Want the Money? Learn the Language!
Michael J. Van Patten
Financial markets aren't getting the glory these days, but they still control access to the green – and if payment for ecosystem services schemes and other conservation projects are going to attract the trillions needed to halt environmental degradation, ecosystem project developers will have to get better at packaging their assets to resemble traditional investment products.
First in an occasional series
examining the convergence of environmental finance and existing capital markets.
24 March 2009 |
The emerging field of environmental finance is based, in large part, on the premise that our modern economy is dependent on ancient natural systems that purify the water, regulate the atmosphere, and provide other ecosystem services that we should be paying for
But try to explain this to a portfolio manager – or anyone else with keys to the treasure chest of finance – and you will typically get a blank stare. That's because the environmental and investment communities speak entirely different languages
- even when they are talking about the same thing.
How a Banker Sees Ecosystem Services
To get money from financiers, you have to think like a financier. You have to ask: what is he looking for?
The answer: assets that are geographically-diverse, appreciable, have real monetary value, and generate real cash flow.
That sounds a lot like many of the wetland mitigation and watershed protection projects profiled on Ecosystem Marketplace
, and mitigation bankers need to see their projects through this prism if they want to attract mainstream investors.
To an investment professional, for example, environmental offsets are assets and collateral that can produce future cash flows and investment returns. The "assets" are the ecosystem services that nature produces, and the "cash flows" are the derived from the resulting credits that are generated from REDD
projects, wetland mitigation and water quality projects
, habitat protection
, sustainable agricultural processes and marine conservation.
By packaging the assets in a way that is more familiar to investors, we open the doors to an entire universe of untapped capital that is becoming more aware of the opportunities that exist to generate real environmental, social and financial returns or double and triple bottom line investing.
Liquidity and the Secondary Market
Traditional capital markets reduce risk in part by creating a central exchange for all buyers and sellers. This liquidity gives market participants the peace of mind of knowing that a quoted price represents the desires of buyers and sellers, and makes it easier for them to conduct their business. (The current "liquidity crisis" shows what happens when a market lacks transparency and participants lose that trust.)
With the exception of carbon, ecosystem markets have not yet evolved this kind of liquidity – but innovative companies such as carbon and biodiversity registry TZ1
, project developer New Forests Ltd.
, and the Cape Cod Fisheries Trust
have all taken steps to correct this shortcoming. They have created infrastructure in the case of TZ1 or financial instruments (such as New Forests's Biodiversity Conservation Certificates
or the Trust's Transferable Quota (Catch Shares) loan fund) that resemble more traditional investment products and services.
By creating these financial structures, they are establishing an asset class that has a standardized common unit of measure and is therefore more easily-traded or transferred on a secondary market. All these qualities create liquidity and transparency which are pre-requisites for the investment community.
But before this secondary market can truly take shape, mitigation bankers and NGOs have to recognize that when they are looking to fund a single project or a group of projects, they have an asset and cash flows from which they can create an investment product that can attract investment capital.
These financing structures can also be used to monetize current unsold credits that the developer may be holding. These prospective structures include:
funding carbon offset and or REDD projects backed by carbon credits
funding conservation or wetland mitigation projects backed by various ecosystem service payments or specific endangered species or other habitat credits
Sustainable Agriculture Notes
funding sustainable agricultural processes and backed by individual or bundled credits for carbon sequestration, water quality, water rights, or ethane capture
Renewable Energy Notes
funding renewable energy projects and backed by renewable energy credits
Sustainable Fisheries Notes
funding purchases of or investments in Transferrable Fisheries Quota Shares or Quota Banks and backed by these shares
Regardless of the type of environmental project or ecosystem service, if cash flows exist, they can be packaged to create a more traditional and attractive investment vehicle.
Before we can create a central liquidity pool, we have to take stock of the barriers to creating one. Some of these barriers are physical, but others are regulatory – such as regulations dictating that only permit holders can buy or sell actual credits produced from conservation or wetland mitigation projects.
The regulation exists to prevent market abuse, but it also inhibits market development. In this case, a private contract can be created to meet both objectives by recognizing the fact that legal title to the underlying credit cannot change hands but that the economic benefit of the credit can be transferred – regardless of who the buyer is.
These contracts are called "Restricted Interest Transferable and Exchange Securities" or RITESTM
make it possible for the mitigation or conservation bank to monetize unsold credits by entering into bi-lateral agreements that transfer only the economic benefit of a credit to a buyer who then owns rights to the future credit sale proceeds.
transaction also makes it possible for the credit to become more easily transferred or "traded" to any party prior to the sale of the underlying credit being completed. This gives the bank holding title to the credit access to liquidity, and makes it possible to free up capital without actually transferring title of the underlying credit. The RITES holder is investing on the hope that the credit will increase in value because of eventual demand from a buyer needing to offset. RITES in theory would allow environmental investors to target certain areas of the country and create diversified portfolios of habitat credits.
The above examples illustrate that a wide variety of financing mechanisms can be created to establish a well diversified portfolio of environmental assets and cash flows, of course various nuances and risks do exist that are unique to each sector and these have to be considered.
NOTE to Readers: this is the first in an occasional series focusing on the convergence of modern finance and payments for ecosystem services. We will be covering the mechanisms outlined here in more detail in the coming months. If you have any ideas you would like to share with us, please contact SZwick(at)ecosystemmarketplace.com
Michael J. Van Patten (firstname.lastname@example.org) is the CEO and Founder of Mission Markets Inc, an electronic marketplace for the environmental and social capital markets. Mission Markets functionality and innovative financial tools allow investors seeking double and triple bottom line returns as well as industry participants, municipalities and investment professionals to cost effectively raise capital, source deal flow and liquidity and access vital information and data all in one centralized location. Markets supported include Ecosystem Services, Renewable Energy, Sustainable Fisheries, Sustainable Water Solutions, CDFI's, Microfinance, LOHAS Sector Enterprises, Sustainable Agriculture.
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