Financing Nature-Based Solutions through Carbon Markets: Lessons Learned from Latin America

Abstract

A global renaissance is underway to tackle climate change. 127 countries, representing 80% of the world population[i], and more than a third of the world’s largest publicly traded companies have set net-zero targets.[ii] Many of these governments and corporations are relying on the voluntary carbon markets (VCM) to reach these goals, covering potentially 2 billion tCO₂e by the end of 2040.[iii] In this paper, I argue that the coming demand for carbon markets could be a boon for Latin American countries who are a hotspot for high-quality nature-based solutions (NbS).

After analyzing the existing landscape of carbon market financing of NbS in Latin America, I provide recommendations on how policymakers can drive carbon market investment towards “blue carbon” and “green-grey” infrastructure projects through the use of natural capital accounting and regulatory policies that embed NbS in new infrastructure.

Introduction

Latin America is considered a “biodiversity powerhouse”, with more than 40% of the world’s biodiversity, 10% of its coral reefs, 12% of its mangrove forests, and the largest expanse of wetlands.[iv] At the same time, it lost more tropical primary forest than any other region as recently as 2019. Given that the region’s economy is uniquely reliant on natural resources, “nature-based solutions” are seen as a ripe opportunity to both combat climate change, enhance resilience against extreme weather impacts, and improve economic and community growth.

What are nature-based solutions (NbS)? They were defined by the United Nations Environment Assembly in 2022 as “actions to protect, conserve, restore, sustainably use and manage natural or modified terrestrial, freshwater, coastal and marine ecosystems which address social, economic and environmental challenges effectively and adaptively, while simultaneously providing human well-being, ecosystem services, resilience and biodiversity benefits”.[v]

According to the UN Environment Programme, approximately $133 billion is currently flowing into NbS projects annually, 86% coming from public funds and 14% from private funds.[vi] As shown in Figure 1, of the $18 billion in private funds, about $5 billion comes through biodiversity offsets with an additional $221 million a year through voluntary carbon markets. Although carbon markets and offsets currently make up a small portion of the NbS financing pie, they are expected to explode over the coming decades. The 2021 report of the Taskforce on Scaling the Voluntary Carbon Market estimates that “demand for carbon credits could increase by a factor of 15 or more by 2030 and by a factor of up to 100 by 2050”.[vii] By 2030, the market for carbon credits could reach more than $50 billion with nearly two-thirds expected to flow towards NbS.[viii] More than 1,500 companies have committed to net-zero emissions by 2050[ix] with corporate actors pledging more than $4 billion towards NbS in 2021.[x]

In light of the expected boom in the use of carbon markets to finance NbS, this paper does a landscape analysis on what this could look like in Latin America. Section I provides an overview of what nature-based solutions entail, the various ways that carbon markets finance and verify these projects, and the challenges with the current approach. Section II contextualizes this for Latin American countries who are currently getting NbS projects off the ground, exploring how “blue carbon” projects and “green-grey” infrastructure represent promising paths to tap into global and regional carbon market financing. Lastly, Section III provides recommendations for policymakers on how blue carbon and green-grey projects can be made more attractive to carbon markets and overcome existing challenges to NbS financing and the credibility of carbon credits.

Section I – Defining and Financing Nature-Based Solutions

Background on NbS: Benefits and Challenges

NbS can be conceptualized and implemented across three different domains: (1) the type of ecosystem – terrestrial, freshwater, and coastal/marine, (2) the type of work – conservation, restoration, protection, and management, and (3) the solution-orientation of the project ranging from climate change, disaster resilience, land degradation, inequality, unemployment, etc. [xi]

NbS can be used to address a range of social, economic, and environmental challenges, depending on the ecosystem that projects are delivered in. Terrestrial projects are implemented in farmlands, forests, peatlands, mountains, deserts, grasslands, and high lands. Freshwater projects are done in lakes, rivers, wetlands, marshes, streams, ponds, and floodplains. Coastal/marine projects are often done in mangrove forests, seagrass beds, coral and oyster reefs, estuaries, salt marshes, sandy beaches, and dunes.[xii]

By enhancing these ecosystems, NbS offers co-benefits to a broader symbiotic relationship between the planet and humans known as “ecosystem services”. These ecosystem services come in four categories as defined by the U.N.’s Millennium Ecosystem Assessment[xiii]:

