NatureScot Research Report 1272 - Facilitating Local Natural Capital Investment - project report

Year of publication: 2021
Authors: Hume, A., Gibson, A., Fitton, R. and Mansfield, J. (Finance Earth)

Cite as:  Hume, A., Gibson, A., Fitton, R. and Mansfield, J. 2021. Facilitating Local Natural Capital Investment – project report. NatureScot Research Report 1272.

Keywords

natural capital; investment; sustainable finance; nature-based solutions; ecosystem services

Background

NatureScot and its partners are exploring approaches to secure more varied and sustained investment in nature through the Facilitating Local Natural Capital Investment project (the “Project”). The Project aims to identify business cases, financing mechanisms and supporting tools that can help to unlock significant investment in the natural environment and have the potential to be scaled up and replicated across Scotland.

The objective of this report is to capture the learnings and findings of the Facilitating Local Natural Capital Investment project. This report should be used to support further efforts to facilitate investment into Scotland’s Natural Capital.

Main findings

• Scotland’s natural capital assets deliver significant levels of ecosystem services, many of which have the potential to attract private investment to maintain or enhance them.
• To catalyse private investment, natural capital project developers and enterprises should explore the opportunities to generate net positive cashflows.
• A natural capital assessment provides a good basis for identifying opportunities.
• There are a range of financial products and investment vehicles that could be applied in the context of Scotland’s natural environment.
• Financing solutions should be applied based on their suitability to the underlying revenue streams of a given project, as well as the regulatory and market infrastructure in the region.
• Public sector support is required to catalyse the growth of natural capital investment markets. This could take several forms, including investment-readiness funding, compliance regulations and price support mechanisms.
• Natural capital investments should be implemented with transparent and robust governance structures to avoid trade-offs between financial and impact goals, and in order to distribute the benefits widely, such as to local communities.
• The development of a Scotland Carbon Fund could facilitate private investment at scale into Scotland’s peat and woodland landscapes and provide a model for funding other nature-based solutions.
• The development of a Price Floor Guarantee mechanism for carbon projects could help to overcome some of the key barriers to market development and improve the efficiency of public spending.

Introduction

“Natural capital” refers to the stock of renewable and non-renewable resources (biodiversity, air, water, soils, minerals) that combine to yield a flow of benefits to people (SEAA, 2020).  Scotland is home to a broad range of natural capital assets, including some of the world’s most important peatlands, extensive forests and hundreds of miles of coastline and marine habitat. NatureScot’s Facilitating Local Natural Capital Investment Project (“the Project”) seeks to demonstrate practical mechanisms to secure private investment into these assets in order to deliver environmental, social and economic benefits.

The objective of this report is to summarise the process, outputs and learnings of the Project conducted between August 2020 and March 2021. Background section briefly sets out the domestic and international context of the Project and the process carried out by NatureScot and project partners to date. Investment opportunities in the Tweed Catchment section considers the breadth of natural capital investment opportunities identified by the Project team across the selected project area of the Tweed catchment. Assessment of Investment Priorities section captures the summary outputs of our analysis of the natural capital investment opportunities identified. Priority Investment Structure - Scotland Carbon Fund section provides a deep dive into the priority investment structure, a ‘Scotland Carbon Fund’, and includes an analysis of aligned financial structures and market mechanisms to further facilitate investment in parallel with the Scotland Carbon Fund. Financial Analysis section summarises the financial analyses carried out to underpin the market impact of proposed mechanisms and structures. Learnings and recommendations section draws together the learnings of the initiative and identifies key recommendations from the Project to carry forward.

The Project Area Characterisation report, produced by eftec to support the Facilitating Local Natural Capital Investment Project, can be found in NatureScot Research Report 1284.

Background

International context

It has been estimated that globally approximately $967 billion of annual investment is required to safeguard the natural environment, but current annual spending is only around $130 billion (Deutz, 2020). There is growing recognition of the importance of the private sector to meet this funding gap, by developing investment opportunities that protect or restore natural capital while generating a return on investment.

Today, the bulk of funding for nature conservation comes from public and philanthropic sources. As of 2019, it was estimated that just c.$20.75bn of private capital flowed to nature positive activity and conservation investments, (Deutz, 2020) although the market is rapidly growing in some parts of the world (Hamrick, 2016). For example, the US restoration industry alone has reached $25 billion in annual economic output, supporting 220,000 jobs, more than the logging, coal mining, iron and steel industries combined (Barrett, 2015).

Scottish context

Within Scotland, there is increasing political interest in natural capital, with recognition of Scotland’s unique landscapes, wildlife and resources for natural capital and renewable energy. With the First Minister’s declaration of a climate emergency in 2019, Scotland aims to reach net zero by 2045, five years before the rest of the UK. In the wake of the COVID-19 crisis, Scotland is now positioned to showcase its plans for a green recovery at COP 26, with an “unequivocal focus on climate change, fair work, diversity and equality” (Scottish Government, 2020).

The Facilitating Local Natural Capital Investment project was commissioned to demonstrate practical ways in which private sources of finance and investment can be facilitated to support nature-based interventions that produce a range of beneficial outcomes – environmental, economic, human and social - that reflect both national and local priorities.

This focus is reflected in the selection of Tweed Forum as local partner and host to the Project. Tweed Forum has provided leadership and expertise to develop a range of nature-based projects spanning the Scottish Borders. While the focus of its work is localised, the learnings are relevant across Scotland.

Literature review

In January 2021, NatureScot published the Facilitating Local Natural Capital Investment: Literature Review (Finance Earth, 2021). This review was carried out by Finance Earth to identify key lessons for facilitating investment in natural capital in Scotland, particularly at the regional level, by looking at relevant experience and initiatives from across the world.

The review assessed a series of natural capital financing products and vehicles used in an international context that may be applied to Scotland’s natural capital assets. The review also identified the key barriers to the development of ecosystem service markets in Scotland, including revenue uncertainty, capacity and expertise, consistency of policy and standards and the scale and complexity of projects. The review also considers how these may be overcome. The key recommendations from the review, including for more investment readiness support and pathfinder funding to catalyse new markets, are echoed in this report. The remainder of the Project has built on the foundations of the literature review and these two documents should be considered in tandem.

Facilitating Local natural Capital Investment Project process

The Project followed a six-stage process to identify and evaluate natural capital investment opportunities across the Tweed catchment.

The following sections of this report capture the learnings and outcomes of each stage of the Project.

Unlike available grant funding, carbon-based finance could be used to fund long term habitat maintenance and compensate for the loss of existing revenues on the land. In this way, private finance may be more attractive to landowners and enable larger-scale restoration compared to short term grants.

Key barriers to investment

The following key barriers to investment and scale have been identified:

• Carbon pricing is currently not sufficient to support the majority of restoration activity. Carbon markets are also considered volatile and opaque, driving uncertainty and restricting the ability for landowners to participate individually in the markets.
• Public funding provided through Peatland Action has been intermittent, and time constrained and has not incentivised private investment.
• Understanding of peatland restoration is limited amongst investors, landowners and contractors. Restoration interventions and associated costs are site specific and may require ongoing active management to secure long-term ecological improvement.
• Peatland condition data is not ordinarily available and baselining surveys are required before intervention
• Market uncertainty has driven under-investment in training and equipment by restoration contractors. This is compounded by the seasonality of restoration works due to weather and ecological factors.

Illustrative investment structure

A Scotland Carbon Fund could provide access to private capital at scale to multiple “carbon-sink” landscape types, including woodland and peatland, and other land uses and habitats in future, as standards are developed.  The proposed mechanism is designed to work in tandem with a price floor guarantee, explained further in Model structure options section.

 

A Scotland Carbon Fund could support private investment into the delivery of peatland restoration and allow for landowners to participate in long term carbon market movements as well as receiving upfront income. It would be more effective if it was able to access a carbon price guarantee mechanism provided by the Scottish Government. A pilot fund would aim to raise at least £10 million of private investment.

1. Under the proposed structure, repayable investment is raised into the Scotland Carbon Fund by a regulated fund manager.
2. The Carbon Fund purchases validated carbon units (Pending Issuance Units, ‘PIUs’) from planned projects prior to restoration activity, thus taking on project delivery risk. These projects are identified through partnership with project developers and networks of local stakeholder organisations such as Tweed Forum, which work closely with landowners to establish new opportunities.
3. PIUs are independently verified over time to become Peatland Carbon Units (PCUs).
4. Carbon units are sold by the fund either to:
   • Private carbon buyers (as either PIUs or PCUs); or
   • Through a publicly funded price floor mechanism as PCUs (explored further in Priority Investment Structure: Scotland Carbon Fund section, thereby generating a return to investors in the fund if sales are profitable.
5. A portion of profits may be used to capitalise an endowment, providing an ongoing revenue stream to the landowner through a revenue share agreement between the Scotland Carbon Fund and the Landowner to support lifetime management costs or account for foregone revenues.
6. Sites are managed over their respective project lifetimes by the landowner/ manager or a third-party operator.

Model assessment

Criteria	Rating	Description
Maturity of business model	Medium	With the recent development of the IUCN Peatland Code, peatland restoration for carbon abatement is a nascent but developing opportunity, with 24 projects validated to date. There are currently limited opportunities to monetise ecosystem services provided by peatland landscapes beyond carbon abatement.
Scale of Opportunity in the Scottish Borders	High	22,000ha of peatland exists across the Scottish Borders, with just 3% classified as in near-natural condition (NatureScot Research Report 1284). Restoration costs are likely to be in the range of £25-45 million (NatureScot Research Report 1284).
Replicability	High	There are more than a million hectares of degraded peatland across Scotland presenting a significant opportunity to scale effective investment models.
Investment readiness in Scotland	Low	The structure of existing funding programmes does not encourage private investment in peatland restoration. There is an opportunity to use public funds more strategically to catalyse investment. The pool of contractors with the relevant skills, equipment and geographical coverage is limited.
Social and environmental outcomes	High	Restoring the 12,000ha of peatland that is in the worst condition would abate the release of 150,000tCO2e per year, supporting national net zero targets (NatureScot Research Report 1284). Restored peat delivers benefits to biodiversity, regulated water flow and water quality. Peatland restoration may compete with or restrict other land uses (i.e., upland grazing). This may have positive environmental outcomes but could also be socially disruptive.

 

Recommendations for further development

The Scotland Carbon Fund opportunity was prioritised for further analysis which is detailed below in Priority Investment Structure: Scotland Carbon Fund section.

Woodland Creation

Woodland Creation was identified as a high priority opportunity for further investigation.

Opportunity Summary

A significant opportunity for woodland creation in the Scottish Borders was identified, based on the existing scale of activity.

In partnership with Forest Carbon, Tweed Forum has delivered 16 woodland creation projects, by connecting with and engaging aligned landowners across the region (Forest Carbon Limited, 2021). This includes a significant focus on riparian planting with a recognition of the multiple benefits generated for the catchment.

Projects are funded through a mix of planting grants and the sale of Woodland Carbon Code-validated PIUs to voluntary offtakers.

Approximately 20% of the Scottish Borders is currently wooded, comprising primarily of commercial coniferous plantations in upland areas. There is a significant opportunity to improve the biodiversity of woodlands through the planting of non-timber oriented, mixed native species.

It was reported that carbon payments typically support 25-30% of capital costs of delivery in the current market. Notably, projects with additional environmental and social benefits such as charismatic biodiversity and local community benefits and engagement can attract a carbon price premium, a trend also evident in international voluntary carbon markets.

