Bridging the Impact Investment Gap: Infrastructuring Tomorrow.
By: Dark Matter
Tags: Fintech, Finance, Government, Cities, Infrastructure

Financing the Transition — Blog1.

This is the first of a series of blogs on financing the transformations that our societies need. It is part of our project ‘Re-coding for a civic capital economy’, co-financed by EIT Climate-KIC, and also builds on ideas developed through the EmergenE Room programme with McConnell Foundation, our work with Viable Cities, and the EIT Climate-KIC supported Long Term Alliance.

Introduction

Our generation is facing an unprecedented long emergency — from climate crisis to economic hardships to health emergencies to social injustice — all further exposed and deepened by the ongoing Covid-19 pandemic. Governments around the world are increasingly aware that the scale of the present calamity requires radical capital, policy, and infrastructural solutions beyond our existing capabilities. The impact of these investment decisions will be felt for generations to come, with all the resulting implications both now and in the future. These intergenerational investments will need to address the needs of societies as a whole, carrying with them an array of accountabilities. To borrow from the future is both to assume responsibility and to operate with a duty of care for tomorrow.

In response, we have seen the development of Green New Deals around the world. Linked in part to recovery from the Covid-19 pandemic and in part to a post-carbon economy, the European Union is targeting initial investment of 646 billion euros to be matched by national governments. It is undoubtedly necessary, given the current state of the world, that investment does not follow the traditional disaster capital route of concentrating wealth. Instead we need to ensure a just and equitable transition to a net-zero carbon economy, advancing not just community benefit but also community wealth in all its forms.

This future is being cast in a moment where we face an accelerating deficit resulting from Covid-related spending in 2020. Governments are equally under pressure to implement rapid solutions intended to jump-start the real economy. This drives the policy landscape, with decisions about recovery funds tending to be based on the rear-view mirror rather than on what lies ahead. Competing incentives for cities and local stakeholders are seeded, with an emphasis on job creation and the repetition of historical approaches. This is at the expense of the innovation required to enable the next generation of solutions.

It has often been stated that societies, civilisations and cities live or die by the infrastructure they build. Many of the current infrastructures across our cities and wider society are no longer fit for purpose. In some cases, they are on the brink of collapse. Furthermore, we are at risk of building the wrong infrastructures for the civilisation of the 21st and 22nd centuries. What are the social, ecological, cultural, economic, physical, and institutional infrastructures that are necessary for this new age of long emergencies?

Over the past twelve months, Dark Matter Labs has been working on this challenge with various stakeholders throughout Europe, including Viable Cities, Scottish National Investment Bank, NatureScot, and other parts of the Scottish government, the EIT Climate-KIC Healthy Clean Cities programme, as well as with partners through The Long Alliance.

This work has made it apparent that the dimensional context and the scale of investments required for initiatives such as the Green New Deal are at an order of magnitude our societies and institutions have not yet grasped. We don’t yet have the tools, frameworks, and mechanisms necessary to bridge the capabilities, capacity, and capital gaps, enabling us to address this transition. We need to ‘re-code’ capital to enable the transformations we need.

In this series of blogs, we seek to articulate an urgent need for bridging the gap between the capital clearly aggregated at a macro scale and the investment needed for implementation of transition infrastructures on the ground.

The first blog outlines the five key intervention areas that present unique opportunities for macro capital to address directly the health, climate, economic, and social crises of our time. By understanding the interventions’ core underlying features we are then able to lay out ten strategic recommendations. All of them are linked together by new, or ‘re-coded’, forms of contractual and governance infrastructure for capital. These, in turn, can help foster net-zero, wealthier, and more resilient communities, with the robust social infrastructure necessary to address this new age of long emergencies.

