Ecosystem Restoration Code (ERC): engagement phase results and analysis

5. Comments and priorities for demand-side aspects of the ERC

Demand-side related issues and proposals for the ERC were discussed at a specific workshop on 5 June (attended by 22 participants) and as part of the workshop with the Scottish Nature Finance Pioneers (SNFP) on 12 June (attended by 43 participants). Demand was also covered in individual responses from several stakeholders and in survey responses.

Demand-side aspects are concerned with what investors in and buyers of nature / biodiversity credits require from the ERC in order to promote and enable their participation in Scottish nature / biodiversity markets.

This chapter summarises the main issues raised in the above two workshops in terms of: (a) workshop participant interests in nature / biodiversity markets and credits; (b) feedback on three specific potential demand-side use cases of nature / biodiversity credits; and (c) comments on the broader question of whether SG should seek to develop an ERC that has the potential to operationalise multiple use cases, markets and metrics for nature / biodiversity credits.

At the demand specific workshop (5 June), breakout sessions were held with the following specific groups of stakeholders: (a) potential investors in Scottish nature / biodiversity credits; (b) potential buyers of Scottish nature / biodiversity credits; and (c) other demand-side actors. Where relevant, results in this chapter are disaggregated by these three stakeholder categories.

5.1 Participant interests in nature / biodiversity credits

As an icebreaker at the demand workshop (5 June) participants were asked to note in the chat function of MS Teams why they or their organisation might want to get involved in nature restoration and nature / biodiversity markets.

This revealed the following themes from the 22 participants present:

• One participant provided legal advice on nature-based solutions (NbS) projects including nature-based carbon and BNG projects;
• Several participants provided brokerage services between suppliers and buyers of nature credits and project developers;
• Nine participants from the energy generation and transmission sector in Scotland were present – collectively they were interested in the potential role of ERC nature / biodiversity credits helping them to meet compensation related regulatory requirements and deliver broader corporate nature positive goals and targets;
• Three participants supported the development of frameworks for high-integrity biodiversity markets, as developers of related codes / standards and as academics working in this space;
• One participant was actively involved in the development of products for carbon and biodiversity related natural capital investment; and
• One participant had a technical role within a membership organisation, advising membership and developing guidance on biodiversity projects and markets.

5.2 Feedback on demand-side use cases of nature / biodiversity credits

The ERC Engagement Paper identified and reviewed three potential demand-side use cases of nature / biodiversity credits^[8], drawing on material from the IAPB Framework^[9]. These three use cases were:

• Use Case 1: Evidence-based contributions / corporate disclosures;
• Use Case 2: Regulatory demand (local compensation / offsetting); and
• Use Case 3: Supply chain insetting / risk mitigation.

The remainder of this section outlines the strengths and weaknesses of each use case, in terms of their potential application in Scotland, as identified in the demand-side workshop and in individual responses to the survey. It also highlights the potential design features for the ERC that could help to operationalise the use case in Scotland. Please refer to the Engagement Paper for full details of the use cases.

5.2.1 Use Case 1 – Evidence based contributions / corporate disclosures

A mixture of strengths and weaknesses were identified in relation to Use Case 1. Key strengths included:

• Many stakeholders suggested that this use case may appeal to large and / or multinational corporates with aspirations to credibly invest in their own nature positive goals and / or make contributions to relevant national and international biodiversity commitments. This was also considered to be the international “direction of travel”, including as part of international reporting and disclosure frameworks (e.g. TNFD, SBTN);
• Related to the above, a few stakeholders outlined how a nature / biodiversity credit product underpinned by high-integrity market governance, MRV etc would be helpful for business / corporate reporting through the demonstration of tangible, measurable, additional etc results for nature. This was seen as particularly positive for ESG key performance indicators (KPIs), supporting better internal and external reporting;
• Several stakeholders highlighted how voluntary credits under this use case may have a broad and scalable application, supporting various biodiversity outcomes and associated global / national targets. This was seen as important for going beyond minimum compliance requirements and meeting ambitious nature recovery targets aligned with the GBF and other related national mechanisms and policies (e.g. the SBS);
• One stakeholder emphasised the flexibility of this use case – because it is not (necessarily) related to compensation / offsetting there is no need for ecological equivalence (like-for-like), as there is no impact to be compensated for. This gives investors and buyers the flexibility to invest in projects and credits aligned with their corporate requirements (e.g. specific nature positive goals, ESG strategy). However, one professional membership / association stakeholder highlighted how any proposed use case (including voluntary) should incorporate the mitigation hierarchy including clear documentation showing the steps that have been taken to prevent / minimise harm before claiming nature positive outcomes; and
• A few stakeholders suggested that this use case, when linked to voluntary action on corporate and national / international biodiversity targets, would be less vulnerable to greenwashing accusations.

