Restoring degraded landscapes and forests has the potential to enhance social and economic well-being while delivering environmental benefits, improving biodiversity by 44 percent and ecosystem services by 25 percent. The challenge is getting the funding to make that happen. Currently, initiatives to improve landscapes get only 13 to 17 percent of what they need, and private finance makes up just 20 percent of that thin sliver. Increasing private investment is crucial to fill the money gap.
The Global Restoration Initiative at WRI has examined this topic through our two regional partnerships for restoration, AFR100 in Africa and Initiative 20x20 in Latin America. We also presented the New Restoration Economy at the Sustainable Investment Forum in New York in September 2016. Drawing on our expertise and discussions with investors, we have developed ideas on attracting private capital to restoration projects that range from ecotourism to rehabilitating degraded areas to make farms more productive.
Increasing private capital for restoration is a three-step process. First, we need to identify a pipeline of investable projects; second, it’s essential to expand the investor base, and third, these projects must be aggregated projects into funds and securities.
Identifying a Pipeline of Investable Projects
Establishing a pipeline of investable restoration projects is the most important step. Private financiers need viable business concepts with attractive risk-return profiles in order to be willing to invest. While the number of restoration enterprises is rising rapidly, most are small, with under $1 million in annual sales.
With funding from the Doris Duke Charitable Foundation, we are working with The Nature Conservancy to identify business models based on restoration, specifically what would stimulate larger-scale operations that could restore bigger areas of degraded land. We see three broad requirements:
- Investment readiness: Restoration companies need to be aware of investors’ criteria. Potential investors typically seek a compelling business concept with strong management, cash flow generation and growth potential. We are developing a practical guide that details investors’ expectations.
- Risk mitigation: Since most landscape restoration enterprises are relatively new, the space is often perceived to be a risky investment. So mechanisms that reduce the risk are helpful. For instance, in the clean energy arena, green banks encourage investment by offering loan guarantees and loss reserves that reduce investors’ risk of loss. As a promising step in restoration, the Global Environment Facility (GEF), through coordination with WRI’s Initiative 20x20, approved a $15 million first-loss guarantee facility for restoration projects to be managed by the Inter-American Investment Corporation (IIC).
- Intermediation: Even with attractive investment opportunities, restoration companies have a hard time connecting with investors, making intermediaries an important part of the solution. For example, the stock market acts as an intermediary between investors and publicly traded companies. For restoration enterprises, though, no database or platform currently exists.
Expanding the Investor Base
Private capital has traditionally come from impact investors attracted to restoration projects for their environmental and social benefits. Impact investors play an essential role in showing restoration is a feasible investment opportunity and will remain prominent as the area continues to grow and develop.
To achieve critical mass, however, restoration must attract a broader group of investors, which means explaining restoration to investors in simple terms. Our discussions with mainstream investors showed most were unfamiliar with the concept of restoration in general and completely unaware that it could be an investment opportunity.
It’s also important to acknowledge that investor profiles vary widely. While impact investors and venture capitalists may provide funding of $1-5 million, other investors—such as large pension funds--may only consider investments of $100 million or more. Also, since most restoration projects have a timeline of at least eight years, it can be challenging to find long-term investors as investment timeframes continue to shrink.
Aggregating Projects into Funds and Securities
Once a robust pipeline of restoration projects and a broader base of investor interest has been established, it’s time to bundle projects into investable products, such as shares or bonds. By pooling the risks of different projects, investors in the fund are not exposed to the fortunes of one particular venture, thus reducing risk.
Aggregation also addresses the issue of size, since $10-20 million projects can be aggregated to form much larger funds. And it enables a broader range of investors—such as pension funds, mutual funds and retail investors—to participate. The greater liquidity provided by an aggregated fund (versus individual projects) also reduces transaction costs dramatically, making it easier and cheaper to invest in restoration.
But aggregation has its challenges. Some level of standardization is required so that ventures are bundled with others that have similar investment characteristics (e.g., size, geography, level of risk). Also, due diligence to understand the underlying fundamentals of the projects is essential. For example, there can be a temptation to bundle low-quality products with high-quality ones, and to brand the whole vehicle as high-quality (the same practice which factored into the 2008-09 financial crisis with home mortgages).