Key Barriers to Investment

The following key barriers to investment and scale in Scotland have been identified:

• Rising timber prices, paired with growing interest in voluntary carbon markets have increased competition for available land, with forestry land prices more than doubling in 2020 (John Clegg & Co, 2020).
• Land ownership is highly concentrated and complicated by a patchwork of tenant farmers, crofters and longstanding land rights.
• Revenue stacking, which involves selling carbon credits alongside other products from the same land such as agroforestry or water quality credits, can raise additionality complexities. Both the Peatland Code and Woodland Carbon Code require projects to pass additionality tests.

Illustrative Investment Structure

A Timberland Investment Management Organisation (TIMO) is a pooled fund that enables investment in landscapes at scale, generating sustainable revenues to support conservation objectives.

A TIMO can be designed to manage a portion of its assets to generate revenues to support biodiverse woodland planting and conservation initiatives. This could include productive woodland subsidising riparian conservation efforts.

A TIMO could be aligned with or governed by a place-based organisation (such as Tweed Forum) or a community enterprise, ensuring that the vehicle remains accountable and that benefits generated are captured locally.

A TIMO structure could support private investment into the delivery of woodland creation and restoration, through the stacking of a series of revenue streams that could include carbon credits, timber (produced through sustainable practice, as defined by the UK Forestry Standard), Natural Flood Management (NFM) payments and enterprise activities.

A TIMO should aim to raise at least £10 million and ideally more than £25 million to access institutional investment, supported by a project pipeline it could be deployed at a regional or national scale.

1. Under the proposed structure, investment is raised into the TIMO.
2. The TIMO purchases or leases target land and forestry assets with a mix of identified revenue opportunities.
3. The TIMO contracts an Asset Manager to generate a range of conservation outcomes and associated revenues from the assets, which could include the creation of new nature-friendly woodlands.
4. Investment returns are generated out of project revenues to repay investors over the life of the TIMO.
5. Surplus returns may be reinvested or donated to an aligned community entity as a ‘conservation dividend’ providing indirect social and environmental benefits, and tax efficiencies.

Model assessment

Criteria	Rating	Description
Maturity of business model	High	Carbon, timber and enterprise revenues can be derived from a woodland creation (or sustainable management) project. While the forestry sector is mature in Scotland, it has few examples of impact-led woodland creation and management models that have been successful internationally.
Scale of opportunity in the Scottish Borders	High	20% of the Scottish Borders is forested, of which 85% is coniferous plantations (NatureScot Research Report 1284). Scottish Borders Woodland Strategy targets 25% land coverage (Scottish Border Council, 2005) compared to a national target of 21% (Scottish Government, 2020).
Replicability	High	Woodland creation and sustainable management approaches are widely applicable across Scotland and benefit from economies of scale.
Investment readiness in Scotland	Medium	Existing woodland creation grants and the Woodland Carbon Code support investment in woodland creation. Current policy and tax incentives are designed to benefit productive woodland. A price floor policy intervention or tax incentives for nature-friendly woodland could support the growth of biodiversity rich woodland carbon opportunities.
Social and environmental outcomes	High	A 5% increase in forest cover could sequester 138,000tCO2 and provide a range of additional ecosystem services including biodiversity, recreation and NFM (NatureScot Research Report 1284). Increasing the share of native woodland presents a major opportunity for nature recovery. There is a risk that without investment models that target nature rich forestry, national targets for woodland creation could compromise biodiversity, through inappropriate tree species selection and planting locations. The Land Use Strategy pilot identified the most suitable locations for planting in the Scottish Borders, avoiding sensitive areas (e.g., peatland and productive agriculture).  TIMOs can be designed to provide community benefits and potentially facilitate community ownership in the long term.

 

Recommendations for future development

The TIMO structure could facilitate project development, improve environmental outcomes, access to capital and scale for biodiverse woodland creation and management projects. Growth could be driven by the development of the voluntary carbon market, or through enterprise opportunities.

The Scotland Carbon Fund and price floor guarantee opportunities detailed in Priority Investment Structure: Scotland Carbon Fund section may also be applicable to woodland creation projects. However, peatland and woodland carbon markets are distinct and at different phases of development in Scotland. As such further analysis and application of the model to woodland project examples is required to assess this opportunity further.

Nature Friendly Farming

Nature friendly farming was identified as a medium-term opportunity.

Opportunity Summary

As key landowners and beneficiaries of ecosystem services across the Tweed catchment, farmers and farming practices are critical to the protection and enhancement of natural capital.

As depicted in Figure 5, more than 75% of land across the Scottish Borders is used for agricultural purposes (NatureScot Research Report 1284). This is comprised of:

• 2,500 farm holdings;
• c.190,000ha of arable farmland and improved grassland concentrated in lowland plains; and
• c.170,000ha of rough grazed land (mostly sheep grazing).

With this scale of land use, sustainable management of farmland has a vital part to play in the management of Scotland’s natural capital. This includes building on the significant ongoing activity led by farmers while also allowing the sharing and development of new practices.

Farming community organisations have a key role to play in setting standards and building shorter and more impactful supply chains. This includes organisations such as Scottish Agricultural Organisation Society (SAOS), National Farmers Union, Scotland (NFUS), Scottish Land and Estates, Local Agricultural Discussion Societies and the Border Union Agricultural Society.

Key Barriers to Investment

The following key barriers to investment and scale have been identified:

• No/Few ‘keystone’ beneficiaries willing to pay for natural capital enhancements have been identified to date. Where key beneficiaries can be identified farmers and landowners may come together to delivered nature-based solutions at an aggregated scale.
• The complexity of existing supply chains may dilute or confuse relationships with retailers and end consumers.
• Complexity of engaging with large group of farming stakeholders and managing varied local priorities.

Lack of market evidence for premiums for products produced under existing agricultural standards.

Illustrative Investment Structure

Sustainable farming and land management practices can be supported through an Agricultural Standard and kitemark scheme. Through this approach, farmers can be encouraged to commit to specified practices where certification can be expected to result in increased sales and/or margins. Farmers may also be able to access new revenue streams through conservation payments or benefit directly from additional revenue streams linked to interventions.

Agricultural Standards and other kitemark models are a potential gateway from intensive land uses to sustainable practice including organic farming. This approach has been used successfully by organisations including LEAF (Linking Environment and Farming), the Soil Association and the Pasture Fed Livestock Association.

Agricultural Standards

An Agricultural Standard may be piloted at a local scale and grown over time or established at a national level. This may be limited to a single flagship product or designed to support all products from a given region. Revenues are generated through membership fees and/or licensee fees from manufacturers and retailers.

1. Under this structure, funding is provided to set up the Agricultural Standard and develop a network of participating farmers, brands/retailers and consumer engagement.
2. Participating farms commit to and carry out specific sustainable land management practices e.g., maintaining a portion of land as nature-friendly habitat.
3. An independent auditor verifies compliance with the scheme.
4. Agricultural products certified under the Agricultural Standard are sold to manufacturers/ retailers.
5. Consumer products carrying the Agricultural Standard kitemark are purchased by consumers.
6. Manufacturer/retailer pays the Agricultural Standard provider a licensee fee based on percentage of certified product sales revenue.

Model assessment

Criteria	Rating	Description
Maturity of business model	Medium	Agricultural Standards are well-established across a range of products and farming practices internationally. To more fully understand the potential for this model in Scotland further market analysis, supply chain review and stakeholder engagement is required.
Scale of opportunity in the Scottish Borders	High	Farming is the predominant land use in the Scottish Borders, accounting for c.80% of land uses (both arable and livestock) (NatureScot Research Report 1284). A successful nature-friendly farming scheme could provide widespread environmental benefits with a range of natural interventions, such as riparian planting or soil management.
Replicability	High	A Scotland-wide scheme could be delivered to provide environmental benefits and economic uplift, potentially leveraging Scotland’s strong brand appeal.
Investment readiness in Scotland	Low	The model is reliant on engagement with a large group of stakeholders throughout agricultural supply chains to assess appetite and build demand. Further market analysis is required to understand appropriate producers, products, standards and purchasers. Successful schemes typically require significant investment in consumer engagement to drive demand.
Social and environmental outcomes	High	Nature-friendly farming at scale could deliver soil carbon sequestration, soil maintenance, biodiversity improvement and reduce diffuse pollution. This model is constrained by the demands of land use for food production.

 

Recommendations for future development

Organisations such as Tweed Forum that bring together regional stakeholders are well-placed to lead the development of an Agricultural Standard, working with farmers and other producers to provide positive environmental outcomes. Key recommendations for future development include:

• Identify target environmental benefits and participant activities, working with farmers to create a realistic, attractive and scalable structure.
• Carry out market research on consumer demand for nature-friendly products to identify product opportunities and potential price differentials.
• Carry out market research on suitable products, producers and retailers to engage with a pilot scheme.
• Identify a suitable operator, accreditor and seek funding to develop a pilot programme.

Natural Flood Management (‘NFM’) and Water Environment

Investment in NFM and the Water Environment was identified as a medium-term opportunity in the Scottish Borders.

Further engagement work with key stakeholders and beneficiaries will support development of this opportunity.

Opportunity Summary

Across the Tweed catchment, 8% (4,575) of properties are at risk of flooding (NatureScot Research Report 1284). The attenuation capacity of upland areas has been impacted by processes including peatland erosion, agricultural improvement and monocrop forestry.  

Water bodies are mostly in ‘Good’ condition across the Tweed catchment (SEPA, 2020). However, key pressures arise where there are man-made barriers to fish migration and rural diffuse pollution.

With low native woodland coverage, exposed riparian zones have seen increasing water temperatures and associated falls in fish stocks. This is relevant in a region where sport fishing represents a key driver of tourism.  Watercourses are also subjected to other pressures including weirs, invasive non-native species, topsoil and nutrient run-off and dredging.

Tweed Forum has identified the benefits of landscape scale intervention to manage the impact of changing land use on the water environment across the catchment and has led pioneering NFM projects across the catchment, including most recently on the Eddleston Water (Tweed Forum, 2021).

Key Barriers to Investment

One of the key barriers to investment in NFM and water environment interventions in the catchment has been identified as a lack of engagement from beneficiaries. Although the Scottish Borders Council flood protection scheme represents a source of funding, no further beneficiaries willing to pay for or invest in NFM outcomes have been identified to date.

Scottish Water was identified as a key beneficiary of this type of intervention (through water quality improvements), with the headwaters of the Tweed catchment providing water to the City of Edinburgh, but neither the Project nor Tweed Forum has been successful in engaging with Scottish Water to discuss these opportunities further.

Low beneficiary engagement may be ascribed to several key factors. In the first case, water quality across the catchment mostly meets regulatory standards, limiting interest from regulated entities in arrangements to deliver impact.  Additionally, nature-based solutions for NFM and water environment (e.g., water quality) have a limited track record compared to traditional hard engineered solutions. This creates a barrier for water utilities aiming to ensure that customer funds are used to deliver proven and reliable outcomes. This is compounded by the need for attribution and measurement of benefits in most funding structures for NFM interventions. With the low population densities across the Scottish Borders region, the case for large scale, measurable and concentrated intervention is difficult to prove.

Illustrative Investment Structure

Where a key beneficiary can be identified, an Environmental Impact Bond (EIB) structure can attract upfront funding for delivery of nature-based solutions, with revenue generated from “outcome payers” upon successful performance.

