Blue finance: Fishing for a sustainable solution
Private-sector investors are taking their first tentative steps into sustainable fisheries projects. Alignment of interests and investment returns look good on paper, but there are many practical issues that need to be addressed before radical transformation can occur.
First the good news: of all the environmental challenges facing the world, recovering depleted, over-harvested fishing stocks is perhaps the quickest and most commercially viable to fix.
We should probably throw in the caveat of ‘potentially’ at this point, because, despite the high levels of confidence there are still challenges and financing gaps, and some of the science and the recovery timelines are untested.
But those who have been working on the science and the investment possibilities share this optimism.
“The thing I love working on with fish is that it is probably the most solvable environmental challenge of our time,” says Tim Fitzgerald, director of impact at the Environmental Defense Fund’s (EDF) Oceans Programme. “When you get all the pieces right, the recovery is amazingly fast. We know from our experience in lots of parts of the world that, when you get it right, most fisheries have a turnaround of less than 10 years. And in some cases that can be two, three or four. And that is [an amount of] time that most private investors would like to see.”
Encourage Capital is one of the first investment firms to enter the sustainable fisheries sector. Jason Scott, co-managing partner at Encourage Capital, says his company initially got involved through a research project about the potential for impact investments in sustainable fisheries. He says that after two years of looking carefully into it, two things stood out.
“The first thing that was that from a conventional private-equity basis, there is a lot of opportunity to make profitable equity investment in companies,” he says. “And from a traditional impact investing perspective, there is an opportunity to drive some of these fisheries in a way that protects the environment and has some meaningful social impact.”
The business plan is straightforward. Investment in degraded fisheries is front loaded to fund a reduction in fishing to allow the recovery of the fish stocks. Capacity is cut either by taking vessels out of waters or by reducing fishing times and quotas and tightening size limits. Then the fish stocks recover and the science comes in to calculate the ‘maximum sustainable yield’ of the fisheries.
A report from the Proceedings of the National Academy of the Sciences in 2016 estimates that if the world’s fisheries were being managed to enable maximum sustainable yields, the oceans (combining both deep-sea and coastal fisheries) would produce an additional 16 million tonnes of seafood a year, increasing revenues by $50 billion annually (that is, after that 10-year recovery period).
And that is at current prices. There are some examples that show that some markets pay a premium for fish that can be certified and labelled as ‘sustainable’, meaning that revenues would rise even higher. This, however, is controversial among some involved in the industry, who fear that creating new premium-paying export markets for fish that are now being exclusively consumed locally could have negative social impacts.
Another feature of the industry is scale: estimates of the cost of rebuilding the world’s fisheries hover around $200 billion. But with commercially attractive returns on offer, it should just be a matter of alignment.
“If you can fish better – using size and catch limits – then that helps the fisheries grow at the maximum sustainable yield, which optimizes the rate of return you can make in the upfront investment,” says Scott.
“By restoring the fish stock, you can increase volumes, which increases revenues. And if you are able to certify that the fish is caught sustainably, you can sell the fish more and you create more value for everybody in the supply chain [and not just the private sector because] this makes more money for everybody in the ecosystem. There is more tax revenue for governments. You have more money for science.”
But here the run of good news begins to hit some bumps.
Private investment is really only possible under the right conditions: there need to be ‘investible opportunities’ – a catch-all term that spans a range of practical problems from the identification and demarcation of private-sector fisherman or fisheries, to whether or not the individual country’s regulatory system is fit for purpose and, even it if is, whether or not those regulators are able to monitor and enforce sustainable fishing practices.
Many of these fisheries are in the emerging markets and have sub-optimal regulation to incentivize and encourage sustainable fishing practices. At the moment, many countries are effectively on the ‘no-go’ list when it comes to enabling private-sector initiatives.
Take Brazil, for example, from where Euromoney researched this story. While the rest of Latin America – notably Chile and Mexico – are drawing in private-sector funds to turn around their country’s fishing stocks, the Brazilian authorities’ lack of attention and investment leads Scott to diplomatically describe the country as “still with a little work to do” before it can become a potential venue for investment.
The need to create a regulatory framework that allows such private-sector innovation to flourish is not easy anywhere, let alone in emerging markets. The evolution of governance models usually has large costs that exceed existing budgets and, with public resources always tight, the lack of regulatory development can create financing gaps that prevent the flow of capital from the private sector.
This financing gap is being addressed through a variety of means, using philanthropic funds and other sources, as well as leveraging the scalability of the science that has been developed so far and lowering costs through technological innovation.
EDF’s Fitzgerald calls this a blended capital approach.
“The public sector – whether that’s the government or other sources of development finance – is responsible for the improvement in the necessary elements for sustainable fishing, such as the science and the management [of new regulatory regimes],” he says. “And then, at some point, when some level of sustainability has been reached, private capital feels comfortable enough to come in and invest in the value chain and other things. The transition from A to Z takes time. We hope to see that through a better coordinated approach to blending capital we can align different sorts of finance so that the transition can happen more quickly.”
|Tim Fitzgerald, EDF
Fitzgerald highlights that it is not just a case of public finance creating the conditions to allow private capital to flow. In many cases it has been important to use the early private-sector case studies to show public authorities the potential for private-sector investment if robust regulatory systems are created.
