- Groundwork
- Market Engagement
- Groundwork
- Market Engagement
What kind of risks should I be aware of and how can I manage them?
Like with any aspect of a farm business, risk management is critical – especially for nature market projects that can run over several years. As the landholder, you may be leading the development of the project, be part of a wider group of farmers, or be working with a third-party project developer that is taking the majority of the risk.
In any case, it’s advisable to have a clear understanding of the likelihood of the risks involved, what will happen if the risk materialises, what you as the landholder might be liable for, and how the risk is being managed to prevent this liability.
This Milestone sets out the different types of risks that nature market projects (and the deals that result from them) often carry. The last section covers the types of legal entities that farmers might form, as these can help to manage certain risks and benefit the overall operations of the project.
This milestone contains six subsets of considerations that farmers may want to explore at this stage. Click on each of these to the right to read more.
You can also read case studies of farmers that have addressed the activities set out in this Milestone, along with other useful resources and a checklist summary of the considerations covered for ease.
Physical risk
Physical risks relate to the health of the habitat that delivers the ecosystem service or environmental improvement itself. It is linked to the concept of permanence.
Physical risks usually refer to events that can affect or destroy the habitat, such as wildfires, floods, storms and droughts, or perhaps even failure of the habitat to establish properly to begin with. They can also include chronic or longer-term impacts, including rising temperatures, the growth of invasive species, and plant diseases.
Some considerations around physical risk include:
Climate change and other environmental factors will likely pose a degree of physical risk to many natural habitats in the UK. For instance, increased flooding could affect the efficacy of natural flood management interventions, and heatwaves could increase the likelihood of peat fires.
Again, there are ways of incorporating these considerations into ecological modelling and design. For example, ‘mosaic habitats’ across a landscape can help make these each more resilient and less susceptible to droughts and flooding. Use of different plant species can also help the habitat be more resilient to potential diseases.
Your design and delivery partners – such as ecologists and landscape contractors – should have appropriate expertise, a proven track record and ideally some local knowledge.
If you’ve already engaged with someone to help you assess your land opportunities (see Milestone 1), then you may feel confident in maintaining that partnership. Alternatively, you may want to ask for recommendations from your local Wildlife Trust, Rivers Trust, or other relevant eNGO in your area.
If the project timescale and resources allows, you could also use a Request for Proposals (RfP) or a tender process to solicit bids from multiple organisations
Whether you’re liable to pay for the habitat maintenance or not, a good question to ask is how much money has been set aside for any potential remedial works. As you will know, nature doesn’t always act in line with our best predictions. Tree plantings may fail, extreme weather events may occur, and animals can destroy habitats.
Depending on the way your deal is set up, you may be liable to pay for all maintenance works, a portion of these or none at all. However, an indicator of the deal’s robustness is what research has gone into potential remedial works needed and how these have been costed. If you’re not confident that this has been properly covered, then this can inform your decision on whether to go ahead with the deal, or actions that can address this concern.
Even if you’re working with a third party that is taking on these costs, you’ll not want to face a situation in 10 years where the habitat cannot be maintained and the deal is reviewed – this could have adverse impact on you as the underlying landholder.
For an idea on what work might be required and how much this can cost, farmers can speak to their local eNGOs, which often carry historic data on habitat maintenance and remedial works.
Following on from the above, you as the land manager may also be responsible for the habitat’s ongoing maintenance and monitoring. It’s important to be clear on what you feel capable of delivering, and set any limits on your responsibilities.
For example, you may be able to negotiate an upper limit with the buyer on any maintenance costs that you’re liable to pay. If you’re working with an eNGO or ecological expert, you could also ask for training or resources on how best to maintain and monitor the habitat over the years.
Equally, you could partner with an ecologist or contractor to transfer this responsibility away from yourself – making sure that this works with the separate agreement with your buyer.
If you are using a Standard or Code for your nature market deal, there may be a process or protocol that sets out what happens in the case of habitat failure.
For instance, if you are selling carbon units via the Peatland Code, then 15% of your units over the duration of the deal go towards the Peatland Code Risk Buffer, which is a reserve of units from all ongoing projects. If a farmer’s peatland degrades during the course of the agreement, then the Risk Buffer can be used to draw on replacement units for buyer.