Pathways Forward

What has emerged over the course of our work are five key areas of societal-scale transition infrastructures:

Nature-based assets. These include trees, wetlands, and pools of biodiversity. This future is being demonstrated by work across European cities, from Milan to Vienna and from Glasgow to Madrid, where municipalities are looking for whole-population-scale nature-based solutions. Examples include the planting of millions of street trees and the transformation of canopy cover across a city through the creation of a ring of urban forests. These solutions and future asset classes have some of the highest potential for capturable spillover values, whether that relates to the ‘heat island’ reduction effects of tree canopies, improvements to water drainage systems, or an array of health benefits such as the reduction of asthma rates in children. The need and value of these city-scale interventions are obvious but the viable operational, contractual, and governance means to execute and capitalise this vision are in urgent need of development. For more details, see some of our work at https://treesasinfrastructure.com. Deep retrofitting of our cities. Many municipalities, including Malmö, Sweden, and Sofia, Bulgaria, have announced radical missions to retrofit what amounts to millions of homes across Europe by 2030. Some are exploring pathways for the physical retrofit of their entire cities. Increasingly, our work shows the need to move beyond house-by-house energy retrofits to whole-street and whole-district approaches and whole-city investment cases and business models. This needs to be integrated with parallel vertical-supply-chain innovation and collective strategic procurement across utilities, insurers, governments, and landowners. In these societal-scale aggregative models, the deployment of capital needs to be directly linked to the spillover value of a street-wide or district-wide retrofit strategy, with new mechanisms that allow for the capture of both direct and indirect benefits. By establishing community wealth models at the heart of this approach, we emphasise community-driven outcomes as a key de-risking factor for what is inevitably disruptive work in neighbourhoods.

This approach generates returns on a longitudinal and macro-investment scale, which may not always be captured through more traditional project measures such as internal rates of return (IRR). This is because the spillover effects go far beyond the direct energy savings or even the indirect health implications. They affect a city’s unemployment rates, the local velocity of spending, community wealth and GDP, and drive direct positive benefits with direct as well as more indirect beneficiaries. The contractual integration of this whole value case is vital to creating a sustainable financial proposition, and the community/street-driven transition is the key to growing distributed community wealth, moving us away from the disaster capital concentration of resources, innovation, and new monopolies.

Again, the need and value of city-scale and societal-scale intervention is clear. It enables enormous savings in yearly carbon emissions from existing residential properties — one of the key emissions sources in our cities. Yet, our capacity to institutionally structure and organise the spillover values inherent in these societally entangled interventions is still missing. Without this capacity, residential retrofits will continue to be perceived, wrongly, as unpopular, capital-intensive, revenue-ineffective, and subsidy-dependent interventions, even if they are the only genuinely smart option. Social infrastructures. The social and civic fabric in our cities has suffered significant and chronic under-investement. While new financing commitments are announced regularly, the fundamental challenge lies in the funding side of the business case, specifically targeting mechanisms to recognise and capture spillover values. A good example of a strategic social infrastructure investment is the $7-a-day universal childcare scheme in Quebec, Canada. The programme started in 1997, and over a period of twenty years led to a tripling of the number of mothers with children under the age of five who participate in the Quebec workforce. The impact has been particularly significant for middle-to-low-income women. The resulting economic benefits are vast: $5-billion added to Quebec’s GDP and a 64% reduction in the number households who received social assistance. The spillover effects over the past twenty years of every parent being in a position to choose when or whether they return to work has spread well beyond tax dollars and touched on almost every aspect of Quebec’s society. Empowered women make decisions on what level and quality of schooling their children receive, what local businesses they support, where they invest their education and retirement funds, and what types of communities they want to live in. Strategically investing in public childcare, supporting minority women and first-time immigrants by guaranteeing them a basic universal income, are all examples of social infrastructures that produce returns beyond IRR. Our ability to finance such civic goods is critical for any meaningful transition. New, large-scale, urban developments. Even as the pandemic is undoubtedly impacting on cities’ fundamental economic and residential geography, many cities are (re)developing land for growth and economic adaptation. In this new age, large-scale developments cannot be justified by land value alone. Increasingly, they also need to be structured via a systems value lens — which is critical if they are to be sustainable, including both net-zero carbon in operational terms and from an embodied carbon perspective. As illustrated by our collaboration with the City of Edinburgh (and, more specifically, Granton’s Sustainability and Strategy initiative), they need to reconfigure a city’s housing offer, making it fit for a post-carbon, post-Covid economy. In addition, these developments need to be viewed in the context of how they can drive whole-value-chain innovations, how they support the seeding of new circular material and maintenance economies, and how they support the regeneration and adaptation of adjacent settlements. Equally important is how they can create the new regulatory innovations necessary to drive the wider transition of the city, and how they drive alternative tenures to rent and ownership, with an emphasis on the value of neighbourhoods rather than houses. Large-scale projects need to account for, drive, and value these system impacts if they are to manifest the societal outcomes necessary to support transition, and to justify the real estate sector’s social licence to operate in this age of long emergencies. Agricultural land and our food systems as a whole. Our soil holds the key to both our health, as a source of food, and to carbon sequestration and restoring biodiversity. Any meaningful transition will require us to reconfigure our food and nutrition systems toward regenerative practices. At present, it is more expensive to purchase an organically grown local apple than one cultivated far away, on an industrial scale using environmentally harmful pesticides and chemicals. The latter also accumulates largely underpriced water waste and associated carbon emissions during its transportation to market. A systemic shift in the economy of land and agriculture is vital for the transition. It involves the redesign of incentives, repricing of externalities, the valuing of soil quality maintenance and regeneration, and the inclusion of carbon sequestration potential into the value of land. The system value of the asset is strategically understood, and the case, evidence, and values are increasingly validated. But we now need to build the funding, financing, contractual, and governance structures to manifest this fundamental value.