Provisioning services, such as food, water, building materials, medicinal benefits, and sustainable employment opportunities as half of the world’s labor force is comprised of agriculturally based households which rely on healthy ecosystems.[xiv]
Regulating services, which moderate natural phenomena, like air quality, water purification, erosion and flood control, pollination, as well as carbon storage and climate regulation which increased vegetation plays a critical role in maintaining.
Cultural services like recreation, eco-tourism, spiritual activities and cultural heritage, and aesthetic beauty that comes from wild places.
Supporting services, including nutrient retention and recycling, habitats for keystone species, and the soil and water cycles which allow the planet to support life altogether.

Despite the immensely valuable potential of NbS, several concerns have been raised, including[xv]:

Infringing on the rights of indigenous peoples and local communities: Previous NbS projects have led to backlash from indigenous communities as a form of “land grabbing”, raising concerns about the security of land rights as well as access to natural resources. [xvi]
Distracting from decarbonization: Some consider NbS as detracting from or a substitute to the primary goal which is reducing the production of GHG emissions.
Misinterpretation and misuse of NbS: Given its recency as a concept, NbS can and has been misinterpreted by different stakeholders. There are several frameworks and standards that could be applied to different NbS projects, complicating implementation and integrity efforts. The few that have been institutionalized are the IUCN Global Standard and the UNFCCC requirements for Reducing Emissions from Deforestation and Forest Degradation (REDD+), which require expertise and local knowledge to properly implement. The UN Environment Programme argues there will never be a globally agreed upon set of standards and safeguards for NbS due to the wide range of actions and sectors it encompasses which are covered by several international conventions.
Skepticism about the effectiveness: Due to the lack of standards, measuring the effectiveness and benefits of NbS has been notoriously difficult, though the evidence has been growing stronger[xvii]^{,[xviii],[xix],[xx]}. As a result, skepticism remains about the suitability and likelihood of success for NbS as well as untangling the complexities of attribution when NbS is combined with other efforts to tackle multiple issues.

Financing Nature-Based Solutions Through Carbon Markets

The terms “carbon credit” and “carbon offset” are often used interchangeably. They differ slightly, but both refer to a verifiable metric tonne of CO₂-equivalent of greenhouse gas removal issued by a carbon crediting program[xxi]^,[xxii]. Each credit or offset has a unique serial number which is issued, tracked, and then retired so it cannot be sold again. NbS has great promise for removing GHGs through the restoration and conservation of forests and other ecosystems. However, because of the lack of standardization and measurement for NbS, ensuring the integrity of carbon credits remains one of the primary obstacles to scaling up carbon markets to finance NbS. The table below lays out the principal barriers to credible carbon credits today.

Concern	Description/Example
Leakage	Protecting a forest results in logging to occur in a different forested area
Permanence	A forest fire burns down a protected area, releasing GHGs back into the atmosphere
Additionality	A wetland was going to be protected anyway without the incentive of a carbon credit
Accuracy of measurement	Unable to determine exactly how many GHGs were removed by restoring a peatland
Social safeguards	A river restoration project harms indigenous communities who fish in the area
Double counting	A carbon credit is issued twice for protecting the same mangrove area
Inflated baselines	Asserting that 30% of a forest would have been deforested were it not for the carbon credit when historical averages may be below that

To incentivize corporate investment in NbS through carbon markets, organizations will expect carbon credits of the highest quality that are certified with credible standards, transparent accounting, and robust calculations. The four largest standard setters in carbon markets are the Verified Carbon Standard from Verra, the American Carbon Registry (ACR), Climate Action Reserve (CAR) and the Gold Standard (GS)[xxiii]. For NbS projects specifically the three leading standards for verification are: Verra’s Jurisdictional and Nested REDD+ (JNR), the Architecture for REDD+ Transactions’ The REDD+ Environmental Excellence Standard (ART/TREES), and the World Bank’s Forest Carbon Partnership Facility (FCPF) Carbon Fund.[xxiv] The World Resources Institute found the ART/TREES standard to be the most robust of the three to ensure environmental and social integrity. Most importantly, it would certify NbS credits generated at a jurisdictional scale rather than a project-scale which all NbS projects on the voluntary market so far have operated under. [xxv]

