8.4 - Government effort alone is not enough

Significant investment to improve the environment is required to reverse the current unsustainable trend and to enable future development to be sustainable. Governments continue to spend significant public funds to improve the environment. However, even with the recommended improvements to ensure the regulatory levers of government contribute to restoration, this will not be enough.

The predicted shortfall in restoration funding in Australia is $10 billion annually (Ward & Lassen 2018). It is unrealistic to expect government, and the taxpayer, to fund this level of investment. Philanthropic investment, while helpful, is not of the scale required for long-term restoration.

Some restoration activities will not provide a private return and may come at a financial loss to the landholder, particularly in the short term. It is therefore also unreasonable to expect private landholders to fund such activities for public benefits. There is opportunity though for the Commonwealth to facilitate mechanisms that both incentivise environmental restoration and generate greater private return.

8.4.1 - Private-sector interest

There is appetite to invest private capital in the environment in Australia. Globally there has been a shift towards investment in environmental, social and corporate governance (ESG), which refers to the 3 central factors in measuring the sustainability and societal impact of an investment. The pool of available capital interested in ESG investment has grown rapidly over the past decade. In 2018 the responsible investment market in Australia reached $980 billion and sustainability-themed investments accounted for $70 billion (RIAA 2019). The capital available to invest in environmental outcomes is likely to continue to grow.

Environmental services are provided by a healthy environment – often called ‘natural capital’ (HMT 2020). Despite growing interest in ESG, little private capital flows towards environmentally sustainable land management that can improve natural capital and deliver restoration of matters of national environmental significance (MNES). Given the scale of available private capital, only a moderate change in the way the private sector invests could drive a material improvement to the environment.

Combined, private landholders such as farmers and Indigenous Australians manage 77 % of Australia’s land mass and are key to sustainably managing natural capital and improving outcomes for MNES (Ward & Lassen 2018). Over the long-term, the maintenance and improvement of natural capital is linked to the success of landholders’ businesses and the resilience of regional economies. However, many landholders use their natural capital in ways that unintentionally degrade the environment. This unvalued loss of natural capital is a form of market failure.

The Commonwealth has the opportunity to help resolve this market failure and deliver the scale of restoration required to sustainably manage MNES. In response to the opportunity highlighted in the Interim Report of this Review, the Australian Government has allocated $2.5 million in the 2020–21 budget (Treasury 2020) for further policy work related to environmental markets – including how to best address this market failure. It is the Review’s view that this will be best achieved by government working with private capital investors and landholders to better value their natural capital and invest in the management of privately owned land.

Improved land management can deliver long-term returns at the farm gate, while also minimising impacts on MNES, and in some instances deliver restoration. Willingness exists to consider investment that better supports natural capital and restoration, but the information, tools and systems are not available to deliver the shift. Key issues include:

• the lack of farm-level information and metrics on the dollar value of natural capital or likely returns from investment
• the timeframes for returns on investments in environmental capital can exceed the time horizons of traditional private capital markets
• relatively immature markets for environmental capital, result in high-risk premiums and less investment.

8.4.2 - Commonwealth leadership to better align private investment with national priorities

The Review has identified opportunities for national leadership outside the EPBC Act that should be considered. This includes opportunities for greater collaboration between government and the private sector, to invest in the environment directly and to invest in innovation to bring down the costs of environmental restoration activities.

Attracting greater private investment in natural capital and restoration of private land requires Commonwealth leadership. The Commonwealth is best placed to deliver the mechanisms including the legal, governance and institutional foundations required to support private-sector investment and leverage public investment in restoration. Government is also best placed to improve data and key metrics of environmental health, to provide the market with certainty to encourage investment in activities that contribute to sustainability.

Mechanisms are needed that leverage public and private capital to deliver the scale of investment in restoration that is required.

Some stakeholders have highlighted concerns about the availability of farm-level information on natural capital stock. Information at this granular level will need to be available to enable the formation of environmental markets and determine the return on investment associated with an investment in natural capital.

The Commonwealth should formally work with the private sector and research organisations to investigate the feasibility of mechanisms that leverage private capital to deliver greater investment, including:

• funding innovation to reduce the cost of large-scale environmental restoration
• co-investing with private capital to improve the sustainability of private land management
• establishing a central trust or coordination point for private and public investment (including offsets)
• using opportunities to leverage existing markets, including the carbon market.

