This is a part of the bite-sized series of explainers for biodiversity credits.
Biodiversity credits (BC) projects operate similarly to many other financed projects, with money flowing into the project through the sale of products (in this case, credits generated), and money flowing out to support the generation, verification, and sales of credits, and to share the economic benefit with stakeholders. To follow the money flows, the key is to ask when, from/to whom, and how.
Asking “when” reveals the financing gap due to timing mismatch, where upfront costs are incurred before revenue can be generated from result-based BC projects, a formulation undertaken by many existing BC methodologies. Therefore, there is a need for projects to source funding to support costs associated with project design, project registration, and early phase on-the-ground implementation. Cash flows from selling biodiversity credits usually become available in the interim and/or during the final stages of the project when credits are issued upon verification.
Upfront finance that addresses the timing mismatch is mostly pulled from blended sources, including public, private, for-profit, and charitable funds. Prepayment from BC buyers for to-be-awarded biodiversity credits is also a commonly seen approach to address the early phase financing gap.
The blended nature of funding for BC projects underscores the level of risk inherent in this nascent market, where private money still demands government and philanthropic funding to decrease the risk of their investments. On the brighter side, private capital’s interest and involvement are a testament to the investability of biodiversity conservation. As introduced by Mariana Sarmiento, the founder of Terrasos, the pricing of their biodiversity credit ensures a 15% to 20% internal rate of return[1].
Revenue generated from the sales of BC is designed to be shared, a commonality amongst several formulations of BC. ValueNature, for example, prioritizes “biodiversity custodians” to receive “80% of revenue generated from our Biodiversity Credits”[2]. Biodiversity custodians, as defined by Value Nature, are local communities, land managers, and local governments that are “responsible for protecting and growing these assets (biodiversity credits)”, as pointed out by Simon Morgan, the CEO of ValueNature.[3]
Benefit sharing with local stakeholders takes different shapes. Direct payment, for example, distributes a predetermined share of cash to the local government, community, or household. Payment through employment and leasing is a more common approach. Mariana Sarmiento states that monetary distributions to local communities through payrolls and leases account for 70% of all costs incurred for their biodiversity credits[4].
Certain biodiversity credit models like ValueNature’s and Wallacea Trust’s extend benefit-sharing mechanisms to the secondary market, so that the primary owners of the BCs (i.e. the communities, and local partners) can be protected against the price volatility. (The secondary market is where BCs are sold and resold after the initial offering, e.g., corporations, government, and private individuals who invest and may later resell).
“…60% of the difference between the cost of those credits versus the [secondary] selling price …keep feeding back to the local stakeholders”, as introduced by Alex Tozer, the CEO of Wallacea Trust.[5] ValueNature also devised a similar mechanism, where 80% of the biodiversity credit price inflation in the secondary market flows back to the biodiversity guardians. In some BC models, this vision is enabled by blockchain technology that tokenizes the credit transaction history and ownership.
This page reflects the author’s perspective. For further discussion and feedback, please contact Jinsui Song jazzy.song@yale.edu.
[1]Personal communication, November 9th, 2022
[2]Personal communication, March 7th, 2023
[3]Personal communication, March 7th, 2023
[4]Personal communication, November 9th, 2022
[5]Personal communication, October 28th, 2022