The framework builds from the ground up an understanding of the risks and returns which are common to all investments – not just nature-based solutions. The traditional risk assessment explores the most general indicators for risk and return including foreign exchange rate, jurisdiction, market and counterparty risks. General investment policies are also identified as a driver of risk or return. This provides a foundation on which to build the more specific landscape-based risks and returns.
Foreign exchange rate risk is the risk associated with generating cash-flows in a denominated local market currency and converting this to a base currency.
- International value of a denominated local currency
- Value of the base currency
- Future events that could cause currency price volatility
The general investment policies relate to the jurisdictional policy environment associated with investing in a given region and/or commodity or service.
- Voluntary reporting and disclosure
- Mandatory reporting and disclosure
Jurisdiction risks are the legal and political risks associated with investing in domestic or foreign markets. They arise from the stability or volatility of governance structures and policies in the invested region, the rule of law, contract enforceability and the relative strength of institutions.
- Stability of governance in the region
- Policies in place within the jurisdiction in which the project is based
- Effectiveness of governance systems to enforce these policies
Counterparty risk arises from the potential for strategic partner(s) to incur social, operational or financial risks during the investment operation. Strategic partners include project managers, supply chain partners, purchasers, service providers, capital partners and other third parties whose contributions are important to the success of an investment.
- General risk of default counterparties such as project-developer, asset manager or supply chain partners
- Credit risk of counterparties
Market risks are related to systemic conditions of the market at a given time. These conditions affect the volatility and trends in market prices or demand for certain commodities. Market risk will be different in emerging and established markets.
- Price trends for products
- Price volatility
- Size, depth and diversity of markets
- Market structure
The conventional forest investment approach identifies the risks and returns typically associated with conventional commercial timberland investments. It considers the particular investment case, the landscape approach, tangible asset risks and policies and standards for land-based investments in managing risks and revenue drivers.
Type of forest intervention is the forestry activity that is funded on the ground. Different types of activity will generate different commodities or provide different ecosystem services – each with their own unique revenue streams.
- Type of forest management include conservation, restoration, improved management of existing forests and afforestation/reforestation
- The use of native vs. exotic species
- Forest landscape approach, such as mosaic forestry
The scale and scope of the investment is a measure of the total tangible or intangible output. For example, a larger commodities-based project will be able to bring more end-product to market. Care must be taken when considering the scale to understand how this affects the provision of all forest services.
- Total size of the land
- Internal landscape topology and structure
Cash flow incorporates the duration, timing, amount and regularity of different streams of return from the investments.
- Expected regularity of returns e.g. harvesting periods
Landscape stakeholders are communities and groups that would be affected by an investment within their local landscape. The legal ownership status of the land will affect what type of forestry activity can be funded. Beyond legal requirements, efforts should be made to understand how forest projects will affect local communities.
- Legal status of the land
- Application of the principle of Free, Prior and Informed Consent (FPIC)
- Grievance mechanisms in place
Infrastructure relates to the availability to store, process and transport products to market. Established infrastructure means additional investments in the supply chain will not have to be made thereby increasing returns. Little or poorly conditioned infrastructure will increase the costs of bringing commodities to market or measuring service provision.
- Availability of different infrastructure
- Accessibility of landscape
Landscape condition is the physical state of the land at the point of investment. This affects the upfront investment required to transform the land to a given type of forest activity.
- Land status at the point of investment e.g. greenfield or brownfield
- Landscape condition e.g. forested, planted, deforested or built on
- Landscape topology e.g. steepness of land
Physical risk refers to the effects of extreme weather events, including fires and drought, and long-term climate shifts. The atmospheric and land conditions will affect the growth and health of the nature-based solution. As investments are usually made over a long period, the long-term shifts in climate and the effects of extreme weather should be extrapolated to account for future conditions.
- Probability of drought conditions
- Extent of forest fires
- Rainfall levels and water run-off
- Shifting temperature patterns
Biological risk is the potential for disease, fungi and pests to affect the health of the biological agent being utilized as part of the nature-based solution. Poorly managed biological risk can result in degradation or loss of elements of natural ecosystems. Future trends in biological risk should be calculated to account for changing climates.