The links between these mechanisms and other government environmental management initiatives such as the Agriculture Stewardship Program (DAWE 2020d) should also be examined.

Past Australian Government restoration activities have focused on grants as the primary mechanism to fund innovation in restoration. Grants and other funding programs are biased towards past proven activities, which take precedence over innovative solutions – especially when funding is scarce. They also promote short-term planning and ongoing reliance on government resources. Grants may or may not require co-investment by the private sector. Where private return is possible, the grants model can lead to rent-seeking behaviour by private interests.

New grants are not the right mechanism to invest in the innovation and long-term structural change required to deliver large-scale restoration and should no longer be the central focus of government investment. The exception to this is grant funding where there is a pure public good outcome or for high-risk innovation that is unlikely to deliver a financial return on the upfront cost. In these circumstances, co-investment is not feasible or attractive to the private sector and a grant may be the only mechanism to deliver the innovation.

Encouraging innovation to lower costs

Submissions to the Review have stated the cost of achieving environmental restoration is high (PCA 2020). Substantial opportunities exist for cost reduction through fostering technological improvement in restoration and new business models – and there is a role for government to facilitate this. Previously, similar government programs have aimed to reduce costs of activities that will deliver public benefits. Box 29 provides examples of the role of government in growing the renewable energy sector and biomedical research in Australia.

Fostering private investment

Programs that seek to leverage private-sector capital in new markets often do so by initially using the public balance sheet and its competitive bond rates. Because this involves investment of government funds, they are generally facilitated by government organisations such as government-owned investment bodies. They require an initial investment of public capital, with an expectation of financial returns in the long term while also achieving broader public benefits. The exact investment model and scale of public capital investment required is best determined by government, after thorough consultation with potential market participants.

Capital investments must demonstrate returns over time (both public and private). Therefore, investments should target land-management activities that generate both returns in the real economy, such as productive agriculture or tourism ventures, while also delivering natural capital improvements through restoration. All investment activities will need to ensure a balance between public and private outcomes and focus on activities that are unlikely to occur without government intervention – for example, activities that have higher public benefit than private benefit or substantial upfront costs or other barriers that prevent private capital investment.

The investment model chosen by the Commonwealth will require flexibility in the methods for deploying capital. The Australian Government should explore the merits of different financial products, including debt, equity and hybrid investments (Box 30).

To ensure longevity of the investments, financial returns should be skewed towards the private sector. Equity or hybrids that weight returns to the private sector are a form of subsidy that also provide a return to government. The Biomedical Translation Fund achieves this through returns being evenly distributed between the Australian Government and investors until return is equal to the government bond rate. After that point, the balance of the relevant distribution is split between the Government and the private investors on a 40:60 basis (DIIS & DH 2016).

In practice, investments in natural capital could take the form of:

• providing concessional finance, revenue-contingent loans or ability to refinance existing debt
• building investor confidence by de-risking private investment using equity
• providing subordinated debt to allow projects to secure other sources of funding
• debt for nature swaps in which a debt portion is forgiven on the condition that conservation outcomes are maintained.

Prior to any capital allocation, the Australian Government should set out clear investment principles stating how these investment principles work towards achieving the outcomes established in the National Environmental Standards.

For example, tax incentives can be a useful tool because changes to the tax system avoid the need for a direct public capital investment and can help to balance variable returns to the private sector.

Reducing the tax a business must pay leads to increases in business cash flow and gives that business the ability to invest. Conditional tax reduction can induce behaviour change, leading to greater investment in natural capital. For example, if a farm has increased its natural capital and is more resilient in times of drought, that farm is more likely to be profitable (and pay tax) during a drought. Tax averaging enables private landholders to smooth the often high upfront costs associated with restoration, while tax deductions and investment write-offs would provide annual stimulus for landholders to engage in restoration activities.

A range of incentives are already in place (ATO 2020). However, the Australian Government should investigate opportunities to further incentivise restoration through changes to the tax code. This investigation should consider any additional tax incentives, including tax smoothing, tax deductions, and investment write-offs.

Investment coordination

Governments should consider allowing for development proponents to pay offset obligations to an investment organisation, as a means of discharging their obligations. This could provide an additional revenue source for the organisation, reduce regulatory burden on proponents and allow for strategic purchase of offsets in accordance with regional plans.

To harness the growing private sector demand (section 8.4.1), the Commonwealth should formally investigate and report on the merits of different organisational structures, governance, required financial products, and the potential for tax incentives that would benefit environmental restoration.