5 Barriers That Hinder Green Financing
Implementing nature-based solutions (NbS) can be an impactful strategy to confront biodiversity and climate crises, while promoting sustainable rural development and generating financial, social and investment returns. Despite this, NbS face multiple difficulties in implementation, with lack of financing as a critical obstacle. Unlocking investment to close the gap will require investors, governments and infrastructure operators to include natural capital solutions and to implement specific financing strategies.
Introduction
The finance industry is a key player in achieving global climate and biodiversity conservation commitments, as its contributions will channel the $1.5 trillion required for the transition to green economies. On one hand, banks’ decarbonization commitments will allow the reduction of direct emissions from their operations (scope 1 and 2 emissions), while changes in their loan and investment portfolios (scope 3 emissions) will be strategic in aligning the economy with the goals of the Paris Agreement. In addition, banks must implement ambitious objectives to significantly increase the proportion of investments in sustainable portfolios, catalyzing the energy transition, reducing deforestation and contributing to climate change adaptation.
In recent years, NbS have gained recognition as emerging opportunities to unlock the budget dedicated to initiatives that benefit nature and society. NbS are interventions that harness nature to address urgent social challenges, such as water scarcity or climate change. In particular, they are a way to increase investments in ecosystems and the services they provide, since many of them lack clear markets through which they can be properly valued. As such, NbS foster transformational change in the economy and represent an effort to make the ecosystem services’ role operational in social and economic development.
In addition to representing direct income sources for communities, NbS can be economically viable alternatives that avoid damages caused by the destruction of ecosystems. A cost-benefit analysis studied the economic feasibility of conserving peatlands in Indonesia, revealing that ecosystem maintenance generates greater benefits for society. In particular, it avoided fire-induced damages with a cost-benefit ratio of 19.1 — in other words, for every dollar invested in conservation, a return of 19 dollars was generated in avoided fire damage.
It is estimated that the annual global budget required to safeguard the environment is $845 billion. Currently there is an investment gap of over $700 billion, which cannot be closed with philanthropic and public funds alone. In 2019, NbS global investment was nearly $133 billion, with projects linked to the primary sector receiving the largest investments. Public investments accounted for 86% of annual financing, which was provided by national government agencies, while 14% of investments corresponded to the private sector and were allocated to projects related to sustainable supply chains. For reference, the private sector contributes approximately 56% of annual investments in climate finance.
Current levels of private investment must accelerate and dramatically increase to cover the existing deficit. Among current efforts to increase private financing, the Climate Solutions Partnership (CSP) NbS Accelerator stands out. Its aim is to build and scale the NbS market by creating the necessary conditions to reduce risks and costs, thereby increasing NbS investments.
WRI Mexico recognizes the great potential of NbS and is developing a series of articles exploring the perspectives and roles of the different key stakeholders in scaling NbS. The series will identify NbS in the Mexican and Latin American context, as well as the barriers limiting their implementation, with an aim to find clear courses of action that guide the necessary transformations to promote their development.
For the first installment of the series, WRI interviewed sustainability representatives from three banks in Mexico, looking to better understand their perspectives regarding NbS and the trends in the sustainable finance ecosystem. Banks are key players in the finance sector, are in direct contact with companies and are familiar with international standards regarding sustainability. As such, these institutions offer an inside look at the state of sustainable finance. They also play a fundamental role in scaling NbS, since their risk standards and perspectives are a filter that determines which projects will receive loans and investments.
Development
A study characterized the outlook of NBS in Latin America and identified 156 projects that use this approach to provide public services in the water, sanitation, energy and transportation sectors, among others. When identifying financing models, it was highlighted that none of the projects received private capital contributions, which reveals the lack of private sector contributions for NbS in Latin America. There is currently no detailed analysis of the NbS investment landscape in Mexico, since the federal government does not have figures on private or public spending on NbS. However, it is estimated that most national projects in Mexico have been financed through a mix of international aid and national public funds.
In Mexico, it has been proven that NbS have great potential to manage climate risks related to water (such as flooding or droughts) and can be used as solutions to adapt to climate change and with greater benefits than infrastructure options. A concrete example is Mexican mangroves, which annually avoid $9 billion in property damages from flooding associated with cyclones.
The Private Sector Perspective: Barriers Limiting the Scaling of NbS
A first step to guide the scaling of NbS is understanding the obstacles that, from the banking sector’s perspective, limit NbS investment. The first part of our conversations with banks focused on identifying these barriers, which are as follows:
1) Nature-based Solutions are a relatively new concept
Despite having been defined by the IUCN since the early 2000s, one of the most significant barriers to scaling NbS is that they are still perceived as a new concept. Although NbS have been present in the global discourse since the Paris Agreement and the Convention on Biological Diversity, their spread and reach outside academia and the environmental community has been limited. Thus, they are not recognized as an option that can be integrated among a bank’s sustainability goals. The same happens to concepts deriving from academia, since their integration into other areas occurs when different players drive projects that implement these concepts. For example, climate change has been a topic of discussion among the scientific community since the early 1970s, but it was not until the 90s that it was positioned within the global public agenda. The private sector is increasingly acting on climate, especially as the consequences of the climate crisis become more tangible.