However, there are certain rules attached to the Risk Buffer, such as completion of all required restoration and maintenance activities that are set out in the relevant documentation.
If you are working with a Standard, Code or any other type of market infrastructure, then it’s worth checking whether there is a beneficial process that you can use in the case of habitat failure, and what is required for you to have access to this.
Like a financial buffer, you might decide to set aside some land on your own farm that can be used as a back-up habitat for some of the ecosystem services you are selling.
In this case, it’s important to check what processes must be met for this land buffer to be eligible in your agreement with the buyer.
For example, with BNG units, a farmer may want to register the land buffer site at the same time as the main site, in order for any resulting units to be readily available for replacing those resulting from the main habitat.
Sites used for BNG units must be registered with the with of the local area. At the time of writing, these have not yet been decided for each area in England. BNG units must also be like-for-like, meaning you can’t use a habitat of a different type as a land buffer to that which you are using in your BNG agreement.
Market risk
Market risks relate to changes in market factors such as price, inflation, interest rates and exchange rates – though this latter example is rarely found in nature markets in the UK.
In the context of nature markets, changes in price and inflation tend to be the primary forms of market risk, but it’s also important to think about what other market movements can affect the project.
Some considerations around market risk include:
A major market risk is uncertainty around future prices. Farmers can be presented with the option of selling units or credits immediately, versus selling in the future when there could be an increase (or decrease) in price. This dilemma will be familiar to farmers, as with decisions around when to sell their food produce.
However, they may also go down in value simply due to the overall levels of supply and demand.
It’s near impossible to accurately forecast how nature market prices will move in the future, so if you are reserving units for later sale, then it’s important to conduct extensive market research and know what your breakeven price is per unit, including any income foregone from committing your land (see Milestone 5 for more detail on costs).
Sometimes farmers or project developers will take a mixed selling strategy and choose to sell a portion of their units upfront to create a cash reserve, and then hold onto later units when there may be a favourable shift in price. Depending on the price you achieve, this cash reserve could lead to a lower breakeven price for remaining units.
Note: if you are selling carbon units via the Woodland Carbon Code, then you may be able to access the Woodland Carbon Guarantee, which gives certain project developers in England (such as farmers) the option to sell verified units to the government every five or 10 years up to 2055/56. The WCG runs via rounds of auctions, and you need to apply to be accepted.
Farmers can work with a third party that takes much of the price risk on, essentially buying the rights to the ecosystem services and selling them on to the final buyer. An example of this is with habitat bank companies and Biodiversity Net Gain units.
This may work for you as a farmer, but it’s important to understand the full implications of any such agreement, including any tax implications, maintenance responsibilities and potential lost income.
Farmers that sell their ecosystem services may lose out on a greater uplift in price that the third party is expecting to make, which could be seen as a fair compensation for the market risk they are accepting.
In some cases, farmers can negotiate a profit share on any uplift achieved. For example, if a farmer sells their carbon units for £15 per unit to a carbon broker with an agreement to share 20% of any uplift in value, and the carbon broker then achieves £25 a unit, then the farmer would make an extra £2 per unit.
This might not be negotiable with all third-party project developers, but worth bearing in mind if you think there could be major movements in future prices.
Again, farmers will be familiar with the need to consider inflation. However, nature market deals often stretch over a long period of time, and so it’s important to take into account more historic trends in inflation and use appropriate measures of inflation – such as rural land values versus the Consumer Price Index (CPI).
If you are considering regular or staged payments over the years, it is advisable to build inflation into these figures, or ideally link the amount to inflation directly in your legal agreement with the buyer or funder. For example, Real Wild Estates is working with farmers in the West Wiltshire Downs on a Biodiversity Net Gain project which was budgeted using a relatively high inflation rate on all expected costs over the 30-year contract period to ensure the payments from the sale of the credits would cover ongoing costs.
Interest rates can pose a market risk if you are holding onto interest-earning savings to meet future costs.
For example, if you have set aside a cash reserve to help with the maintenance costs of your habitat over 30 years, consider what interest that cash reserve is earning, and whether it is keeping pace with inflation of these costs.
