The most recent A Community on Ecosystem Services (ACES) conference, which sought to advance science, practice, and decision-making around ecosystem services, exhibited a variety of examples of collaboration between science and finance. The conference was held Dec. 5 - 9 in Jacksonville, Florida.
Private investment in conservation has increased dramatically over the last 10 years, almost doubling from $1.1 billion in 2014 to $2 billion in 2015, according to “State of Private Investment in Conservation 2016,” a report released by Forest Trends’ Ecosystem Marketplace in January 2017.
While increases in investment are encouraging, there are currently more interested investors than investment-ready conservation projects.
The Forest Trends report found that $3.1 billion of the $8.4 billion raised for investment in conservation between 2004 and 2015 has yet to be deployed.
Ricardo Bayon, co-founder of Encourage Capital, said this finding confirms his experience as an investment professional. He said the discrepancy is rooted in the fact that private investors often struggle to find projects that meet their investment standards.
To meet the growing demand for investable projects, scientists and financiers are increasingly coming together to share ideas and to develop and test new methods. ACES provided many examples.
Addressing Obstacles to Investment
The moderators of the ACES town hall meeting “Ecosystem Finance 101: Natural Capital Meets Financial Capital” said three factors are driving surplus investor demand.
First and foremost, conservation-oriented investment opportunities often do not have the risk-return profiles demanded by investors.
Second, fund managers are often unable to point to past records of success. This is a vicious cycle, since fund managers cannot develop track records if no one invests with them. Peter Stein, managing director of the Lyme Timber Company, said managers could use alternative sources – family, friends or foundations – to raise funds to pilot projects and develop past records of success.
Third, projects tend to be small in scale, which can make the associated transaction costs prohibitively high relative to the sizes of the investments. The panel’s moderators said nonprofit energy projects have responded to this challenge by bundling together many small projects. This strategy grows the scale of investments while lowering the relative transaction costs, making projects more appealing.
Pat Coady, senior director at Seale & Associates, said private investors don’t always get the specific information from project developers they require to make decisions. “Finance plans are the bridging mechanism between investors and science.” He said investors want to see plans that document return performance, financial risks, cash flows, and management strategies. Useful plans allow investors to weigh the risks and rewards of conservation-oriented investments in their own terms.
Attendees of the “Ecosystem Finance 101” town hall meeting also discussed how scientists’ and financiers’ different understandings of certainty can slow progress. This includes the certainty required to develop, market and evaluate the impacts of conservation projects.
Participants said the rigor expected in scientific fields is higher than that required by finance professionals. In addition, scientists are inclined to resolve uncertainty upfront while financiers prefer to see how projects play out over time.
Dealing with Uncertainty
There is a constant tradeoff between seeking scientific certainty and unlocking funding quickly. For investors like Bayon, it is critical to work at the pace of the market. He said financiers are comfortable with a degree of uncertainty as long as it makes financial sense. In his opinion, too much time and too many resources are sunk into the pursuit of certainty.
“The marginal benefit of moving from 80 to 95 percent certainty is not worth it,” Bayon said. “Science needs to understand that if you shoot first and ask questions later, you will have the money to ask questions and find answers that may get you closer to certainty.”
The ACES panel “Pay-for-Success Strategies for Government and Philanthropic Funders” introduced one setup that ensures projects have the funding to move forward even with some uncertainty. The ‘pay-for-success’ approach focuses financing on project outcomes. In this model, the rate of return is determined by project performance. The better the project outcome, the higher the investment’s return.
The $25 million DC Water Impact Bond, which was sold to Goldman Sachs and the Calvert Foundation in September 2016, employs this model to fund a green-infrastructure project undertaken by the DC Water Authority. Eric Letsinger, founder of Quantified Ventures, the DC consulting firm that helped structure the bond, said that it is set up with three tiers of environmental performance. Each tier is linked to different investment returns.
