Nature-Based Adaptation Solutions: Ready for Prime Time?

It may only be January, but it’s already clear that nature-based solutions (NbS) will be a big theme in climate adaptation finance this year.

This climate-nature nexus has been well hyped, but now its promise looks to be fulfilled. This month, the Taskforce on Nature-related Financial Disclosures (TNFD) debuted its list of over 300 early adopters, all of whom commit to reporting on nature-related risks and opportunities. One of the principles guiding the framework is “scaling up finance for nature-based solutions.” 

Recent weeks have also seen the United Nations Environment Finance Initiative (UNEP FI) roll out nature target-setting guidance for banks, which includes information on developing portfolio-level targets for nature-based activities that support climate mitigation and adaptation. The US government is championing NbS too, most recently through the Interior Department’s release of an NBS Roadmap.

Then there’s the academic heft being marshaled in support of nature-based solutions. Of special note is the Resilient Planet Finance Lab, a “research and innovation accelerator” nestled within the University of Oxford. Recently, the Lab published “Financing Nature-Based Solutions for Adaptation at Scale: Learning from Specialised Investment Managers and Nature Funds” with the Global Center on Adaptation and Environmental Change Institute. Lab Director Dr Nicola Ranger, a true sustainable finance polymath, is one of the brains behind the report, along with Dorian van Raalte, an Environmental Change Institute alum now ensconced at asset manager Gresham House.

The report provides a useful snapshot of the current state of financing for NBS for adaptation, including a rundown of 25 nature funds and the specialist investment managers that operate them. It also shines a light on the obstacles blocking the scale up of NbS for adaptation, and reveals how the current crop of investment opportunities are skewed toward certain areas at the expense of others.

Navigating the NbS Menagerie

Having spoken with both Ranger and van Raalte, it’s that NbS investments are essential for closing the adaptation finance gap and delivering the environmental, social, and economic co-benefits that can enhance resilience in the world’s most climate-vulnerable regions. At the same time, it’s also blindingly obvious that the present policy, regulatory, and market infrastructure is not wired to facilitate the scaling up of these solutions. 

Total public and private investment in NbS covering both terrestrial and marine (US$bn)

Part of the problem is the NbS “asset class” itself — if it even deserves that label. After all, investments belonging to an asset class are supposed to have similar financial characteristics and behave similarly in the marketplace. This is not the case with NbS. Van Raalte explains when he was researching what sectors should be considered in-scope of NBS investments, “there were lots of different views.”

The report goes into more detail, claiming that while “most existing nature-related investments are in established economic sectors that deliver well understood and attractive commercial returns”, a fledgling category of more innovative NBS projects — such as “green infrastructure” and nature restoration — “continue to face challenges” when it comes to monetizing their benefits. 

Understandably, it’s easier to attract capital to opportunities belonging to the former category than the latter. “We often hear that the big problem with nature finance is that it is all about little obscure projects with low investment returns,” says Ranger. “What we found is, when you look at the data, most nature investment flows are actually into traditional sectors, like agriculture and forestry. These are very big sectors and well-known asset classes. Making investment flows to these sectors nature-positive is a trillion dollar win-win.” Indeed, more than half of the nature funds analyzed in the report focus on the agriculture and forestry sectors.

My question is whether a crowding of investment into these established categories leaves other essential nature-based adaptation activities starved of capital. This may be a problem. After all, the adaptation projects we need in order to withstand a more dangerous climate are many and varied. If NbS finance flows to some but not others, then a) critical adaptation needs may go unfulfilled, and b) too much money may end up chasing too few opportunities — pumping up investment bubbles and tempting investors to shirk due diligence standards while amping up the risk to their portfolios.

However, the report argues that private actors aren’t solely to blame for this skew. True, specialist investment managers have the resources, drive, and backers to explore exotic NbS opportunities, and in some cases face less pressure to yield competitive returns. This isn’t as true of the mainstream. Larger, generalist investors have to be recruited to the NbS cause if the category is to scale, and they need “commodified” investments that are well-structured, easy to audit, and tradeable when necessary. 

