Environmental gains – is there profit in natural capital?

12 May 2021

tractor ploughing field

Barely a day passes without us seeing news on climate change and tackling it is now a mainstream issue. Governments worldwide are shaping policies with the climate in mind and businesses are being compelled to act. One only needs to look at the recent surge in demand for ESG (environmental, social and corporate governance) investment solutions and carbon offset opportunities.

The Agriculture Act 2020 (the replacement for the EU’s Common Agricultural Policy) has now come into force and the Environment Bill is (still) working its way through Parliamentary process and is expected to be enacted by autumn.

One of the main purposes of the Environment Bill is to introduce legally binding targets in respect of environmental components like air, water, waste and biodiversity, and to ensure we reach the government’s net zero ambition by 2050. This ambition is also highlighted in the information published in March by government regarding the new agricultural support schemes (the Environmental Land Management Schemes or ELMS).

The Agriculture Act provides the legislative framework for these new support schemes, with a focus on public money for the much talked about ‘public goods’. Three new ELM schemes have currently been announced:

  • The Sustainable Farming Incentive (SFI);
  • The Local Nature Recovery Scheme; and
  • The Landscape Recovery Scheme.

The SFI will be launched mid-2022 and will be available to all farmers, albeit initially only to those who were entitled to receive payments under the Basic Payment Scheme (BPS). Testing will be commencing shortly and DEFRA has appealed for farmers to help test the concept, which comes with a financial incentive for their time. Whilst this scheme will be open to all, payment will only be made for actions landowners take to manage their land in an environmentally sustainable way (ie going above and beyond the basic regulatory requirements).

The other two schemes are expected to be competitive to apply for and may require collaboration between neighbouring landowners.

All three schemes are intended to make a significant contribution towards the goals of the 25-Year Environment Plan and the UK’s net zero targets.

Monetising natural capital beyond subsidies

There are a number of different ways of ‘monetising’ natural capital, which have been steadily gaining momentum and traction over the past couple of years. Some of the funding available is geographically driven and there are various payments available for ‘ecosystem services’. Bodies such as water companies are often willing to pay landowners to change the way that they manage their land, offering payments to take land out of agricultural production, for example, in order to reduce the nitrogen run-off from the land.

Other ways of monetising natural capital include:

Carbon credits

There is now a well-established carbon credit market, where carbon emitting industries are prepared to pay landowners to carry out activities that sequester carbon (typically by planting forests). There are various requirements that need to be met and ongoing monitoring required to ‘create’ a carbon credit, but these tend not to be too onerous for those that were wanting to plant forestry anyway. From 2020, large companies are required to disclose their carbon usage. There is wide expectation that this will encourage more businesses to focus on their carbon consumption and seek to offset this.

Biodiversity net gain

A requirement is being brought into planning law that developments over a certain size will need to be able to deliver a ‘biodiversity net gain’ of 10%. What this means in practice is that either developers need to find ways of enhancing the biodiversity of the land in and around the developments they are building (such as by the introduction of wetlands, ponds, woods or meadows), or where it is not possible to achieve this full ‘gain’ physically on the development site in question, they will need to find other ways of increasing the biodiversity net gain of the wider local area.

This has given rise to a market for ‘biodiversity net gain units’ which can be created by landowners who are in the same area as development sites and which can be purchased by developers to allow them to meet the planning requirements. This provides a potentially very attractive new revenue stream to landowners that can be used to take unproductive land out of agricultural production and put it to alternative uses.

As the ELM schemes develop, it will be interesting to see how government will deal with the situation where landowners may be paid subsidies to undertake certain environmental activities and where they also receive private money from the open market for things like carbon offsets.

Tax considerations of ‘rewilding’ and similar schemes

Many ways of monetising natural capital involve taking land out of agricultural use. Currently, this creates a potential issue when it comes to inheritance tax and capital gains tax planning, as the land may potentially no longer qualify for Agricultural Property Relief. This issue is being carefully considered by our firm and the wider industry and it is felt that a change of legislation is required to remove this potential financial disincentive from undertaking schemes which are being encouraged by government.