The importance of a good business case

Financing climate adaptation is essential to be able to implement climate adaptation strategies and measures. How to finance climate adaptation measures? How to create financial commitment? Creating a business case for climate adaptation is one of the key challenges European cities face in coping with climate change. As climate change is a systemic challenge, not only the consequences, but also the solutions can be found throughout the entire city stretching out over all its sectors. Hence, climate proofing cities requires a new way of long-term vision making, cross-siloed working, and systems thinking. Experiences in urban development projects have shown that such a systemic view does not fit the siloed and fixed way we have organised and incentivised the investments and cashflows in the urban contexts. Climate adaptation heavily challenges the way in which cashflows, investments and finance opportunities run through the urban environment. This holistic and embedded view on the financial aspects of climate adaptation is important. To consider the economic aspects early on in a project prevents actors from long-lasting processes. As adaptation to climate change is very often a technical and design challenge (dikes, water run-offs, buildings, critical infrastructure etc), working towards a viable business case often is the final piece of project. There is a significant chance that earlier designed measures and solutions do suddenly appear to be financially unfeasible.

Why is this a key challenge

Climate change is driving a paradigm shift towards zero carbon energy and mobility systems, climate adaptive cities and circular production chains. Local authorities have a unique role to play in these societal challenges as they – of all authorities – have the closest relationship with citizens, local stakeholders and businesses. At this city level, unlocking appropriate finance for climate adaptation measures has proven to be a challenging task. The outcomes of many sustainable district initiatives show that translating collaborative visions into bankable implementation measures often fails, due to institutional and stakeholder complexities.

Looking at the city as a complex system really challenges the fit between interconnected layers and networks on the one hand and siloed, domain oriented departments, plans, incentives, subsidies, investments and accountancy mechanisms on the other hand. Ubiquitous calls for innovative finance -, investment-, business and organisational models at district level should overcome this mismatch, however these innovative delivery mechanisms often lack proper anchoring in in-depth knowledge on the real complexity and interdependencies of the district system. In general one could say that climate adaptation in cities faces 8 challenges:

Challenge 1: Investment costs of climate adaptation measures are (simply) too high to bare Climate adaptation measures often concern large and expensive infrastructures, such as barriers and levees (please see also the RESIN Adaptation Option Library and OPPLA (nature based solutions) and Climate Adapt). Investments in such measures are significant. But also smaller investments, such as private water gardens and storage tanks may be expensive for individual home owners. The consequence is that such crucial measures are not taken and the resilience capacity of the city is not being improved.

Challenge 2: Pre-financing is not possible or too expensive due to risks and time As climate change measures are sometimes complex and involve many stakeholders, there are lots of (financial) risks involved, which increases interests rates and reduces feasibility. Moreover, the time from initial investment till first cashflows (benefits or cost reduction) is sometimes too long to get proper financing. In the field of climate adaptation the issue is not only that return on investment period is too long, but it is also concerning the uncertainty when a measure will pay back itself at all. In other words: when will a one in a hundred year flood event occur?

Challenge 3: Non-financial benefits are not being quantified and taken into account Part of the Societal Cost Benefit Analysis will be the non-financial benefits of climate adaptation measures. It is a complicated task to quantify these benefits and take them into account for an investment decision properly. There is more and more research being conducted on how to include a Social Return on Investment in an overall decision making process (see for instance Emerson, 20031)Emerson, J. (2003). The blended value proposition: Integrating social and financial returns. California management review, 45(4), 35-51.). These kind of ‘soft benefits’, although very relevant are often overlooked in a process where money is considered most relevant.

Challenge 4: Non-financial costs-investments are not being quantified and taken into account On the other hand are also on the costs side several elements not being taken into account that can help to make a business case more feasible. For instance, the unpaid labour home owners put in maintaining their gardens and public space, can help to increase feasibility and have other positive (health) effects as well.