Environmental Impact Bond

A EIB structure could enable private investment into the delivery of NFM and water environment interventions across the Tweed. This is achieved through the transfer of asset performance risk to investors with the agreement of a payment-for-success mechanism with a key beneficiary or beneficiaries. In this regard, the EIB mechanism relies on the identification of beneficiaries willing to pay for outcomes, and impact investors willing to take on a portion of performance risk.

To support the costs of ongoing monitoring and measurement and cover transaction costs associated with the mechanism, an EIB would likely look to raise a minimum of c.£10million.

1. An EIB is set up based on contractual obligations of outcome payers to pay for specific environmental outcomes once verified. Assured by these contracts, impact investors provide upfront investment by subscribing to the EIB.
2. The EIB is used to fund the implementation and operation of nature-based solutions to deliver the target outcomes. During the period of the EIB, it may pay a basic return to investors.
3. An independent verifier confirms the environmental outcomes after a specific time period (this may need to be a period of several years).
4. Outcome payers remunerate the EIB for the delivery of verified outcomes, based on performance against pre-agreed metrics.
5. The proceeds received from outcome payers are used to repay investors. Investor returns are linked to the performance of the intervention against expectations – higher returns in the case of outperformance, and lower or nil returns in the case of underperformance.

Model assessment

Criteria	Rating	Description
Maturity of business model	Low	Funding models to support investment in NFM and water quality are reliant on a robust evidence base and the identification of outcome payers. There is a track record of EIBs in use overseas to implement green infrastructure to protect urban communities and the model is well-tested in the UK’s social investment sector but has not yet been trialled to address UK environmental issues.
Scale of opportunity in the Scottish Borders	Low	With 8% of properties in the Scottish Borders at risk of flooding there is an opportunity to deploy NFM interventions. Eddleston catchment modelling results suggest flood damages could be reduced by 3-5% through targeted NFM, delivering £2.7-4.5 million in NPV of cost savings over 60 years (NatureScot Research Report 1284), suggesting a limited scale of opportunity for an EIB in the area. 82% of water bodies are rated ‘Good’ but a range of environment pressures remain. Investment is limited by the lack of suitable outcome payers identified and willing to engage (NatureScot Research Report 1284).
Replicability	Medium	Nature-based solutions for water environments may be more applicable in other regions where outcome payers can be identified such as areas with greater population densities or where environmental compliance targets are not being met. The model is generally bespoke as it is reliant on a suitable outcomes payer in the area, although national bodies such as Scottish Water could apply the model across the country with local adaptations.
Investment readiness in Scotland	Low	Responsibility for water environments is divided between local authorities, SEPA and Scottish Water. NFM projects are only investable on a case-by-case basis without increased beneficiary engagement or targeted policy intervention (e.g., increased regulatory obligations on key stakeholders).
Social and environmental outcomes	High	National level assumptions give an annual expected flood damage of c.£3.3 million in the Tweed catchment. Spatially targeted NFM measures could reduce flooding costs by approximately 3-5%, while supporting biodiversity enhancement and carbon sequestration (NatureScot Research Report 1284).

 

Recommendations for future development

Further engagement with beneficiaries of water environment interventions is key to the further development of this approach. This includes further mapping of the beneficiaries of interventions, and the ecosystem services from which they benefit (or environmental hazards to which they are currently exposed).  This model may be more appropriate in other regions of Scotland where issues are more severe, or where willing outcomes payors can be identified.

Riverwoods

Investment in riparian woodlands, or ‘Riverwoods’ as explored by the Scottish Conservation Finance Initiative, was identified as a medium-term opportunity for private investment in the Scottish Borders.

Riverwoods may be delivered through the funding models explored for woodland creation, nature-friendly farming and for investment in NFM and water environment.

Opportunity Summary

Riverwoods is an initiative to create a network of riverbank woodlands supporting healthy and resilient river systems, able to adapt to Scotland’s changing climate. This has been identified as a high ecological priority by the Tweed Forum.

Multiple benefit analysis carried out in the Eddleston catchment demonstrated the range of NFM, water quality and environment, biodiversity and amenity benefits provided. This is in addition to other known benefits (e.g., carbon sequestration).

Ongoing work led by Tweed Forum has identified an approximate cost of £10 million to deliver 200km of riparian woodland (width of 50m) in the Tweed (Tweed Forum, 2020). This may be subsidised by further productive woodland.

Priority areas include Upper Tweed, Ettrick and Yarrow, Teviot, Bowmont and Leader/Gala as priority catchments for diffuse pollution, provision of flood protection or as part of the Borders Forest Trust Wildwood area.

The Tweed’s riparian woodlands could be supported by identifying and engaging with the beneficiaries of the multiple outcomes delivered as well as the relevant landowners/land managers. Tweed Forum has also identified prospective funders interested in increasing the resilience of fisheries through riparian woodland planting. Riparian planting has also been delivered in the UK as part of nature-based solutions projects such as integrated constructed wetlands for water quality located on rivers alongside wastewater treatment plants to clean the outflow.

Key Barriers to Investment

The following key barriers to investment and scale have been identified:

• As a linear landscape feature, land suited to riparian woodland is typically distributed across a range of landowners, creating stakeholder complexity to deliver at scale.
• Riparian woodland provides multiple recognised benefits. Stacking and monetising these is often complicated, with specific barriers to each revenue stream.
• While NFM and water environment benefits are established, measurement and attribution can be complex, as can beneficiaries’ engagement.
• Carbon benefits may only be monetised where additionality can be demonstrated.
• Monetising biodiversity benefits requires policy development.

Illustrative Investment Structure

Riverwoods was identified as an opportunity to demonstrate the use of blended finance under the Scottish Conservation Finance Project’s The £1 Billion Challenge (Scottish Conservation Finance Project, 2020). Blended finance is the use of private repayable finance alongside concessionary or ”first-loss” capital to support a project. By structuring finance in different tiers of capital, mainstream investors can be attracted to projects due to the lower risk of losses provided by the public and/or philanthropic capital tiers.

While not exhaustive, key models explored in this report that may be applied to Riverwoods include the Scotland Carbon Fund, TIMO structures, EIBs and Habitat Banking. While each of these structures have unique challenges, several have the potential to be “stacked” to increase and diversify revenue streams to attract more investors to riparian planting projects. In addition, while no specific market or product (e.g., credit) for riparian woodland currently exists, further policy development could unlock a bespoke model for the delivery of riparian planting.

Model assessment

Criteria	Rating	Description
Maturity of business model	Medium	Riparian planting can be achieved through stacking grant funding, emerging funding opportunities (e.g., carbon) and cross-subsidisation through more mature revenue streams. Tweed Forum has delivered several riparian planting projects using a mix of grant and biodiversity offset payments.
Scale of Opportunity in the Scottish Borders	Medium	Restoration work carried out by Tweed Forum has demonstrated the opportunity to deploy riparian woodland across the Tweed – scoping work has identified 200 km of riparian woodland planting covering c.1,000 ha (Tweed Forum, 2020).
Replicability	Low	Riverwoods projects across Scotland will face comparable challenges to investability but revenue streams generated by projects may vary.
Investment readiness in Scotland	Low	The delivery of pathfinder funding and further pilot projects could identify more viable business models. Policy incentives, such as price floor mechanisms or outcomes payments, could stimulate a market for ‘woodlands for water’ interventions.
Social and environmental outcomes	High	Multiple benefits of riparian planting have been recognised, especially relating to soil erosion, river flow and biodiversity. These also create social benefits through improved fishing grounds. Riverwoods along the Tweed would increase ecological connectivity at landscape scale.

 

Recommendations for future development

• Delivery as part of wider woodland creation schemes based on agri-environment and/or carbon revenues.
• Explore opportunities to pilot stacked revenue stream development and multiple benefit monetisation, especially involving beneficiaries in the recreational fishing sector.

Nature-based Tourism

Nature-based Tourism was identified as a medium-term opportunity for investment in natural capital in the Scottish Borders.

Opportunity Summary

Nature-based tourism presents a significant opportunity with 3.3 million visitors to the Tweed annually.  The natural capital of the Tweed catchment was identified as a primary driver of tourism in the Scottish Borders with popular recreational activities including mountain biking, hiking and fishing (NatureScot Research Report 1284). This relationship underpins the case for investment in natural capital by the sector.

Tourism Business Improvement Districts (TBIDs) can be used to capture and direct investment to maintain and enhance natural capital for residents and visitors. Alternative levy mechanisms such as taxes on local visitors or charges on fishing permits could be applied in a similar way.

GoTweedvalley is Scotland’s second TBID and was implemented to create a cohesive tourism destination marketing strategy to promote the Tweed valley. Through the TBID, 103 businesses will provide (expected) levies of £70,000 p.a. to invest in a range of schemes over five years (Tweed Valley Tourism Bid, 2020).

GoTweedvalley TBID aims to attract visitors to grow adventure tourism revenue streams. TBID revenues could be used to support larger capital investment in supportive tourism infrastructure or investment in the natural capital assets that underpin tourism opportunities.

Table 2. GoTweedValley business plan (2021-25) extract.

Breakdown	Expenditure (5 year Total)
Management and Organisational	£125,000
Marketing and promotion	£112,500
Infrastructure	£40,000
Corporate Tourism	£30,000
Contingency	£17,500
Events and Festivals	£15,000
Support and Advocacy	£10,000
Total	£350,000

 

Tweed Valley TBID

Key Barriers to Investment

The following key barriers to investment and scalability have been identified:

• The scale of funding available through the GoTweedValley TBID is currently limited. However, this may grow over time should this model gain traction with local tourism providers.
• Existing TBID mechanisms only allow for a five-year repayment horizon, limiting the term for investment.
• Limited appetite and financial capacity of businesses for levies, with many strained by the Covid-19 pandemic.
• TBID activities need to provide universal benefits to participating businesses, limiting the nature-based interventions that can receive direct support.

Illustrative Investment Structure

A TBID uses a revolving five-year business levy to support collective initiatives. Levy revenues could be leveraged to attract private investment.

A TBIDs five-year voting horizon limits the scale of investment that can be secured. A ‘licence based’ model with a longer review horizon may be used to increase the scale of opportunity.

Levies are paid by all (tourism) businesses in the TBID area, calculated as a percentage of business rates.

TBID and Bond Model

1. Businesses vote on the creation of a TBID in a specified area, based on a pre-defined business plan and levy, and commit to paying levies to the TBID over several years.
2. The TBID leverages its projected TBID revenues to issue a bond instrument, potentially via a separate SPV to which it provides guarantees and/or payments. The size of issuance depends on the scale and certainty of the potential revenue streams.
3. Bond proceeds are used to finance shared nature-based infrastructures, sustainable enterprise or community initiatives providing benefits to all participating businesses.
4. Bond investors are repaid by TBID levies over the term of the TBID. Any returns generated by investee projects are returned to and recycled by the TBID.

Model assessment

Criteria	Rating	Description
Maturity of business model	Low	Tourism is an established market and is widely nature-based in the Scottish Borders. A ‘TBID’ structure is already in place to aggregate business spending. The use of TBID and bond models to leverage investment in enterprises and natural assets is relatively novel.
Scale of Opportunity in the Scottish Borders	Medium	A range of trekking, mountain biking, fly fishing and other nature-based tourism businesses attract 3.34 million visitors and a spend of £124 million per annum across the Tweed (NatureScot Research Report 1284). As this sector grows enterprises could be expected to reinvest in the underlying natural assets of the Tweed’s tourism industry.
Replicability	Medium	Tourism is reliant on underlying market factors. Replicability will be based on local characteristics. TBID and enterprise investment funding models can be applied broadly where a suitable market exists.
Investment readiness in Scotland	Low	GoTweedvalley is only the second TBID structure in Scotland and is currently operating with an annual revenue of just £70,000. This may grow in future as the benefits of the TBID is recognised and be directed to secure investment in natural capital infrastructure. Further engagement with tourism enterprises is needed to assess capacity to take on repayable investment and the value businesses derive from high quality natural capital.
Social and environmental outcomes	Medium	A 10% growth in the tourist economy would generate c.£9 million per year in GVA and could create 400 new jobs (NatureScot Research Report 1284). Excessive growth in tourism could compromise the natural environment although TBID expenditure could be used to make the natural environment more resilient.

