FREE CHAPTER from ‘A Practical Guide to Payments for Environmental Services’ by Ben Sharples

CHAPTER ONE – REVIEW OF CURRENT LANDSCAPE

While development of both urban and rural landscapes have contributed to climate change and biodiversity loss, it is in the rural environment that one finds the potential to unlock large scale mitigation solutions. Such solutions can be found through payments for environmental services arising from changing land management practices.

Environmental services and their associated revenues involve the utilisation of natural capital assets which are, in the main, managed and controlled by landowners and farmers. To understand this nascent marketplace, it is therefore necessary to consider natural capital and how its utilisation can fit in with the rapidly changing agricultural sector, as well as how the sector receives governmental support. The Government’s policy shift from production-based incentives to “public money for public goods¹” in particular is worth closer scrutiny.

More broadly, the UK’s exit from the EU has given the Government greater flexibility in implementation of domestic agricultural policies. This provides the UK with the opportunity to not only reshape its agricultural and environmental policies through devolved powers but also to pick a new pathway through the maze of European legislation and caselaw.

This time of seismic change provides a great opportunity for those tasked with the management of rural land. The preference of government seems to be that the private sector lead the way in how the markets for nature-based solutions develop so there is a certain requirement to run with the ball and frankly, get on with it.

What is Natural Capital?

Natural capital represents “the stock of renewable and non-renewable natural resources that combine to yield a flow of ecosystem services.”² It can be more easily explained by breaking down the term into its individual components. “Natural” in this context refers to the natural world and its resources, in contrast to man-made. “Capital” is a store of wealth which can also be used to generate value. A computer holds value not just because of its physical components, but also because it can be used to create other valuable assets. A woodland is valuable not just for its timber, but also because of its myriad environmental benefits, from enriching local biodiversity to combating climate change by capturing carbon. A computer is capital; a woodland is natural capital.

Unfortunately, while natural capital may produce benefits which are critically important to the wellbeing of the planet, these benefits may come at a financial opportunity cost to the owner. Preventing livestock from grazing near a riverbed may be good for the river, but it limits the grazing land available to the farmer and therefore the revenue which can be generated from the land. While we are all conscious of the long-term costs of environmental degradation, we must also pay our bills. Furthermore, the burden of transitioning to a more environmentally sustainable national economy is not borne equally by all economic participants: it’s one thing to ask urban residents to be more judicious in sorting their rubbish, and another to ask a farmer to leave acres of their land ungrazed for the greater good.

In recent years, governments have sought to better align these economic and environmental incentives by introducing schemes that allow landowners to monetize their natural capital. Tax write-offs help offset losses incurred by foregoing development, while nascent biodiversity and carbon marketplaces provide income to landowners via the biodiversity units and carbon credits generated by more environmentally friendly uses of their land. By recognizing and commodifying the value of natural capital, governments are making it easier for landowners to make environmentally friendly decisions without sacrificing their own livelihoods.

The Agricultural Sector

There is a long history of political influence in the agricultural sector. The Corn Laws, passed in 1815, attempted to alleviate the strains placed on the industry by the Napoleonic Wars. The laws included government-imposed tariffs on imported grain, which artificially propped up the domestic market. The Corn Laws were repealed in 1846, largely due to the Irish Famine. Surprisingly, there was no resulting plunge in domestic grain prices, underscoring how markets don’t always behave as expected; this was an early lesson in the difficulties of controlling the price of basic commodities.

While this book is will not go through the evolution of UK agricultural policy in detail, it is helpful to identify the main historical links in the chain of events leading to the present day. Suffice it to say attention was focused on maximising production even before Britain joined the European Economic Community (“EEC“) in 1973.

These main links in the chain are:

• Second World War
• EEC Membership 1973
• MacSharry Reforms – 1991
• Agenda 2000 – 1999
• Mid Term Review – 2003
• Single Payment Scheme – 2005
• CAP Health Check – 2009
• Basic Payment Scheme – 2015
• Brexit – 31 January 2020
• Agriculture Act 2020
• Transition Period 2021-2028

UK Environmental Land Management Schemes (ELMS)

A brief history of UK agricultural policy

The modern framework for governmental influence over national agriculture markets was born from the experiences of the Second World War, where the UK in particular experienced significant food shortages. These experiences shaped the Agricultural Holdings Act 1948, with its focus on production and the rules of good husbandry.

