What are finance mechanisms?

A "financial mechanism" or "payment mechanism" can be defined as a mechanism to calculate the unitary charge of a service provider to a service buyer in return for the service. Related to ecosystem services, it can be defined as a tool to capture the value of an ecosystem good or service in monetary terms. A set of rules and procedures is usually used to effect the movement of money or a payment instruction from a service buyer to a service seller.

Types of financing mechanisms:

Finance mechanisms will vary according to their ecological, social and political context. Four broad types of mechanisms can be distinguished, in declining level of government involvement (Scherr et al., 2004; Powell et al., 2002).

1. Public payment schemes. The government provides the institutional foundation for a program and directly invests in it as well. Examples include:
   • Permanent conservation easements
   • Contract farmland set aside for conservation
   • Programs to co-finance investments in afforestation or sustainable forest management
   • Payments for the confirmed presence of endangered wildlife species.
2. Open trading under a regulatory cap or floor. The government defines a mandatory level of a specific ecosystem service to be provided. But to achieve this level the regulated party can choose either to comply directly with the requirement or to pay others, who are in the position to supply the service more cheaply, to do so. Examples include
   • Wetland mitigation banking in the USA
   • Tradable Development Rights
   • Salinity credit trading in New South Wales, Australia
   • Carbon emission offset trading
3. Self-organized private deals. Direct, usually closed, transactions between offsite beneficiaries of forest services and forest landholders responsible for the services. Examples include:
   • Hydro power companies paying land owners upstream for managing forest cover in the designated watershed
   • A Non Governmental Organization (NGO) partners with local people to restore degraded land
   • A pharmaceutical company paying for access to a certain area or for the collecting work by local people of potentially valuable organisms.
4. Ecolabelling of forest or farm products. Also this process is also handled by private actors, payments for ecosystem services is embedded in a traded product. Examples include:
   • FSC (Forest Stewardship Council) timber and non-timber certification
   • "Salmon-safe" labelled products from farmers in the northwerst US.

Why finance mechanisms are needed:

While scientists can nowdays determine the (monetary) value of "nature" pretty good, its value is for the most part not accounted in the world market. Only the most obvious benefits, such as the production functions of nature (timber, fish, etc) and just recently carbon sequestration, are being accounted for. This lack of accounting of benefits is mostly due to the fact that ecosystem services are regarded as positive externalities or public goods. A key characteristic of these type of public goods is that they are non-rival and non-excludable, meaning that nobody can be refused to use the public good even if they do not pay for it, while at the same time the use of the good does not reduce its availability to others (Landell-Mills and Porras, 2002). These two characteristics undermine the creation of a market for these goods, as nobody is prepared to pay for it.

A result of this lack of payment has repercussions on welfare, since there is systematic under-investment in the protection and management of these services. Consequently, the depletion of ecosystem services is far greater than it would have been without market failure. However, everything has a price: sooner or later we are going to face the consequences of our current behaviour. There are already cases known in the world where the (threat to) deterioration of the environment causes individuals, communities, government agencies and the private sector to look for innovative solutions to cope with. Finance mechanisms can, if well established, provide a cost-effective solution to further internalize the value of nature into the (global) market by seeing it as a good or services that can be traded between suppliers and users of these ES.

Incentives to become involved in markets for ecosystem services:

Forced to:

• Regulatory compliance. Examples include:
  • Law
  • Cap-and-trade
  • International convention

Clear business benefits:

• Business opportunity. Examples include:
  • Ability to earn money through carbon offsets or the water market (financial intermediaries).
  • Reduce environmental risk (insurance firms)
  • Eco-enterprise operations
• Secure, sustain or reduce costs of key natural resource inputs required for business operations. Examples include:
  • Uncontaminated water needed for bottling plant
  • "Charismatic" macro fauna for ecotourism
  • Genetic resources for pharmaceutical companies (i.e. bioprospecting)
  • Conservation of watershed to secure water flow regulation / high quality drinking water
• Securing license to operate: Reputational risk management/managing potentially difficult relationships:
  • Better relations with regulators, supporting formal license to operate in the future.
  • Better relations with local communities, supporting informal license to operate, avoiding disruption/losses from protests.
• Enhance or maintain the financial value of land, forest or other assets belonging to the company.

Indirect business benefits

• Enable strong "green" branding by the company (for marketing to consumers, investors or others committed to green products
• Improved staff pride and morale, enhanced recruitment and retention of superior staff.
• Reflect/consistent with broader business values of the corporation (commitment of CEO to "good husbandry")

Not-business related

• Philanthropy / Charity

 

References:

Landell-Mills, N., Porras, I.T., 2002. Silver bullet or fool's gold? A global review of markets for forest environmental services and their impact on the poor. International Institute for Environment and Development, London, UK.

Powell, I., White, A., Landell-Mills, N., 2002. Developing markets for ecosystem services of forests. Forest Trends ISBN 0-9713606-3-4.

 

Scherr, S., White, A., Khare, A., 2004. For services rendered: The current status and future potential of markets for the ecosystem services provided by tropical forests. International Tropical Timber Organization (ITTO) Technical Series No 21.

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