“The term nature-based solutions is still difficult to assimilate, since nature is a concept which is not generally completely understood either. There is a need for more training and dissemination to be able to convey the real importance that nature has for different economic sectors…” -Britzia Silva, Deputy Director of Sustainability and Responsible Investment, Banorte
“It is strange to mention NbS to interest groups, precisely because there are not yet … enough examples in the industry to consider them as success stories.” -Britzia Silva, Deputy Director of Sustainability and Responsible Investment, Banorte
The lack of ownership of NbS in the private sector reveals that gaps are still present between the international environmental agenda and the financial world, since environmental issues are still not fully understood, despite efforts to incorporate nature into the language and logic of this sector.
2) The Return on Investment on Nature-based Solutions is not evident
“I believe that the lack of investment is because some companies do not associate it with the business… the problem with sustainability is that we many times say: ‘Hey! But where is the business? Because at the end of the day it’s investing, investing, investing, and I don’t see the profit I can have there. I think it is important to work on these issues and learn more about the relationship they can have when obtaining efficiency, innovation, and of course, a positive impact on society.” -Aidée Olmos, Director of Corporate Sustainability, HSBC
NbS projects are characterized for generating multiple co-benefits and positive externalities, which derive from strengthening ecosystem services in the habitats they are implemented. They are also cost-effective and adaptable toward uncertainties associated with climate change. However, it is not obvious to investors how nature generates economic returns. Moreover, positive externalities generated by NbS, such as avoiding landslides or reducing flood risks, are difficult to interpret as “economic gains.” They are not integrated into the benefits obtained, even though there are many methods for this, such as estimating avoided costs or conducting economic valuation of ecosystem services.
The current data on the economic viability of NbS corresponds to investment indicators guided by estimates that only consider the returns generated directly by the projects, which underestimates the economic benefits of working with nature, especially long-term. This leaves NbS options at a disadvantage, since they do not typically generate income in the traditional sense of cash flows. Instead, they provide a number of direct benefits to communities, as well as positive externalities in the form of avoided costs and added benefits. When traditional investment indicators, such as the Internal Return Rate (IRR), are modified to include such benefits, NbS stand out as options that generate greater benefits for society. This was the case for an exercise that analyzed the economic viability of forest restoration to maintain and improve water yield in Indonesia. When externalities and avoided costs were accounted for over a period of 30 years, conservation obtained an IRR of 74.8% compared to -4.8% when calculated in the traditional way.
“One of the most important barriers is that there are other alternative solutions that seem to be cheaper and more efficient that can be implemented at a cost well below nature-based solutions, and they can also be implemented in a shorter period.” -Fernando Puente, Deputy Director of Sustainability, Banorte
The lack of clear payoffs means that allocating funds to NbS projects is perceived by the private sector as a social responsibility or a philanthropic act, instead of investments that could generate income and a variety of benefits for society and biodiversity. In addition, NbS have the great potential of being included in corporate strategies to reach companies’ internal sustainability commitments; yet they compete against short-term alternatives which are more popular and have been previously implemented.
Even though NbS may seem to be costly alternatives, it has been proven that their benefits overcome maintenance and implementation costs in many contexts, such as disaster risk reduction on coasts and basins. Furthermore, evidence of NbS profitability versus gray infrastructure alternatives is becoming more abundant. For example, coastal ecosystems restoration has been identified as a two to five times cheaper strategy to provide coastal protection from breakwaters or levees. NbS stand out from other strategies because they derive from a deep understanding of nature, where synergies and connections among different environmental components are identified. In this way, NbS can contribute to specific goals, such as adaptation to climate change, while addressing greater challenges such as biodiversity conservation, carbon sequestration, water and food security, among others.
3) NbS require long investment times and involve high risks
“We cannot magically make a tree grow; time has to pass.” -Irma Acosta, Director of Responsible Business and Sustainability, BBVA
Nature and the finance sector are governed by different rhythms. The great challenge posed by NbS is finding a point of convergence between the two. Although natural processes cannot be accelerated, measures can be taken to ensure they happen at expected times.
“For us, there must be always a guarantee behind it, if that guarantee does not exist, then the rate is obviously very high.” -Irma Acosta, Director of Responsible Business and Sustainability, BBVA
NbS projects are conceived in the medium- and long-term, so the return on investment they generate, such as carbon credits, takes time. They require strong preparation and big investments during the initial phase, as well as a constant commitment from the developers and communities involved. This complexity is linked to uncertainty and high risks, as there is a danger that projects will be abandoned and investments therefore lost. All this signals to investors that NbS do not offer enough guarantees that the investments made will provide returns. However, NbS focused on carbon sequestration that incorporates native species, avoids damages to ecosystem diversity, respects social safeguards and offers great mitigation opportunities with key benefits for the local population. Likewise, in the economic valuation exercises of NbS focused on mitigation, carbon sequestration stands out as one of the ecosystem services that adds the greatest value to these options and increases their financial attractiveness.