The other way you can be exposed to interest rates is where you are taking on repayable finance – namely debt (as opposed to equity) that has a variable interest rate, or is tied to the Bank of England base rate, as in the case of fixed-rate loans.
Instances of farmers taking out debt for a nature market deal are very rare, as this space is still nascent, with farmers and lenders alike generally reluctant to borrow or lend.
More detail on the use of repayable finance can be found in Milestone 7 (Using Repayable Finance).
In theory, exposure to changing exchange rates can have an influence on your deal. When this takes place, it is usually on the cost side as ecosystem services are rarely sold to buyers beyond the UK.
Exchange rates can present a risk for things like specialist machinery bought in from abroad, or raw materials, such as seeds or tree saplings.
Reputational risk
Reputational risk is simply the risk of damage to your reputation. This damage could lead to a material loss, such as a loss of confidence from the buyer who then exits the nature market deal.
Reputational risk should be considered carefully in the context of nature market deals and transactions, as many have doubts as to whether they are capable of being an overall force for good – in terms of the robustness of the environmental gain, but also issues like displacing food production and exclusion of local communities.
On the other hand, a strong reputation can present lots of opportunities for the farmer – such as more negotiating power with the buyer, engaging the local community, and influencing wider market thinking as a high-integrity practitioner.
Some considerations around reputational risk include:
A common concern for farmers and other landowners in nature markets is that they are delivering environmental gain to sell to polluting companies that have no interest in the environment – but that are using the deal to greenwash their public image rather than making any real efforts to reform their business models.
This is an entirely fair concern and, as the seller, you are entitled to ask questions of your potential buyers and explore how ethically aligned they are with your own efforts in the deal or trade.
Having an ethically-aligned buyer can also help the deal overall, separate to your own judgement. For example, if you are looking for support from your local authority, having an ethically-aligned buyer can help garner support from them.
Some basic questions that you can ask to start discussions include:
- In proportion to its size, does the buyer have a sustainability strategy that is relevant to the trade – e.g. a decarbonisation strategy that links to them buying carbon credits from you?
- Is this strategy aligned with any external frameworks or certification standards, such as the Science Based Targets Initiative?
- How is the sustainability agenda or strategy actioned within the buyer’s organisational structure? Is there a person or team that is leading this specifically?
- Does the buyer invest part of its profits into research and development of more sustainable processes to use in its business model?
- Is the buyer building a holistic picture of its impacts and dependencies on nature more widely, for instance with the use of the TNFD framework?
- Does the buyer engage in wider initiatives to work towards a more sustainable state, e.g. the UK Business and Biodiversity Forum. What have been its own actions other than signing up?
Note: the issue of buyer integrity in nature markets is being addressed by government and other market stakeholders. Notably, Defra have launched a four-year partnership with the British Standards Institution to develop an overarching nature markets framework that tackles issues like greenwashing. You can read more about this work here.
On the other hand, buyers and other stakeholders in the deal will naturally want to know about how you are an ethically-aligned seller and doing what is best for the environment.
For example;
- How can the buyer be assured that you’ve designed the habitat to best suit the environment and not simply maximising financial gain?
- Where else on your farm are you pursuing nature-positive outcomes?
- Can you prove that you’ve not intentionally degraded the site being used to benefit from a lower baseline, and therefore a higher uplift with more to sell?
Note: this latter example is called a perverse incentive, and is a concern shared by many in the nature markets space. To prevent this, some Standards, Codes and methodologies have processes in place to help sellers prove this is not the case.
Sometimes the exact wording on a press release or social media post can be crucial. Stakeholders in the deal – including you as the seller – might inadvertently make public claims that can be misinterpreted or accused as false. This can cause serious reputational damage to the deal and all of its stakeholders.
For example, buyers of carbon credits can be restricted to how they claim these against their own targets. There is a distinction between ‘Net Zero’ and ‘Carbon Neutral’ labels for businesses, where the former doesn’t accept carbon credits generated from peatland restoration.
If you’re talking about the deal or trade publicly, it’s advisable to have a consistent message that everyone agrees to, and a system in place where any public communications are reviewed.
