Tracey Fung l Palladium - Jan 30 2023
Palladium Study Reveals Lessons for Fund Managers Raising Climate Capital

Photo Credit: Santarém ©MarahuFilmes

Global demand for beef is rising, and the expansion of cattle ranching has directly contributed to an estimated 93% of deforestation in the Amazon and 70% in the Cerrado. At the same time, the increase of soy production within these biomes has similarly contributed to the largescale conversion of natural habitat and biodiversity destruction. The combined effects of these activities have threatened some of the planet’s most important stores of carbon, freshwater, and biodiversity.

As the world races to reduce deforestation and greenhouse gas emissions to reach Net Zero goals over the next decade, companies and investors alike are looking for ways to engage in climate positive activities from new angles, including through innovative financing mechanisms.

The Innovative Finance for Amazon, Cerrado, and Chaco (IFACC) coalition is one such mechanism. Led by The Nature Conservancy, Tropical Forest Alliance, and The United Nations Environment Programme, IFACC brings together thirteen signatories, including companies, asset managers, and investors that are developing innovative finance tools to support deforestation- and conversion-free beef and soy in biomes stretching across Brazil, Argentina, and Paraguay.

IFACC’s product offerings consist of highly innovative private debt and equity-like vehicles that aim to prevent further deforestation caused by agricultural production. For instance, they offer ways to incentivise the restoration of degraded pastureland, as well as provide longer-term financing to help local farmers adopt regenerative agricultural practices that limit greenhouse gas emissions and sequester carbon from the air.

While several funds within this initiative have already received some support from development finance institutions (DFIs) and corporations, these products are relatively new to investors and need support to reach their collective fundraising goal of US$10 billion by 2030. “There is growing interest from lenders and investors in innovative mechanisms, and several have been deployed already,” says Greg Fishbein, Director of Agriculture Finance at The Nature Conservancy “But there are multiple challenges to scale implementation, including the need to clearly articulate the role of finance and how it can be deployed effectively.”

Palladium was selected to help landscape the market of capital providers to scale these funds and test the products with investors to understand how they would be received. The study found several interesting observations that fund managers and other institutions should consider when raising capital for similarly innovative vehicles in emerging markets.

1. Catalytic capital markets are narrowing

Several of IFACC’s products use blended finance structures to help mitigate risk to senior investors within the fund by incorporating the use of catalytic capital. Catalytic capital is patient, risk-tolerant capital used to ‘de-risk’ investments and help make them more bankable to private investors. Traditional providers of catalytic capital include DFIs, development facilities, foundations, and select impact funds and family offices.

Through extensive discussions with over 29 impact and commercial investors, the team found that the market for catalytic capital is narrowing as shifting investor preferences have funders looking for outcomes-oriented investments which also offer higher returns. Moreover, catalytic capital providers have specific investment mandates which may further limit the pool of capital available for innovative facilities. Fund managers approaching catalytic investors to seed or subsidise their funds should anticipate an increasingly scrutinised and demanding fundraising process.

2. Failure to demonstrate impact additionality will hurt the fundraising process

Fund managers looking to raise capital from catalytic investors must be able to demonstrate impact additionality, or that the impact they look to achieve would not have been possible without their intervention and without the participation of the funder. Catalytic capital funders are paying more attention to the additionality of their investments as they continue to evaluate outcomes from previous investments to understand what has and has not achieved the social or environmental impact they seek to make. As catalytic capital providers raise diligence standards on promised returns to impact, fund managers should be prepared to deliver measurable outcomes that will help investors understand how impact can be directly attributed to the activities of the fund.

3. Early engagement with investors should be considered during fund development

Amidst a challenging fundraising environment, fund managers can expect that raising capital for innovative vehicles that are new to investors will be even more difficult. Early engagement with investors during the development of the vehicle can help fund managers anticipate which features may be a point of concern to investors, such as risk exposure from underlying investments. This provides a pathway for funds managers to build in de-risking mechanisms prior to product launch, which can help prevent the fundraising timeline from dragging on simply from mismatch with investors’ risk-return preferences.

The final results of the study provided IFACC and its signatories with detailed guidance on how to deepen institutional support for their products among investors and design products that offer a compelling financing alternative for producers within the value chain to adopt deforestation- and conversion-free agricultural practices.

“Through this, the IFACC initiative is able to continue working to overcome barriers to create a systematic transformation towards sustainable land use,” explains Fishbein, “Whereby agricultural commodity production is decoupled from deforestation and investments into agriculture can lead to landscape restoration and climate change mitigation and adaptation.”

Download the full report or contact to learn more.