In order to address the key challenges and asset classes of the future, we recognise there is an urgent need both to organise capital in an unprecedented manner and to re-code capital in contractual and governance terms — amongst other things, to enable the equitable and effective collaboration of public and ‘private’ capital. We believe that this re-coding of capital is fundamental to unlocking these near-now asset classes in order to generate their future values.

Re-Coding Capital

In order to manifest these near-now asset classes, three structural innovations are necessary.

Long Financing: New investment instruments for the long-term allocation of capital

Assets operating and functioning like infrastructure require both long-term vision and long-term allocation of capital. Building the capacity to finance a growing list of long-term transformational infrastructures will be a vital component of transition capital provision. This is hard to achieve within the constraints of short-term budgets and the need for rapid recycling of capital. How could we aim to reconfigure our cities and our communities for seven generations to come, if the nature of underlying investment remains locked to a period of eight-to-ten years?

For example, the idea of Smart Perpetual Bonds allows us to update an old financial instrument so that it meets the societal needs of the 21st century in a complex changing world. They:

Replace the need for repayment of capital with the in-perpetuity offer of fixed income.

Create the capacity for the contingent pricing of value based on preconfigured variables with minimum transactional overheads.

Offer radical, real-time transparency in the factoring and distribution of value providing smart provenance for investment.

Offer the option for the fractional trading of smart coupons on digital secondary markets, enabling the return of capital and income.

By implication, Smart Perpetual Bonds create pathways for financing a new class of assets that yield value across the long term.

Analogue versions of these methods have long been in existence, and their digital transformation is well underway. Raising capital using digital solutions ensures additional protection against arbitraged appreciation and fixes the true value of underlying investment rather than the cumulative effect of trading opportunities and excessive servicing costs.

There is another benefit. The next generation of value-conscious investors are seeking long-wealth opportunities that both ensure a viable fixed return and lead to radical societal transformation. Private banks entrusted with managing their wealth are in search of solutions. Structuring a portfolio of long-financing instruments, with Smart Perpetual Bonds being one of them, will transition vast amounts of progressive wealth towards the solutions that our communities require.

Through The Long Alliance, we will further develop the Smart Perpetual Bond as well as exploring other methods to channel long-term capital towards ‘long assets’, which are designed to provide returns far beyond our own lifetime.