Reputational damage can result if people that are affected by the deal or trade aren’t having their views taken into account.
A common example here is with local communities, who might be affected by changes in public access routes, local employment, reduced affordable housing and eco-tourism opportunities, to name a few. Risk of community exclusion in nature markets falls under the concept of a Just Transition, which you may hear in discussions with buyers, government and other major stakeholders in the deal or trade you’re developing.
It’s therefore advisable to ask where other stakeholders that are affected are having their views considered, how they can be represented in the deal, and whether they should receive a share in the financial returns of the project.
Building on the above, your local community can play a more active role in the development and execution of your deal and the nature-positive outcomes that it delivers.
For example, some farmers in the UK have involved community members in the design of their new habitats, included citizen science in the monitoring processes, and created new eco-tourism opportunities to benefit the local economy.
Along with the more direct benefits that these examples bring, a stronger community role can bolster the public reputation of the deal, which can bring further benefits such as increased negotiation power with your buyers, or access to additional public funding opportunities.
Operational risk
Operational risk relates to flawed processes and systems that can disrupt the execution of the deal. This is a broad type of risk that speaks particularly on how you are working with others to keep things running smoothly.
Questions that you can ask around your operational risk include:
As nature market projects (and the underlying legal agreements) often stretch over many years, it’s advisable to think about the paper trail of the decisions that form the deal and how key information is being recorded.
Smaller and simpler deals may rely on unanimous agreement between a few core stakeholders. Larger and more complex projects will likely need structures to show that decisions are taken wisely and in line with the deal’s stated aims and core values.
In many cases, it’s common for teams to form a Board of Directors or Steering Group with all key decision makers and defined terms of engagement. This process is often formalised through the formation of a legal entity for the project and the registration of directors with voting rights (see below).
It’s important to think about what measures of success you’re using to define the deal, and how often these are being recorded.
The actual delivery of the ecosystem service will be a core measure of success – as this what the buyer is paying for – such as tonnes of carbon sequestered or kilos of nitrate removed. This should be covered in the monitoring strategy you’re using (see Milestone 3).
However, other measures of success might be:
- Net profits to you (the farmer) – including comparisons to any income foregone.
- Ecological co-benefits – benefits that weren’t necessarily targeted by the buyer, but can increase the value of the deal. For example, you can record the abundance of a particular species in your area that is depleted or threatened.
- Community benefits – such as visitor numbers, revenue of closely linked businesses, shared profits with local charities, and educational opportunities.
You can think about the major milestones in your deal – in both its development and once it launches – to try and anticipate where there might be potential bottlenecks, and how you can plan accordingly. These can be driven by both internal and external processes.
- Permits and permissions granted: Some nature habitats will require environmental permits or planning permission. For example, to build a wetland, a particular permit is needed from the local planning authority. Other planning considerations could be cycle paths, gate designs and the planting of trees.
- Legal contracts agreed: Anecdotally, it can take much longer to finalise the fine print on legal contracts. This is particularly true if you are working with larger companies that have built up legal assurance processes, such as a corporate buyer.
- Validation from a certification body: Some deals – especially those that use Standards and Codes – need to get their plans validated by a third party like the Soil Association, or Organic Farmers and Growers in order to use the Standard and Code. Anecdotally, some deals can wait several months for this validation to be given.
- Completion of initial habitat works: Creating or restoring the habitat is often a key moment in the deal. Sometimes, this is tied to the release of buyer payments or philanthropic funding. However, things like bad weather, a shortage of physical inputs (like tree saplings), or bird breeding seasons can set this completion date back.
Single points of failure mean that when one part of a system stops working, it brings the whole system to a halt. This can happen in nature market deals or transactions when only one person can be relied on for a particular task, activity or role.
For example, if this person is on sick leave, on holiday or even exits the deal entirely, this can cause a disruption in operations that leads to huge delays or even financial loss. You might think about who you’re reliant on in your deal’s development and whether there is another person, or organisation that can help if they were absent.
For example, if you’re seeking important advice from a legal firm on a planning permission, then it’s advisable to have more than one point of contact at the firm who knows about your deal and can assist you if your main contact is off sick.