National and local governments are much more interested and willing to engage with NGOs in discussions about creating standards that achieve ‘sustainability’ if they can see the direct and financial benefit to communities from this work. And these case studies can show that sustainably managed fisheries can over time increase total yields, tax revenues and private-sector income.
The Meloy Fund goes a step further. Its projects not only work to develop the financial outcome of the fisheries themselves but also stress the other societal and community benefits. It is wholly owned by Rare, a global conservation organization
Manuel Bueno, fund director at Meloy, tells Euromoney that sustainability of fisheries should be seen within the “wider environmental challenge [such as] coral reefs, sea grass and the broader coastal fisheries ecosystem.”
Bueno points out that while 50% of all fishing catches come from coastal fisheries (with the other half deep-sea, industrial fishing) these fisheries generate “around 99% of all the jobs. You have collapsing stocks and millions of people whose livelihoods depend on coastal fisheries, with the destruction of the broader fisheries ecosystem. When you talk about mangroves, protection against extreme weather events… you are really talking about a broader ecosystem and essentially millions of people’s livelihoods under threat. Many communities know they are running out of fish. Often when we go to these communities, they are resigned to that: ‘What can I do?’”
Sometimes the investment opportunity is in the fisheries supply chain and not necessarily the fishery itself. For example, investment in cold storage and production facilities can improve the efficiency of local operations and the value of sold products. Impact investments in such horizontal assets can be effective. However, whatever the strategy, community-wide engagement to optimize such investments is often crucial.
“We create a broader supporting network that involves the public sector, the municipality, sometimes universities, sometimes non-fisheries stakeholders that want to engage in managing the fisheries properly,” says Bueno. “And a key challenge here is making sure that there is enforcement: how do you enforce these rules if the government doesn’t have the money to cover that area?”
There are ways that market-based investments can accelerate better governance and management, and there are ways that those investments can accelerate more negative behaviour - Jason Scott, Encourage Capital
Technology is beginning to work to lower these regulatory enforcement costs. In California, for example, the authorities stepped in to address crashing fish stocks – such as black cod, which was close to collapse in 2000. Quotas were assigned to individual fishermen and they had to adhere to strict catch-size limits to prevent the fishing of juvenile fish.
New monitoring rules were part of the new regulatory system; independent monitors now accompany every fishing vessel to ensure they comply with the fishing rules. Clearly this is expensive. So new technological systems are being developed that will enable authorities to be satisfied that fishermen are maintaining compliance standards without the need for physical assessment. This also helps eliminate the costs associated with cancelled fishing trips that occur when the independent monitors fail to show up.
Such technological developments will be critical in emerging markets, where other traditional supervision and enforcement methods are costly and often impractical.
Meanwhile, the Meloy fund emphasizes more community-based monitoring. Whatever the solution, it has to be effective otherwise fishermen face a type of prisoners’ dilemma: if the other parties cannot be trusted, then acting correctly risks losing out.
“Once you start engaging these businesses, many of them want to behave in a sustainable way,” says Bueno. “But they say: ‘I don’t want to be the sucker who sacrifices for someone else to take advantage of me.’”
This issue is often called ‘leakage’. It is the reason why, for example, Encourage has not engaged in stand-alone projects in countries that do not have sufficiently rigorous fishing regulations.
“These principles help us determine in an objective way if it’s OK to intervene in the fisheries, because you want to encourage the government or the other actors before you start putting private capital to work,” says Scott. “In some ways, private capital is rewarding the government and the local communities for good governance and following the rules.”
Without this good governance in place, flows of private capital can do more harm than good by being a lever that creates further exploitation of the fisheries.
“There are ways that market-based investments can accelerate better governance and management, and there are ways that those investments can accelerate more negative behaviour,” says Scott. “It depends how the investments are done and how they are managed. The challenge with something like seafood is that there really is no way to invest responsibly if there isn’t a proper legal scientific framework that has been agreed. The regulatory and governance issues can determine when the time is right to invest in fisheries: when your dollars make a difference and when your dollars accelerate further destruction of a fishery.”
This is because private finance signals potential profits to everyone – not just the public sector. And so even if a sustainable project is undertaken and follows all the emerging scientific rules on catch sizes and limits for fish restoration, there is the chance that it could lead to a non-sustainable project just down the coast.
This 'leakage' is something Phoebe Higgins, director of EDF’s California Fisheries Fund, a subsidiary of the EDF, grapples with.
Higgins works with private investment funds such as Althelia that are interested in full-scale transitions of fisheries from depleted fishing stocks to certification of best sustainable practices.
EDF works across 12 fisheries geographies to provide the science for fisheries’ management and sustainable optimization, as well as advocating for policy change and designing fishery systems that create market-based incentives for good behaviour.
Higgins says eight investment institutions have now adopted EDF’s principles for sustainable fisheries.