New Public Governance Models: Off public balance sheets yet for public interest

Societal-scale interventions and whole-city transition infrastructures require new models of governance and organisation, which are fundamentally wired to acknowledge the societal entanglement of value. This involves building new institutional structures, which need to be:

Systemically machine-readable. Off public balance sheets yet publicly accountable. Smart civic asset managers, which transparently balance the flows of value and interactions across an ecosystem of stakeholders with evolving incentives.

These civic-development institutions are crucial mechanisms for contracting system value flows and the adjacent many-to-many spillovers. They represent the necessary progression of Public Private Partnerships (PPP), acknowledging our complex reality while limiting rent-seeking incentives that are traditionally structured into investment propositions.

These institutions would bridge the gap in terms of:

Originating new approaches to financing. Structuring and contracting the uplift value of these infrastructure investments. Investing in the development of many micro community-driven assets — such as a network of urban forests — for generating collective outcomes. Pooling and balancing flows of value across the system.

Such civic-development vehicles will disrupt the existing dynamics of public/private relationships and prevent the use of rent-seeking mechanisms that are currently layered in every investment opportunity.

Innovating Funding: New mechanisms for contracting value flow

The challenge of financing this near-now transformation asset class is not the development of new funds in itself, but rather the structuring and contracting for spillover value in order to service the capital. This requires new ways and means of commingling the distributions of value and liabilities, generated and mitigated by these novel societal infrastructures.

This has all been made possible by developments in the application of smart contracts and distributed ledger technologies. Smart contracts give us the capacity to construct whole new sets of value flows and currencies. They allow and enable radically transparent, open, contingent, micro flows of value between stakeholders, facilitating an automated and almost frictionless means to transact, pool, aggregate, and couple across the ambient, micro, and known distributions of value and their spillovers, which, to date, were unaccountable and untradable.

While this future offers radical possibility, it also requires new digital institutional infrastructure, such as digital public registries for land. The provision of this public infrastructure is vital for unlocking this future and for creating next-generation investment markets for Civic Infrastructure Assets.

Ten Initial Recommendations

Making this future manifest in the near term requires tangible action now. A series of critical issues need to be addressed together if we are to make the necessary transition. For example, how Green New Deals and recovery investments concerning the effects of the Covid-19 pandemic are structured over the next two quarters are essential to the direction we will take. While we continue to engage in research and development across several projects and with stakeholders from all sectors, the following initial recommendations are targeted in particular at governments (national and municipal) and strategic investment decision-makers. They form a six-month roadmap to create the necessary scaffolding that will enable a just transition to a post-carbon, post-Covid economy.

