Knaves Turned Honest

Predator-prey relationships, host species and parasites, and more mutually rewarding interactions like those between plant and pollinator all illuminate patterns by which species have learned to co-evolve over time.

Can 21st Century Finance Sustain 21st Century Agriculture?

Predator-prey relationships, host species and parasites, and more mutually rewarding interactions like those between plant and pollinator all illuminate patterns by which species have learned to co-evolve over time. Less familiar, but equally intriguing, is the symbiotic relationship between finance and sectors of the economy, and food is no exception. From agricultural derivatives in Ancient Greece, to forward contracts used by medieval French merchants, to today’s commodity index funds – financial tools have underpinned the development of our global food markets throughout the ages.

Global food demand is set to rise sharply in the coming decades. Population growth, changing diets and environmental constraints will combine with declining global agricultural productivity to further pressurise the food system. It is likely that there will be an investment boom in agriculture and agribusiness infrastructure to meet this forecast demand. In this article we ask how the finance industry and policy makers could respond in a way that does not lead to further ecosystem destruction and yet deploys the capital into primary production infrastructure and the broad range of technologies across the value chain that will be required. We hone in on two specific challenges: the urgent need to protect ecosystems services and the equally pressing challenge of ensuring the purchase of hard assets does not increase hunger in already vulnerable societies.

Unwelcome symbiosis: eco- and food price inflation

Our food system relies heavily on what are known as ecosystem services: pollination, high quality soil, and freshwater. Globally, of the 1,330 crop plants grown for food, beverages, fibres, condiments, spices, and medicines approximately 1,000 – or 75 percent – are pollinated by animals. Of every three mouthfuls of food we eat and beverages we drink, at least one is the result of services delivered to us by pollinators. Good quality soil is essential to agricultural production, and without fresh water, there is quite simply, no life.

Despite the vital importance of these services and notwithstanding impressive conservation efforts over the past decades, we are doing nothing near enough to protect or safeguard them in the long run. The Millennium Ecosystem Services Assessment, a groundbreaking study of global ecosystems, argues that sixty percent of the benefits provided by natural ecosystems are currently being degraded or used unsustainably. This year a new report, The Economics of Ecosystems and Biodiversity (TEEB), – heralded as equivalent to the Stern report on the economics of climate change – is likely to amplify calls for a more systemic approach to secure and invest in the ecosystem services that underpin the food supply base.
Investing in Ecosystems Services

There is already interest in this space, as evidenced by the emergence of investors such as Generation Asset Management, EKO Asset Management and Earth Capital Partners. Likewise, food companies and agribusiness investors, concerned about the risks of ecosystem degradation to supply chain resilience, are committing to longer contracts and more stable prices for key input commodities.

Such approaches need to be the norm, not the exception, but creating investment instruments capable of recognising such services will not be easy. Although natural assets and ecosystem services are calculated to be worth US$33 trillion, quantifying and then marketing this value has so far eluded investors. To break the deadlock, two barriers need to be overcome. The first is the need to create a recognisable market based on a clear understanding of the asset. The second is the need for a radical shift in emphasis from privileged conservation sites, to a focus on sustainable agriculture. While pure-play conservation will still be necessary, it is the challenge of establishing an investment approach that captures the full value of all contributing factors (farmers’ livelihoods, water, soil and carbon sequestration, wildlife habitat and scenery) in a sustainable agricultural system– that is the greater challenge.

Defining and monitoring the offer

To identify the asset – as was also the case in carbon finance and microfinance initiatives – it is necessary to aggregate projects to sufficient scale to be a viable investment proposition. It is also important to create a trusted intermediary body able to identify appropriate projects and monitor and report on their activities. This, for example, is the role that Blue Orchard plays in the microfinance world, permitting bigger firms, like Morgan Stanley, to invest in loan pools.

To support these activities it would be possible to develop an ICT platform to act as a market clearing-house for local project financing. This could not only overcome deal-flow barriers, but also ensure a degree of accountability if environmental monitoring was integrated into the platform. The real-time data monitoring of environmental indicators across project sites could provide investors with assurance that carbon and other environmental claims were being met.

A third component of ecosystem services investment could be to exploit a logical adjacency, namely carbon market infrastructure. As many institutions are already geared up to manage natural assets for carbon outcomes, expanding that management to more holistic environmental criteria would be a win-win for carbon sequestration and agricultural sustainability. There are numerous examples of this approach, from investing in sugar production that “avoids” carbon emissions and improves soil quality, to enhancing the energy efficiency of water transport in agricultural systems. This sort of approach would also allow ecosystem services to achieve some sort of price discovery through the cost of carbon.

Hungry for Land

How any ecosystem arrangement affects the livelihoods of poor people who share a reliance on these services will determine the success or failure of the mechanisms. Rainforest protection schemes that do not address the needs of migrants who clear the land to feed their families have failed. Likewise, if the overuse of soil by poor farmers does not tackle why they attempt to eke out so much from the land, then desertification will continue.

If financial players are to enter the field of sustainable agriculture they will find the imperative of addressing social concerns as vital as ecological need. The limp finale of the recent Copenhagen climate talks was due to human development arguments not climate science. And the issue of access to productive agricultural land is likely to be as thorny as they come.