Challenge 5: Split incentives in actors – investment actor doesn’t receive the (full) benefits Split incentives are a main concern in the urban development context. If additional investment costs for a particular actor lower costs for other actors, there is usually no incentive to really look for co-benefits. It is often considered too complex to exchange benefits.

Challenge 6: Split incentives in time – optimising the adaptation measure at point t does not stimulate to reduce costs at point t + x The classic split incentive problem is describing the fact that investors (for instance housing developers) do not benefit from costs reduction during the lifetime of the houses they build (for instance due to installing flood proofing on cellar doors, or solar panels with decreased energy bills). The consequence is that very often investors/developers do not look for opportunities to increase quality and add elements that help the users.

Challenge 7: Split incentives in space – optimising a particular investment does not stimulate to think about consequences for other areas. This challenge relates to the complex systems approach towards urban development. Urban development projects should be seen in close connection with each other. Investments in a particular area may move or even spread specific problems to other parts of the city. An holistic vision should be applied. It is, for example, the house owners uphill, who need to implement adaptation measures, to prevent flooding of the cellars of the homes downhill.

Challenge 8: Significant path dependencies created by current infrastructures and sunk costs As climate adaptation measures often concern infrastructures (also critical networks) an asset approach is necessary. The book value of these assets is often still too high to make adjustments or replacing economically feasible.

How to develop a business case

Investments in the urban environment are targeted at specific challenges and problems. Properly tackling these challenges well-legitimises the investments. The concepts of ‘future values’ and co-benefits are crucial here. They challenge the unidimensional view on urban investments. Each investment decision can either create path dependencies (and thus create lock-ins) or can be shaped in such a way that it triggers other investments.  Investments from a specific domain can evoke other investments from the same or other domains. If well-orchestrated these spin-offs can all lead to solutions directed towards the same goal, or can at least be directed in such a way that they do not create lock-ins. This approach is based on the definition of strategic, encompassing goals, such as inclusiveness and resilience. Investments from each domain can be assessed on their contribution to this higher goal and can each contribute their piece of the puzzle. Thinking in terms of co-benefits leads to multiple value creation. A single investment or project (if well-designed) not only solves a specific policy (or urban) problem but also creates value for other actors, areas, domains. This concept of multiple values, or co-benefits2)C40. (2016) Co-benefits of urban climate action: A framework for cities. Economics of Green Cities Programme, LSE Cities, London School of Economics and Political Science, is popular for two reasons:

  • It legitimises specific investments, because of the multiple added value (which is of course a win-win situation)
  • Because a single investment creates multiple benefits it creates the opportunity for those sectors and actors that actually co-benefit, to bare a part of the investment costs and/or help to optimise the design or investment.

Within RESIN an process approach towards co-benefits was developed.

urban-financial-metabolism-dashboard

The steps on the upper row of the dashboard relate to the qualitative steps in the process in which collaboration with relevant stakeholder is sought and cities secure that the right processes are in place. In particular the steps at the bottom row of the dashboard refer to the actual financial part of the climate adaptation process and the search to bundle cashflows and optimise the added value of implementation measures. Especially the step ‘determine main cashflows and their characteristics’ is being worked out at this moment in the Climate KIC project Urban Financial Metabolism.3)This project is currently under development by TNO, the city of Zwolle and the Radboud University. The first results are expected at the end of 2018. There is lots of attention for innovative business models, and new strategies to create multiple values (see for instance Sustainable Finance Lab and Neighbourhood Economics initiatives) and improve bankability of climate adaptation measures. Three main strategies are presented below: financial engineering, project finance and land value capture. These strategies are underlying principles of the  Bart tool and Optioneering Methodology, that were collaboratively applied by Arcadis and TNO in Greater Manchester (Bolton), Genth and Nijmegen within the RESIN project.