“Leakage is a big concern everywhere,” says Higgins, who gives the example of Chilean hake fisheries that are structured in multiple cooperatives along the country’s coastline.
“One of the issues is there is a fair amount of illegal fishing, even by participants in the sustainable regulatory system,” she says. “Some over-harvest and don’t report, and they are catching very small, juvenile fish.”
Leakage is less of an issue when nationwide rules and enforcement are put into place, Higgins says. In Belize, the government has implemented new sustainability-driven regulations regarding lobster fishing. However, while some investors need to see tough sustainability regulations in place before committing capital, Higgins thinks that there is value in private-sector projects in places before the evolution of local rules.
In the absence of regulation, “you could do an investment project that is going to move the needle – maybe a pilot project to encourage better management,” she says. “That is something that happens a lot in the US. We have exempted fishing projects to test all kinds of things to demonstrate to fisheries managers and regulators how a new approach would work.”
Higgins says these pilots are complex given the multiple stakeholders involved.
“I feel we start with the low hanging fruit,” she says. “You need people to be engaged and part of the collaborative effort, and sometimes therefore you are already with the best actors to get these things off the ground. But sometimes just demonstrating that new management techniques work well is a good way to bring around those engaging in non-sustainable fishing.”
Higgins sees the entrance of private capital through institutions such as Althelia, Encourage and Meloy as a hugely positive signal that private capital will flow into this emerging industry. (For their part, investors point to the growing interest from banks as a positive signal for them: Credit Suisse, for example, hired a risk analyst to work on a fisheries risk model as the prelude to working in sustainable fisheries finance.)
“The fact that these funds exist is a huge benefit – they can probably see the missing pieces the best,” says Higgins.
And those investors are bullish, despite the broader challenges that accompany emerging industries. When Scott began researching the area his first question was: are these investments big enough?
“And you know, it’s a massive industry,” he says, answering his own question. “It’s a half-trillion dollar market from an export perspective from Latin America and domestic consumption perspective in the US and Europe.”
The potential is so good that he implies a threat from the entrance of traditional private equity should countries drag their feet on sustainability regulation.
Scott says there are many companies that have the characteristics that traditional private equity looks for.
“There are lots of companies that have $20 million to $50 million in revenues – some up to $100 million – and they are growing at a reasonable rate, so I think it’s pretty easy to find enough supply for deal flow. But if you define it as sustainability projects, then it becomes a tiny, tiny market.”
However, private equity firms analyzing fisheries opportunities would likely see the value in applying sustainable practices in their investments (as it is the best way to maximize fishing yield and optimize revenues over time) and the benefits from operating in countries that try to minimize the leakage impact.
“Projected returns are easy,” Scott says. “It’s straightforward to demonstrate the potential for PE style returns. Actual returns are always an issue.
“The mainstream PE firms haven’t jumped in yet,” says Scott, but he “would see that as an opportunity to partner with local PE firms or mainstream PE firms in the US who have an interest in the same type of risk/return profile as Encourage.”
Encourage's model is equity based. The projected returns should be sufficient to attract equity investors as the industry develops. There is more of a question about the applicability of ‘blue bonds’, which are essentially green bonds whose funds are channelled to marine projects.
In theory, blue bonds hold potential for fisheries finance. The lower expected returns and the bigger scale coming from tapping institutional debt investors could be powerful. In practice there has been little activity save for one $20 million bond in the Seychelles, which is being watched with interest.
Some debt financers contacted by Euromoney doubt that the Seychelles bond holds much direct replicability given its unique circumstances and small scale, but they do say there is a lot of talk about blue bonds and that it has the potential to engage a large, liquid investor base if the size can reach around $50 million to $100 million – and ideally larger. They also note that fisheries may not be the underlying asset for the first blue bonds – perhaps other ‘blue’ sectors may lead the way, or perhaps there could be a portfolio approach with a blend of ocean-related investments.
Scott is wary. He implies that green bonds have over-promised on their level of impact in environmental terms: “Like Toyota building a Prius factory! That’s great but not really going to have the impact that we want to see on the ground.”
However, he says there is opportunity for blue bonds in fisheries finance: “We are hoping that the market discovers the right mix between large and not impactful and small and impactful.”
Fitzgerald agrees that care needs to be taken to ensure any blue bonds deliver financing that effects actual change with regards to sustainability.
“We don’t want people to write off the idea as ‘blue-washing’ before it has had its time in the sun,” he says. “In terms of many issues, such as certification, the fish industry is 10 or 15 years behind the green industries of agriculture, forestry and renewable energy. But I have no doubt that sustainable finance and blue bonds will follow the same trajectory”.
That makes sustainable fishing both an exciting and a frustrating industry.
“We can say we were there in the early days and we are at a really good point to demystify fisheries for a whole range of investors,” says Fitzgerald. “If we can standardize what it means to invest sustainably in fisheries, then that 10-year recovery timeline is actually attainable and that’s really exciting.
“But we also know that we have a couple of years ahead of pounding our heads against the wall while we figure things out from scratch.”