Novel types of infrastructure. It is vital that we broaden, at a policy level, the definitional scope of infrastructure beyond roads, public transport and energy, to include both civic and nature-based assets. We need to recognise the vital role novel infrastructure will play in the transition our cities and places face. This reclassification of infrastructure also needs to acknowledge the role tangible and intangible assets play in the functioning of our cities. While cities accept that these assets need substantial investment to enable net-zero transition, they are burdened by legacy financing and accounting mechanisms, as well as by the practical inability to capture value; both issues prevent them from making this intuitive leap. Impact investing. Social finance has paved the way for analysing a portfolio of returns rather than simply targeting a financial KPI. Now is the time to embed and advance these understandings and our initial outcomes-based finance strategies, developing a new investment thesis for transition infrastructures with a whole portfolio of impacts that can be captured in contracts. This will allow cities to escape the singularities of silo-value optimisation and the financial risk-return management of traditional infrastructures. It will enable them to capture a more holistic, population-scale stream of benefits from their transition investment portfolios. Co-beneficiary infrastructures. It is clearly critical that we take a co-beneficiary view of all our infrastructure investments, designing them specifically to build synergies instead of optimising investment in solutions for singular outcomes. For example, we can choose to optimise nature-based solutions for carbon sequestration (which will encourage us to establish fenced-off forest reserves, replacing critical agricultural land and possibly ignoring biodiversity) or we can approach nature-based solutions as vital co-beneficiary assets, which have carbon-capturing capacity but also the means to manage heat island effects for energy utilities, health outcomes for communities, sustainable urban drainage benefits for water utilities, flood risk reduction for insurance companies, and which address our growing biodiversity crisis. In this way, a tree becomes an excellent source of return beyond a traditional measure of IRR and the means to regenerate our cities. The design of infrastructure assets for co-beneficiary returns requires intentional advocacy and horizontal policy infrastructure. This will be vital if we are to use our intergenerational transition investment for greatest efficacy. Preferencing micro-infrastructures. Both resilience or anti-fragility, and community wealth development are necessary in an age of long emergencies. Across the global development landscape, we require a significant shift in our investment thesis, moving from a preference for large-scale, monolithic infrastructures to micro-networked, distributed infrastructure provision. To date, our urban and societal infrastructure development models have been skewed towards the large-scale and frequently disconnected from the local. A single, large forest is not the solution for cities, even if it feels easier and more efficient in terms of land assembly, procurement, and management. Instead, we need a network of dispersed micro urban forests, established and maintained by communities and neighbourhoods across the city, if we are to construct the intangible and tangible properties of these assets. This preference for micro and networked assets needs to be hardwired into our procurement thesis with appropriate community development and participation mechanisms. Rapid investment in digital infrastructure and capacity. The migration from analogue to digital infrastructure needs to be systemically advanced at scale and speed in order to facilitate the transitional revolution. Technical innovation investment will need to permeate a new spectrum of open, real-time, digital public services, ranging from data-sensing with Agent-Based-Models (ABM) capabilities to advanced digital public registries. Public investment in the development of these digital and oracle infrastructures — including the legal, financial, and regulatory standards and protocols — is vital to unlocking the new classes of business and value models necessary for an equitable transition. Transitioning from shovel-ready to shovel-worthy. Governments need to rapidly reassess the flow of infrastructure projects they have committed to fund, whether part of the Covid-19 recovery or pre-existing. This is necessary to ensure that they meet the priorities of the 21st century and are not locked into 2017/18 projections of the world to come. It also applies to investments in real estate, energy and transport, as these projects are often still ruled by short-term financing structures, with isolated linear value flows and private governance detached from the community wealth generation necessary as part of this transition investment. Building the rapid capacity for municipalities and provincial governments to undertake this review is vital and urgent, especially in a moment where there is increasing fiscal pressure and where economies worldwide are in a hiatus, providing a limited window of opportunity to redesign and reset infrastructures Developing new viability tools, mechanisms, and protocols. Our existing viability assessment tools and mechanisms are completely outdated, and do not take into account the strategic risks our cities and societies face. For example, we cannot speak about transformation of our food systems and urban landscape without addressing the land valuation practices that discount regenerative farming and that deprioritise urban forests in favour of condominium developments. These deeply embedded practices span appraisal firms, accounting practices, building permits, zoning regulations, and municipal tax rates. If governments commit to strategic investment into the novel infrastructures discussed here, the positive effect on adjacent industries’ assessed spillover values is bound to be significant. Strategic creation of lead markets for nature-based solutions will ensure the emergence of e.g. innovation sectors around finance, remote-sensing technologies, and smart-contracting services in cities and countries. Rebuilding public viability assessment tools, valuation mechanisms, discount rates, and appraisal incentives to take into account such upsides is a vital and necessary component of an investment system fit for an age of long emergencies. We make what we measure and, currently, we measure the wrong things. Developing alternative governance futures for transition infrastructures. PPP arrangements have not yielded the desired outcomes. Engineering a new typology of civic development vehicles that are off public balance sheets and yet publicly accountable should be the priority of every government. Rapid experiments on the ground. It is essential that governments invest early and quickly in a portfolio of experimental probes that advance novel micro-infrastructure financing experiments, from whole-street retrofits to urban forest networks. The development of adjacent supply chains, policies, institutional infrastructure, innovation, and data-and-evidence collection is equally essential. Investing to learn and build the capabilities of vital adjacent industries will be essential to the success of any large-scale deployment. We are involved in several EIT Climate-KIC projects that are already doing this, such as ReCode, the Health Clean Cities Deep Demonstration, and the Pandemic Response Projects focussing on district retrofits. Many more are needed. Market-making instruments.