A lack of access to credit has plagued agricultural workers for centuries. It is only in recent years with the evolution of microfinance that the first tentative steps have been taken to address the sector’s abysmal record in providing credit to the rural poor across the globe.

The recent recession has proved a backward step and has led to a further drying of credit flows. Predatory lending agencies offering financial products to domestic farmers at exorbitant interest rates are now far more commonplace than offers of microfinance. In India, with interest rates on loans as high as thirteen to fourteen percent, it is cheaper for a farmer to purchase a car than to buy seedsv While recent surveys in Honduras, Nicaragua, and Peru show that nearly 40 percent of agricultural producers are credit-constrained. This lack of access to affordable financial products means that more farmers are being pushed into debt or forced to sell land. Extending credit to farmers at reasonable interest rates is a vital first step in protecting local livelihoods.

Larger and more mainstream investors have not, however, ignored land. The desire to fund alternative investments uncorrelated to equities and bonds have led to a flood of investments into what are sometimes described as “real assets” – assets where value and return are directly linked to inflation. And one such asset is land.

The opportunities are huge and the ethical perils commensurate, making conversations about the ethics of fair trade pale in comparison. Aware of growing needs to secure food for burgeoning populations and of the environmental limitations within their own borders a number of governments are seeking to secure food supply from other countries. Increasingly known by the condemnatory term “land grabs” – richer nations and investors are buying agricultural land from poor countries – many of them in Africa – to secure long term food supply for their people.

The sellers are amongst the poorest countries on the UN Human Development Index. Ethiopia, Mozambique and Sudan all rank amongst those with histories of famine and ongoing problems of hunger for large swathes of the population. Ethiopia’s 2008 contract to sell vast tracts of agricultural land to Saudi Arabia was signed at the same time that UN reports indicated 75,000 Ethiopian children under age five were at risk from malnutrition and an estimated eight million people in Ethiopia were in need of urgent food relief. Saudi Arabia’s also bought 500,000 hectares in Tanzania at the same time. India too has lent money to over eighty companies to buy land in Africa.

There are development experts who argue that this is not necessarily a bad thing. African governments are making rational choices about valuing their assets and that the foreign agricultural investors with whom they are making deals offer the opportunity to boost land productivity, build infrastructure, transfer technology, and create jobs. These are all laudable outcomes, but in a world of hunger, the legal access to their agricultural resources by the poor at times of need and the degree to which domestic food markets are protected under such schemes becomes critical. As the politics of food heat up, a question becomes: what levers in the financial system can be utilized to positively shape the international food trade?

Agreements like the Equator Principles, which provide banks with environmental and social guidance on project financing, is one lever, but tends to be overly focused on “what not to do.” Alternatively, low-cost certification of project financing might actually be a stronger channel for creating the right incentives. If deals were certified along dimensions of producer inclusion, recognized land rights, and environmental sustainability, foreign investment could help to transform farming in developing countries. In addition, creating domestic stakes in foreign land investments either through joint-ventures or shared ownership structures, not only provides an opportunity for wealth inclusion, but allows domestic countries to play more of a “watchdog” function – ensuring that local food production needs are not being by-passed.

The extension of credit to farmers and domestic firms will also be critical to ensure domestic producers are given the same opportunities as external investors. Currently, at the same time that land is being purchased for export, local production is being squeezed by domestic liquidity challenges. This means that financial liquidity is favouring export-oriented markets, weakening the bargaining power of domestic producers.

A happy ending is not assured. First, there is a question of competence. Is our current financial model structured appropriately to deliver sustainable agriculture? The mainstream financial market – despite the spectacular collapse of a year ago – is still unable to think long-term. Conventional investors (who manage most of the money) still operate on the principle that the time value of money says that higher returns now – unburdened by the eventual cost of externalities – is worth more than the eventual value of a more sustainable approach – irrespective of its long-term value. The consequence of this is that the market must be tempered. Governments will have to assume a central role in defining the value of the services, regulating their usage and aligning incentive structures that permit the markets to evolve in a way that builds environmental protection and social equity into outcomes.

Second, more practically, the experience of carbon markets shows how the lack of consensus price on the “commodity” at hand leaves markets unstable and volatile. In the weeks since the Copenhagen talks ended the lack of hard numbers has led the bottom to fall out of the carbon market. And ecosystem service markets are likely to have similar challenges. The value of the different services will be difficult to define and responsibility for their protection will be disputed.

Finally, the ethics of consolidating a privatised approach to public commons – water, food and land – are important to consider. The assumption that common goods have to be privatised or managed by a central authority is the subject of considerable dispute. The 2009 Nobel Prize for Economics was awarded to Elinor Ostrom who demonstrates that the best managers of natural resources can, in fact, not be the owners, but the users of those resources. The full implications of this should be built into proposals for how to sustainably manage agriculture.

The financial community’s recent forays into healthcare, microfinance and renewable energy shows that if capital can be channelled differently and more equitably it can play a tremendously positive role in addressing urgent sustainable development challenges. Looking at the cross-section of food and finance, it will be equally vital to ensure that the relationship that develops is one of symbiotic benefit and not one in which the parasite wakes up one morning to find that its host has expired.