 

Recommendations for future development

Further growth of the tourism sector and the increasing recognition of businesses of their reliance on a well-functioning natural environment will expand the opportunity for NBS-focused TBIDs. The model will also benefit from:

• Development of TBID structures across Scotland, building on the precedent established by VisitInvernessLochness TBID and the GoTweedvalley TBID.
• Engagement with participating businesses to determine the scope and appetite for investment in specific nature-based solutions, and local natural capital priorities for participating businesses.
• An enterprise investment fund to support nature-based tourism enterprises was also identified as a potential opportunity for the use of finance. To develop this idea, further research into the investment needs of existing enterprises across the Tweed catchment is required.
• Evaluation of a more established, wide scale tourism levy for nature.

Biodiversity Offsetting

Biodiversity offsetting was identified as a longer-term opportunity in the Scottish Borders. While existing activity is innovative it is likely to require policy change and increased development demand to mature.  

Biodiversity offsetting mechanisms are limited by the current policy environment. Policy change could support the development of this opportunity in the medium to long term.

Opportunity Summary

Biodiversity offsetting presents a key opportunity for strategic regional investment in natural capital that could be replicated across Scotland.

Biodiversity offsetting is currently delivered on a ‘no net loss’ basis in the Scottish Borders under local planning policy using section 69 and 75 agreements. This is led by Scottish Borders Council (‘SBC’).

SBC has secured £1.76 million over 11 years supporting a total of 13 offset schemes to date. Demand is hard to predict and has been primarily generated by windfarm development.

Biodiversity offsets across the Scottish Borders are currently delivered:

• On a qualitative basis;
• On aligned landowner land with limited long-term protections;
• On an ad-hoc basis; and
• Post-development, exposing the offset to delivery risks.

A strategic, quantified approach supported by a suitable policy mechanism could facilitate investment while supporting more cost efficient and ecologically impactful offsets while safeguarding the mitigation hierarchy.

Key Barriers to Investment

The following key barriers to investment and scale of this approach have been identified:

• There is currently no national policy for biodiversity mitigation from land use change. Internationally, standardised biodiversity offsetting or net gain policy has been a key prerequisite to the development of offset markets.
• Demand for offsets in the Scottish Borders has been driven by windfarm development. Development demand is inconsistent and hard to forecast in the region.
• Assessment of biodiversity mitigation is currently carried out on an ad hoc and qualitative basis (although like-for-like offsetting is targeted). Qualitative assessment may undermine credibility in negotiation with outcome payers (and subsequently investors). 
• With a total population of c.115,000, the Scottish Borders is the 7^th least populous council area in Scotland. As such, the demand for offsetting may be comparably lower than that of more densely populated regions (National Records of Scotland, 2019).

Illustrative Investment Structure

A market-based approach to conservation, Habitat Banking enables upfront investment in the creation and/or restoration of habitats to mitigate habitat loss elsewhere in the future as a result of development.

Habitat Banking

1. Under this structure, investment is raised into a Biodiversity Fund.
2. The Biodiversity Fund in turn invests into an SPV, known as the ‘Habitat Bank’. The Habitat Bank delivers nature restoration, either through land purchase, or through covenant agreements with long term landowners.
3. The regulator (or an accredited, independent auditor) verifies and approves registration of the habitat bank and future offsetting delivered. This is likely to include a quantitative assessment of the biodiversity value of the habitat. Policy change could enable the commodification of value as ‘credits’, improving fungibility.
4. To fulfil planning obligations (under section 69 and section 75 or future policy agreements) or under voluntary arrangements, developers make payments to the Habitat Bank for biodiversity offsets in accordance with the mitigation hierarchy.
5. A portion of income received from developers can be captured to provide an endowment for the long-term management of the habitat site.
6. Remaining funds are used to repay investors through the Biodiversity Fund.
7. The site is managed by an operator on an ongoing basis, funded by the endowment.

Model assessment

Criteria	Rating	Description
Maturity of business model	Medium	£1.76 million of offset projects have been delivered in the Scottish Borders since 2009 through section 69 and 75 payments. Biodiversity offsetting mechanisms such as Habitat Banking are established internationally.
Scale of Opportunity in the Scottish Borders	Low	The scale of opportunity in the Scottish Borders is limited by the expected development pipeline. There are currently 13 windfarm projects of greater than 5MW total capacity within the planning pipeline in the Scottish Borders (Scottish Borders Council, 2021). It is not known if all or any of these will be delivered. Beyond windfarms, no development activity that might require offsetting was identified in the project area.
Replicability	Medium	This model is highly replicable where suitable market and policy conditions exist. Without policy intervention there is limited scope for large scale Habitat Banking in Scotland.
Investment readiness in Scotland	Low	This model is highly dependent on policy mandating biodiversity offsetting or net gain. Current legislation does not provide suitable support for the growth of this market. Future planning guidance and regulation may support biodiversity offsetting in the medium to long term.
Social and environmental outcomes	Medium	Where a net gain policy is established, the environment is expected to receive a net benefit from this approach. Social value is not necessarily factored into biodiversity offsetting measures, however site selection can be prioritised based on additional value delivered to local communities, such as public access.

Recommendations for future development

• The development of effective biodiversity policy to support a Habitat Banking market in Scotland is key to the further market development.
• Any future policy should be sensitive to local and regional needs and provide flexibility to allow the development of the market.
• Any future policy should be quantitative and clear for market participants. National policy may be designed for implementation at a regional level to ensure sensitivity to localised needs and priorities.
• Net gain policy should be considered as a legal requirement for all residential, commercial and infrastructure development, which if effectively designed can streamline planning while delivering net gains for the environment.

Other Investment Models

A range of additional investment models were considered as part of the assessment of opportunities in the Tweed catchment. While each of these could support Natural Capital investment, key barriers to deployment may prevent practical implementation at this stage.

Landscape Enterprise Networks (LENs)

LENs projects aim to link the management of and investment in landscapes to the needs of businesses and society as a whole. LENs projects focus on aggregating linkages between the providers and beneficiaries of ecosystem services

• Linking beneficiaries to providers allows them to impact the management of landscapes to support the needs of their businesses, enabling them to influence assets, services and risks relevant to their business from the landscapes in which they operate.
• LENs aggregates the supply of ecosystem services, reducing the transaction costs of contracting with multiple landowners across a landscape, and aggregates demand among multiple investors, creating collaborative value chains that avoid trade-offs between ecosystem services and minimise piggybacking of non-investing beneficiaries.
• LENs approaches hinge on the identification and matching of suitable buyers and sellers of ecosystem services. The Project identified a limited network of potential beneficiaries that may be willing to pay for environmental outcomes across the Scottish Borders, restricting further development of the LENs approach.
• The ability to attract private investment to deliver interventions is dependent on clear evidence of demand for the outcomes from paying beneficiaries. Where a bespoke LENs structure is established, there may be an opportunity for finance.

Place-based trust

• An independent vehicle is established to provide strategic management of assets funded through an endowment and/or relevant natural capital revenue streams.
• This model is suitable for managing assets and co-ordinating projects which can be governed by a single entity (e.g., urban greenspace, community woodlands, Marine Protected Areas etc).
• Tweed Forum currently performs many of the functions of a place-based vehicle effectively within the project area.

EnviroCAT Bond

• A catastrophe bond is used to finance natural assets to decrease the likelihood of insurance trigger events.
• Well suited to large scale financial risks and defined interventions but requires close cooperation and engagement with the insurance and/or reinsurance sectors.
• This approach requires a minimum scale of environmental (and financial) risk to support the case for development. The Project did not identify a suitable case for development in the Scottish Borders.

Assessment of Investment Priorities

The overall assessment of each natural capital business model has been refined through market analysis and engagement with local and national stakeholders.  Table 3 details the ranking of each opportunity against the five key assessment criteria outlined in Longlist Opportunities for Investment section.

Table 3. Opportunity Assessment Matrix.

Opportunity Theme	Maturity of business model	Scale of opportunity in Borders	Replicability	Investment in Scotland	Social and environmental benefits
Woodland Creation	High	High	High	Medium	High
Peatland Restoration	Medium	High	High	Low	High
Nature Friendly Farming	Medium	High	High	Low	High
NFM and Water Quality	Low	Low	Medium	Low	High
Riverwoods	Medium	Medium	Low	Low	High
Tourism	Low	Medium	Medium	Low	Medium
Biodiversity	Medium	Low	Medium	Low	Medium

 

The opportunity for a Scotland Carbon Fund to support investment in peatland restoration and woodland creation was identified as the highest priority for further investigation for the remainder of the Facilitating Local Natural Capital Investment project. The structure was selected based on the opportunity to deliver landscape scale change both across the Tweed catchment and nationally, while facilitating market development in the two highest priority investment opportunities. 

Existing market infrastructure under the Woodland Carbon Code and the Peatland Code was also considered sufficient to support a pilot programme without the need for further policy development or an extended period of stakeholder engagement.

Priority Investment Structure - Scotland Carbon Fund

Scotland Carbon Fund

The opportunity for a Scotland Carbon Fund, supported by a price floor mechanism, was selected for further research and application to a case study project in the Tweed catchment.

The leverage of private capital through the fund will facilitate efficient, large scale habitat restoration to sequester or avoid carbon emissions and deliver a range of additional ecosystem benefits. The fund vehicle achieves this by providing carbon market liquidity and transparency, reducing the friction costs of transactions and attracting more investment to the sector through scale and project diversification. Market development will also promote competition driving efficiencies in the sector.

A price floor mechanism can be used to further the benefits generated by reducing the cost of capital to the fund and encouraging development of the market.

In this section we consider the Scotland Carbon Fund, price floor mechanism and aligned tools in further detail. Model structure options section provides a summary of structural options for the fund while Price Floor Mechanism section considers the function of a price floor as a policy tool in supporting market development. Benefits / Outcomes section summarises the expected benefits and key target outcomes of this approach, with an indicative fund structure explored in Indicative Structure section. Finally, Further Mechanisms section provides an introduction to key aligned tools enabled by the fund, including mechanics around revenue shares, endowments and conservation dividends.

Model structure options

Three distinct financing mechanisms were considered to support the delivery of carbon offset projects across woodland and peatland landscapes, considering both project finance and liquidity structures.

Project Finance

A traditional project finance vehicle provides funding to support capital delivery works (e.g. habitat restoration) in advance of revenue generation.

Currently, under the Woodland Carbon Code and Peatland Code, pre-verified credits (termed ‘pending-issuance units’ or ‘PIUs’) may be sold early in the project life, in advance of verification. This upfront or ‘ex-ante’ sale of pre-issuance carbon units to support long term financing removes the need for project finance by bringing forward lifetime carbon revenues to the start of the project.

Therefore, instead of requiring funding for capital delivery works, project developers require liquidity to ensure that credits can be sold easily at a suitable price to support viable project delivery. The Scotland Carbon Fund is designed to be this liquidity provider.