Financial engineering

In approaching funding some basic principles are best followed as these will then ensure that market accepted tools and approaches are used. All funding solutions are seeking to bridge the gap between the receipt of income (in whatever form e.g. land values, user fees, insurance savings, economic growth) and the need to commit capital spend and commence asset maintenance. The greater the uncertainty as to time and the final amount of those future receipts will determine whether the public sector (who may have more control or influence over those receipts) or the private sector should take those risk and price it into their required returns. The transparent dialogue between the public and private sector will help close the perception of risk and better allow a joint understanding of the price being attributed to it. Well based research and data (evidenced through tools such as the BART) will also be essential in informing this risk dialogue.

The following guidelines are important:

  • Development of a Business Case to attract Government funding: Using techniques such as policy led multi criteria analysis (PLMCA), which will balance pure financial outputs with other key policy objectives and facilitate contribution
  • Widen the Business Case: This may solicit more policy beneficiaries and funding
  • Private Sector Funding: Two key parallel work steams then need to be undertaken that seek to secure effectively private sector funding contributions.

Project Finance

To use private finance involves typically the use of a ‘project finance approach or the ring-fencing of ‘cash flows’; capex (invesment costs) and opex (maintenance costs) and an ‘income’ (in terms of financial and non-financial benefits). This way the climate adaptation measures really is seen as a business case in terms of a solution that has both costs and benefits. Ideally there will be minimal interfaces with other asset cash flows and minimal interdependencies with other parties, to minimise risk and complexity for private partners. Such private project finance can be attracted by a Public Private Partnership collaboration that is developing adaptation measures. However, an alternative approach to private finance models can emerge where assets (adaptation measures) with attached income streams (such as rent, availability fees, contributions) are initially developed by the public sector are then ‘sold’ to private sector (for specified period) such as HS1 in the UK.

Land Value Capture

Very often (climate adaptation, or other infrastructure) investments in the urban domain have a postive impact on the land and real estate value. With or without a project finance approach the investors and finance partners can look to capture this value increase (either directly or via increased real estate tax incomes) and use this as a ‘cross subsidy’ to infrastructure projects.

Various mechanism are available ranging from:4)Gielen, D. M., & Tasan-Kok, T. (2010). Flexibility in Planning and the Consequences for Public-value Capturing in UK, Spain and the Netherlands. European Planning Studies, 18(7), 1097-1131.5)der Krabben, E. V., & Needham, B. (2008). Land readjustment for value capturing: a new planning tool for urban redevelopment. Town Planning Review, 79(6), 651-672.

  • a ‘statutory’ contribution/collection basis from other landowner/developer activity
  • selling or leasing (with ground rents) public land when the planning benefit has been secured to
  • a more proactive model where a private public partnership may become the Master Developer who undertakes;
    • master planning, land assembly, place making and infrastructure roll out in order to maximise the value of land to then be sold (in varying lot sizes) at optimal value and timing to the market.
    • land can be pooled between public and private sector owners to facilitate greater scale, strategic thinking and possibly greater contribution to infrastructure needs.

Most encountered in

It is wise to start considering the economic dimensen of climate adaption when determining the adaptation approaches and in prioritising the adaptation options.

Footnotes   [ + ]

1. Emerson, J. (2003). The blended value proposition: Integrating social and financial returns. California management review, 45(4), 35-51.
2. C40. (2016) Co-benefits of urban climate action: A framework for cities. Economics of Green Cities Programme, LSE Cities, London School of Economics and Political Science
3. This project is currently under development by TNO, the city of Zwolle and the Radboud University. The first results are expected at the end of 2018.
4. Gielen, D. M., & Tasan-Kok, T. (2010). Flexibility in Planning and the Consequences for Public-value Capturing in UK, Spain and the Netherlands. European Planning Studies, 18(7), 1097-1131.
5. der Krabben, E. V., & Needham, B. (2008). Land readjustment for value capturing: a new planning tool for urban redevelopment. Town Planning Review, 79(6), 651-672.