Lastly, a critical dimension of carbon markets facilitating investment into NbS going forward is through the Paris Agreement Article 6 process.[xxvi] Article 6 provide a framework for countries to be able to buy and sell GHG reductions through a Global Carbon Market Mechanism (GCMM). The Article 6 rulebook was formalized at COP26 in Glasgow, with finer points of detail still being hammered out at Sharm El-Sheikh in COP27 and beyond. One of those is Article 6.4 which established a new type of carbon credit known as mitigation contribution emission reduction (MCER). MCERs could also represent carbon removals as well as “other international mitigation purposes”. [xxvii]

Observers believe the inclusion of “other international mitigation purposes” in the governing text indicates a willingness to include private sector buyers purchasing carbon credits in the voluntary market – even though the Paris Agreement has no jurisdiction over it.[xxviii] This opens the potential for private sector actors to finance NbS and have those reductions be traded in the Article 6 carbon market as well as the voluntary market. Given that nearly half of the Nationally Determined Contributions (NDCs) include the use of international cooperation through carbon markets[xxix], Article 6 could see substantial public and private financial flows go into NbS as the carbon market rules become final.

Section II – Nature-Based Solutions in Latin America

Landscape of NbS Projects in Latin America

A study between the World Resources Institute (WRI) and the Inter-American Development Bank tracked more than 156 NbS projects currently underway in Latin America. The countries with the most projects are Mexico (31), Colombia (21), and Brazil and Peru (17).[xxx] Roughly 72% of the projects aim to serve the water and sanitation sectors, following by housing and urban development, transportation, and energy. Per Figure 2 and Figure 3 the overarching objectives for most NbS projects in the region are water quantity, water quality, urban flooding, coastal flooding and erosion, landslide risk, and river flooding with forests being the primary sector of investment.

Figure 4 details the opportunities for Latin American countries to leverage NbS to improve drinking water quality and riverine and storm water flood mitigation, finding that cities in Colombia, Venezuela, and Brazil would benefit the most from NbS, as well as showing. The primary challenge though is a lack of financing. 60% of current NbS projects in Latin America are still actively seeking funding or investment with three quarters of the projects relying on government grants as a key part of the funding model.[xxxi] Here, carbon markets could play a vital role to scale up finance for NbS.

Carbon Markets in Latin America as a Catalyst for NbS Finance

After Europe, Latin America has the highest number of sub-national jurisdictions that have pledged to reach net-zero – spanning five regions and 209 cities.[xxxii] Achieving these goals has seen the region experiment with both compliance and voluntary carbon markets, as shown in Figure 5. Colombia, Chile, Mexico, and Argentina are the region’s leaders in developing carbon markets with carbon taxes and a voluntary carbon market at the national level. Colombia has a mandate to develop an emissions trading system, while Brazil is in the process of deliberating on legislation to institute carbon pricing instruments, in particular a voluntary carbon market.[xxxiii]

Carbon taxes have been a popular instrument in the region due to the revenues generated which are used for numerous social projects. There are also several pilots under Article 6 of the Paris Agreement, including between Switzerland and Norway with Peru, Canada and Sweden with Chile, and Japan with Mexico, Costa Rica and Chile under the Joint Crediting Mechanism.[xxxiv]

In the voluntary carbon markets, Latin America is the second largest provider of carbon credits with around 20% of the global supply coming from the region between 2020 and 2021. More than 80% of those credits come from Peru, Brazil and Colombia representing 71 megatons of CO₂e. [xxxv] Projects certified by Verra represent 70% of those credits, largely under REDD+ forest projects, followed by the Gold Standard at around 15%. A recent analysis found that NbS projects are poised for the most “significant and lasting growth” within voluntary and compliance carbon markets in Latin America.[xxxvi] Even though current prices for carbon credits are in the $3-5 range per tonne of CO₂e, NbS has the prospect of attracting higher prices because of the additional benefits through the form of ecosystem services.

