Where there's muck there's brass

The prospects for the UK’s recycling sector may be bright, but venture capitalists have been turning up their noses. Will an innovative new government-backed fund help chart a course for private sector investors? Mark Nicholls reports

In common with many environmental markets, the growth prospects for the UK recycling sector are, in theory, excellent. The UK is lagging far behind its European peers in its levels of recycling, and domestic and European Union regulations are in place mandating that these levels rise. The technologies exist to recycle a range of waste materials cost-effectively. And there are potentially lucrative markets for recycled products.

But the private sector has, thus far, proved reluctant to provide the capital required to expand the domestic recycling industry. In an effort to plug this so-called ‘equity gap’, an innovative public–private venture capital fund was launched last month.

The Recycling Fund, established by the government- funded Waste and Resources Action Programme (WRAP) and managed by environmental sector specialist Impax Asset Management, will invest in small- and medium-sized UK-based recycling companies. Its mandate is to “establish a successful track record of investing in recycling”, according to WRAP chief executive Jennie Price.

Jennie Price, WRAP: "lack of technological and market understanding among investors" about recycling

“This pilot equity fund is fulfilling a genuine market need,” she says.“There are currently no funds focused on recycling, but we believe that this is because of a lack of technological and market understanding among investors rather than a lack of good investment opportunities.”

WRAP, a not-for-profit private sector company, was established in 2001 with an initial £55 million ($92 million) of government money over four years to promote sustainable waste management. It has carried out extensive research into the barriers to increased recycling and the development of markets for recycled materials in the UK.

Certainly, the country is starting from a relatively low base. Only 12% of UK municipal solid waste is recycled,compared to 47% in the Netherlands (the UK government has set a target of 33% by 2015). Furthermore, the UK’s landfill tax rate of £14/tonne is set to rise to £35/tonne over 10 years, providing a further incentive to recycle as dumping becomes more expensive.

As well as a regulatory push, the sector also stands to benefit from the pull of developing markets in recycled products. Across the range of recycling markets – paper, glass, plastic, wood, aggregates, and compostable materials – WRAP has identified opportunities for higher value-added products. In glass, for example, the “default option” of selling recycled glass for use by the glass container industry brings in around £20/tonne. However, processed glass for use in water filtration systems commands £250/tonne.

According to figures from WRAP, the UK recycling sector turns over £12 billion/year. It estimates that this could reach £30 billion by 2020.

“So why isn’t investment going in?” asks Price. Research carried out byWRAP in spring 2002 found that investors consider the sector to be too small, lacking readily available information, largely comprised of small- and medium- sized enterprises (SMEs) “which are often seen as more trouble than they’re worth”, Price says, and high-risk.

Ian Simm, managing director of Impax Asset Management, adds a couple more factors to the list:“There is concern that new regulations [mandating increased recycling] haven’t been in place long enough and that there are technology risks to overcome.” The latter perception is easy to refute by looking abroad to the US or the Netherlands, where recycling technologies are well established.

Regulatory risks are less easily addressed – any policy-driven market can be undone if political support evaporates (although Price points to a “flood of legislation and widespread public support for recycling”). But this risk, and the complexities introduced by new regulations, also promise healthy profits for those investors able to understand the issues, they say. “We expect double-digit returns,” Price says.

One of the key objectives of the fund, says Simm, is to “create SME success stories” that will help encourage private capital into the market. The Recycling Fund is small, at only £5.5 million. Of that, £4 million is government money, via WRAP, although Barclays Bank, waste management firm Wastelink Services and Partnerships UK, a public–private partnership, contributed a further £1.5 million. Simm says that WRAP deliberately kept the private sector contribution small – originally planning to raise only an additional £1 million – to ensure WRAP remains the lead investor.

However, the fund is looking for private sector co-investors, and is already in discussions with two venture capital houses – Bridge Community Ventures and Foursome Investments – says Simm. Price also expects that, after the three-year pilot, the fund “will become a test case for larger funds – we hope to improve sector knowledge and awareness in the City”.

And Simm is clear that government backing does not mean the fund will be dispensing free money. It aims to make between 10 and 15 investments, of £300,000–650,000 each (the maximum allowed under EU state-aid rules) – but will set rigorous selection criteria.The fund managers will be looking for: clear market opportunities; proven technologies; management with entrepreneurial experience; the ability to manage materials price risk; and good governance structures.

“We’ll avoid businesses based on standards or regulations yet to be put in place … and unrealistic management expectations on equity positions or upside,” he adds.

Such a fund has its precedents. Since 1998, Impax has managed the Photovoltaic Market Transformation Initiative (PVMTI), a $25 million solar energy venture capital fund for the International Finance Corporation, the private sector arm of the World Bank. The Recycling Fund is “taking a similar approach to the PVMTI,” says Simm. “It’s using public money, in a private-sector wrapper, to overcome a market barrier – namely a lack of entrepreneurs.”

The UK recycling sector faces unique challenges. But it also faces challenges shared by many environmental markets – how to attract venture financing into policy-led, emerging industry sectors that are poorly understood by investors. The proof of the Recycling Fund’s success, say investors, will be the extent to which private money follows public.