Does the UK Government have the right financing and policy mix for nature?

The Government is keen for the private sector to take on part of the cost of nature restoration, but private investment remains a relatively minor contributor to UK environmental funding. Leo Mercer and Tom Gegg propose a set of fiscal levers to accelerate progress towards the UK’s nature goals without adding to the public balance sheet.

Nature finance – whereby the private sector contributes payments for environmental outcomes such as carbon storage, habitat restoration and clean water – has become a key pillar of the UK’s nature recovery strategy. Its appeal within government has grown as stretched public finances have led departments to explore new ways to keep costs off the Treasury balance sheet. There is also a level of consensus among policymakers, researchers and some in the private sector that it is prudent, and perhaps even profitable, for businesses to make investments that reduce impacts on climate and nature. In 2021, to cement the Government’s endorsement of nature finance, the Treasury set a target to raise £500 million per annum in private finance for nature recovery by 2027, rising to £1 billion per annum from 2030 onwards.

Private finance can be channelled to nature recovery projects in several ways. Voluntary carbon standards such as the Woodland and Peatland Carbon Codes create markets in which various actors can purchase carbon credits. In England, the Department for Environment, Food and Rural Affairs (Defra) has put in place regulation to support the trade in biodiversity and water quality outcomes via the Biodiversity Net Gain and Nutrient Neutrality schemes.

However, the UK is still off track in efforts to achieve many of its environmental targets, and nature finance has not yet materially changed the quantity of funding available. New research into £1.1 billion of funding for nature recovery in financial year 2023–24 found that direct private finance made up just £142 million (13%) of the total, and that half of this was corporate philanthropy rather than payments for ecosystem services. Only around £20 million of the funding was directly generated by nature markets.

Will businesses pay for nature recovery outcomes?

A nature recovery strategy that leans heavily on private finance requires companies to systematically choose to fund nature projects. They need a robust business case to do so. However, in many sectors, engagement with carbon and nature markets relies on self-imposed corporate commitments. The UN climate conference COP26, held in 2021 in Glasgow, prompted many companies to commit to ambitious voluntary net zero targets, but recent economic and political headwinds have led many to quietly deprioritise or abandon their climate goals. Many proponents of nature finance have, therefore, called for government to instead use regulation to compel companies to allocate funding to nature recovery. Regulation of this kind would carry significant economic trade-offs, and its fairness would depend on how the burden is distributed. Arguably, costs should fall on all sectors responsible for environmental harms, not simply on those that government finds easiest to regulate – such as housebuilders.

Are nature projects “investable”?

For a nature finance investor, a project’s ‘investability’ depends on the price that companies will eventually pay for a nature-positive outcome, the risk investors bear and the time it takes for them to earn a return. Nature projects tend to score poorly in all three categories. Price forecasts are uncertain, because the drivers of demand for nature credits are based on voluntary commitments or policies that can shift abruptly, as shown by recent slowdowns in voluntary carbon markets and changes to Biodiversity Net Gain policy. The vagaries of complex ecosystems and natural hazards may delay or erase expected nature outcomes. Extended periods of negative cash flow are also challenging: a new woodland can take 15 years to produce any revenue. During this period, the owner must fund maintenance work while sacrificing farming income.

Together, these features produce a risk profile and rate of return that most private investors do not find attractive. This could be seen in the failure of NatureScot’s Nature Investment Partnership to attract the institutional investors it had hoped for.

How to fund projects that produce public and private goods?

The main challenge is in how to fund nature projects that deliver a mix of private and public goods. Traditionally, economists have treated environmental outcomes as purely public goods, which are normally funded by taxes. Indeed, most nature recovery projects generate substantial ‘spillover’ benefits for society: from cleaner water and carbon sequestration to recreation opportunities and reduced flood risk. New nature markets have enabled some of these outcomes to be packaged as credits and sold to companies, potentially for a profit. This is good news for the Treasury, as it means that not all nature projects need to be treated purely as providers of public goods that depend on government grants.

So far, however, the Government has made little progress in finding a new funding model that fairly blends public subsidies and private revenue while providing taxpayers with decent value for money. This problem is solvable – and we are supportive of a public investment-led model.

Other options: repurpose subsidies and better target tax relief for agriculture

Nature finance can make a greater contribution to UK nature recovery if it addresses these challenges. Yet, while the emphasis on increasing the quantity of funding is understandable, we think the Government could also explore opportunities to use its existing resources much more effectively.

One such opportunity is in repurposing some agricultural subsidies.The Government allocates several billion pounds a year to farming subsidies. England’s Environment Land Management (ELM) reforms have shifted some of this money towards support for environmental outcomes but, across the UK as a whole, a significant share of public subsidies are still allocated to food production on very low productivity farmland. For example, sheep grazing in the uplands occupies an estimated 4 million hectares, or 16% of the UK’s land area, while producing only 1% of the calories consumed in the UK. These livestock farms are mostly kept afloat by public subsidies. Upland sheep farming also has heavy environmental costs, making Defra’s continued subsidies for rough grazing a poor fit with the wider objectives of the ELM programme. Accordingly, we see a strong case for phasing out subsidies for inefficient food production on marginal uplands. This money could be gradually repurposed to pay landowners a steady long-term income for restoring nature instead.

There is also an opportunity to better target tax relief for agriculture.HM Revenue & Customs provides farmland owners with 100% relief from inheritance tax on assets valued up to £2.5 million per person, following recent reforms to Agricultural Property Relief (APR). The justification for this subsidy is premised on food security: inheritance tax burdens could force farmers to break up their landholdings, undermining farming efficiency and weakening the UK’s domestic food production. However, for the UK’s most marginal land, this justification is weak, as these holdings produce very little food. The Government could, therefore, withdraw APR tax benefits for marginal land used for food production – thereby removing a key incentive for inefficient use of land. Coupled with the 2025 extension of APR to land managed for nature recovery, this change in approach to tax relief would create a powerful incentive for transitioning marginal farmland to nature restoration.

A way forward

The UK Government’s reliance on nature finance has been shaped as much by fiscal necessity as by confidence in the concept itself. Markets do have a role to play, but the problems described above will limit how much new funding the private sector can contribute to UK nature recovery. This is not an argument for abandoning nature finance, but for a greater level of candour about its limitations and for consideration of a wider set of fiscal levers.

We have described two levers that could be pulled to support nature restoration: repurposed subsidies and better targeted tax incentives for the UK’s most marginal land. The Government could draw on its recently published land use frameworks (for England and Scotland) to change these fiscal incentives in a fair and targeted way.

These reforms would not require additional funding from the Treasury. But that does not mean they would be straightforward. As recent protests over inheritance tax reform have shown, any attempts to adjust farming subsidies and tax relief policies will be fiercely contested. The greatest obstacle to large-scale nature restoration in the UK may be a lack of political, rather than financial, capital.

Tom Gegg is an independent researcher in land economics who has previously developed natural capital projects in the UK, Indonesia and West Africa.

The views in this commentary are those of the authors and do not necessarily represent those of the Grantham Research Institute. Daisy Jameson and Wallis Greenslade provided valuable feedback on an earlier draft of the commentary.

This commentary was co-published with the LSE British Politics and Policy blog.