Collective risk management facility. We need new hybrid institutions to pool and manage risk across both governmental departments and non-governmental sectors such as banks, utilities, and insurers. This pooling function will create the capacity to address the unmanaged long tail and the cascading risks that are a feature of the age of long emergencies. This function would further crystallise the demand for integrated procurement and co-beneficiary investment in civic infrastructure assets, thereby building the pathways for achieving outcomes such as lower asthma rates and decreased flooding occurrences.

Transition finance innovation sandbox. This should operate across government and non-governmental agencies, including policy-makers, regulators, professional institutes, standards agencies, investment houses and intermediaries, insurance organisations, rating agencies, and fintech startups, among others. Its primary purpose will be to support the design, experimentation, and implementation of new financial instruments and the necessary adjacent institutional infrastructure, including protocols, regulations, and standards for enabling the next-generation financial markets for transition investing.

Whole-value-chain investment. Governments will need to build on the learning from the many difficulties faced in initial Covid-19 response procurement, and invest in whole-value-chain renewal and innovation for a post-carbon, post-Covid economy. Addressing this crisis is not just about investing in a school or building a bridge, or even an urban forest. Its scale requires us to invest in the development of all of the resources and supply chains needed to truly build back better. The scale and speed of transition means we cannot wait for organic supply and demand matching and coordination to emerge. This will require the intentional acceleration of innovation capacity across whole supply chains.

For example, nature-based solutions require investment in remote-sensing capabilities as well as new financial instruments, and investment in elements as diverse as the production of seedlings, new labour market skills, or the capabilities and organisational cultures in municipal green space departments. The acceleration of these near-now infrastructure assets need rapid, coordinated investment across this whole supply chain, not only to match increased demand but to innovate practices, methods, and machinery for a post-carbon economy.

Building the institutional capacity to support the investments and innovation across whole value chains is vital to addressing the challenges of the transition and requires immediate governmental investment. This investment thesis needs to work in synchrony with the Green New Deals to drive the whole value chain innovation necessary for a post-carbon economy transition that is just and inclusive.

Conclusion

The structural transformation our societies and cities need present us with systemic challenges that requires a system-based response. The announcement of new commercial or quasi-commercial funds will not resolve this issue.

Our investment thesis is straightforward: we see the deep need for a new typology of value structuring which is macro in scale with regards to systemic orchestration, and micro and hyperlocal in the development of co-benefinary responses. We do not believe that projects simply connected to linear KPIs, funded by short-term investments, and governed by divergent long-term interests, are able to meet the urgent challenge any longer.

We see the roadmap unfolding through the parallel development of fundamental yet practical innovations across key asset classes, such as nature-based solutions and whole-city or whole-district retrofits. The political will and commitment is already manifest, yet the technical and functional capacity remains underdeveloped. To achieve the necessary scale and speed of systemic change will require a movement of open innovators and strategic sponsors across governments, sectors, and geographies.

We see cities and countries emerging as leaders and lead market makers as they invest in the digital transformation of their systems, creating secondary industries of technical expertise, and viewing their cities as platforms for novel asset development.

The next phase of this journey for us and our many partners is to develop on-the-ground experiments and to gather evidence in order to test and validate our investment hypothesis. We will openly share what we discover and learn.

If you want to find out more about how to engage with this mission, please contact Indy Johar, Anastasia Mourogova Millin, Raj Kalia, Joost Beunderman or Chloe Treger at info@darkmatterlabs.org.