Liquidity Structures

The project considered the options for both short and long lifecycle vehicles to provide liquidity to market participants. It was identified that a long-term vehicle was best suited to supporting restoration activity.

Short term liquidity

A liquidity vehicle aims to support project delivery by facilitating market transactions in PIUs. This provides benefits including market transparency, efficiency and price discovery. By providing a reliable and straightforward source of demand for PIUs in the market and reducing friction costs for sellers, a fund will provide access to more buyers, and at a greater scale.

A short-term liquidity vehicle purchases, aggregates and sells pre-issuance units to corporate offtakers within 1-3 years. The vehicle provides a return to its investors based on a margin between the PIU purchase and ultimate sale price of aggregated credits. This model is highly speculative and relies on short term market price increases to generate returns for investors.

Long term liquidity

Unlike a short-term vehicle, the equity fund will look to buy and hold either all, or a portion of, PIUs purchased through to verification as Woodland or Peatland Carbon Units (W/PCUs). Investor returns are driven by the increase in value of credits over time and through verification. In this way, the vehicle can afford to pay a higher price for the purchase of PIUs than the short term vehicle, thereby passing more value through to the underlying project and its stakeholders. Additionally, the project (or landowner) may form an agreement with the fund to share in the upside of `the long-term growth in the value of carbon credits based on their own risk appetite. 

Table 4. Target fund models.

Type	Description	Type of capital	Lifecycle	Investor Risk Profile	Indicative Investor Return
Short term	PIUs are purchased upfront and sold within 1-2 years to corporate offtakers	Equity	Short (2-5 years)	High	15%+
Long term	PIUs are purchased upfront to cover delivery costs, and a portion are held by the fund for sale over time	Equity	Long (5+ / Evergreen)	Medium/ high	5-15%

 

The equity fund structure was selected as the most suitable approach for the Scotland Carbon Fund, providing liquidity to market participants, flexibility for sellers and passing through maximum value to the project. The lower end of the spectrum for the investor return is likely to rely on a floor price mechanism to provide greater price certainty.

Price Floor Mechanism

A price floor mechanism is a form of guarantee that increases the opportunity to attract private investment. Price floor mechanisms are used to accelerate market development by removing the risk that prices fall in the future through a guarantee to recipients. The market function of a guarantee mechanism is reflected in Figure 13 below:

A Carbon Guarantee would mitigate against the risk of the public sector crowding out private funds, a problem often seen with standalone upfront grant programmes and reportedly a current issue with the design of the Peatland Action programme in Scotland (as explored by Professor Mark Reed in Annex 3).

Key benefits include:

• Providing certainty to investors/developers over future revenues.
• Mitigating market risk for investors at the fund level thus enabling the fund to access a lower cost of capital as investors are satisfied with a lower target return.
• This mechanism may allow for the targeting of specific outcomes by setting guarantee qualification criteria accordingly e.g., targeting more biodiverse projects.

Precedent Guarantee Mechanisms

Price floor mechanisms have been used to accelerate development of new markets in other contexts. Key recent examples in the UK include the Feed-in-Tariff for renewable energy and the Woodland Carbon Guarantee (in England only) and are detailed below. Under these structures, price floors are set by government agencies to support market development. Floor-pricing can be set by the guarantor either as a fixed price for all guarantee recipients or at different prices for recipients up to a maximum price, awarded via competitive reverse auctions.

Feed in Tariff (FiT)

The FiT was a UK government programme introduced in 2010 designed to promote uptake and financing of renewable energy generation technologies by providing market access and price certainty for energy generated alongside subsidy payments. Guaranteed prices are set centrally at fixed tariff rates (based on technology type), providing revenue for 20 years.

Woodland Carbon Guarantee (WCG)

The WCG is a £50 million government scheme designed to stimulate woodland creation in England through a guaranteed price for Woodland Carbon Units generated by 2055/56. Projects compete in reverse auctions for price floor agreements, bidding below a maximum (reserve) price determined by the Forestry Commission which runs the scheme.

A Peatland Carbon Guarantee for a Scottish Carbon Fund

Scotland has committed to delivering £250 million of funding to Peatland Restoration through the Peatland Action programme by 2030. A portion of this could be used to provide a price floor mechanism to help deliver this target by leveraging private sources of finance. A price floor mechanism may be used to reduce private investor risk, attracting investment at a lower cost and so reducing market friction costs. Where market prices rise in the future beyond the guaranteed price level, guarantee holders will sell PCUs into the market instead of to the guarantor, thus potentially reducing the financial burden on the public sector.

This report proposes that the price floor mechanism will be most effective when delivered alongside the Scotland Carbon Fund. This differs from the approach taken by the Woodland Carbon Guarantee operating in England which operates through a reverse auction system working with landowners and project developers. A fund level structure is expected to provide a more streamlined and straightforward funding process with fewer friction costs for participants, thereby increasing the proportion of the carbon payment delivered to the project. Importantly, a fund level structure is expected to attract investment on a more competitive basis. By aggregating investment opportunities, the fund can drive competition amongst prospective investors. Aggregation also may provide access to the most cost-effective forms of capital including institutional investment. Institutional investors typically have a minimum investment value and specific risk and management requirements. This can be delivered at the fund level in a way that is not economical on a project-by-project basis.

While this section is focused on the opportunity for peatland restoration, in practice this approach may also be applicable to other landscapes (e.g., woodland). Further analysis of woodland creation case studies would need to be carried out to refine the fund structure to suit the specific characteristics of the woodland carbon market.

How it works?

1. A price floor is set by the Scottish Government and awarded to the Scotland Carbon Fund for a certain volume of PCUs.
2. The carbon fund raises finance from impact investors seeking exposure to UK carbon markets.
3. Projects sell PIUs to the fund, with proceeds of sale funding site delivery.
4. Income is generated by the fund from the sale of:
   1. PIUs to corporates or brokers;
   2. PCUs to corporates for use as offsets; or
   3. PCUs to the guarantor where the market price is below the guarantee price.
5. The guarantee reduces downside risk for the fund’s investors, enables cheaper finance to be accessed and as a result higher PIU prices are offered to projects, thereby stimulating market supply.

This mechanism has been endorsed in principle by the UK IUCN Peatland Code team as an important means of expanding Scotland’s peatland carbon market and overcoming barriers to market growth (as explored in Annex 3).

Investor Implications

Investors in the Scotland Carbon Fund are exposed to two main forms of risk, project and market risk.

Project risk relates to the risk that PIUs are not successfully verified as W/PCUs due to failure to comply with the terms of the management agreement under the Peatland Code / Woodland Carbon Code. Where PIUs are not verified, the investor will lose out on their investment (as W/PCUs cannot be sold). Project risk can be mitigated by diversifying across a portfolio of projects and through other tools, such as contractual agreements with landowners.

Market risk relates to uncertainty in the pricing of PIUs and verified carbon units (PCUs for Peatland Code projects and WCUs for Woodland Carbon Code projects) in the voluntary carbon markets. This is driven by a range of external economic factors such as inflation. Where a price floor is agreed, the risk to investors falls, as shown in Figure 15. As illustrated, investor is only exposed to market risk above the price floor (shaded in blue). If the price of carbon rises above the price floor the investor benefits from the market pricing; should the price fall, the investor is protected by the price floor mechanism.

Under normal market conditions, the target or ‘risk adjusted’ return required to attract investors is proportionate to the perceived risk taken. By reducing market and project risk and aggregating opportunities, the target return required to attract investment can be reduced. At the same time this may make the fund more attractive to more and larger scale investors.

Government spending under a price floor

Table 5. Illustrative floor price mechanism.

Funding Round	Starting Floor Price (£/ carbon unit)	Year 1 Price	Year 5 price
Round 1	£15	£15.38	£16.97
Round 2	£13	£13.33	£14.71
Round 3	£11	£11.28	£12.45

 

As depicted in Table 5, the price floor is set in individual funding rounds. A starting floor price for a given funding round is set based on analysis of market needs. Future starting floor pricing may be adjusted over time to respond to changing market conditions (e.g., falling restoration costs). Once set, the floor price inflates from the starting price overtime, in line with RPI. Floor pricing can also be designed to prioritise / rewards specific project qualities.

Table 6. Illustrative government spending based on annual carbon price growth to support a £50m fund. 'Government Expense over life' discounted at 3.5%. Modelled fund assumptions are identical to those detailed in Indicative Structure section.

Annual Carbon Price Growth Rate	Investor IRR (30 years)	Government Expense over life (NPV)
0%	3.5%	£39 million
5%	5.2%	£1.79 million
10%	9.3%	£nil
15%	11.0%	£nil

 

Under all scenarios, it has been assumed that the guarantee is able to leverage 1.3x of upfront private investment on a Net Present Value (“NPV”) basis. In the “worst case” illustrative scenario, carbon market prices are flat or decline and the price floor is fully exploited, investors receive a return of 3.5%. This is achievable with 45% percent of PIUs sold upfront to generate a return.

If market prices rise by greater than 6.38% p.a. it is expected that all of the guarantee holders will sell entirely in the market, and not exercise any rights to the price floor guarantee. This will result in a future windfall to the guarantor of the full value underwritten, which can be recycled or used to support the sector. In the case that prices rise by 5% per annum, the total value of government payments under the guarantee would be less than £2 million on an NPV basis.

Benefits / Outcomes

Despite significant interest from private investors and carbon offtakers, inadequate supply of suitable projects limits uptake of either the Peatland Code or Woodland Carbon Code, the latter particularly in relation to nature-friendly forestry planting and practices. Used in conjunction, the proposed Scotland Carbon Fund and Price Floor Mechanism could help to overcome many of the key barriers to project delivery identified. These include:

• Carbon pricing – prices paid for PIUs are too low to incentivise action or compensate for revenues foregone and do not account for value of other ecosystem services provided.
• Price uncertainty – carbon prices are volatile and highly project-dependent while voluntary carbon markets lack transparency and are complex to access, generating uncertainty for landowners and project developers.
• Contractor availability – a limited body of skilled contractors are available to carry out peatland restoration work. Underinvestment is driven by uncertainty over market demand.
• Agri-environment income uncertainty – landowners are concerned that actions may limit eligibility for agri-environment scheme revenues now or in the future.
• Design of public funding programmes – capital grants (e.g., Peatland Action) are often considered as substitutes for carbon financing.
• Contract length – landowners are concerned by the length of contracts without attached revenues and the risk that entering into a long-term commitment may depress land values.

Table 7 explores how the proposed market mechanisms can overcome these barriers.

Table 7. How the Scotland Carbon Fund and Price Floor Mechanism overcome key barriers to market development.

