Secondary trade in biodiversity credit markets: how the middle man helps
To meet global biodiversity and climate goals, the UN Environment Programme estimates that annual investment in nature-based solutions must almost triple, from current levels (US$200 billion) to reach US$542 billion per year by 2030.
Carbon, biodiversity and other environmental credit markets will require a new level of maturity if they are to scale to meet these targets. A more mature market landscape will require new market players, including secondary traders - like investment funds and liquidity providers.
Skjander is an example of an early entrant in the secondary trading space. We are an alternative investment fund focusing on environmental and natural capital markets. Skjander’s NSW Biodiversity Opportunities Fund #1 is a ‘buy and hold’ investment option for NSW Biodiversity Credits – buying credits now that we know will be in demand under the NSW Biodiversity Offsetting Scheme (BOS) in association with developments in key parts of the state over the coming 3-7 years.
So what does a fund prepared to invest ahead of demand offer to the market? And why are liquidity providers vital for the proper functioning of markets?
Catalytic investment for market development
There is a wealth of economic theory about the role of secondary trade in improving the efficiency of both financial and environmental markets. Trade of listed instruments has improved liquidity, standardization, transparency, and price discovery in global carbon markets. It could bring these same benefits to biodiversity markets.
The role and impact of secondary trade in biodiversity markets is in its infancy and is context specific. It varies depending on the design features of individual credit markets. We demonstrate key financial and environmental benefits arising from secondary trade in the context of the NSW BOS market below.
Bringing the balance sheet makes projects viable: A biodiversity market without balance sheet investors is like a housing market without mortgage providers; only the wealthy could afford to buy a house (or buy land and proceed to generate biodiversity credits). This scenario is currently playing out in the NSW Biodiversity Market. The 2022 NSW Audit Office report found that 40% of NSW BOS projects have not proceeded to financial close, suggesting the financing problem in the BOS Market is already a critical one.
Landholders who seek to develop NSW BOS credits incur high upfront costs, including ecological survey costs that run into the tens or even hundreds of thousands of dollars and capital gains tax that is payable at the time that credits are created. There is also usually a significant time lag before credits are successfully sold. Based on credit currently listed on the NSW register, there can be a delay of 5 or more years while landholders are looking for a buyer for their credits. Combined, these issues mean that environmental credit projects that might otherwise be viable from both an environmental and a financial perspective cannot proceed - they are stuck until an eventual buyer appears.
A credit fund reduces the lag time from credit creation to credit sale. It may also defray upfront project costs by purchasing options or forward contracts, introducing an income stream much earlier in a project timeline. This can make conservation projects viable for a much larger number of landholders and help boost market participation.
Initiating time-critical conservation works: We know that timely action is crucial to prevent species extinction by maintaining habitats and functional landscape connectivity, especially in high development areas. But even when landholders choose to participate in the NSW BOS, and even once they have listed their credits on government registers, conservation works at the site do not start until their credits are purchased. As discussed above, many credits sit unsold on government credit registers for years, which means that critical biodiversity conservation works are delayed.
A credit fund helps to bring conservation works forward in time: at Skjander we are purchasing biodiversity credits an estimated 3-5 years ahead of developer demand. This goes some way to closing the ‘offsetting gap’, where biodiversity losses associated with development would otherwise be incurred before the conservation actions that are designed to offset those impacts.
Attractive returns boost private investment into biodiversity: Biodiversity credit markets are a rare opportunity for environmental and financial returns to be delivered simultaneously. From a financial perspective, we expect investors to be rewarded with good ROI if market prices for biodiversity credits continue to move upwards - as they have done in the NSW BOS market over the past 2 years, and as we would expect them to do in response to increasing future demand for credits.
Strong investor returns encourage for-profit investment, at scale, into the environment. This represents an important first step away from reliance on philanthropy and public entities as the only contributors to biodiversity conservation, and harnesses private investment to help close the ‘biodiversity funding gap’. If one looks for historical precedent, consider the amount of investment in solar energy generation when doing so was a “philanthropic” thing to do back in the 1970’s and 80’s. Only tiny amounts of very specific renewables entered into generation. Substantive investment into grid scale renewables only occurred once compliance markets were established and delivering investor returns.
Streamlining market access for nature positive purchasing: Initial demand in biodiversity markets is associated with offsetting for compliance purposes: developers or others who impact biodiversity are required to purchase biodiversity credits to offset their impact. In some cases (including NSW) biodiversity offsetting policies aim to go beyond just offsetting, and provide ‘nature positive’ outcomes.
But biodiversity credits and biodiversity offsets are not one and the same. It is possible to purchase and retire biodiversity credits even in the absence of development. For example, a company may purchase and retire biodiversity credits to mitigate its supply chain impacts, or for purely philanthropic reasons. In this context, biodiversity compliance markets are a crucial first step for building market infrastructure and establishing a base level of liquidity and trade. Once these have been established, voluntary credit purchasing can help to amplify impact and achieve large scale biodiversity outcomes.
Intermediaries are usually required for voluntary biodiversity credit market transactions. They can provide robust corporate footprint - biodiversity credit matching (metrics are rarely standardised and are not always straightforward to align) and help purchasers to navigate the administrative hurdles that are typical of government-run markets (for example by aggregating credit holdings from many small landholders into a single fund).
Where to on the global stage?
We believe that private funds like Skjander have an important role to play in helping global biodiversity markets to achieve the scale that is required for meaningful and sustained biodiversity conservation. Many global environmental policy makers and NGOs agree - although often with some caveats or conditions:
The Nature Conservancy (TNC) supports secondary trade in biodiversity credits if it occurs within a country or programmatic jurisdiction.
The World Economic Forum (WEF), supports secondary trading when there is “clear and accurate attribution of the originator of the credits and full details of safeguards covering claims, and double counting in the publicly available registry” and when an appropriate proportion of profit flows back to the project proponents.
TNFD sees a future with nature-related opportunities for new listed equity offerings stock exchanges.
As an early market entrant, Skjander provides true catalytic investment into the development of liquid, transparent, global biodiversity markets. We expect many others will follow, and we support the evolution of a mature market landscape that helps to shape the future of conservation.
References
The Nature Conservancy (TNC). (2024). TNC View: Biodiversity credits. https://www.nature.org/content/dam/tnc/nature/en/documents/TNCView_BiodiversityCredits_EXTERNAL.pdf
Biodiversity Credit Alliance (BCA), International Advisory Panel on Biodiversity Credits (IAPB) and the World Economic Forum (WEF). (2024). High Level Principles to Guide the Biodiversity Credit Market. https://www3.weforum.org/docs/WEF_High_level_Principles_to_Guide_the_Biodiversity_Market_2024.pdf
TNFD. (2023) Recommendations of the Taskforce on Nature-related Financial Disclosures. https://tnfd.global/wp-content/uploads/2023/08/Recommendations_of_the_Taskforce_on_Nature-related_Financial_Disclosures_September_2023.pdf?v=1695118661
Audit Office of NSW. (2022) Effectiveness of the Biodiversity Offsets Scheme. https://www.audit.nsw.gov.au/our-work/reports/effectiveness-of-the-biodiversity-offsets-scheme
Spilker & Nugent. (2022). Voluntary carbon market derivatives: Growth, innovation & usage. https://www.sciencedirect.com/science/article/pii/S2214845022001053
Fusaro et al. (2005). Green Trading Markets:: Developing the Second Wave. Green Trading Markets:: Developing the Second Wave - Peter C. Fusaro, Marion Yuen - Google Books