Two promising venues to scale NbS through carbon markets in Latin America is through “blue carbon” and “green-grey” projects. Blue carbon projects entail the management of three types of coastal ecosystems: mangroves, saltmarshes, and seagrasses. These three ecosystems are the most carbon-dense on the planet, removing ten times more carbon from the atmosphere than terrestrial forests.[xxxvii]^,[xxxviii] Green-grey projects combine the conservation and restoration of ecosystems with traditional “grey” infrastructure to enhance climate resilience, including flood mitigation, stormwater management, and water quality.[xxxix]

As carbon markets seek out high-integrity and high-value projects, blue carbon represents a ripe opportunity for Latin American countries to become investment destinations. One example of this is Colombia’s Blue Carbon Cispatá Project, known as “Vida Manglar,” to preserve mangrove forests along the Caribbean coast. This was the first blue carbon credit project approved for a voluntary carbon market, with participation from Apple, Conservation International, and Verra to calculate the carbon content above water, in the roots, and soil.[xl]

The project found that Cispatá Bay’s 27,000-acre mangrove forest would sequester nearly 1 million metric tons of CO₂ over a 30-year horizon, verified by Verra’s Verified Carbon Standard and the Climate, Community, & Biodiversity Standard.[xli] This has established a precedent for a new carbon measuring methodology to create scalable blue carbon investment across the region. Further, 92% of the income from carbon credit revenues of this project was invested back into the project itself, a higher percentage than most carbon credit projects. This will fund training and equipment for local communities to assist in monitoring, data collection, and conservation.[xlii]

Colombia’s government is looking to replicate this effort to six other locations along the Caribbean coast while Conservation International is also looking to scale this model by conducting feasibility studies around Latin America including Brazil, Chile, and Mexico.[xliii] Other countries in the region are taking notice, including Belize and the Dominican Republic who are looking to stand up blue carbon projects for coastal wetlands[xliv].

Green-grey projects also present similarly promising opportunities. Roughly half of NbS projects underway in Latin America fall within the green-grey category with the implementation of nature-based solutions alongside or incorporated with traditional infrastructure. One example is an urban drainage system in Mérida, Mexico that includes a bioswale – a vegetated channel that soaks in and filters stormwater runoff.[xlv]

To date, the carbon markets have not been significantly used as a funding vehicle for these types of projects even though infrastructure expenses are expected to skyrocket over the next decade. Projections show the region needs to invest between $179 – 313 billion annually to maintain and build new infrastructure to prepare for the impacts of climate change.[xlvi] Traditional grey infrastructure alone (e.g. dams, seawalls, pipes, water/sewage treatment facilities, etc) would not only make these projects more expensive but may fail to be resilient to climate change.

NbS can help, like natural shoreline stabilization in conjunction with levees and sea walls to buffer storm surges and greening urban areas and homes to cool cities from extreme heat. NbS components incorporated into these infrastructure projects could generate carbon credit revenue which can help finance these expenditures. In addition, the revenues from the existing compliance markets across Latin America could go towards greening infrastructure. This would set off a virtuous cycle of generating even more revenue from carbon markets, while also reducing costs on infrastructure construction and repair.

Predictive studies reveal impressive potential cost-effectiveness by implementing green-grey NbS solutions. For example, forested buffers near roadways at risk of landslides in Colombia would be 16 times more cost effective than repairing damages. Revegetation to reduce siltation in the Panama Canal would be five times more cost-effective than dredging and restoring forests around Rio de Janeiro, Brazil could avoid $79 million in water treatment costs over 30 years and reduce the use of chemical products by as much as 4 million tons.[xlvii]

Section III – Recommendations for Policy Makers

Recommendation #1: Infuse Natural Capital Accounting into Blue Carbon Projects

Blue carbon projects are relative newcomers to the carbon markets compared with land-based sequestration but are expected to have great potential moving forward. There has especially been interest in the tourism and marine transport sectors to purchase blue carbon offsets[xlviii] and Conservation international is planning to lead a global coalition on blue carbon with the Governments of France, Costa Rica, and Colombia, along with, non-profits, multilaterals, and financial institutions like AXA, Bank of America, Climate Asset Management, IUCN, the Voluntary Carbon Markets Integrity Initiative, IOC-Unesco, HSBC, and Verra.[xlix]

However, the international demand for blue carbon projects far outstrips the supply.[l] While Colombia’s Cispatá project has built confidence and demonstrated the value of blue carbon credits, it is one of only five projects launched under approved methodologies as of 2020 and that too with fairly small carbon reductions compared to other NbS projects as per Figure 6. In order for the pipeline of projects to grow, blue carbon credits need to both encompass a wider variety of ecosystems and be robustly verified with the full range of services they provide so the pricing mechanism accurately reflects their benefits.