Barrier	Scotland Carbon Fund	Price Floor Mechanism
Carbon Pricing	Project aggregation provides access to a wider audience of carbon offtakers, providing more sale options with potential for higher pricing. Aggregation also provides cost efficiency in sales and marketing processes.	Provides certainty of a future price, reducing risk and catalysing private investment. Where specific restoration or biodiversity outcomes are desired, funding can be ringfenced via guarantee criteria.
Price Uncertainty	By providing access to a wider offtaker audience, the fund offers stability and transparency to market prices, providing confidence for landowners considering entering the sector. The fund also may allow for access to a revenue share mechanism providing further assurance and participation in long term market upside.	By reducing market risk for the fund and investors, it enables the fund to provide higher, more certain and more stable pricing to projects for the purchase of PIUs.
Contractor Availability	Aggregated and long-term demand provides more certainty for capital investment in equipment and human resources.	Carbon finance is not restricted by limitations of annualised funding rounds from public funding programmes such as Peatland Action. Long term financial commitment from the public sector sends strong signals to the market of ongoing support.
Agri-environment income uncertainty	The ability to stack carbon funding with agri-environment schemes depends on additionality tests set out within the Woodland Carbon Code and Peatland Code, and the design of future agri-environment schemes.	A guarantee scheme may be accompanied by clear guidance and rules on eligibility of schemes for agri-environment payments, reducing uncertainty.
Design of public funding programmes	Government funding used to leverage private investment instead of cannibalising opportunities and allowing for potential future windfalls from unused guarantee funds. Opportunity for NatureScot to provide governance and recycle any excess profits generated by the fund into further market support. Learnings for the development of future public-private mechanisms.	Private funding leveraged to increase impact of government funds and potentially make long term savings. By replacing upfront grant funding with a long-term guarantee, the government can access cashflow benefits. Government funds can be applied more strategically to mobilise private investment into neglected areas through guarantee criteria. Depending on market pricing, funding could be freed up over time and could be used to support aligned activity (e.g., awareness raising and training programmes for advisors and contractors to further facilitate project delivery).
Contract Length	A fund mechanism could provide an ongoing revenue associated with land through a revenue foregone payment or revenue sharing mechanism with landowners.	By providing certainty over future revenue streams to the fund, it facilitates the fund to enter into more attractive long-term arrangements with landowners.

 

Key stakeholder outcomes

By overcoming these barriers, the delivery of private investment through the Scotland Carbon Fund would provide significant benefits to a broad range of stakeholders, especially if supported by a price guarantee mechanism. The proposed structures have the potential to be delivered in line with, and further the goals and principles of the Just Transition.  Some of these beneficiaries are explored below.

Nature and the environment – the Scotland Carbon Fund structure provides increased opportunity for peatland restoration and woodland creation with associated biodiversity, water environment and carbon benefits. The fund could provide market leadership in voluntary carbon quality to ensure counterparts follow robust standards.

Communities – the fund investment criteria can be structured to reward community benefits such as public access, ownership or where appropriate, enterprise, in line with the principles of the Just Transition. Where community ownership is promoted (through the Scotland Carbon Fund or aligned vehicles) local participation will facilitate the reinvestment of profits within the community.

Landowners and managers – the proposed structure for the Scotland Carbon Fund resolves key barriers to market participation faced by landowners, as explored in Table 6. This includes increased flexibility of compensation with the accommodation of both an upfront payment and/or annualised maintenance revenues. The Scotland Carbon Fund may also be designed to promote or prescribe specific payment structures to align landowner incentives to the delivery of specific environmental (or social) outcomes.

Project developers and contractors – benefit principally from the scale up and aggregation of the market and greater certainty of ongoing market demand. The Scotland Carbon Fund is also complementary to developers by driving demand, providing liquidity and reducing the ‘friction’ costs of transaction. Particularly relevant in the case of peatland restoration, this will enable investment in equipment and training of specialist delivery providers. Finally, where successful, this model builds the business case and mechanism for further restoration (or creation) markets.

Government and public policy – benefit through not only the progression of national targets for climate and nature, but also improved efficiency of public spending on restoration. Under the proposed model, public spending is reserved for targeted and impactful interventions with a larger share of the market serviced with private funding. The price floor mechanism has the potential to reduce overall public spending if existing publicly funded grant schemes are applied, and private finance assumes the risk of delivery (with a price floor mechanism only linked to verified credits). Implemented together, these mechanisms can remain flexible and responsive to target changing priorities. The proposed structure also offers wider benefits, including green job creation, growth of the restorative economy and increased engagement from more mainstream institutional investors in natural capital markets. This can be achieved while maintaining alignment with wider priorities for Scotland’s natural capital, with the option for NatureScot and other partners to be involved in fund governance and oversight (if preferred).

Key risks and mitigations

While this project has identified the significant opportunity for a Scotland Carbon Fund to facilitate increased private investment into Scottish peatland and woodland, there are risks to the successful delivery of this model. Table 8 sets out the key risks, and proposed mitigants to the successful operation of the Scotland Carbon Fund.

Table 8. Key risks and mitigants to the success of the Scotland Carbon Fund.

Risk	Risk level	Mitigating factors
Lack of landowner and project developer awareness or capacity to take advantage of the Scotland Carbon Fund.	Medium	The Scotland Carbon Fund can be marketed to landowners through local landowner and stakeholder organisations (such as Tweed Forum in the Scottish Borders and Regional Land Use Partnerships across Scotland). The fund can be designed to prioritise accessibility.
Fund seen as private sector profiteering enterprise.	Medium	Mitigated by governance of the fund by NatureScot or other public sector entity. Mitigated by structure of the fund (e.g., capped investor returns, use of conservation dividend, aligned charitable activity).
The value of PIUs of later vintages is heavily discounted by the market.	Medium	Further piloting and monitoring are required to understand the discount associated with later life units and the impact on the financial case.
The Scotland Carbon Fund is unable to attract private investment for initial capitalisation.	Low/ Medium	Access to an aligned guarantee mechanism improves the risk-return profile for investors. Piloting the project at a smaller/moderate scale will improve investor confidence in the market readiness of the proposed model. The Scotland Carbon Fund presents an attractive investment opportunity to industries that are exposed to rising carbon prices.
Lack of demand for credits from carbon market offtakers.	Low	Market reports indicate a rapidly growing demand for carbon credits in Scotland and internationally. Recent research published by UCL forecasts the global voluntary carbon market to grow to £18 billion per annum by 2030 compared to just £0.3 billion in 2020 (Trove Research, 2021).
Investor appetite is weighted towards shorter investment terms.	Low	Designed to target investors with corresponding investment horizons e.g., pension funds and industries which are exposed to long term price movements.
Projects are economically unviable based on carbon revenues alone.	Low	The Scotland Carbon Fund can be designed to be used alongside existing grant schemes to deliver more impactful, but less economically viable projects.  This can also be structured to encourage revenue stacking to generate co-benefits (where these are achievable).

 

Indicative Structure

As an investment vehicle, a Scotland Carbon Fund would operate as a “market maker” providing liquidity to market participants. The function and operation of the fund vehicle is illustrated in Figure 16. which displays the projected lifetime cashflows of a £50 million Scotland Carbon Fund focused on peatland restoration.

As depicted, the proposed fund has a 30-year lifecycle, with capital raised and deployed within the first 5 years and investment returns realised by year 30. The model assumes that the fund is able to deploy a total of £50 million within the first 5 years, purchasing PIUs from peatland restoration projects across Scotland. In this illustrative structure, 45% of PIUs purchased are sold to market offtakers prior to verification with the remaining PIUs held until maturity as PCUs (In a shorter-term fund, a greater proportion of PIUs are sold upfront, in advance of verification). Sales are structured so that PIU vintages associated to abatement beyond the fund life are sold first, so that near-term PCUs can be verified and monetised. Profits from the sale of carbon units are used to repay investors. 

Modelled assumptions are summarised in Table 9. Key outputs are summarised in Table 10.  As detailed, the £50 million fund illustrated would support the restoration of 35,000ha of degraded peatland, abating 5.4 million tCO₂e over 50 years.

Table 9. Scotland Carbon Fund modelled assumptions.

Key assumptions	-
Fund size	£50 million
Lifetime	30 years
PIU price in year 0	£8/PIU
Verification premium	50%
Carbon price growth	5%/ year
Fund Management	2% during investment period (year 0-5) 0.4% during holding period (year 6-30)
Transaction Fee	£10,000 per project
PCU Price Floor	£15/PCU in year 1 falling to £11 in year 5. RPI linked for 30+ years

 

Table 10. Scotland Carbon Fund Modelled Outputs by modelled annual carbon market price growth (%). Outputs dependent on carbon price growth, price floor and other assumptions modelled.

Lifetime Fund Outputs	-	-	-
Annual carbon market price growth	0%	5%	10%
Investor IRR (30 year)	3.5%	5.2%	9.3%
Peatland restoration supported	35,000ha	-	-
Lifetime carbon abatement supported	5.4 million tCO2e	-	-

 

Further Mechanisms

To optimise the benefits associated with this model, two additional financial mechanisms could be deployed as part of the Scotland Carbon Fund structure. 

Revenue Share

A revenue share agreement may be used to incentivise landowner engagement with the Scotland Carbon Fund and provide additional revenue over the operating life of the project. The revenue share mechanism can provide landowners with the potential to participate in the long-term profitability of Scotland Carbon Fund, in the case that carbon prices rise.

Under the revenue share, as verified credits are sold to the market by the Scotland Carbon Fund over time, a percentage of revenues generated above a certain level are shared with the underlying project(s) and landowner, with detailed terms agreed bilaterally between the landowner and the fund.

Endowment

An endowment is a financial vehicle designed to generate a stable investment return to provide a reliable ongoing cashflow. Endowments are frequently used by large institutions (e.g., universities) to supplement operating revenues. An endowment fund operates in a similar way to a pension fund.

An endowment presents an effective tool to provide ongoing funding for the maintenance and monitoring of a peatland project over its operating life. Under the Scotland Carbon Fund, an aggregated endowment fund could be established to support the ongoing maintenance costs of participating projects.

Under the Scotland Carbon Fund, an endowment could be capitalised through revenues generated from the sale of PIUs or from the revenue share agreement. Returns generated by the endowment are used to support project maintenance costs.

Depending on the initial capitalisation of the endowment, and the level of annual operating costs, the endowment may be structured to provide a perpetuity, or be exhausted by the end of, or within, the individual project terms. The function of the endowment at the project level is explored in the following sections.

It is recommended that the use of these two mechanisms in parallel with the Scotland Carbon Fund is explored further in future phases of work.

Conservation dividend

The Scotland Carbon Fund is designed to catalyse market growth in carbon sequestration and abatement projects across Scotland. This is achieved by improving the market environment and economic viability of underlying projects to attract more project developers and encourage more landowners to make long term commitments to deliver and maintain woodland and peatland schemes.

Economic viability varies from project to project with some unlikely to generate a financial return due to high delivery costs and limited monetiseable benefits. These projects will remain (at least partially) dependent on grant funding. The Scotland Carbon Fund may be able to offer a new source of grant funding through the use of a ‘conservation dividend’. Under this structure, investors in the Scotland Carbon Fund would be invited to donate a portion of their upside returns towards direct conservation activity, supporting uneconomical but highly impactful nature-based projects across Scotland. As a donation, investors may also receive tax benefits for participating in the conservation dividend. This mechanism could also be used to top-up endowment funding for the long-term maintenance of projects, or the augmentation of social and biodiversity benefits generated.

A conservation dividend would be managed by an aligned regional or national vehicle with transparent governance and a strong track record of targeting impactful projects. In the Scottish Borders, Tweed Forum is well suited to perform this role. More widely, Regional Land Use Partnerships may be well placed to provide governance and co-ordinate activity at a landscape level.

Scotland Carbon Fund: Market Illustration

Figure 17 below illustration provides a high-level view of the interaction of the Scotland Carbon Fund, aligned mechanisms and existing market participants, based on the findings of the Facilitating Local Natural Capital Investment project.

Financial Analysis

Methodology

To test the financial and commercial viability of the proposed investment model, it was applied to a case study Peatland Restoration project and a number of different scenarios were run. Financial outputs are indicative only and are based on market assumptions developed through the Facilitating Local Natural Capital Investment project process which may change over time.

The case study analysis was developed following a three-stage process, consisting of:

1. Input identification and verification;
2. Financial model structuring; and
3. Scenario analysis, testing and refinement.

