Capital, culture and compliance

Although the value of natural capital is being recognized, tighter regulation, greater financial incentives and a cultural shift will all be required in agri to safeguard returns and the environment.

Capital comes in many forms, including one that is perhaps not always appreciated but can be seen all around us. Natural capital is made up of all the ecosystems, habitats, plants, animals and, indeed, every natural resource in the world. But while the planet’s reserves of natural capital may be vast, they are also finite.

While it’s broadly true that natural capital is increasingly appreciated as an economic asset, there remain many industries that do not seem to value it especially highly. Agriculture performs badly here, with data from McKinsey & Company indicating that crop agriculture alone accounts for 72 percent of freshwater consumption, 61 percent of nitrogen runoff pollution and 32 percent of terrestrial biodiversity loss.

“Agriculture is one of the main sources of the depletion of natural capital across the world,” says Jose Maria Ortiz, head of impact investment at Palladium, a global impact firm. “For thousands of years, humans have been deforesting and transforming rich biodiversity habitats into monoculture systems that provide food for us. These intensive agricultural models have been critical in feeding population growth over the last three centuries, but at a price: the destruction of rich habitats, the reduction of biodiversity, the excess consumption of water and the transformation of natural habitats from a carbon sink to a carbon emitter in many parts of the world.”

Fortunately, there is a growing awareness of natural capital’s value in the agricultural sector. This appreciation stems not only from scientists and environmentalists who have long championed sustainable farming, but investors too. The key is finding ways to prioritize returns in terms of both financial and natural capital.

Still in the growth stage

In 2012, the United Nations Environment Program issued its Natural Capital Declaration, a commitment from CEOs of over 40 financial institutions to integrate natural capital criteria into their financial reporting. While this suggests a closer alignment between natural capital and other assets, many agricultural businesses continue to show a lack of compatibility with natural capital improvement.

“Any attempt at preserving natural capital without considering the financial trade-offs for farmers is doomed to fail, in my opinion”

Davide Ceper

“We are, in general, at the very early stages of natural capital deployment and investment in agriculture,” says Davide Ceper, the CEO of Varda, an agtech start-up. “Even in markets where regenerative agriculture is increasingly discussed and there is a rich ecosystem of companies that mobilize financial incentives for farmers to adopt regenerative agriculture practices, like the US, the covered area still represents less than 10 percent of the farmland.”

As Ceper admits, investment in nature-positive agriculture does appear to be growing in prominence – albeit slowly. Climate Asset Management, for instance, has recently secured commitments of more than $650 million for natural capital projects across Europe, the US and Asia-Pacific. Australia’s Clean Energy Finance Corporation (CEFC), meanwhile, is investing $200 million – alongside one of Canada’s biggest pension fund investors – in Wilga Farming, a sustainable agriculture platform. It is just one of many natural capital co-investments made by the CEFC, which is often referred to as the Australian government’s ‘green bank.’

Protecting biodiversity, enhancing carbon sequestration and minimizing soil erosion are just a few of the factors that agriculture investors are increasingly viewing as important considerations. PepsiCo, for example, is investing $216 million in regenerative agriculture. In June, a climate-positive agriculture start-up fund was announced by global sustainable agriculture specialist UPL. Agriculture investors’ interest in natural capital is clearly growing, but questions remain about whether progress is fast enough.

While there may be a growing awareness of the problems caused by natural capital depletion among consumers and companies, things remain extremely complex. Agriculture can be a fragmented industry, and farmers are often under pressure to meet food demands while turning a profit. This is easier said than done.

“Investing in the transformation of traditional agricultural practices into regenerative models, or to transform some farms into carbon projects, is a very expensive activity that requires lots of capital and long-term visibility of the price of the products,” Ortiz adds. “These two conditions do not exist in the agricultural space.”

Even where favorable conditions exist to preserve natural capital in agriculture, a short-term investment focus threatens to undermine sustainable projects. A 2023 Boston Consulting Group study, for instance, found that, although producers that embrace soil health or regenerative agriculture could experience a long-term profitability increase between 15 and 25 percent, farmers should expect revenue losses in the first three-to-five-year transition period.

“Another major challenge is convincing farmers to change practices,” says Adam Gibbon, Natural Capital lead at AXA Investment Managers. “Farmers are already under pressure with climate change and other macroeconomic forces, so the additional uncertainty of new farming models can be a barrier. Here, financial models need to support the farmer with predictable revenue flows.”