The policy focus on production continued throughout the 1950’s and 60’s. Farmers were offered grants for removing hedgerows and ploughing up grassland with a higher rate of £30 per hectare.³ It is fair to say that carbon sequestration was not high on the agenda at the time. Some did call⁴ for preservation of grassland, but only in the context of its ability to support a greater national beef herd and sheep flock.

A significant development was UK membership of the EEC in 1973. All members—including the UK—were subject to the Common Agricultural Policy (“CAP“), a negotiated policy which sought to balance trade between member countries whilst keeping their individual agricultural sectors afloat through export subsidies and other price support.

This interventionist method of propping up commodity prices eventually became the subject of considerable criticism. References to “wine lakes” and “butter mountains” were commonplace, as EU member states had the ability to place agricultural commodities, such as beef and dairy products, into storage. This had the effect of artificially supporting the price by reducing supply. The theory was that the stocks could be released onto the market when prices recovered; however, in practice, the mere knowledge that such supply exists applied downward pressure to market prices, as buyers knew the market could be flooded with supply if prices increased too rapidly. Whilst the EU Commission has since tried to reduce reliance on intervention buying, it is worth noting that the UK Government has specifically reserved a power to intervene in the market in the Agriculture Act 2020⁵.

Mounting stocks of agricultural commodities led to the MacSharry Reforms in 1992, in which then-Agriculture Commissioner Ray MacSharry published a paper⁶ setting out wide-ranging problems with the system. Many of these issues were caused by government subsidies that were tied to production, driving supply beyond demand levels and leading to gluts in the market. Production-linked subsidies also encouraged economies of scale, prompting industry consolidation and driving out smaller businesses.

The MacSharry Reforms included cuts to support prices (which were replaced by direct payments to farmers) and the introduction of set-aside, where producers would only qualify for such payments if they took a percentage of their land out of arable production. Schemes were introduced across a wide range of agricultural products, ranging from sheep and beef to arable crops.

The set aside rate—the percentage of land that must be set aside for farms to qualify for the subsidy—was originally set at 15%, then reduced to 10% in 1996. In 2000, the EU set about making major reforms to the CAP under what it called “Agenda 2000;” however the set-aside rate remained unchanged until the Mid Term Review in 2005, where it was reduced to 8%. It was finally reduced to 0% in 2008 before being abolished later that year as part of the CAP Health Check.

While Agenda 2000 left the set-aside rate unchecked, it did take a hatchet to support prices for commodities and diverted those funds to direct payments to farmers. The CAP budget was also split into two “pillars” of production support and rural development. It is the second pillar which funded the rural development programme and environmental schemes under CAP.

Since the implementation of the Mid Term Review in 2005, most of the direct payment schemes were amalgamated into an area-based scheme, the Single Payment Scheme, which was renamed the Basic Payment Scheme in 2015. In England, this resulted in a swift move away from production-based subsidies. Wales and Scotland took a more gradual route to an area-based scheme, likely due to their increased need to support upland farms.

The CAP has been subject to major and seemingly continual reforms in recent years. The most significant change has been the shift from support of the commodity to support of the producer, with the quantum leap in this regard being the introduction of the Single Farm Payment under the Mid-term Review of the Common Agricultural Policy⁷. A key characteristic of the Single Farm Payment was that it could be claimed by producers, even though they were not producing any commodities at all. There was a requirement that a claimant be a farmer and one who was exercising an “agricultural activity.” However, simply keeping the land in “good agricultural and environmental condition” constituted such an activity, so there was no imperative to actually grow a crop.

This evolution continued, with the Basic Payment Scheme also being decoupled from production, but the Agriculture Act has taken it a step further with the direct payments being decoupled from the occupation of land itself.⁸

Agricultural policy post-Brexit

Until this point, the UK’s agricultural policy was unable to deviate from that of the EU. This changed following the UK’s exit from the EU on 31 January 2020.