The following weaknesses were identified with Use Case 1:

• Although less exposure to greenwashing accusations was identified as a strength, many stakeholders also identified greenwashing concerns as a key weakness. This is mainly related to a lack of clear guidance / position on how voluntary nature / biodiversity credits could be used and the types of claim that could be made (e.g. if used for TNFD reporting). Accordingly, better alignment of the ERC and its metric framework with key international frameworks (e.g. TNFD) was identified as a priority;
• Many stakeholders identified weak demand for voluntary nature / biodiversity credits as a key, multi-faceted challenge with this use case. Particular issues identified included the challenge of scaling demand from a “small core” of interested corporates, the apparent current / ongoing “backlash” against ESG impacting voluntary drivers and, relatedly, insufficient demand without a “regulatory push” (e.g. from a mandatory TNFD). For example, one natural capital fund in Scotland designs its projects “carbon first” (with biodiversity a close second) as this is seen to be the only viable market currently;
• A smaller number of stakeholders identified uncertain / weak returns on investment (IRR) as an important barrier to investment in voluntary credits, linked to weak demand. As a result, it was considered that investors would only incorporate voluntary nature / biodiversity credits on a heavily blended basis with a more reliable / marketable credit (e.g. carbon);
• For the nine energy sector participants at the demand workshop, voluntary nature / biodiversity credits were simply less relevant to them as they mainly operate within compliance regimes (planning, Ofgem). There was a concern that any engagement with voluntary markets may lead to measuring / paying / reporting twice. The energy sector may consider voluntary credits though, for example if / when sector specific TNFD guidance becomes available; and
• Two stakeholders outlined specific corporate risks / challenges associated with the use of voluntary credits. A point was raised about methodological uncertainty in calculating a company’s “fair share” of contribution towards national / international biodiversity targets and how this might be translated into credits. A point was also made about the need for education and awareness-raising amongst corporate leaders in terms of culture change and decision-making skills to engage with biodiversity credits as part of corporate nature positive goals etc.

The following design features were identified as having the potential to improve the ERC in terms of Use Case 1, if this was taken forward:

• Ensure alignment / interoperability of the ERC with relevant international standards and therefore global markets (e.g. use of Scottish nature / biodiversity credits as part of TNFD reporting);
• Credits issued under the ERC should be highly traceable and grounded in place-specific projects and benefits. Corporates value “storytelling” which can be associated with localism, links to landscape scale action delivering local benefits for people / nature and projects working with charismatic habitats and ecosystems (e.g. temperate rainforest);
• Related to the place specificity point, ERC should facilitate / allow the reporting of co-benefits, whether stacked or bundled (e.g. water, community, carbon);
• The mitigation hierarchy should be built into the ERC, even for voluntary use case. The ERC should help to facilitate impacts on nature / biodiversity being “designed out” from corporate business models, supply chains etc and ensure that buyers do not claim voluntary credits for compensation of their direct negative impacts on biodiversity. This could be achieved by restricting sales of ex-ante credits and issuing clear guidance on restrictions on usage / claims, secondary trading of credits etc;
• For contribution claims, ensure that there is a robust methodology available for calculating the contribution made by ERC nature / biodiversity credits to national and international biodiversity targets; and
• Where possible, ensuring alignment between voluntary markets / use cases and potential compliance markets / use cases (e.g. to provide a regulatory “backstop” if credits don’t sell in a voluntary market).

5.2.2 Use Case 2 – Regulatory demand (local compensation / offsetting)

As with Use Case 1, a mixture of strengths and weaknesses were identified with Use Case 2 (NB: Use Case 2 was discussed hypothetically in the interests of a comprehensive approach to considering demand drivers). Key strengths included:

