17 January 2024

The birth of a biodiversity offset market

Dasos Habitat Foundation and Eurowind Energy have entered into a first-of-its-kind biodiversity offset transaction, to compensate for the residual impacts on nature that will be caused by a proposed Finnish wind farm. Tapani Pahkasalo explains the thinking behind the novel transaction.

Environmental Finance: Dasos Habitat Foundation is pioneering a novel biodiversity impact offsetting market. What's the thinking behind the new market?

Tapani Pahkasalo: The basic point is that we see tremendous interest from consumers, investors, and society at large in protecting nature. We see that demand in the media and public discussion all the time: biodiversity loss is a growing issue. Legislators across Europe have responded to this with new national regulations and also internationally with the Montreal-Kunming agreement, signed at the meeting of the Convention on Biological Diversity in 2022.

There is demand to protect biodiversity. Harming biodiversity remains largely an externality, it is not captured by market prices, and nature is not being priced correctly in investment decisions. The 'polluter pays' principle will reduce harm for nature and channel more funds to restoration and conservation. We wanted to come up with a market-based solution that allows those who are impacting biodiversity to contribute to restoring nature and eventually produce more nature.

EF: You've just entered into your first transaction. Who and what did that involve?

TP: We have just closed our first Biodiversity Positive Renewable Energy transaction, with Eurowind Energy, a Danish renewable energy company that is developing the Tielampi wind farm, in Lapinlahti, Northern Savonia, in Finland. The company will offset the residual impacts on nature that the wind farm creates, from the construction of the wind turbines themselves, as well as from the transmission lines and from the road network, by restoring areas of the same habitat type, nearby.

The project will be nature-positive, creating a net gain of biodiversity. At this point, because the wind farm has not yet been through the permitting process, we don't know exactly how large the farm and what the final impact will be, but we will restore an area many times greater than the land affected, with the aim of delivering overcompensation.

EF: It's enabled by Finland's new Nature Conservation Act. What does the act do?

Tapani PahkasaloTP: The Finnish parliament updated the Nature Conservation Act in 2023 to, among other things, introduce provisions on voluntary ecological compensation. What it practically means for biodiversity impact offsetting is that it provides an agreed format for measuring biodiversity, with defined units of measurement, creating consensus and transparency.

The act enables project participants to measure biodiversity loss and gain, with the same agreed methodology, and propose actions to improve the current state of nature. It sets out how to measure nature and biodiversity, how to measure loss, and how to measure gains produced by means of nature restoration and conservation. It also creates potential to record projects in a public registry, enabling transparent evaluation of losses and gains.

"Producing biodiversity loss-free electricity is not very expensive when mitigation measures are correctly used and offset sites are well chosen."

The legislation uses a concept called 'habitat hectare', which is based on nature in an intact state for various types of habitats, whether old-growth forest, sand dune, peatland etc. You can then measure the current state of nature, expressed in habitat hectares that vary between that intact state and a completely degraded state. An equivalent or larger amount of the lost 'nature units' will need to be created to offset the impacts. Those additional and permanent nature units need to be created in the same type of habitat that is being impacted by the development.

EF: To what extent is such a market replicable elsewhere? Is specific legislation required in different jurisdictions?

TP: The market in Finland is completely voluntary and exists outside of compulsory legislation. Private markets can similarly be created elsewhere, without the need for specific legislation. However, what the legislation in Finland does do is create consistency and transparency on the unit of measurement. Clearly, biodiversity loss is a global problem, and there is a strong case for such consistency to be created as widely as possible, whether at the European level or globally.

Obviously, biodiversity impacts tend to be local. Similarly, solutions using offsets will have to be local. Offset markets have to be adapted to the types of habitats that are found in specific geographies. Trading units between different countries and types of nature is not meaningful. This means there are likely to be many local markets, but they are likely to operate under similar principles.

EF: Can you talk to the costs of this service? How material is it to a wind or solar project developer?

TP: The relative cost of biodiversity offsetting depends on how intensively a particular project uses land, and the value added per hectare that is developed.

Our focus is on the land-use sector, and in projects that impact areas with forests, but it can be used in other habitats as well. Renewable energy projects, for example, should be able to pay for this. For other sectors, such as the construction sector, the costs are unlikely to be prohibitive by any means.

"Nature is not being priced correctly in investment decisions"

We believe that the costs are marginal compared with the benefits they can produce. Producing biodiversity loss-free electricity is not very expensive when mitigation measures are correctly used and offset sites are well chosen. For example, by creating biodiversity-positive projects and products, companies could increase the prices they charge and eventually earn more. Similarly, they are likely to be able to access cheaper financing. For example, we are seeing that some funds that are seeking to register under Articles 8 or 9 of the Sustainable Finance Disclosure Regulation will, in future, require any investment they make to address its biodiversity impacts.

EF: The opponents of offset markets often raise concerns around their environmental integrity. How does the scheme address those concerns?

TP: Correctly placing a price on a unit of nature will encourage developers to reduce and mitigate their impacts. We follow the mitigation hierarchy: economic actors should first avoid impacts, then minimise those impacts, before seeking to compensate for unavoidable impacts using an offset mechanism.

Putting a price on nature creates incentives to protect it. If a project developer faces greater costs from damaging land that has greater biodiversity value, it will be encouraged to reduce how much it does so. We are already seeing biodiversity offsetting leading to behaviour change. There are cases where it might be optimal for a wind turbine to be placed on an area of wetland; but having to compensate for the greater impact might be sufficient to persuade the project developer to place the turbine in a less environmentally damaging spot.

EF: How would you respond to critics who say that nature is priceless, and shouldn't be traded?

TP: There are certainly cases where nature is indeed priceless and shouldn't be traded. For example, a habitat that includes species that are at risk of extinction should be protected. Existing conservation areas should not be taken into economic use, regardless of whether impacts are offset elsewhere, even if that impact is offset ten-fold.

We take the view that offsets in this scheme should 'trade up'. So, if the developer is affecting a fairly common habitat, there's not a great deal of point creating more of it. Instead, they should be seeking to restore or create rarer habitats, with greater biodiversity value. Similarly, we seek to create larger-scale, connected compensation areas. This is in line with the ecological metapopulation theory that finds that large areas have greater biodiversity value per hectare than smaller ones.

EF: What would you say is the potential for biodiversity offset markets in future?

TP: It is very clear that challenges around biodiversity loss are far from being solved. It is a critical topic in the markets that we operate in at Dasos Habitat Foundation, and we see strong demand from consumers and a willingness to pay for habitat protection. We think there is potential for most land-use sector projects to fully offset their impacts on nature and, as well as our first transaction in Finland, we are also seeing inspiring projects emerging elsewhere.

We are excited to be part of the first deal of this kind, creating new markets for biodiversity and creating new channels for nature financing.

Tapani Pahkasalo is a partner at Dasos Capital, based in Helsinki, Finland.

For more information, see: www.dasos.fi