Conservation Finance, an Untapped Investment Opportunity
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Conservation Finance, an Untapped Investment Opportunity

"Conservation finance represents an undeveloped, but emerging private sector investment opportunity of major proportion," said Credit Suisse CEO Tidjane Thiam in a new report.

What Is Conservation Finance?

Conservation finance can be defined as a mechanism through which an indirect or a direct financial investment is made to activate one or more cash flows. Part of the returns are used to conserve the values of an ecosystem for the long term, while the remainder goes back to the investors.

Two years ago, Credit Suisse, WWF and McKinsey published a first-of-its kind thought-leadership report that focused on introducing an investor's perspective to the conservation finance field. The report highlighted the unmet demand for conservation funding, accessible cash flows, and the investment capital that would be available on a large scale. In the newly released follow-on report, "Conservation Finance – From Niche to Mainstream: The Building of an Institutional Asset Class" co-authored by Credit Suisse and the McKinsey Center for Business and Environment, the focus lies on defining specific paradigm shifts that could unleash the next period of growth in the conservation finance field. 

The continuing disappearance of our planet's remaining healthy ecosystems is no longer news. The extinction of species, for example, is about 1000 times more frequent now than it was in the pre-human period, according to a Brown University study published in the journal Conservation Biology. Future extinction rates are likely to be even 10,000 times higher. One major challenge to the better conservation of nature is the lack of available funding. 300 billion to 400 billion dollars per year are estimated to be needed to preserve healthy ecosystems. "Filling this gap to finance the preservation of the world's precious ecosystems will require 200 billion to 300 billion dollars in additional capital, and private investment capital may be the only source," said Tidjane Thiam, in the report's foreword. Conservation finance may well be part of the solution.

How Could Conservation Finance Expand?

There is currently a large, unmet demand for conservation funding. Three paradigm shifts are essential to overcome some of the key barriers to the expansion of conservation finance, according to the study namely: incubating, scaling and mainstreaming. Incubating addresses how a project moves from a conceptual idea to a commercial business model. Scaling tackles the issue of moving from small-scale to proven projects, while mainstreaming takes tested, medium-scale projects to the next level, developing large-scale and established conservation finance products attractive to mainstream investors. The focus on such shifts could provide a major boost in funding. In total, they have the potential to create a conservation finance investment market of 200 billion and 400 billion dollars between now and 2020. And investors are indeed turning to new investment opportunities in the current low-interest environment. They increasingly not only seek financial returns, but also look for a nonfinancial impact from their capital through direct or indirect investments in environmental conservation – also known as environmental impact investing.

Investment potential of mainstream conservation finance instruments

Investment potential of mainstream conservation finance instruments

Source: Credit Suisse, McKinsey & Company

Existing Conservation Finance Products and New Opportunities

Today, the prevalent financial vehicles found in the conservation finance market are debt and equity funds, as well as the proceeds of bonds and notes. As investors increasingly welcome new investment opportunities with reasonable risk-return profiles, and with no or little correlation to equity markets, the demand for impact investing is rising fast. Conservation assets generally have a lower correlation to financial markets than other assets, as natural resources such as forests are independent from macroeconomic developments. New types of collaborations between investors, NGOs and public entities are also emerging, enabling investors to diversify their portfolios further. The number of "value projects" available in the conservation space is rapidly growing as demand for sustainable agriculture or FSC-certified forest products now exceeds the traditional non-conservation segments of their markets. New technologies and tools are another factor in favor of conservation finance, as they dramatically raise the transparency and measurability of the impact of conservation efforts, in turn enhancing the credibility of the market. 

Current conservation finance products

Current conservation finance products

Source: Credit Suisse, McKinsey & Company

Existing Challenges

A strong demand for conservation finance does, however, not mean that the market faces no challenges. Five barriers are singled out in the study: Search costs to identify conservation projects with good risk-return profiles remain high. Few project developers have a track record in developing cash-flow generating conservation projects. Adequate collateral, which can be used to reduce financing costs and lower the financial risk of investors, is often missing as many project developers are unaware of what could be used as collateral. Scalability remains an issue, as most projects are not replicable beyond a 5-million-dollar threshold yet. This leads to high transaction costs. And monitoring is another barrier, as there is a lack of tested and standardized frameworks for monitoring conservation impact.

Product Structures That May Act as Catalyzers

The field of conservation finance could greatly benefit from a more systematic approach to scaling and replicating projects in order to massively reduce high transaction and structuring costs. Replicating homogenous project types and financing these through equity and/or debt, or structuring multiple heterogeneous projects and then bundling them into a single financial product, should further accelerate growth in the conservation finance market. Minimizing transaction costs through a standardized project evaluation process, as described in the study, could also greatly improve the situation. Finally, risks mitigation concerns involved also need to be tackled, for example through operational assistance or guarantees. Whatever the direction chosen, it will be critical to develop and package investment proposals that provide market-rate return and leverage multiple sources of finance to reduce risk and maximize impact. "Nature must not be turned into a commodity, but rather into an asset treasured by the mainstream investment market," Thiam concluded.

Common risk mitigation strategies

Common risk mitigation strategies

Source: Credit Suisse, McKinsey & Company