Input identification and verification

Market assumptions were identified and verified through a process of stakeholder engagement and research. Key information sources included:

• Project Area Characterisation report (NatureScot Research Report 1284);
• Peatland Action reports and project data;
• Commercial market data provided by Tweed Forum; and
• National and government datasets

Where appropriate, low, medium and high scenario assumptions were used to understand the range of potential outcomes. Once consolidated, key assumptions were tested by engaging with market participants including Peatland Action, Tweed Forum and Forest Carbon as well as local landowners and environmental NGOs. Ultimately, all assumptions made in this analysis are those of Finance Earth except where clearly stated or referenced.

A range of existing data was used to support the financial modelling process. Wherever possible assumptions are based on actual data from historic projects. These included:

• Project attributes (e.g., relating to abatement and restoration timescales, landscape condition and ecological risks);
• Capital works delivery costs (e.g., the cost of land acquisition, restoration, development and project validation);
• Operational Costs (e.g., maintenance costs, operational overheads for the project and fund vehicle, verification costs);
• Market fundamentals (e.g., carbon pricing, market demand, inflation)

This step was completed first to develop an input sheet for the development of a baseline financial model. Assumptions were updated over time to reflect new and more detailed information as it became available.

Financial model structuring

During the second phase, baseline project and fund level models were developed based on the inputs identified.

A base case project model was developed through discussion with project partners and stakeholders to reflect existing market dynamics. This provided a platform for analysis of suitable funding structures to deliver against market needs identified (i.e., the need to support ongoing management costs).

Scenario analysis, testing and refinement

During the third phase of work, modelled assumptions were applied to a case study site. This was used to support scenario analysis based on a series of proposed financial structures. The findings and outputs of this work are detailed below.

Case Study Project

The Talla, Gameshope and Carrifran project developed by Forest Carbon in partnership with Tweed Forum, Borders Forest Trust and Peatland Action was selected as a case study to illustrate financial outputs of the Project.

Talla Gameshope and Carrifran

Borders Forest Trust took ownership of the site in late 2013 as part of a larger fundraised acquisition spanning an area of 1,832ha. The site was acquired for the purpose of landscape-scale habitat restoration and protection. The peatland restoration project spans across 104ha of this site over 3 distinct areas.

For centuries, the land across Talla, Gameshope and Carrifran has been used for upland sheep farming. Historical land management practices across the site have led to the degradation of the fragile uplands. Borders Forest Trust is following a gradual programme across the site to restore native woodland and upland landscape (Borders Forest Trust, 2020).

Prior to restoration, the site was broadly characterised by drained blanket bog with a small proportion (approximately 2.5%) of the site found in actively eroding condition. This compares favourably to an average of 22% of peatland in actively eroding condition identified across the Scottish Borders (NatureScot Research Report 1284).

Key project characteristics

The Talla, Gameshope and Carrifran restoration project has signed a 100-year contract under the Peatland Code, for the abatement of over 24,000 tCO₂e. After accounting for risk and calculation buffers under the Peatland Code, this provides a total tradable carbon value of 18,379 tCO₂e. According to the Peatland Code, the average project length is 58 years with eligible periods ranging from 30–100-year contracts (IUCN UK, 2021).

Based on data provided by Forest Carbon, Peatland Action and Tweed Forum, a restoration capital works cost of £910/ha was used.  This does not account for project management, and development costs or remedial works. Values were tested against market assumptions for comparable project types. Development costs (but not capital works) were supported with funding provided by Peatland Action.

Modelled Outputs

Base Case Model Scenario

This scenario illustrates the typical approach to delivery in Scotland today, from the perspective of the landowner. In this scenario, restoration is funded through the sale of PIUs, with upfront working capital provided by the project developer. Either no or limited ongoing payments for maintenance are agreed.

No additional revenue streams beyond the sale of carbon units have been considered. In practice, additional sources of funding such as grants and agri-environment payments (to support specific maintenance activities) may be used (where additionality allows).

While operational assumptions are based on the characteristics of the Talla, Gameshope and Carrifran project, for the purposes of this report, financing assumptions are illustrative only. This scenario is represented in Figure 19 below.

As represented in Figure 19, the majority of cashflows occur in the early years of the Project. PIU sales revenues are generated in the first five years (based on development timelines) and are used to fund project development and restoration costs (represented by capex in Figure 19). This includes a top-up for remedial works in years 5-10. Where project development and delivery costs are incurred prior to the receipt of PIU revenue, the project may require short term funding such as a working capital facility.

Excess PIU revenue is used to support long term operating costs, in the model depicted this is limited to lifetime verification costs only. In practice, verification obligations may be held by the Project developer, with an appropriate adjustment to carbon pricing.  The landowner is obliged to carry out maintenance and management activity in line with the terms of the Peatland Code restoration management plan agreement (See IUCN UK, 2021, Introduction to the Peatland Code for Projects for further detail). Should the landowner fail to fulfil management obligations PIUs will not be verified.

This model is designed on a break-even scenario. Where a higher PIU price is achieved, benefits are realised by the landowner. The key assumptions and outputs generated by this base case model are captured in Table 11 below. Outputs have been provided on a non-discounted basis.

Table 11. Base Case Scenario Key Assumptions and Outputs.

Key assumptions	-	Key outputs (undiscounted)	-
Required PIU price to support	£7.55	Total carbon revenue	£145,918
PIUs sold upfront	100%	Total Capex	£111,608
Operational expenditure	Verification Only	Total Operating expense	£31,084 (verification only)
Inflation assumed	2%	-	-

 

Key limitations/risks associated with this approach are captured below:

• Under this model a project does not receive long term ongoing revenue. This increases ecological risk (as the landowner may be unable to support costs of restoration) and risk to carbon buyers (as PIUs may not be verified). Failure to verify PIUs may also undermine the credibility of the Peatland Code in the future.
• Under current market practice cash generated to support verification is typically held by the project developer, exposing the project to long term risk especially considering verification will be required for several decades.

Proposed Model

This scenario has been designed to support long term project sustainability, providing for a management agreement and long-term maintenance payments to the landowner. This is achieved through the use of financial mechanisms including a revenue share agreement and endowment as described in Further Mechanisms section.

The use of these mechanisms helps to address the mismatch in timing between projected revenues and costs which presents a risk that future maintenance requirements will be unaffordable. They also have to provide governance arrangements that secure and protect cash received for long term expenditure. This scenario considers how staggered sales of (verified) carbon units, or a revenue share agreement can support the Project when paired with an endowment.

As depicted in Figure 20, key capital expenditure outflows occur within the first five years of the project lifecycle. This includes a top-up for remedial works in years 5-10 in line with the Base Case scenario.

Operational costs include lifetime verification costs and annual maintenance payments to the landowner/manager to support ongoing upkeep of the site. In this example, maintenance payments have been modelled to be inflation-linked and end in year 65 (as the endowment is exhausted) on the assumption that by this time, there will be agri-environmental schemes available to support habitat management.

Based on the model depicted in Figure 19, the optimum scenario for the long-term sustainability of the project was found to involve the sale of 80% of project PIUs upfront (to the Scotland Carbon Fund or other market offtaker). The sale of PIUs is used to fund early project development and restoration costs (in line with the Base Case model). The remaining 20% of PIUs are held by the Scotland Carbon Fund until they can be verified and are sold on validation as PCUs at 10 yearly intervals. The staggered sale of credits on verification provides exposure to market growth in carbon pricing. In practice this can be achieved through a revenue share agreement with the Scotland Carbon Fund or equivalent vehicle.

Revenues generated through the sale of PCUs are used to capitalise an endowment to support verification, management and maintenance costs for the remaining operating life (years 10-100). The endowment is structured to release funds annually in line with project operating costs. The endowment acts to spread the income out over the life of the project, assuming a 3.5% return on capital held.

As in the Base Case scenario, this model is designed on a break-even basis. Where a higher carbon price is achieved benefits may be used to support a larger and longer-term endowment or be released to the landowner/manager or other stakeholders on the sale of PIUs. The key assumptions and outputs generated by this model are captured in Table 12 below.

Table 12. Proposed Model Scenario Assumptions and Outputs.

Key assumptions	-	Key outputs (undiscounted)	-
Required PIU price to support	£10.20	Total carbon revenue	£408,075
PIUs sold upfront	80%	Endowment uplift	£220,199
Verification premium	50% (above PIU price)	Total Capex	£127,462
Operational expenditure	Verification, Management agreement	Total Operational expenditure	£499,415 (verification, maintenance)
Endowment Return	3.5%	-	-

 

Key considerations based on analysis of the Proposed Model scenario are summarised below:

• This model demonstrates how a long-term management agreement could be supported by retaining a portion of PIUs to be sold as PCUs over time to fund an endowment structure, offering greater long-term site protection.
• A revenue share agreement can be used to further incentivise landowners to participate in this structure by offering them some exposure to upward future carbon price movements.
• The combination of the Scotland Carbon Fund and floor price mechanism would facilitate the higher PIU price that enable this approach.

Table 13. The comparative outcomes of the base case and proposed models.

Consideration	Business as usual (Base Case Scenario)	Scotland Carbon Fund enabled approach (proposed approach)
PIU/PCU pricing	The minimum PIU price necessary to support this model is lower.	Requires a higher PIU price to sustain long term operational costs of projects. The Scotland Carbon Fund is expected to facilitate access to higher pricing as represented. The Scotland Carbon Fund is expected to unlock efficiencies of scale in the aggregation and sale of credits, allowing the fund to support higher project costs.
Long term management	Revenue from carbon sales is only sufficient to support lifetime verification costs. In practice a small surplus may be generated from the sale of PIUs. This would likely be less than 30% of total capex. Long-term management obligations fall to the landowner, with no ongoing compensation. This is expected to increase the chance of project failure with resulting impacts for the environment, the PIU holder and the credibility of the Peatland Code.	A higher carbon price, provided by the Scotland Carbon Fund, facilitates the use of a revenue share and endowment. The revenue share mechanism provides access to market upside to the landowner, it can also be used to capitalise an endowment. The endowment provides a long-term source of revenue, supporting the landowner with costs associated with site maintenance and upkeep.
Type and timing of compensation	The landowner benefits from an upfront payment for the costs of restoration and any available surpluses from the sale of PIUs.	The landowner has a high degree of flexibility over compensation. Options include upfront payment from PIU sales (as per status quo), exposure to market risk and potential upside through revenue share and /or a long-term stable revenue funded by an endowment.

 

Learnings and recommendations

Process learnings

Table 14 explores key learnings from each stage of the Facilitating Local Natural Capital Investment project.

Table 14. Facilitating Local Natural Capital Investment project process learnings.

Stage	Learnings
Local Partner selection	There is a strong community of Scottish natural capital pioneers and practitioners. Partners have varied experience and capacity to engage with novel funding approaches. It is difficult to identify a region or local area that is representative of Scotland as a whole. The viability of funding models should be considered at both a local and national level to support further development.
Market Review	A growing range of natural capital market opportunities, investment products and case studies were identified to be applicable to a Scottish context. Limited capacity building and policy support exists to address key barriers to building investment pipelines. Financing structures should be designed based on the suitability of the underlying revenue streams, regulatory and market infrastructure.
Local Area Characterisation	Nationally available data and collation methods should be used to enable replication. Local plans are key to identifying needs: e.g., Regional Land Use Strategy. Established local delivery partners such as Tweed Forum can facilitate identification and engagement with relevant stakeholders and enable a clearer understanding of local opportunities. Data availability can vary across natural capital assets and some condition assessments are not consistently available (e.g., peatland condition)
Funding model development	Near term investment opportunities should be prioritised to develop a practical understanding of natural capital investment in Scotland. Pilot projects are very useful to demonstrate proof-of-concept but require investment-readiness support. Investment models that are not currently viable in the Tweed catchment may be applicable in other regions in Scotland. Investors can be attracted by supportive government backed financials mechanisms (e.g., price guarantees).
Case Study application	Local application provides a useful approach to test the viability of priority investment models and the validity of project assumptions. The investment model would benefit from being piloted on a smaller scale or regional basis to demonstrate proof-of-concept. Ultimately, however, the investment model may need to be applied at a larger regional or even national scale in order to aggregate projects to a sufficient scale to attract institutional investment.

