancillary benefits accounted for, at the end of the investment period in order to determine the rate of return. It is estimated that such projects can achieve an internal rate of return of 6 percent to 10 percent, with both project type and scale key factors in determining such returns.
Investors are looking to more innovative ways in which to grow this rate of return, with a particular focus on stacking and bundling assets. Creating and combining multiple revenue streams from a single project is one approach currently being explored to scale investment in nature-based projects.
With interest in natural capital rising, there has been a surge in nature-based fund establishment that offer investment opportunities in aggregated project portfolios. Aggregating small projects with diverse natural capital revenue streams into a single investment will help diversify investment risk profile and lower transaction costs. This is a rapidly evolving area. It is no longer only specialized asset managers offering natural capital strategies – mainstream fund houses are also now taking interest in this asset class.
New market forms of income streams are also being considered. A biodiversity credit-based system is becoming increasingly attractive, building on the frameworks established by the carbon markets. Biodiversity credits are currently under development which are intended to be tradable biodiversity units based on a quantifiable impact. As seen with the carbon markets, trading in these credits will direct private finance into the biodiversity conservation projects under which such credits are generated. Establishing integrity in a nascent biodiversity credit market will be crucial.
An existing mechanism which has been established in the voluntary carbon markets is the ability to ‘tag’ a carbon credit with a supplementary biodiversity additional attribute or co-benefit. The value and integrity of carbon credits which have this additional attribute is enhanced due to the fact that the carbon credit is not just representing the removal or reduction of a tonne of carbon dioxide from the atmosphere, but is also representing a positive biodiversity impact. If the requirements of the relevant voluntary standard (or certification body) are met, regenerative agriculture and sustainable forestry projects which can generate carbon credits by reducing or removing carbon emissions, may also be eligible for obtaining a biodiversity additional attribute which would be tagged or ‘bolted on’ to the carbon credit.
Complexities of valuation and pricing are key challenges to widespread investment in natural capital across Africa. Natural capital, by its nature, does not have a direct market value – resulting in the measurement and assignment of value to biodiversity proving difficult. To both incorporate natural capital into fund portfolios and develop alternative market-based mechanisms, quantitative measurements to assess biodiversity and price biodiversity credits will be required. In respect of biodiversity credits, buyers need to be able to distinguish between credits that have differing levels of biodiversity benefits and therefore integrity.
The policy and regulatory landscape for natural capital preservation is still evolving and varies extensively between jurisdictions. As noted above, most engagement to date has focused on raising awareness and knowledge of the risks and opportunities that natural capital provides, rather than substantive policy or legislation development. As with all nascent investment types in Africa, a clear and predictable regulatory regime will help provide clarity and certainty to investors, increasing appetite to invest in, and hence scale the development of, natural capital projects. Natural capital is an increasingly valuable part of Africa’s natural resources and must be legislated for and valued as such. However, care must be taken that reactive legislation does not jeopardize future investments. Private sector participants should therefore involve relevant government authorities in early-stage constructive dialogue.
Investment in natural capital must also involve the local communities whose heritage it represents. Meaningful and early-stage community engagement and alignment of stakeholder interests is essential for the success of natural capital investment.
The establishment of baselines and methodologies, standardization of valuation methods and improvement of data availability and collection will also be key in overcoming barriers to investment. Improving satellite imagery and other cutting-edge technology is a key part of this. As has been seen with the carbon markets, any biodiversity impacts must be capable of being properly quantified in order to build integrity in this asset class and create real change.
Addressing these challenges requires collaborative efforts from financial institutions, governments, conservation organizations and local stakeholders – and we anticipate increasingly frequent and close collaboration between these groups as the natural capital asset class develops.
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