“These [NbS adaptation] projects are lengthy, and to monitor and ensure they are delivering impact that does require a lot of local expertise,” says Ranger. “It will be difficult to see if you can replace that initially. Over time as we standardize these projects it may get easier, but for now it's a challenge for institutional investors to do the due diligence.”

Steps to Standardization

The report proposes a few ways that “greater standardization” could be brought about. One is through improved investor disclosures, which may help publicize the “commerciality” of NbS projects (something the TNFD may catalyze). Another is the development of common adaptation metrics and targets (which the Global Goal on Adaptation and Intergovernmental Panel on Climate Change have on their to-do lists). 

I’d add that financial engineering has a role to play, too. Perhaps sustainability-linked bonds (SLBs) — which have grown popular in recent years as financial mechanisms for driving sustainable practices at issuing firms — could be augmented to incentivize businesses to spend on NBS. Alternatively, they could provide the scaffolding to transfer credit enhancements for NbS projects from public financial institutions to private investors. SLBs have similar characteristics and documentation as standard bonds, and are easier to trade in secondary markets than project finance loans. 

I also wonder whether packaging up and tranching NbS cashflows could help attract a wider range of investors. Naturally, this securitization approach depends on their being cashflows to package up in the first place. Investments that produce carbon credits, or emerging biodiversity credits, as a by-product may be good candidates. So would projects that generate revenues via “payment for ecosystem services”, whereby the beneficiaries of, say, enhanced natural hazard protection or watershed maintenance pay the providers of these for their trouble.

There are other barriers to “commodification”, however. One issue is the idiosyncratic nature of NbS. Projects are generally “highly tailored to the local environment”, the report says, which “increases complexity and makes replicating and scaling of projects difficult.” The peculiarities of NbS make them expensive, too. Investment managers need to charge higher fees to cover the significant costs and resources needed to implement the strategies, as well as compensate for the associated reputational risks.

However, a “new generation” of nature investors have less to lose, and can afford to be more bold, says Van Raalte. He adds that one way to catalyze nature finance is for public, bilateral, and multilateral actors to seed new specialist asset owners and managers, or even to support team members spinning off strategies.

The Public Sector’s Role

All the disclosures, financial engineering, and investment expertise in the world still won’t make it so private actors can scale NbS on their own. Ranger and van Raalte are clear that the public sector has to step up, too.

Governments, regulators, and public financial institutions can catalyze investment in a variety of ways. Ranger talks of the importance of an “enabling environment” for unlocking private capital. “The reason why you can invest and get returns on climate mitigation is because the regulatory frameworks have been developed for 20 years. For NbS adaptation, we need more work on the public sector side,” she says.

For his part, van Raalte says it is imperative that “well-regarded public, bilateral, and multilateral” outfits continue investing in nature funds to get them off the ground, build a track record, and “give them a stamp of credibility.” This is a common pattern among the funds and investment managers showcased in the report. For example, the &Green fund, which invests in line with its mission to delink deforestation from major commodity supply chains, has raised capital from the Norwegian and UK governments. This last December, it also received US$180mn from the Dutch entrepreneurial development bank FMO. Similarly, Climate Investor Two, a vehicle set up by Climate Fund Managers, includes concessional capital from the Dutch Fund for Climate and Development (DFCD). This contribution is intended to absorb risks in the portfolio, providing private investors with a buffer against losses.

The report argues that much more public funding is needed, however, in order to attract he required flood of private capital to NbS. This is particularly important in the context of NbS for adaptation, as it is harder to generate revenue streams from the benefits they provide. Public finance is also needed to take some of the risk of investing in NbS off the table and make these projects bankable, as FMO is doing for Climate Investor Two.

On the plus side, Ranger and van Raalte see plenty of evidence that private investor demand for NBS is on the rise, and are confident the models for investment showcased in the report can be replicated. Key to NBS’ future success will depend on getting this message out there, and convincing private and public actors alike that the adaptation services provided by these solutions are well worth the money.