January 2008 Matching Supply and Demand: Private Sector Engagement in Payments for Ecosystem Services By Sissel Waage, Ph.D. & Alice Ruhweza with Primary Research and Text Contributions By Ivo Mulder, Kerry ten Kate, Sara Sherr, Ph.D., Jackie Prince Roberts, Amanda Hawn, Katherine Hamilton, Ricardo Bayon, Nathaniel Carroll

Introduction & Overview Background Current State of Play Motivations for Private Sector Engagement Barriers to Private Sector Engagement Opportunities for Engagement Conclusions

Background: the Private Sector & Ecosystem Services One of main challenges to PES schemes is finding potential buyers Although not always recognized, the private sector depends on ecosystem services, for raw material inputs, production processes, and climate stability. Advocates of environmental markets assert that the private sector has incentives to pay for ecosystem servicesranging from regulatory compliance to direct, supply chain-related business benefits through to positive community relations. But…..large-scale private sector engagement with markets for ecosystem services is likely to only emerge from one (or several) of three shiftsrelated to: 1.Regulation 2.Clear financial returns / business case 3.Stakeholder demand / expectations (especially shareholders, investors, or customers)

Understanding the Incentives The private sectors role as both buyer and seller of ecosystem services is key to enticing businesses into markets and payments for ecosystem services These dual (buyer / seller) roles of the private sector are importantas managers in companies have incentives to: –Protect the bottom-line –Build the brand / companys positive reputation –Produce top-line growth of new revenues through new products, services, etc.

Current State of Play Carbon Market interest from the private sector interest is rapidly growing due to: –Scientific consensus –Business implications of climate changeparticularly highlighted among insurers and increasingly investors. –Regulations and likelihood of further regulatory action –Stakeholders, including shareholders, demanding climate change-focused action Water-Markets & Interest in PWS (Payments for Water Services) from the private sector is likely to increase within the next 5 years given: –Water-related implications of climate change in many regions –Scientific and regulatory agency concerns about nutrient loading in waterways –Businesses concerns about access to water, particularly multinational firms operating in developing countries that rely on maintaining local goodwill for license to operate Biodiversity-Related Markets & PES-type Transactions are likely to see more ad hoc growth, as some businesses are recognizing the importance of these issues, particularly in terms of: –maintaining license to operate –Stakeholders, including shareholders, demanding action

Motivations (I) Type of motivationMotivationExamples RegulationLegal Comply with regulations Laws Cap-and-trade regulatory systems International conventions VoluntaryBusiness benefits Act on business opportunity Earn money through carbon offsets, etc. Reduce environmental risk (e.g. insurance industry inducements, investor requests, and/or eco-efficiency related) Build brand through greening enterprise Secure, sustain or reduce costs of key natural resource inputs required for business operations Clean, reliable flows of water needed Intact ecosystems essential for maintaining charismatic mega-fauna for eco-tourism operation Genetic resources needed for pharmaceutical company (i.e. bioprospecting) Maintain license to operate by managing potentially difficult relationships Improve relations with regulators and/or enjoy regulatory good will Improve relations with local communities, who are key in: - maintaining informal license to operate, and - avoiding disruption/losses from protests Source: Mulder, Ivo Private Sector Engagement in PES. Washington, D.C.: Forest Trends, Internal Report Prepared for the GEF Grant Application Process.

Motivations (II) Type of motivationMotivationExamples VoluntaryBusiness benefits Enhance or maintain the financial value of land, forest or other assets belonging to the company Manage land in order to improve ecosystem structure and function (e.g., improving habitat, sequestering carbon, entering PWS deals, etc.) Manage reputational risk and/or build brand Invest in ecosystem service payments for marketing purposes to influence consumers, investors or others committed to green products Increase employee morale and enhance both recruitment and retention of high-quality staff Improve quality of applicants and employee retention rates as people feel positive about working for the company Align business values with all aspects of operations Improve quality of applicants and employee retention rates as people feel positive about working for the company VoluntaryNot related to core business Charitable donations Improve relations with local communities, who are key for informal license to operate, and enable avoiding disruption/losses from protests Improve quality of applicants and employee retention rates as people feel positive about working for the company Source: Mulder, Ivo Private Sector Engagement in PES. Washington, D.C.: Forest Trends, Internal Report Prepared for the GEF Grant Application Process.

Barriers to Private Sector Engagement Barrier Type / Constraint IssueExplanation DemandCompanies are unsure about ecosystem services Businesses are, overall, less familiar with what ecosystem services are and/or why a firm should pay for these services. DemandCompanies do not immediately perceive benefits from investing in ecosystem services Ecosystem services have generally little priority for businesses within current corporate assessment methods. Signalsfrom investors, insurers, and key stakeholdersmay begin to shift perceptions, however, as is occurring related to carbon. DemandThe transaction costs are too high Potential seller communities represent a crucial link in the chain. Without their willingness and support, deals are in most cases doomed to fail, especially when these communities are the suppliers of the service. Financial compensation of suppliers must cover opportunity costs. At the same time, the deal becomes less interesting for an investors point if transactions costs are high. This balance will be addressed with experience in putting together more deals. The challenge is having an adequate pipeline of private sector buyers from which to learn. SupplyThere is often a lack of defined property rights, especially in developing countries This lack of clarity over who owns land hampers involvement in ecosystem services deals, particularly with potential suppliers who are poor, lack capacity and therefore have no means to enter the market. Source: Mulder, Ivo Private Sector Engagement in PES. Washington, D.C.: Forest Trends, Internal Report Prepared for the GEF Grant Application Process.

Opportunities Continue documenting and highlighting the business benefits associated corporate engagement in markets and payments for ecosystem services, both in terms of: –Positive press / brand / reputation –Financial business benefits / business case elements Use the media coverage on the carbon market to highlight water and biodiversity markets / PES deals –Particularly focus on voluntary carbon markets and potential co-benefits as well as additional engagement in water and biodiversity markets / payments Draw on financial service institutions interest in managing their own environmental risks to: –Seek formal incentives / policies that encourage corporate engagement in markets and payments for ecosystem services –Particularly focus on pension fund managers and banks investment screens

Private Sector engagement in markets and payments for ecosystem services is emerging For many businesses, significant questions remain about why they should begin paying for something that they neither have funded to date, nor which they expected any entity other than the government to fund Further questions emerge about quantifiable returns, particularly given the elevated risk level of engaging in what are effectively emerging markets Relative newness of these markets and payments translates into a lack of experience within companies to put together these deals, which in turn leads to higher transaction costs. Conclusions

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