• In theory, with regulated demand in a compliance market, demand is “baked-in” which should feed through to buyer and investor confidence, contributing to the achievement of biodiversity goals over time (e.g. one investor stakeholder commented that “the effect of mandatory BNG in England has been transformative”). However, one other demand-side actor stakeholder cautioned that although there is clear demand in a compliance market, this is only for a bare minimum of biodiversity benefit / uplift;
• Several stakeholders commented that the ERC’s proposed ecosystem approach could add value to conventional approaches to compliance markets for biodiversity, for example by encouraging developers to think more holistically about their impacts on nature;
• The breakout group with potential buyers of nature / biodiversity credits identified three distinct strengths of the ERC for a Use Case 2 type scenario. Firstly, they were interested in meeting their regulatory requirements for biodiversity enhancement by contributing to impactful landscape scale projects aligned with ecosystem approach principles. Secondly, the potential to go “above and beyond” by investing in ERC projects may help improve the acceptability of the development (i.e. support a “social license to operate”). Finally, the larger, more strategic nature of ERC may make it easier to invest in a pipeline of projects / credits ahead of time; and
• One stakeholder from the other demand-side actor breakout identified the potential for secondary trading within a compliance market context as a strength. However, the scope for high-integrity secondary trading in biodiversity markets is unclear (see section 5.2.1) and the IAPB do not currently support secondary trades^[10].

The three separate groups of stakeholders in the demand workshop breakouts each identified distinct sets of weaknesses with Use Case 2:

• The breakout group comprising potential investors identified three weaknesses. Firstly, the potential size of a compliance market(s) for biodiversity in Scotland was considered to be small / limited. Secondly, issues with scale were identified – the 200ha minimum was seen as too large for compensation needs and NARIA potentially an unsuitable metric for smaller projects. Finally, stakeholders identified constraints within the Scottish planning system for using this type of credit-based approach to managing the biodiversity impacts of development;
• The breakout group with potential buyers identified three weaknesses also. Firstly, a need for clarity on the location of offsite delivery and what might be acceptable in terms of investment in strategic nature restoration projects away from the locus of the development / impact. Secondly, there is a lack of clarity on the relationship between the ERC, NPF4 and the NatureScot planning metric. Finally, one buyer stakeholder identified risks with ERC credit durability (see section 3.3), especially whether the supplier of the credit would maintain the project for the required length of time and to the correct standard; and
• The breakout group made up of other demand-side actors identified three distinct weaknesses. Firstly, the primacy of the mitigation hierachy was emphasised along with uncertainty of how this could be followed robustly, given the technical process required. Secondly, the challenge of ensuring a high-integrity process (beyond the mitigation hierachy) was mentioned by several stakeholders, especially in relation to key technical aspects (e.g. assessing and determining ecological equivalence between impact and compensation). And thirdly, there was concern that BNG type approaches are only likely to deliver a bare minimum of biodiversity enhancement and would not contribute to realising the full ambition of SG biodiversity objectives.

The following design features were identified as having the potential to improve the ERC in terms of Use Case 2, if this was taken forward:

• Firmly embedding the mitigation hierachy in any compliance-based compensation / offsetting scheme pursued;
• Recognising the importance of enforcement for nature markets in general but for compliance markets in particular, including consideration of institutional capacity for ensuring MRV, long-term oversight and robust enforcement action where necessary;
• Exploring the potential role of NPF4 and other regulatory frameworks (e.g. energy, water, agriculture) driving compliance demand for nature / biodiversity credits, including in conjunction with / supported by an ERC type mechanism;
• Providing flexibility to invest in large scale, strategic nature restoration projects away from the locus of the development / impact;
• Ensuring that small projects, landholdings and landowners can benefit from this investment opportunity for nature restoration;
• Ensure clarity on policy goal (i.e. no-net-loss vs net gain) and what is permissible in terms of ecological equivalence between impacts and compensation credits; and
• Where possible, ensuring alignment between voluntary markets / use cases and potential compliance markets / use cases (e.g. to provide a regulatory “backstop” if credits don’t sell in a voluntary market).

5.2.3 Use Case 3 – Supply chain insetting / risk mitigation

For Use Case 3, more weaknesses were identified than strengths. However, awareness of the importance of investing in the biodiversity (and climate) resilience of supply-chains is growing^[11][12]. Key strengths of Use Case 3 included:

• Makes clear the linkages between financial related nature risk and ecological decline / biodiversity loss. The use case has the potential to be attractive to buyers as there is a clear link to their business objectives. Where this is the case, demand drivers should be strong and the investment case to corporates and business should be clear;
• Along with Use Case 1 (see section 5.3.1), this use case is potentially more relevant to the TNFD as it supports action “further up the chain in the mitigation hierachy” and is not reliant on being the last resort once other impacts have been planned and designed out (i.e. compensation / offsetting);
• Several stakeholders highlighted the important flexibility that this use case presents in terms of investing in multifunctional projects that can provide a diverse range of co-benefits, including climate resilience. This is likely to be attractive for corporates with diverse sustainability strategy / target needs; and
• There is an attraction of codifying this use case through the ERC and verified nature credits as this underpins integrity and provides assurance of the benefits being delivered.