At this stage, you’ll likely already be working with advisors and experts to make your deal more robust. For example, farmers can work with ecologists and their local eNGOs to design new or restored habitats, plan the initial capital works, and work on estimates for the habitat’s maintenance over the lifetime of the deal.
Depending on the complexity of the deal, it may be worth considering where else you can use specialist expertise to make your operations smoother. For example, you can typically work with your land agent or a financial advisor to sense check your cashflow forecast (see Milestone 5).
A risk register – sometimes called a risk matrix – is a simple but often used method of assessing and keeping track of risks, including all types of risks that are covered in this Milestone.
A risk matrix will typically list out all the risks in rows, giving a score / rank on both the likelihood and the impact of the risk materialising, which can help to give an indication of what risks you should pay closer attention to and put more effort into managing. These risk management strategies should probably be reviewed periodically, to make sure they are up to date.
A well-structured risk matrix can also be helpful for other stakeholders to assess their own risks and liabilities – including any other farmers engaged, the buyer, any government entities involved, contractors, supporting eNGOs and community members, for example.
This may seem like common sense, but it’s important to clarify exactly who is responsible for what actions across the lifetime of the agreement – such as any reporting requirements to a third-party verifier. Another consideration is who is liable if these processes fail. This person may not necessarily be the same as who is responsible to begin with.
For example, if a buyer is purchasing carbon credits from a third party that is leasing land from you to restore a degraded peatland, what will happen if the peatland catches fire? Who is liable for delivering the promised carbon credits to the buyer? Would the buyer have rights to claim a refund from you as the underlying landowner, or are they comfortable to take this potential loss?
For good measure, this consideration is also mentioned in Milestone 8 (Signing Legal Agreements), but naturally you will want to be clear on who is responsible for what actions in the project and who is liable if things go awry, before you get to a stage of drawing up legal contracts.
Political risk
Political risk relates to how political decisions, legislation, or events affect the nature market deal.
Political risk is very hard to manage, but clear lines of communication with government, regulators, and other rule setters are always advisable and could help farmers spot and prepare for potential changes down the line.
Farmers are understandably concerned about the political certainty of nature markets. Key pieces of legislation and regulation exist now, but generally the political landscape is expected to change significantly in the years to come as nature markets develop further.
This is not to say that farmers that are signing up to agreements now will face consequences when future changes are made, but if you’re developing your plans then it can be helpful to understand which laws or regulations your deal or trade is reliant on, so that you can be prepared in case any potential amendments or replacements are being discussed publicly.
Examples of legislation and regulation that nature markets are governed by include the Environment Act 2021, the National Planning Policy Framework, and the Habitats Regulations 2017.
Where relevant, it’s advisable to build a strong relationship with your local government for the development of your plans and your nature market opportunities.
Good communication channels can help farmers to stay informed about policies, regulations, blended finance opportunities and incentives related to nature markets. It can also allow farmers to voice their concerns, seek assistance, and actively participate in community initiatives.
Due to the localised way that some nature markets work, your local government can also have a significant influence over the deal or trade itself. For example, if you are building a wetland to help with nitrate run-off, then working early on with the local planning authority to build an understanding of the plans could help to secure any planning permissions you need in a more timely manner.
You may consider how your habitat plans fit in with the Local Nature Recovery Strategy (LNRS) that is being developed in your area.
Under the Environment Act 2021, all local authorities are obligated to create an LNRS to help with England’s nature recovery. There are 48 responsible authorities that are in charge of developing these, which will agree nature recovery priorities, map the most valuable existing areas for nature and establish shared proposals for what action they should take and where.
Responsible authorities are required to work with as many local stakeholders as possible, including farmers, to develop their LNRSs.
It could be a huge boost to your natural capital plans and, as an extension, your nature market opportunities to be aligned with your local LNRS. As of October 2023, no responsible authorities have submitted their LNRS, so your feedback can help to strengthen your relationship with your local government.
Use of legal entities
A nature market deal or trade will involve a legal agreement that includes you as the farmer, which will mean a legal entity to represent you in the agreement.
As a business owner, you may ask yourself whether its worth setting up a new legal entity for your involvement in the deal, as well as any other farmers that you’re working with. This was mentioned briefly with Aggregation Models in Milestone 2.