 

Further conclusions from the Case Study Project

Rapidly developing carbon markets can be used to deliver large-scale restoration, but care must be taken to ensure offsets are robust, used appropriately and ecological benefits are long term. In particular there is a need to ensure that carbon buyers can demonstrate their carbon reduction targets and alignment with the environmental objectives of the fund, ensuring that credits are not used as a ‘license to trash’. To ensure this is achieved governance arrangements for the Scotland Carbon Fund should be developed strictly in accordance with Scotland’s Just Transition principles.

The carbon market in Scotland is currently limited by a lack of certainty around market pipeline, future prices and interaction with current and future agri-environment schemes.

The need for project finance is reduced by the opportunity to sell PIUs upfront and the extended timeframes associated with the sale of verified units. However, financing mechanisms if appropriately designed can play an important role in supporting the development and delivery of carbon projects by attracting more landowners to the market, reducing ‘friction costs’ and increasing market liquidity.

Recommendations for facilitating investment in natural capital

The Facilitating Local Natural Capital Investment project identified significant and wide-ranging barriers to private sector investment into nature, including an unfavourable policy environment, uncertainty and complexities over revenue streams and lifetime costs, a lack of track record of investment and competition for capital with less nature-friendly projects.

Recommendations to Policymakers to facilitate market development

Learnings from the development of the Scotland Carbon Fund and the wider project process can be applied to a wide range of natural capital opportunities, including but not limited to those outlined in Investment Opportunities in the Tweed Catchment section, to overcome or mitigate against barriers identified. To support the sector, it would be transformative if the Scottish Government adopted a holistic approach across the following four areas of influence:

Policy - Consider the use of innovative but proven market mechanisms such as price guarantees in the delivery of public funding to leverage private investment and ensure long term environmental outcomes. Policymakers could also better define the role of planning and regulatory bodies in creating demand for nature-based projects and removing barriers (e.g., regulatory demand for water quality improvement, biodiversity requirements for forestry, biodiversity requirements for built development). Greater certainty over the eligibility of projects for current and future agri-environment schemes will also improve market confidence.

Standards, Market Rules and Regulation - Support the development of technical standards and methodologies such as new carbon codes and metrics for other ecosystem services (e.g., biodiversity). Replicate the success of the Woodland Carbon Code to create incentives, national registries and regulatory oversight for emerging NFM, water quality and biodiversity markets. This should include embedding new regulatory standards within planning frameworks and guidance.

Investment Readiness - Provide an investment readiness facility for capacity building and technical assistance to help prepare environmental projects for commercial investment by assisting in the creation of robust technical and financial business cases.

Investment Pathways - Provide ‘pathfinder’ capital to support investment-ready projects and “crowd in” private capital. This could be in the form of repayable grant/first loss capital, concessionary capital, match funding or sub-market rate investment through debt, equity or mezzanine structures, and can be directed to projects or be used to seed new investment funds and aggregation vehicles.

Recommendation to develop a Scotland Carbon Fund

The development of a Scotland Carbon Fund and aligned price floor guarantee mechanism will support the scale up of the carbon market in Scotland, increase the efficiency of public spending, improve project developer access to carbon markets and provide greater certainty of environmental benefits. The Scotland Carbon Fund and price floor mechanism require pilot testing for further refinement. Recommended steps towards the development of the Scotland Carbon Fund are outlined in Recommendations for facilitating investment in natural capital section.

Recommendations to Practitioners

The Project engaged with a range of proposed and operating nature-based projects and enterprises across the Scottish Borders. In addition to specific recommendations for the development of each opportunity, the following key learnings were identified:

Appropriate use of finance – private finance can be a flexible and effective tool to support the delivery of nature-based solutions. With a range of available financial products, it is important that practitioners ensure that finance used is appropriate to the needs and characteristics of the underlying project.

Stakeholder engagement – place-based organisations, such as Tweed Forum play an invaluable role in convening and educating local stakeholders. Such organisations are well placed to draw together landowners, project delivery providers and outcomes payors and co-ordinate new natural capital initiatives.  

Stacking revenues – Nature-based solutions provide multiple benefits for a range of stakeholders. Where viable and where additionality tests can be met and compliance with environmental markets guaranteed, practitioners should explore the opportunity to stack together revenue streams to unlock novel opportunities or improve the social and environmental benefits associated with a given project. While stacking revenue streams introduces more complexity, it is likely to facilitate more impactful and sustainable projects.

Implementation of the Scotland Carbon Fund

Steps toward the delivery of the proposed Scotland Carbon Fund are illustrated in Table 15.

Table 15. Delivering the Scotland Carbon Fund.

Further Stakeholder Engagement	Business Case Development	Fund Structuring	Investee and Contractor Engagement	Investor Engagement and Fundraise	Deployment of Capital
Soft testing of proposals with: Investors and carbon buyers: To develop understanding of project risk and return considerations Landowners and developer: To further test attractiveness of proposed model and identity pipeline projects Policymakers: To advocate for supportive policy and explore price support opportunities	Development of a full business plan for a pilot fund, including: Identify pipeline projects Refined financial model Fund corporate governance structure Fund capital structure Engagement with partner entities (e.g. project developers and investors)	Creation of Terms of Reference for investment team and committee Identifying an investment team Legal, accounting and tax structuring Design governance to manage objectives, risk sharing and minimise risk of excess profiteering	Formally engage with leading project developers and contractors Carry out initial discussions and due diligence with prospective investments	Dataroom preparation for investor due diligence Competitive investor engagement and fundraising Negotiate investment terms Update financial model	Incorporation and set up of fund vehicle Finalise contracts with landowners (investees) Deploy capital to develop investee project Sell carbon units in accordance with fund objectives and contract terms (PIUs first and then secondary market and PCUs) Manage interest and capital payments

 

References

Barrett, K. 2015. Ecological Restoration is a $25 Billion Industry that Generates 220,000 Jobs. Ecosystem Marketplace.

Deutz, A., Heal, G. M., Niu, R., Swanson, E., Townshend, T., Zhu, L., Delmar, A., Meghji, A., Sethi, S. A., and Tobinde la Puente, J. 2020. Financing Nature: Closing the global biodiversity financing gap. The Paulson Institute, The Nature Conservancy, and the Cornell Atkinson Center for Sustainability.

Finance Earth and Economics for the Environment Consultancy, 2021. Facilitating Local Natural Capital Investment: Literature Review. NatureScot Research Report No.1260.

Forest Carbon, 2021. Forest carbon | planting UK Woodlands for Carbon Capture and Ecosystem Services.

Hamrick, K. and Goldstein, A. 2016. Raising Ambition States of the Voluntary Carbon Markets 2016. Forest Trends' Ecosystem Marketplace.

IUCN UK, 2021. Peatland Code Projects.

John Clegg & Co, Tilhill Forestry, 2020. The UK Forest Market Report 2020.

National Records of Scotland, 2019. Statistics and Data.

Scottish Borders Council, 2005. Scottish Borders Woodland Strategy.

Scottish Borders Council, 2021. Windfarms.

Scottish Government, 2017. Scottish land rights and responsibilities statement.

Scottish Government, 2020. Towards A Robust, Resilient Wellbeing Economy for Scotland: Report of The Advisory Group on Economic Recovery.

SEEA, 2020. Natural Capital and Ecosystem Services FAQ | System of Environmental Economic Accounting.

SEPA, 2020. Water Classification Hub.

The Borders Forest Trust, 2020. Talla & Gameshope.

Trove Research, UCL Geography, 2021. The Global Voluntary Carbon Market.

Tweed Valley Tourism Bid, 2020. Draft business plan for consultation 1 April 2020 – 1 April 2025.

Annex 1 – Glossary

Term	Definition
(T)BID	(Tourism) Business Improvement District
Blended finance	The complementary and strategic use of public, private and philanthropic funds to increase private sector investments and sustainable development, resulting in positive results for both investors and communities.
Carbon trading	Carbon trading and markets refer to the trading of carbon credits representing units (tonnes) of carbon dioxide.
Conservation finance	Investment mechanisms that activate one or more cash flows generated by the sustainable management of an ecosystem, which in part remain with the ecosystem to enable its conservation, and which in part are returned to investors
Ecosystem services	The direct and indirect contributions of the natural environment to human wellbeing
EIB	Environmental Impact Bond
Green infrastructure	Nature based structures providing benefits from nature to people. Green infrastructure aims to enhance nature’s ability to deliver multiple valuable ecosystem goods and services, such as clean air or water, replacing or supplementing traditional infrastructure.
Impact investing	Impact investments are made with the intention to generate positive, measurable social and environmental impact alongside a financial return
LENs	Landscape Enterprise Networks
Natural Capital	Natural capital is the environmental resources (e.g., plants, animals, air, water, soils) that combine to yield a flow of benefits to people
Nature-based solutions (NBS)	The use of nature and the environment to help tackle socio-environmental challenges, providing benefits to people and nature
Natural Flood Management (NFM)	Refers to measures to restore or mimic natural functions of rivers, floodplains and the wider catchment, used as an alternative to engineered grey infrastructure solutions.
Project developers	Individuals, organisations, or businesses involved with designing and implementing projects to support nature-based solutions (e.g., woodland creation).
Outcome payer	An entity that has agreed to pay for the delivery of a specified outcome, e.g., an improvement in water quality (as opposed to the actions/service to deliver the outcome).
Reverse Auction	In a reverse auction, sellers bid for the prices at which they are willing to sell their goods and services. This is distinct from a traditional auction where buyers bid on an item to be sold. Reverse auctions are often used for procurement purposes.
SPV	Special Purpose Vehicle
TIMO	Timberland Investment Management Organisation

 

Annex 2 – Local Partner Selection Questionnaire

No	Criteria	Question
1	Applicability, Scalability, Governance	Prospective partners were asked for key information: key contact, organisational type and details of the geographic area (including maps).
2	Local Partner Ambition	Please introduce your organisation and why it is well placed to host this study.
3	Local Engagement, Appetite for Investment	Please provide evidence of the appetite of key stakeholders in your area (i.e. businesses, land managers, NGOs etc.) in trialing new natural capital financing approaches.
4	Existing Initiatives, Scalability	Please describe any existing initiatives (up to a maximum of 5) that are seeking to develop new investment approaches in the area. For example, biodiversity offsetting mechanisms, carbon credits, payments for ecosystem services, business levies, landscape enterprise networks etc.
5	Data Availability	Please describe the spatial data currently available to map the distribution and quality of natural assets in the specified area? Describe relevant local data that is available, including its resolution, date of collection and frequency of update. Describe how local data relates to nationally available datasets.
6	Governance & Resourcing	Please outline the resources available (staff time or funding) to support the delivery of the Project, such as to convene stakeholders, facilitate stakeholder engagement, share information and provide data.