Many potential weaknesses with Use Case 3 were identified, including:

• Several stakeholders queried the likely demand for this use case given the relatively light “supply chain exposure” in Scotland (potentially stronger sectors mentioned include food and drink / agriculture and forestry products). One energy company stakeholder in the potential buyers breakout group highlighted that most of their supply chain is overseas, so they would be unlikely to invest in supply chain resilience via Scottish nature credits;
• Related to the point above, a few stakeholders suggested that habitats / ecosystems not impacted by supply chains in Scotland would likely “lose out” under this use case;
• Several stakeholders identified some fundamental corporate challenges with this type of use case. Firstly, it is predicated on corporates being able to identify their nature related supply chain risks and being comfortable acknowledging that these risks exist and therefore that their supply chains are contributing to negative environmental impacts. And secondly, getting supply chain resilience projects / investments off the ground is likely to be resource intensive – both in the board room (justifying the business case) and on the ground (identifying areas for investment / projects, supporting collaboration between partners – there are no “off-the-shelf” projects);
• Stakeholders identified technical risks with credit-based approaches for boosting biodiversity related supply chain resilience. Firstly, there is a risk of “free-riding” whereby there are likely to be many non-paying beneficiaries of the environmental outcomes achieved. Secondly, despite the assurance of the robust MRV etc used in nature credits, linking credits to the precise improvements required by the corporate in highly specific locations (e.g. at the field / hectare scale) can be challenging; and
• Corporates are likely to require a broader range of benefits than nature / biodiversity from their investment in this type of ERC use case (e.g. water resources, community). Two stakeholders queried whether nature credits would provide a suitable proxy for these wider co-benefits. The additional costs of co-benefit MRV would likely add further challenges to the investment case.

The following design features were identified as having the potential to improve the ERC in terms of Use Case 3, if this was taken forward:

• Adopting a sector-based approach to prioritise the ERC towards sectors of the economy that are likely to have most supply-chain exposure to biodiversity risks and therefore the greatest need to manage these risks;
• Broadening the appeal of this use case by quantifying the co-benefits (e.g. water, soil health) delivered alongside nature / biodiversity;
• Providing a market place / prospectus type function to help corporates find projects that meet their place-based biodiversity risk management needs (i.e. ensuring geographic specificity);
• Build in mechanisms / design features to minimise the risk of “piggy-backing”; and
• Where possible, designing this use case as a means of helping to address systemic risk to biodiversity, not just specific risks to individual businesses.

5.3 Should the ERC seek to operationalise multiple use cases?

In both the specific demand-side workshop and the demand-side breakout group in the SNFP workshop, participants were asked to consider whether the ERC should seek to operationalise multiple use cases, markets, metrics etc? This sought to understand whether SG and NatureScot should seek to develop an ERC that could support two or more of the use cases described at section 5.2 above (e.g. an ERC that works for both compliance and voluntary markets), or indeed other use cases not yet considered. The attraction of this would be having a market mechanism that could work across different contexts, scales and types of nature / biodiversity project.

Part of the answer to this question lies in the analysis of feedback on the individual use cases in section 5.2 above. Namely that each use case has its own mixture of strengths, weaknesses and delivery challenges that could also be relevant (or even compounded) within an ERC mechanism that seeks to integrate different use cases.

Several stakeholders in both workshops suggested that the ERC should start with a basic model that works rather than seeking to develop something overly complicated that could confuse the market and wider stakeholders. Stakeholders also commented that (hypothetically) seeking to pursue a compliance use case (linked to planning / NPF4) alongside a voluntary use case would be overly complicated, technically challenging (e.g. achieving ecological equivalence) and would most likely confuse implementation of Policy 3 from NPF4.

Whilst there was limited support overall for taking an integrative approach to ERC use cases, one stakeholder from the SNFP workshop did support this approach if the ERC could be developed as a flexible overarching framework that could: (a) accommodate multiple metrics / credits; whilst (b) setting consistent expectations (e.g. in terms of project ecological and administrative performance). This approach was seen as having the potential to maximise funding opportunities (and therefore supply-side participation, outcomes for biodiversity etc), though this would need to be balanced against the known risks.

Demand related priorities for next stage of ERC project

• Design considerations: identify / review and prioritise key design considerations to inform the ERC. Test these with stakeholders and integrate these with ERC development as required; and
• Demand-side horizon scanning: light-touch research / engagement to further refine understanding of emerging risks and opportunities for voluntary demand, and SG levers to stimulate demand.