Figure 6 – Source: McKinsey & Company, 2022

For example, mangroves have been the primary focus of blue carbon endeavors because they have some of the best scientific understanding of carbon flows and restoration techniques. Salt marshes and seagrasses, and even more emerging blue carbon stocks like kelp forests, seaweed farming, and bottom trawling[li], are relatively poorly understood, limiting their investment potential. [lii] Because investors are heavily dependent on reliable quantitative information, the broad range of services from various blue carbon systems needs to be quantified to achieve results-based monetization in carbon markets. Natural capital accounting could be a solution.

Natural capital accounting (NCA) refers to the use of accounting frameworks to measure the stocks and flows of natural capital which are the “renewable and non-renewable natural resources (e.g., plants, animals, air, water, soils, minerals) that combine to provide benefits to people.”[liii] These benefits include the ecosystem services defined in Section I. The premise of NCA is to recognize the assets that nature provides to the economy and to quantify it so that it can be integrated into frameworks like the System of National Accounts which helps define economic variables like GDP.

The System of Environmental-Economic Accounting (SEEA) is considered the international standard for natural capital accounting, adopted by the UN Statistical Commission in 2012, by bringing together “economic and environmental information in an internationally agreed set of standard concepts, definitions, classifications, accounting rules and tables to produce internationally comparable statistics.”[liv]

Their Ecosystem Accounting tool encompasses five accounts, as indicated in Figure 7: Ecosystem Extent, Ecosystem Condition, Ecosystem Services, and Monetary Ecosystem Asset[lv]. These five accounts collectively record the condition of ecosystem assets in terms of specific characteristics to measure overall health at different points of time, with examples[lvi] shown in Figure 8, as well as record the supply of ecosystem services and their consumption by economic units.

Australia leveraged the SEAA framework for a blue carbon bonds project in 2021 in partnership with The Nature Conservancy and HSBC. SEAA metrics were used to identify how NbS on the mid-north New South Wales coast would improve livelihoods, biodiversity and climate change mitigation outcomes, quantifying the economic and environmental contribution of marine ecosystems.[lvii] In the context of carbon markets, leveraging natural capital data can help put a premium price on a carbon credit by linking projects not just to tons of CO₂ but to broader ecosystem services making clear all the stakeholders that would benefit from restoration or protection. While SEEA focuses mostly on national level data, because its foundation is geospatial data it can be utilized to any spatial scale which is ideal for blue carbon projects whose scales can differ significantly.

Unfortunately, NCA is lacking in two-thirds of Latin American and Caribbean nations. According to the 2022 SEEA global assessment report, only ten Latin American and Caribbean have compiled at least one SEAA account in the past five years out of 33 nations in the region (Brazil, Colombia, Costa Rica, Dominican Republic, Ecuador, Guatemala, Mexico, Panama, Peru, and Uruguay)[lviii].

Of these, only half are regularly compiling and disseminating NCA data (Brazil, Colombia, Costa Rica, Ecuador, and Mexico). All remaining countries in the region should begin standing up SEAA accounts as mechanisms to incentivize voluntary carbon market investments in blue carbon projects. Those with compliance carbon pricing systems, like Chile and Argentina, would benefit enormously by incorporating NCA as an additional tool to more accurately price domestic carbon removal projects aimed at meeting emission requirements.

Recommendation #2: Regulate Carbon Disclosure of Green-Grey Infrastructure

Of the 156 NbS projects currently underway in Latin America, roughly half involve green-grey infrastructure projects with most reliant on grant funding and are actively seeking new sources of funding and investment. Carbon markets could present themselves as an attractive funding source for green-grey infrastructure. The key challenge is two-fold.[lix] The first being the ability of projects to generate a sufficient quantity of carbon credits that would justify the cost of certification.

The second is the ability of the project developers to be able to parse out the “green” components of the infrastructure from the “grey” parts to calculate how many metric tons of CO₂ are being avoided. Here, the traditional challenges with scaling up carbon markets present themselves like permanence (how long will the green infrastructure stay/sequester carbon), accuracy of measurement (can we determine exactly how much CO₂ is sequestered), and social safeguards (does this infrastructure project displace or harm local communities).