Regardless of the project’s performance, DC Water must pay back the loan’s principal. If the project outperforms a pre-determined set of expectations, investors will receive an additional “outcome payment” from DC Water. The high level of performance required in this scenario still guarantees a net benefit for the utility. If the project underperforms then the investors owe DC Water a “risk share” payment, which serves to spread the risk among investors.
Letsinger said pulling off this project required “well defined metrics [to measure success] and methods for calculating those metrics that were written into the contracts.” Although project developers were always working within a range of certainty, these metrics and methods were based on the best science available.
Eric Hallstein, economist and director of conservation investments at The Nature Conservancy, said there are many questions you can’t answer until you undertake the work. Incorporating adaptive management strategies into conservation projects on both the science and finance sides of the metrics can help account for evolving understanding of certainty over time.
Building Relationships, Skills and Knowledge
Scientists and financiers are increasingly coming together at events like the ACES conference to build their professional networks, knowledge and skills. “Many people continue to work in isolation,” said Peter Stangel, senior vice president of the US Endowment for Forestry & Communities. “The ACES conference is helpful to get to see what others are doing and share ideas.”
For the ACES conference, Coady and other organizers put together a Finance Track focused on the role of finance in supporting ecosystem services. Coady said the primary goal was to “move people out of siloes.”
The Finance Track offerings included eight panels, a networking reception, and one-on-one advisory sessions. Attendees who were present for at least four events received a Finance Track Certificate. Many of the panels reviewed existing financing options for conservation, including forest resilience bonds, the clean water state revolving fund (CWSRF), and program related investments (PRIs).
Coady said he was pleased with Finance Track attendance and that he hopes participants left thinking about “the gap between finance and science and how to close it.”
Lydia Olander, director of the Ecosystem Services Program at Duke, said another way to improve communication between scientists and financiers is to publish more scientific papers focused on distilling complex concepts. These reports help non-scientific audiences, including private investors, to understand the concepts underlying project development and evaluation.
At Duke, the Technical Working Group on Agricultural Greenhouse Gases (T-AGG) synthesizes scientific research to support the inclusion of agriculture as a climate mitigation option in the US and abroad. T-AGG’s reports are written with a variety of audiences in mind. These include regulatory agencies that oversee GHG mitigation, private and voluntary carbon markets and registries, and corporations working to create more sustainable supply chains.
Encouraging Future Collaboration
Coady said he believes there’s room for intermediaries to play important roles in bringing together scientists and financiers in future. Potential intermediaries include research centers and resource networks with the means to convene diverse stakeholders and translate scientific and financial concepts.
The ACES conference itself is an example of this cross-fertilization, with eight sessions directly devoted to bringing scientists and investment managers together. On an international scale, the Coalition for Investment in Private Conservation (CIPC), which launched in September 2016, connects private investors with conservation projects around the world. The coalition also helps conservationists to build financial and scientific expertise.
To encourage these positive trends, both scientists and finance professionals will need to continue collaborating, experimenting, and innovating. NRCS’ Conservation Innovation Grant (CIG) program provides federal funding for agencies, nonprofits, tribes and individuals to test innovative ideas in agricultural conservation. In 2017 the program will invest $25 million to incubate innovative projects across the country.
Kari Cohen, deputy chief for science at NRCS, said these grants are useful to fund early-stage ideas that won’t necessarily make money. If the pilot phase goes well, NRCS’ early investment has the potential to stimulate private investment with larger-scale conservation impacts.
Philanthropic foundations, which are able to take on more risk than private sources given their focus on mission-driven returns, can play an important role in catalyzing private investment. Foundations can help to identify good ideas by funding project development and pilot work. In addition, they can fund industrywide events that build skills and bring together practitioners.
Future success hinges on the intentional cultivation of skillsets and knowledge that promote clear communication and efficient working relationships between collaborators. Efforts to expand financial and scientific literacy can be undertaken by individuals, encouraged or mandated by employers, and emphasized at industry-wide events.
Note: Eric Hallstein and Peter Stein are both on CFN's advisory board. The sources cited in this article have not commented on their quotes.