There was much discussion as to the shape of future agricultural support during the period between the vote to leave the EU and the UK’s actual departure. Policymakers eventually decided that the UK would move from area and production-based support to the policy of “public money for public goods”, with a strong emphasis on protection of the environment. Such a major change in direction would potentially have quite a severe impact on producers, so the Government elected to introduce the new system over a seven-year agricultural transition period from 2021-2028. This transition involved gradual changes to the existing Basic Payment Scheme, the simultaneous running of pilots of the new ELMS scheme and an eventual transfer between the two by 2028.

The UK Transition Period until 31 December 2020

The UK’s departure from the EU is on the terms of the Withdrawal Agreement,⁹ which provides for a transitional period lasting until 31 December 2020.

During that period, the UK Government confirmed¹⁰ that the Basic Payment Scheme (BPS) will remain largely unaltered, having provided a funding guarantee. This safety net was critical as, under the terms of the Withdrawal Agreement, all EU funding for direct payments (formerly CAP Pillar 1 payments) in 2020 would move to be under domestic control one year before all other EU policy areas, as CAP expenditure was paid for out of the following year’s EU budget. EU CAP subsidies were divided into those paid under Pillar 1 (direct schemes) and Pillar 2 (rural development schemes).

Since then, we have seen the enactment of the Agriculture Act 2020 and the Environment Act 2021 together with relevant secondary legislation. This legislation is shaping the new landscape in which farmers and landowners are now operating and they are having to learn to comply with a different set of rules and regulations.

Mixing and Matching Credits: Stacking, Bundling and Additionality

The use of public money to procure services from farmers and landowners has the potential to be a controversial topic and it is certain that any payments for environmental services will be closely scrutinised. The slightest suggestion of greenwashing or double counting will be equally unwelcome to civil servants or their counterparts in private commerce. There has already been much discussion of the additionality principle which in simple terms means a landowner will only be rewarded for benefits accruing from a new and quantifiable environmental input. There will be no reward for habitat or trees that would have been in existence anyway.

As such, a number of principles have been identified in order to ensure such market integrity and the key one is additionality.

This is a phrase which is often encountered and it is probably worth taking some time to properly understand the issues. Additionality, could, simplistically be viewed as ensuring that Mother Nature gets her money’s worth. That is, money invested in natural capital inputs must lead directly to environmental improvement.

There are various additionality tests which have arisen through the operation of market schemes or from the various consultations that have taken place.

For example, the Woodland Carbon Code assesses additionality with a legal and investment test. Any new planting must not be required by way of an existing legal obligation and must be uneconomic without the carbon credit income.

Referenced in the BNG Consultation,¹¹ the Treasury Green Book¹² defines additionality as:

“a real increase in social value that would not have occurred in the absence of the intervention being appraised”

The British Standard on BNG is more restrictive in that the Green Book would encompass benefits outside the ambit of BNG whereas here the definition is:

“Property of measures to achieve biodiversity net gain, where the conservation outcomes it delivers are demonstrably new and additional and would not have resulted without it.”

The BNG Consultation is clear that any nature-based interventions which are already required by law or agreement cannot be used to support claims for BNG or other emerging markets.

Using an example to illustrate these points, if a landowner of Whiteacre has been required to plant trees to replace others felled due to development those trees cannot be used to claim carbon credits because they were required to be there as a result of a planning obligation. There is no additional benefit in the form of increased carbon sequestration hence no carbon credits.

Under the Green Book definition, a different landowner of Blackacre might take land out of agricultural production and claim nutrient neutrality credits as a result. The recent Government response and summary of responses to the BNG Consultation has indicated that BNG and nutrient neutrality credits may be sold from the same nature-based intervention. This means that if habitat is created on the former agricultural land then both those types of credits can be generated and sold. However, a landowner would not be able to claim soil carbon credits on the same area of land unless the carbon sequestration achieved would have happened in the absence of the nutrient neutrality and BNG measures set out above.