- Outbreaks of disease, fungi or pests in the region
- What actions are being taken to combat biological risk and whether there are measures to mitigate this risk such as planting or maintaining a diversity of species
Social risk incorporates the risk to the investment from poorly planned social management, competing land claims, unsettled land tenure or other social issues or conflicts in the region which may or may not be directly related to the investment activity.
- The extent to which local communities are involved in project development
- The right for local communities to live on or utilize lands
- The impact of the nature-based solution on local economies and resource requirements
Voluntary standards are those that project managers are not obliged to follow but are normalized to ensure project best practice. These provide a benchmark for investors to ensure they are financing best-in-class projects. In the absence of independent standards, investors must rely on their own due diligence, monitoring and definitions of best practices which may increase complexity and reputational risk.
- Forest Stewardship Council
- IFC Performance Standards
- The Sustainability Policy Transparency Toolkit (SPOTT)
- The use of trusted and robust third-party certification auditors
Mandatory land-use policies are those that relate to land ownership or activities that can be conducted on the land. These policies may incentivize certain types of land-use or land management practices.
- Land-rights and entitlement
The conventional investment approach for forest-based activities has limitations in its ability to capture the many varied benefits and risks that investing in landscapes can have on the environment and local communities. The integrated approach unpacks the risks and returns across environmental, social and governance attributes and how these can link to a range of tangible and intangible outcomes where new revenue streams may be added in the future.
Landscapes can provide a range of ecosystem services such as carbon sequestration, water quality and quantity, wildlife habitat, biodiversity and recreational amenities among others. In some cases, downstream water users, recreationists or other users of such services will compensate landowners for their provision.
- Generation of carbon credits
- Biodiversity premium pricing on carbon
- Bond structures that pay dividends for increased fire resilience or water purification and retention in ecosystems
Many of the environmental benefits of nature-based solutions may be quantifiable but difficult to standardize and generate a cash-flow from. In many cases, measurement and monitoring can be costly. Measurable indicators can, however, increase performance in financial reporting and ensure that ecosystem services are in fact being delivered.
- The provision of biodiversity protection is measurable but there is not currently a mature business model to generate a cash-flow
While not all environmental benefits have a direct financial impact, they are still an important aspect that investors should consider. Poorly managed ecosystem services, not only provide a reputational risk to investors, but run the risk of future legal liability. As measurability and business models develop, these as-yet unmeasurable opportunities could become more material in the future thereby driving new types of cash-flows.
- Availability of environmental resources, such as water, for local communities to access
The social outcomes of investing in nature-based solutions can provide a new stream of revenue.
- Tax benefits or subsidies received for increased rural employment, training or other financial support received because of the social impact of an investment
- Nature-based solutions that also integrate sustainable tourism opportunities
Many social benefits do not explicitly provide cash-flows but are indicators that the project is delivering positive impacts for society. Some of these can be measured. These reduce the reputational risk of investment, can be reflected in expanded reporting and offer potential for future revenue streams.
- The role of local groups in project development and management
- The number of rural jobs provided
- Employment of historically underrepresented communities
- Increased participation of local community members in education or governance
Many social benefits are difficult to fully capture in traditional quantitative measurement techniques. They are, however, important to ensure that projects deliver benefits to local communities and can help investors reduce reputational or social risk.
- Local attitudes towards the project
- Total external investment in a region due to a thriving local nature-based economy
Governance and ownership can provide new forms of cash-flow for an expanded group of stakeholders.
- Community or joint-ownership forest governance measures
- Capacity for local communities to govern how resources generated from the project should be used to promote local socio-environmental development
Good governance can give nature-based projects security over the period of the investment and ensure that benefits are being shared with all affected stakeholders. Many indicators of good governance are measurable.
- Diversity in the backgrounds for those involved with the governance decisions of the project management
Some examples of good governance can be tricky to quantify or measure meaningfully. Efforts should be made to ensure that proactive actions are taken to reduce the risk of poor governance.