In addition to the long time frames, another source of uncertainty is that the capacity of ecosystems to provide environmental services and benefits for communities also depends on their resilience to the impacts of climate change. This phenomenon can increase ecosystem exposure to pressures such as fire, drought and the indirect impacts of human migration. Although recent progress in modelling to predict effectiveness of NbS in reducing threats is helping mitigate this uncertainty, one way to guarantee that NbS work well is to take decisive actions to decarbonize the economy.
4) Quantifying and disseminating results is complex
“Nature is so broad: ecosystems, biotic and abiotic systems… requesting information from our clients to begin generating databases is not an easy task, it requires a specific analysis by sector to prioritize the most relevant indicators… I believe that quantifying is a key aspect that is currently limited by availability of data and knowledge of the proper methodologies.” -Britzia Silva, Deputy Director of Sustainability and Responsible Investment, Banorte
For the private sector, it is important to know the reach of the capital in investments. Because NbS generate benefits beyond the economic realm, quantifying projects results, such as cooling temperatures in cities, involves complex methodologies. Added to this is the need for results to be reported by indicators that are easy to understand by the reviewers, while correctly reflecting the scope of projects. This complexity, associated with quantifying, further increases the perception of risk in NbS investments.
“Transparency is one of the fundamental issues, that is: ‘I am having this collaboration which I know is going to have a certain impact, what size is it? What is the effect at short-, medium-, and long-term for the community? -Aidée Olmos, Director of Corporate Sustainability, HSBC
In addition to challenges associated with quantifying results, there is no common framework of guidelines and metrics to assess performance of NbS, leaving an information gap that prevents investors from guiding their financial decisions. Moreover, there is a lack of transparent and public data on the performance and return of investment of NbS projects. Furthermore, the market is opaque, with many private and bilateral transactions. All of this makes it difficult for investors to know what is happening in the market, to assess or analyze the risks and returns available and to overcome the notion that NbS projects cannot achieve returns at market price.
In light of this, efforts are being made to standardize the methodologies that measure some of the benefits generated by NbS, such as carbon sequestration, certifying the data obtained and making performance comparable among various NbS. Similarly, NbS projects incorporate monitoring and evaluation indicators that allow evaluating performance throughout their implementation. Among other significant efforts, the Nature-based Solutions Evidence Platform stands out, which compiles a variety of scientific articles that evaluate effectiveness of NbS for climate adaptation. However, the need to fill information gaps will involve working with existing NbS markets and platforms to help standardize outcome definitions and metrics, since current efforts are still under development.
5) Lack of government incentives and an established taxonomy
“It doesn’t help that there is a lack of a defined taxonomy for Latin American countries. Government tax incentives or benefits are essential to achieve a greater impact.” -Aidée Olmos, Director of Corporate Sustainability, HSBC
Scaling up NbS requires the working hands of multiple actors. Integration of NbS in Nationally Determined Contributions (NDCs), as well as in national legislation and policies on climate and biodiversity, are actions led by governments that provide visibility to NbS and promote their implementation in other sectors. Likewise, governments have the authority to create market instruments and regulations that favor the development of NbS projects. However, there are still no tax incentives, such as tax exemptions or reductions, that could increase the attractiveness of investing in this type of project.
In finance, a taxonomy is a system for classifying what is considered “sustainable” or “green.” They include detailed criteria that each activity must meet to earn the sustainable label. They are vital tools for sustainable finance since they provide transparency and clarity to investors and reduce the risk of practices such as greenwashing. Setting up a green taxonomy in Mexico that describes and considers NbS will promote investments in these initiatives. This will facilitate the filtering of projects that do not meet the criteria and will make definitions transparent, which in turn will attract investors interested in a portfolio with climate, environmental, social and international benefits.
Conclusion
The bank members agree that barriers to scaling NbS are diverse. The financial standards created in the areas of climate change and sustainability, such as the Task Force on Climate-related Financial Disclosures or the Environmental, Social and Governance criteria are an optimistic precedent that can be used in favor of scaling NbS. Another noteworthy initiative is the Net-Zero Banking Alliance, made up of a global group of banks that have committed to aligning their loan and investment portfolios with net-zero emissions by 2050.
NbS can be incorporated into the transformative process that is taking place within banking in search of having operations aligned with global climate efforts. However, as NbS cover a variety of objectives, new alliances need more ambitious agendas and to stop focusing solely on emission mitigation.
“We are working on how to tell… our stakeholders and investors, our clients, our colleagues… that investing in nature-based solutions has a positive impact on the planet, on the institution’s reputation; but above all, it has a very significant, transformative impact on the communities where they are.” -Aidée Olmos, Director of Corporate Sustainability, HSBC
NbS financing is a way to invest simultaneously in solving multiple environmental and social problems, including disaster risk reduction, climate change mitigation and adaptation, food security, water security, biodiversity protection and human health. The private sector plays a critical role in unlocking the great potential of NbS and closing the current financing gap. A first step to encourage private sector involvement is to identify the barriers that limit investments in these projects. It is also important to know which solutions are envisioned by the private sector, which provides a clear course of action that various actors can follow to scale NbS.
Source: wri.org