Below offers an overview of the options available to you and types of legal entities that each have advantages and disadvantages.
As a farmer, you’ll likely already have a legal entity for your farm business that holds its contracts, bank accounts, assets, liabilities, ownership rights and tax treatments.
It can be appealing to use your existing legal entity to take part in the deal, as setting up a separate legal entity will take time and resources. You may also lose certain benefits that come with your existing set up.
However, a new legal entity can separate the liability of the deal from your existing farm enterprises, protecting these against financial loss or litigation. You might also create a new entity to better reflect the nature of the deal, such as a joint venture with other farmers, a focus on community benefits, or use of any philanthropic funding.
If you’re in doubt, consider your options and then take legal advice on whether to form a new entity for the deal.
Ltds are the most common form of legal entity amongst farmers, and their governance processes are well understood. They can be limited by shares or by guarantee.
If you want to keep the profit of the deal as personal income, a limited by shares company is usually the best choice. If you want to run the entity as a non-profit venture and retain all of the profit in the company, a limited by guarantee company might be advisable.
Pros:
- Company legislation is familiar and well understood.
- The ongoing administration is not overly burdensome.
- Ltds have access to loans, including development funds and other third-party funders, e.g., Government Agencies, Local Authorities etc.
Cons
- Ltds are not crafted to fit social enterprises.
- They are tax opaque, with no charitable tax breaks.
- There is a slight restricted ability to pay out dividends (only payable from distributable profits).
A Limited Liability Partnership (LLP) is similar to a Limited Company in terms of liability but offers more flexibility in the structuring of the business as there is no separation between the shareholders and management team.
Pros:
- The legislation is generally familiar to farmers and well understood.
- An LLP has flexibility, for example its profit distributions and ownership can be tailored to partners’ needs.
- The LLP can access loans, including development funds and other third-party funders, e.g., Government Agencies, Local Authorities etc.
Cons:
- LLPs face public disclosure rules, for example the earnings of individual partners are part of the public record.
- There is a higher risk of partner exit – if all but one partner decide to exit, the LLP has to be dissolved.
- LLPs have fewer tax breaks compared to other structure, and you can’t hold over profits to the next accounting year for tax purposes.
A cooperative (co-op) is owned and controlled by its members – such as farmer groups – to meet their shared needs. A co-op is a democratic structure in which all members have equal say in how it is run and how profits are used.
Pros:
- Cooperatives can be built to suit different commitment levels and fewer responsibilities of certain members.
- The shared decision making instils an atmosphere of collaboration and democracy.
- A cooperative can also offer tax benefits through patronage dividends.
Cons:
- Cooperatives are largely untested in nature markets.
- They are complex and costly to set up.
- They can experience slower decision processes.
- There are fewer incentives to lend or invest capital in the entity.
CICs are a special type of Limited Company that exist to benefit the community rather than private shareholders. Like Ltds, they can also be limited by shares or by guarantee. However, any surpluses generated from the CIC’s activities are primarily reinvested for social benefits that the CIC defines in its creation. This is done by an ‘asset lock’ that can vary between 35-100%.
Pros:
- CICs are socially focused enterprises – they face an asset lock and community benefits regulation. This can provide a lot of reassurance to stakeholders, such as buyers, local communities, relevant government officials – that the entity will deliver social benefits, which can shore up reputational risk.
- CICs are easier to set up compared to fully fledged charities.
Cons:
- CICs are generally not eligible for charitable tax breaks or charity-specific funding.
- There are restrictions on profit sharing with the asset lock.
- CICs are more complex to set up and report on, compared to Ltds and LLPs.
As a sole trader, you and the entity itself are considered one legal entity, so you are entitled to all profits after tax, but you also face unlimited liability. This is the only legal entity type included here that does not limit your liability.
You can have employees but remain the sole owner of the business and must register as self-employed with HMRC to pay tax through the Self-Assessment process.
Pros:
- A sole trader is easier to set up, ongoing reporting, tax processes.
- There is no sharing of profits.
- You as the farmer have complete control and flexibility.
Cons:
- There is unlimited liability on the owner (you) for liabilities, such as debt and litigation.
