Protecting our natural areas is one of the most important yet challenging things we can do as a society. Our wetlands, forests, and marine areas prevent floods and fires, store carbon, and protect biodiversity. One long lived financial mechanism that has been utilized for conservation is Payment for Ecosystem Services (PES). A new, private sector based sustainable investing mechanism – Natural Asset Companies (NACs) – was created in 2021. The NYSE and Intrinsic Exchange Group (IEG) aim to protect natural ecosystems through this new publicly traded asset class of NACs.
History of Payment for Ecosystem Services
Protecting ecosystems through payments has been around since the 1950s. In PES schemes, people managing and using natural resources, typically forest owners or farmers, are paid to manage their resources to protect watersheds, conserve biodiversity or capture carbon dioxide. The global value of ecosystem services is estimated to be worth $125 trillion per year. PES schemes are present in the US and internationally.
United States
The 1936 Soil Conservation and Domestic Allotment Act enabled the US government to pay farmers to conserve soil and reduce erosion. The 1956 US Agricultural Act authorized the government to pay for land improvements that increased soil, water, forestry, or wildlife quality if the farmer would agree not to harvest or graze contracted land. The program has evolved into the Conservation Stewardship Program under the 2018 Farm Bill.
Costa Rica
Costa Rica has implemented since 1997 a national PES program focused on forest conservation. To date, more than 18,000 families have benefited from the program, with an investment of $524 million in the PES projects and more than 1.3 million hectares of forest under PES contracts.
Marine Conservation Areas
In 2019, The Nature Conservancy (TNC) announced its plans to increase the world’s marine protected areas by up to 15% within a decade. The initiative follows a massive project TNC piloted in 2014 to help the Republic of Seychelles protect 30% of its national waters.
Through the Blue Bonds for Conservation program, TNC helps island and coastal nations to refinance their national debt and create long-term sustainable financing for marine protection, sustainable economic development and climate change. The Government of Belize made a September 2021 announcement that the country expects to work with TNC to finance a debt restructuring.
Why Natural Asset Companies?
NACs were created in 2021 as a new way to enable natural asset owners to convert nature’s value into financial capital. This capital can then be used to finance conservation and sustainable development. The asset class was developed as an alternative to non-profit and public sector-focused PES programs. The aim of NACs is to enable wider exposure to the opportunities created by the estimated $125 trillion annual global ecosystem services market.
What are Natural Asset Companies?
NACs are sustainable enterprises that hold the rights to ecosystem services produced by natural, working, or hybrid lands. The NAC manages a parcel(s) of land or marine area(s). These companies are typically characterized in the following general categories:
- Natural Areas: protecting and expanding existing conservation areas and intact landscapes, including restoration of degraded lands, to protect biodiversity and ecosystem services production
- Working Areas: converting existing conventional agricultural practices towards regenerative practices, which increase the health of the land and the surrounding air and water, provide room for nature to expand, increase farm incomes and improve the nutritive value of food
- Hybrid Areas: integrating natural lands, working lands, and built infrastructure in a single project to produce the most value across diverse assets
Who Is Developing the Natural Asset Companies Framework?
IEG has developed an accounting framework to measure ecological performance. IEG received initial funding from the Inter-American Development Bank (IDB), The Rockefeller Foundation, Aberdare Ventures and Entertaining Ideas. The NYSE is also a minority investor in IEG.
The NYSE will develop and seek Security Exchange Commission (SEC) approval for listing for NACs. Upon SEC approval, IEG and the NYSE will work with the first NACs to help prepare them for listing and trading as publicly held entities on the NYSE.
How Do Natural Asset Companies Work?
NACs Creation Process
The process to create a NAC can be seen in Figure 1.
NAC Valuation
The ecosystem services can be measured through a process called Ecosystem Service Valuation (ESV). Values included in the valuation can be seen in Figure 2. Further details are provided in the appendix.
The ecosystem service values are combined with the traditionally monetized revenue streams to provide the complete NAC value.
When Will NACs Be Available?
NAC listing standards and accounting information will be filed with the U.S. Securities and Exchange Commission in the fourth quarter of 2021. If the SEC grants approval, NACs may be publicly trading as soon as 2022.
Can NACs Succeed?