However, the same landowner could then plant trees on Blackacre (already being utilised for BNG and nutrient neutrality credits) and claim carbon credits as long as the trees are not required to contribute to the metric calculation for BNG purposes or are factored into the nutrient neutrality calculation as increasing phosphate or nitrogen uptake. If those criteria are satisfied then the trees are a new and additional nature based intervention and so the additionality rules are satisfied.

It should be noted that where Natural England insist on tree planting as part of a nutrient neutrality scheme then those trees could not be used for carbon credit purposes because they would have been there anyway as a result of the nutrient mitigation works.

Such principles then need to be implemented which requires rules, standards and governance.

The rules bring together the three most important factors for nature markets to succeed:

• Stacking and bundling;
• Additionality; and
• Blending of public and private finance.

Stacking

Stacking is where different types of credits are derived from one or more activities on the same piece of land. Using the example above, you could stack BNG, nutrient neutrality and carbon credits on Blackacre but the activities are different. The land is the constant on which the credits are stacked and there is no requirement that they emanate from the same nature-based intervention. Land managers will still need to navigate the stacking rules of individual schemes.

Bundling

Bundling is where several different environmental benefits are combined in a single credit. The bundle may be explicit in that the separate benefits are identified and quantified or it may be implicit in that only one benefit is identified with everything else thrown in as part of the deal.

An example of an implicit bundle is the offering under the UK Woodland Carbon Code where the wider benefits of woodland creation are sold along with the carbon. It seems doubtful that such generous terms will continue much longer.

The Nature Markets Framework¹³ issued by the Government commits to greater use of stacking and explicit bundling as it encourages efficient land use and environmental improvement. The additionality risks inherent in stacking and bundling are identified in that subsequent habitat improvement must be delivered on top of an initial activity – as I set out above in the Blackacre example. As that shows, the greatest jeopardy lies in the mixing of regulatory and voluntary markets and this aspect will be kept under review.

Additionality

I have set out the existing additionality rules above and the Framework states that a move might be made to a single financial additionality test which could be applied across multiple nature markets. It appears that the concept of regulatory 2+2=5 which allows BNG and nutrient neutrality to be claimed from the same intervention will remain.

A single environmental project can advance multiple objectives simultaneously. Planting woodland, for example, both captures carbon and improves local biodiversity. Can its owner therefore use the same woodland to claim both BNG credits and carbon credits?

The principle of additionality requires that the benefits made by the improvement on which the landowner is relying to apply for a credit scheme would not have occurred in absence of the application. If the landowner planted woodland in order to meet another contractual or statutory obligation (e.g. to meet a “favourable condition” standard on land designated by Natural England as a “site of special scientific interest” (SSSI)),¹⁴ the woodland would have improved local biodiversity regardless of whether the landowner sought BNG credits and therefore would not qualify for the BNG scheme.

Different projects on the same site

It should be noted that the principle of additionality is project-specific, not site-specific. That is to say, if a landowner plants a woodland for carbon credits, they may then further improve the woodland from a habitat perspective to acquire BNG credits. Each improvement satisfies the additionality principle: carbon was captured in pursuit of carbon credits, and the site was further improved in pursuit of BNG credits; neither of these benefits would have occurred otherwise.

The government has provided guidance on combining different environmental payments;¹⁵ however, as nature markets are in the early stages of development, this guidance is subject to change.

Stacking on protected habitats

Landowners may enhance land on which development is restricted (e.g. “Sustainable Alternative Natural Greenspaces” (SANG)¹⁶ or SSSIs) to qualify for credits so long as the additionality principle is respected (a specific improvement is made to enhance the site) provided the improvement does not disrupt existing protections. ¹⁷

Summary

• Landowners cannot claim multiple types of credits from the same improvement on the same piece of land.
• Landowners can claim multiple types of credits from different improvements on the same piece of land.
• Each activity must satisfy the principle of additionality to qualify for a distinct type of credit.
• New activities may not disrupt the benefits derived from existing improvements.

Natural capital markets are a nascent and growing field, many of these rules are based on government guidance and remain untested in law. Expect these rules to be modified and refined by precedent and additional legislation.

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