- The capacity for local communities to access transparent grievance and complaint mechanisms
- Complaint mechanisms which are actionable
These are the emerging policies that will explicitly target nature-based activities and investments. They could affect supply of capital, investor behaviour, market end-demand and certainty of cash-flow. Uncertainty in whether these policies will be put in place over the time-horizon of an investment can discourage investment.
- Supply chain policies
- Land-conservation policies
- Investor behaviour policies
- Demand drivers such as the systematization of bioeconomies
What are nature-based solutions?
In this framework, we take the definition of the International Union for the Conservation of Nature, which defines nature-based solutions as: ‘actions to protect, sustainably manage and restore natural and modified ecosystems that address societal challenges effectively and adaptively [while] simultaneously providing human well-being and biodiversity benefits’. 1
How can the framework be used?
The framework provides a conceptual model of the drivers of risks and returns when investing in nature-based solutions. The framework is organized across three layers which build on each other to provide a full picture of the considerations needed to generate a more complete picture of the risks and returns of investing in landscapes.
There is no one order in which to apply these layers. You can use the investment attributes in each layer to explore the key drivers of risk and return and indicative examples of the types of information these cover.
What is the applicability and limitations of the framework?
This framework currently describes the investment attributes of private equity or debt investments in forest landscape nature-based solutions. It excludes carbon offsets because its purpose is to facilitate the delivery of nature-based solutions in conjunction with the deep decarbonization pathways needed across other sectors.
The framework is not a substitute for due diligence processes. It is a learning tool which can be used to help inform the types of risk and returns in an analysis for investments in nature.
The framework also does not provide an exhaustive overview of the risks and returns for current or future nature-based activities. It will be updated and expanded as knowledge is generated from an increasing number of successful investments.
How has the framework been developed?
This framework has undergone an extensive co-creation process in three stages: hosting of feedback workshops, input from an expert panel of advisors and road-testing of the framework.
At workshops held between December 2020 and September 2021, the Chatham House Sustainability Accelerator invited mainstream investors, expert environmental organizations, nature-based impact investors and land-based investment experts across the public and private sector to provide input into the framework design and content. 52 participants from 38 organizations, with headquarters based across 10 countries in five continents, gave feedback at these workshops.
The total assets under management (AUM) of landscape investors at these workshops was greater than USD 20 billion as of December 2021. This equates to approximately 40 per cent of market holdings of the 20 largest Timberland Investment Management Organizations calculated at 2017 market structure.2 The AUM of mainstream investors – defined as investors in assets beyond just landscapes – sums to USD 45.3 billion as of December 2021. Investor network organizations with membership AUM totalling USD 166 trillion as of December 2021 joined the workshops.3
The Chatham House Sustainability Accelerator formed an expert panel of advisors to provide regular advice and feedback on the framework creation. This panel consisted of forest-fund managers, mainstream investment experts, civil society organizations and bioeconomy specialists. Members of the expert panel were David Brand (Chief Executive Officer, New Forests), Mariano Cenamo (Director of New Business, Institute of Conservation and Sustainable Development of the Amazon), Jukka Kantola (Founder, World BioEconomy Forum), Nick Silver (Director and Co-founder, Climate Bonds Initiative), Roberto Waack (President, Amazon Concertation) and Mark Wishnie (Chief Sustainability Officer and Head of Landscape Capital, BTG Pactual Timberland Investor Group). The expert panel secretariat was based at the Chatham House Sustainability Accelerator led by Ana Yang (Director), Suzannah Sherman (Research Associate) and Henry Throp (Research Assistant).
The framework was also road-tested against seven real-life investment cases for land-based investments across four continents: Asia, Africa, South America and North America. These investment cases encompassed a variety of forest-based activities including sustainable natural forest management, diverse species plantation and timberland investments. Organizations who joined the road-testing sessions include New Forests, Symbiosis Investimentos, Precious Woods, Blue Forest Conservation and Manulife Investment Management, Timberland and Agriculture.
To get in contact with the Sustainability Accelerator team to learn more about the framework, please e-mail [email protected].