I had questions about whether NACs could be a successful means for conservation. To find answers, I looked to PES programs. Karin Berardo is the Sustainable Debt Director for NatureVest at The Nature Conservancy. NatureVest is TNC’s impact investing unit. Karin is enthusiastic to see this conservation finance innovation that uses a private-sector vehicles like NACs. However, she is also cautious and eager to better understand how the vehicles will work. She and I discussed two potential NAC challenges – motivations and owners. We also discussed a potential solution to the challenges.
Motivation
NACs are privately held assets. Private companies focus on returns, typically in the form of financial returns. Generating sufficient financial returns from conservation areas is challenging, especially as markets for ecosystem services, are still developing.
Many investors are still in the process of defining clear conservation and other environmental, social, and governance (ESG) performance metrics. However, in many cases they expect these ESG benefits to be an addition to market-based financial returns. Conservation returns may be a secondary priority.
Creating and maintaining conservation areas requires essential but time-consuming (and potentially costly) activities. These activities include capacity building and stakeholder engagement. Some investors may not yet have the patience required for these activities. It will take time to create the recipe that rewards investors with financial and ESG returns and provides long-term ecosystem conservation.
Ownership
PES experience has shown that delineating conservation areas and productivity rights is challenging. Delineating privately held conservation areas may be even harder. Who is allocated, and trusted with, the right to manage and potentially profit from a NAC?
IEG states that NACs can be owned by citizens, government, investors and other stakeholders. Some of these potential owners, e.g. governments, may not be accustomed to either focusing on financial returns. Others, e.g. investors, may not be used to focusing on conservation returns. Creating ownership structures that enable both will require coordination.
Solution
Blended finance solutions offer one potential strategy to overcome the challenges of motivations and ownership. Blended finance solutions combine public and private funds with one goal, such as conservation. As an example, Karin mentioned the Global Fund for Coral Reefs (GFCR).
The GFCR is a 10-year, $625 million blended finance vehicle established through a coalition between United Nations agencies, financial institutions, and private philanthropy sources. The GFCR supports business models that can sustainably finance key conservation and development goals for coral reefs via two initiative windows.
- Grants: Technical assistance, capacity development, monitoring, and evaluation are provided via the grant window that provides grants, recoverable grants and concessionary loans. These activities can help with prioritizing both financial and conservation returns. They can also help to diminish the challenges of ownership by clarifying stakeholders and both financial and conservation outcomes and strategies.
- Investment: The investment window direct commercial debt and equity into de-risked and well-define impact projects incubated during the grant window. The investment window can be complementary to the NAC structure.
How Can You Get Involved?
NACs may be available for purchase as early as next year. NACs may soon be an innovative asset that helps diversify sustainable investment portfolios. Visit IEG’s website to stay updated. Finally, learn more by listening to the “Inside the Ice House” podcast episode with IEG’s CEO, Douglas Eger.
Appendix
Intrinsic Value: The value of nature for what it is (that inherent quality unique to itself), rather than its utilitarian value to people. The model of nature as a productive workforce fits ecosystem service production but misses the complete value of nature. First, we don’t know all the services, nor their value so natural assets are more valuable than just the known services they produce. Second, nature has value beyond a benefit to humans — value in and of itself. We are using Intrinsic Value as the umbrella for values not yet identified or quantified as well as values such as cultural, social, aesthetic, spiritual, etc.
Natural Production: The value of goods and services produced by natural assets (ecosystem services). Though some services, like freshwater production may be monetized directly, most ecosystem services currently are not.
Store of Value: A Natural Equity is a store of value like any other security or monetized asset. The stocks of water, timber, biodiversity, soil, carbon, fish or other natural assets make life on Earth possible and are thus the ultimate store of value for investors.
Traditional Production: The use of natural resources, built assets, financial capital and labor to produce goods and services that may be valued and included in the rights granted to the Natural Asset Company or obtained by investment.
Risk Reduction: By recognizing positive and negative externalities, and the full suite of co-produced ecosystem services, risk is more transparent, can be reduced, better mitigated and in some cases converted into an asset/income stream where IEG Natural Equities reduce risk for other entities.
Countercyclical Assets: IEG Natural Equities may hedge against systemic economic downturns such as the 2007 financial crisis. For example, the value of, and demand for, potable water did not decline during the crisis. Even in a pandemic, nature is working 24/7 and retains value.
Financial Asset Realization: The equity of a Natural Asset Company captures all of the above elements of value, creating financial realization via a security, whereby the full value of natural assets is priced in a market transaction.