UK Pension Reform, Investing in Nature and the Fall of the Berlin Wall – What can we Learn from History?

This is part of our series of myth-busting blogs from consortium members, outlining one thing they wished everyone knew about the land use transition for net zero. This editions comes from LUNZ Green Finance TAG Lead, Ania Zalewska.

35 years ago, the world was taken by surprise by the fall of the Berlin Wall, the dramatic culmination to a year that (quoting the BBC) “reshaped the modern world”. Nowadays the world is being reshaped by climate change, and this change, unlike the fall of communism, is neither welcome nor expected to be economically and socially beneficial. Strangely enough, however, some of the difficulties associated with achieving the green transformation resemble the difficulties associated with free market reforms that followed the fall of the Berlin Wall.

In the years after the fall of the Berlin Wall, market reforms spread throughout the Post-Soviet Block as communist models were dismantled. Stock markets are often considered the lifeblood of capitalism and soon many stock markets sprang up in these countries. By the mid-1990s, Central and Eastern Europe (CEE) was the cradle for the largest number of emerging stock markets in the world. These stock markets were not there as a fancy of the post-communist countries wishing to look like their developed EU neighbours. They were part of the large-scale privatisation programmes, and the expectation was that the markets would attract much needed capital, especially from big international institutional investors.

However, as much as the hopeful eyes of the East were turned towards the big institutional investors of the West, the heads of the West were turned away. The CEE stock markets, being small and fragmented, offered limited investment opportunities, and the big institutional investors had little interest in them. The responsibility of the large institutional investors towards their own shareholders meant that money had to flow to projects and regions that offered more transparency, more liquidity, lower risk and, ultimately, better returns.  Thus, although collectively the CEE needed big money to facilitate transition, individually it could not attract what was needed, simply because the individual projects were too small, too illiquid and too risky.

35 years on and the problems that the markets face with financing nature projects are reminiscent of those that emerged after the fall of the Berlin Wall. The estimates how much it will cost to restore nature capital are huge (ONS figures suggest that it will cost up to £30bn to restore UK peatlands alone), but action to achieve this restoration will be primarily built around small-scale projects: projects to restore peatlands, plant trees, reduce the probability of flooding, improve energy provision for local communities, etc. These projects struggle to attract big institutional investors, not because the work is not essential, but because individually they are too small to attract big money. And it is not only the size of the individual projects that keeps big investors at a distance. There are numerous issues with assessing the projects’ potential risk exposure, financial and nature benefits, diversification benefits, future liquidity, and so on.

One could say this is simply a part of a bigger problem of UK large investors, such as pension funds, not investing enough in the UK economy. This is a problem that has been much discussed in recent years. There are thousands of small pension funds and current government policy is to merge them to create larger funds and, in many cases, create more megafunds. This includes plans to pool the assets in the existing UK local authorities’ pension funds, to create megafunds by consolidating defined contribution (DC) schemes and to impose a limit on the minimum size of DC schemes.  The current approach is very much ‘Big is Beautiful’. There is no question that big projects need big money, big money needs big investors. Having thousands of small pension funds that, individually, have limited investment capacity and high running costs, is an inefficient way of doing business for the country.

But this direction of travel is not helpful as far as improving the contribution of large investors to nature preservation and restoration projects. To begin with, it is important to acknowledge that even if there are not enough domestic megafunds, there are already many megafunds operating in overseas markets. If these do not rush to invest in the UK, it is because they find appropriate investment opportunities elsewhere. If this is so (i.e. good investment opportunities exist outside the UK, why should the UK pensioners not benefit from them, too?), why should the UK pension funds be restricted to investing in the domestic market when there are good reasons to diversify abroad?

Moreover, to mobilise nature capital more is needed than simply “create” lots of money looking for investments. Increasing the number of big (domestic) investors will not increase their appetite for investing in small projects.  Indeed, the effect may be the exact opposite. Projects need to be attractive to investors, and as the size of investors grows, the size of projects they invest in is likely to grow too.  Thus, there is a desperate need to scale up the investment opportunities that preserve and restore nature capital.

For this to happen, at least two things are needed. First, it is important to better understand, document and assess the characteristics of environmental projects, both financially and environmentally and, second, the appropriate securitisation needs to be developed that will allow pooling of small projects to create scale and diversify some of their risks.