Published March 24th 2023

Natural Capital – from a lender's perspective

What is Natural Capital?

Natural capital is the reserve of renewable and non-renewable natural resources, such as plants, animals, water, soil, and minerals that are combined to provide “ecosystem benefits”. “Ecosystem benefits” are benefits of services that underpin our economy and society, and thus make human life possible. Although referred to as capital, natural capital is not a replaceable asset, but rather a way to describe nature’s ability to harness and add value to our decision making to benefit businesses and society. To learn more about natural capital, please visit our Natural Capital page.

Why should lenders consider natural capital?

Financial institutions support businesses across numerous public and private sectors through their banking, asset management and investment activities. These businesses interact daily with natural capital whether it be directly or indirectly. For example, businesses operating in the agricultural and environmental sectors have natural capital at the heart of their enterprise, and the development and construction sectors are indirectly affected by the increasing focus on environmentally sustainable development. All businesses interact with natural capital indirectly, with the environmental impact of a business playing an increasingly important role.

The responsibility for managing natural capital was perhaps traditionally perceived to be for landowners, land managers and farmers. However, the financial sector also has a key role to play to fund growth and investment in those businesses, allowing innovative techniques to develop in order to manage both food production and care for the environment in tandem.

How are the markets developing to value natural capital?

Ascertaining an exact value of natural capital on a cellular level is proving to be complex, but in 2020 the ONS reported the total stock of the aspects of UK natural capital we can currently value was estimated to be worth £1.8 trillion. Various frameworks are being developed in different markets, for example for the valuation of biodiversity or carbon as specific natural capital assets. However, despite being a hot topic of discussion, the market recognition of what natural capital is worth in pounds and pence is still unclear at this stage.

Can natural capital be charged as security?

As the market develops, the valuation of natural capital will underpin the bankability of these assets and there is a great opportunity for this extra layer of value to be chargeable. Where security is taken in the form of land, that security simultaneously encompasses the natural capital associated with that land. Increasingly, lenders may look to consider “land” as security in its component slices, for example these could include agricultural value, development value, mineral value and natural capital value.

From this, a valuation challenge arises; the natural capital value component will likely be more susceptible to fluctuations depending on the land management decisions made day-to-day on the ground. For example, the latent value in the soil health could be dramatically affected by arable cropping decisions from year to year, or the biodiversity value in a hay meadow could fluctuate depending on whether stock are grazed or the timing of mowing. Although the market is still in its infancy, initially it seems that a floating charge type arrangement would be more appropriate for natural capital assets.

There is also a discussion to be developed about the impact long term environmental schemes have on the underlying value of land held as security, and whether more onerous environmental obligations have a depressive effect on the value of security held.

Summary

Although it seems that there may currently be more questions than answers, given the rising focus on ESG there is a wealth of opportunity in the financial sector as businesses are continuing to search for new ways to unlock their ESG value.

For further information about this topic, Michelmores has a market-leading team with knowledge and expertise in the ESG sector, spanning various practice areas including Banking, Agriculture and Property.

Annabel Goodwin is a Solicitor in our Banking and Finance team, and also a Fellow of the Central Association of Agricultural Valuers and so brings a unique perspective on this topic.