There may be significant momentum behind sustainable investments generally, but in agriculture, environmental protection and financial returns are sometimes in conflict – particularly for smaller-scale producers. When this is the case, it’s easy to see why natural capital may not be an immediate priority for farmers or investors.

“Natural capital investments need to take into account that a farmer’s primary service to society is to provide food, and they do this with considerable challenges on the profitability side, given the increasing capital intensity and variability in climate conditions, just to name two factors,” Ceper says. “Any attempt at preserving natural capital without considering the financial trade-offs for farmers is doomed to fail, in my opinion.”

A focus on climate and capital

Natural capital presents an opportunity to generate long-term value, according to one investor dedicated to its stewardship

Climate Asset Management was founded in 2020 as a joint venture between HSBC Asset Management and Pollination with the ambition to create the world’s largest asset management company dedicated to natural capital.

Late last year, Climate Action Management announced it had raised $650 million across two funds, one dedicated to the transformation of 400 hectares of traditionally flood-irrigated farmland into regenerative, high-value almond production in the Extremadura region of Spain, and the other to support the Restore Africa Program. The latter initiative aims to restore almost two million hectares of land and directly support 1.5 million smallholder farms.

For Climate Action Management, its strategy is two-fold, viewing natural capital as an opportunity for investors to generate long-term value from Earth’s finite resources while managing them in a way that protects and enhances those assets for future generations. The asset management firm expects to make further announcements throughout 2023 and beyond.

From producers to stewards

Undoubtedly, significant challenges are hindering the promotion of natural capital in agriculture. These include a lack of access to finance for farmers, the unavailability of relevant data, and, in Ortiz’s view, cultural factors. “For the last 100,000 years, humans have been trained to transform rich biodiverse lands into high-performing farms,” he says. “Now we need to change our mentality to models that produce the same outcome but respect biodiversity, which is a huge cultural shift.”

As is often the case, financial rewards will be vital in engendering the necessary cultural change. The EU’s common agricultural policy (2023-27) promises at least 25 percent of its budget for eco-schemes. And the US Department of Agriculture is offering a $60 million award to fund agroforestry in 29 states. But more incentives for farmers and landowners are still needed to ensure producers are effective stewards of natural capital. The risks for farmers considering a shift away from intensive practices are substantial, so the rewards must at least be equal to them.

“The combined potential for agricultural land to contribute to the nature-positive agenda is extremely large,” says Ceper. “So with the right incentives and data accessibility for verification purposes, it can deliver a lot of value for the parties involved and for society as a whole (and this is without considering that some drivers of sustainability, such as water consumption, soil health and water contamination, can seriously be improved only by tackling agriculture).”

According to the World Economic Forum, an estimated $44 trillion annually – or over half of all global output – is moderately or highly dependent on natural capital. Much of this value can be captured by investors backing the right assets. In fact, research by McKinsey also suggests that a net-positive ROI of $700 billion could be achieved if several initiatives to conserve natural capital, including switching to regenerative agriculture, reducing food waste and reducing plastic pollution, are pursued.

Crucially, the biggest returns on natural capital can only be achieved if wider society is on board too, not just investors and corporations. But while consumers may need little convincing of the importance of natural capital, other entities may need to be encouraged through tighter regulation.

Fortunately, legislation is already being enacted that ensures natural capital is treated with the importance it deserves. The Science Based Targets initiative (SBTi), for example, is a useful guide for companies, while regulations like the EU’s carbon removal regulation proposal and the US Growing Climate Solutions Act suggest that natural capital preservation may increasingly be a necessity for compliance.

“Setting up targets is critical to progress,” says Ortiz. “A combination of policy making and voluntary net-zero commitments are necessary. We encourage governments to be bold in policy setting. Voluntary commitments to SBTi or other net-zero methodologies will achieve relevant commitments, but nothing replaces government policy when it comes to setting targets. We all need to comply.”

Agriculture’s role within natural capital is significant. Despite the damage that the sector causes to the natural world, there is a movement to prioritize agriculture assets that can be utilized without causing harm to the environment.

The potential ROI of natural resources not only offers a positive financial impact for investors, but is also advantageous for society, the climate and biodiversity. This is precisely why agriculture, far from being purely associated with environmental degradation, has become a focal point for impact investors.