National and sub-national governments can play an important role in tackling these challenges. First, governments can condition grant-funding on reporting requirements detailing the CO₂ impact of the “green” part of the infrastructure. This can provide a stable, reliable source of data for corporates and other investors looking for high quality carbon credits. Second, there is a role for governments to play in providing sovereign guarantees to investors which help make NbS investments more financially viable.[lx] As part of these sovereign guarantees, governments can require project developers to enact social safeguards to ensure the projects aren’t disrupting indigenous populations or vulnerable groups. Third, cities and local municipalities can wield several tax and fee levers on NbS projects in ways that encourage verified data collection and maximizing the “greening” of infrastructure. Fourth, countries with established carbon pricing systems, like Chile, Mexico, Colombia, and Argentina, can require a portion of carbon tax revenue to go towards green-grey projects to reduce costs.

Infrastructure service providers are relatively new to the practice of constructing green-grey infrastructure. Building capacity within their teams to incorporate NbS into traditional infrastructure projects will be critical so that they eventually become routinized in the planning and design of new infrastructure. These firms could explore apprenticeship, fellowship, or rotational programs for academics and non-profit/NGO workers to bring subject matter expertise in conservation, ecology, and restoration to be at the table to maximize the potential of carbon sequestration and ecosystem services for any green-grey infrastructure project. Government policy can play are role here as well by requiring new infrastructure projects to incorporate green components. Peru and Colombia are two such examples, passing national policies requiring utilities to set aside specific funds to incorporate NbS into future projects.[lxi]

Lastly, development banks play an important role in the adoption of NbS practices. Institutions like the Caribbean Development Bank, Inter-American Development Bank, and World Bank have been pioneers in providing lending and technical assistance for bankable green-grey infrastructure projects. In Latin America, development banks are financing roughly 14% of all NbS efforts.[lxii] They can leverage their concessionary capital and project preparation support to ensure green-grey projects rigorously measure and maximize carbon sequestration potential to make them attractive to carbon markets.

Conclusion

With pressure on countries and corporations to meet their net zero goals the market for carbon credits could be worth upward of $50 billion in 2030. This paper explores how carbon markets could more effectively finance nature-based solutions in Latin America. Nature is critical for the functioning of the global economy and its degradation poses severe threats to our ability to combat climate change. By leveraging natural capital accounting and national regulation on infrastructure providers, Latin American countries have an opportunity to channel billions of dollars of resources towards nature-based solutions which restore and protect ecosystem services in the region. Two future areas of research would be unpacking how natural capital accounting systems could seamlessly integrate into carbon credit verification schemes and compiling verified metrics of CO₂ sequestration from completed green-grey infrastructure projects underway globally. Successfully implementing these policy tools can help overcome several legacy challenges in carbon markets ranging from accuracy of measurement, permanence, and scale of projects, ultimately unleashing billions in climate investment.

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[i] https://www.theguardian.com/commentisfree/2021/mar/03/climate-crisis-carbon-accounting-tricks-big-finance

[ii] https://zerotracker.net/insights/pr-net-zero-stocktake-2022

[iii] https://www.ieta.org/resources/Resources/Reports/Status-and-Trends-of-Compliance-and-Voluntary-Carbon-Markets-in-Latin-America.pdf

[iv] https://www.wri.org/insights/3-ways-scale-nature-based-solutions-latin-america-and-caribbean

[v] https://www.unep.org/resources/report/nature-based-solutions-opportunities-and-challenges-scaling

[vi] https://www.unep.org/resources/state-finance-nature

[vii] https://www.iif.com/Portals/1/Files/TSVCM_Report.pdf

[viii] https://www.mckinsey.com/capabilities/sustainability/our-insights/a-blueprint-for-scaling-voluntary-carbon-markets-to-meet-the-climate-challenge#/

[ix] https://www.wri.org/insights/corporate-financing-nature-based-solutions-what-next

[x] https://wwfint.awsassets.panda.org/downloads/wwf___beyond_carbon_credits_blueprint.pdf

[xi] https://wedocs.unep.org/bitstream/handle/20.500.11822/40783/nature_based_solutions.pdf?sequence=3&isAllowed=y