Identify and Work with Buyers

Identifying buyers and motivations

The Wyre Catchment NFM project was originally initiated by members of the ultimate buyer group, including: the Environment Agency, Flood Re and United Utilities, as well as Co-op Insurance, who may become a buyer for non-flood risk benefits in the future (see below). The project was first explored by these buyers due to the impacts of Storm Desmond. When Storm Desmond hit the UK in 2015, 5,200 homes were flooded and over 43,000 homes lost power in Cumbria and Lancashire.

As a result, representatives from each of these buyers started a steering group for the project in 2016 (See Milestone 1 for early project scoping and rationale for the project’s focus on NFM).

Each of these initial buyers had different motivations for exploring the project.

The Environment Agency is responsible for managing the risk of flooding from main rivers, reservoirs, estuaries and the sea in England. It views NFM solutions as a way to support existing grey infrastructure that reduces flood risk, and as a potential alternative for communities that cannot access flood schemes, for example when further grey infrastructure would have minimal flood risk reduction benefits – such as in the case of Churchtown. It therefore had a clear mandate for exploring the project’s potential and paying for outcomes.

United Utilities is a water company in the Northwest of England. It is the only private organisation acting as a buyer in the project and had several reasons to pay for the reduction in flood risk. Firstly, it aims to reduce the cost of damages to its own physical assets that are caused by flooding. Within the Wyre catchment, it has c.30 sites and assets that include network pumping stations and wastewater treatment works. Secondly, United Utilities have customers across the Wyre, and often get an influx of customer complaints and requests when heavy flooding occurs. Thirdly, United Utilities self-insure for disaster events such as severe storms and flooding, with a dedicated pot of funding to explore innovative solutions that can address such events. Though this project is focused on a small area, United Utilities considered the potential to scale the project’s solutions across the Northwest of England.

Flood Re is a specially formed public sector organisation which is designed to enable insurance companies to offer affordable flood risk protection to households by subsidising the premiums, whilst at the same time encouraging household flood protection measures and other innovations such as natural flood management techniques .  Flood Re has been designed to have a finite life until 2039, at which point is should have achieved its objectives and returned the flood risk insurance market to a free state with no government intervention. Flood Re considered this project as a strategic investment, wanting to develop a blueprint and pilot project where insurance companies and reinsurers could potentially act as future buyers for similar schemes.

After the project’s steering group was formed, two other buyers were identified and approached; the Wyre Council and the North West Regional Flood and Coastal Committee (RFCC).

The North West RFCC is one of 12 RFCCs across England established by the EA in 2010. RFCCs approve the EA’s annual programme of flood and coastal risk management work in their region and set the local levy that funds the priority activities. The North West RFCC has clearly stated the ‘investment in the development of innovative green finance mechanisms’ as a priority in its business plan. The project team therefore viewed the RFCC’s mission as well aligned to the project.

The Wyre Council was the last potential buyer identified for the project, after it was decided to base the project in the Wyre catchment (See Milestone 1 for rationale). The Wyre Council delivers flood-related services to the catchment, including support to local flood action groups, supplying sandbags, opening emergency centres and assisting displaced residents in the event of extreme flooding. Though the council is not directly responsible for managing flood risk in the catchment, it is often seen as liable by its residents for managing the response to severe flooding and storms, such as Storm Desmond. Flooding also imposes large costs on the Council, both in emergency response and post-flood clean-up.

All these motivations were clarified once these buyers agreed to initially explore the project. Once this was achieved, the project team used a short survey, which it called a ‘Buyer Engagement Tool’, to make sure that it understood what was driving buyers. This helped to clarify what claims the buyers wanted to make publicly, for example whether they were buying flood risk reduction locally or supporting the wider strategic value of this project to addressing flood risk across the UK.

 

Approaching buyers

Early appetite to explore the project was established by informal discussions with relative representatives of each buyer group. Once the potential was established, the project team then re-approached senior executives of each individual buyer, around six to eight months after discussions first began. These more formal meetings lasted around one hour and the project team used pitch decks.

The initial decks contained high-level details on the project, including the history of the catchment in relation to flooding, the overall objectives of the project, the types of interventions to be used and early cost scoping. These decks were also slightly tailored to the buyers being presented to, such as their aligned business mandates and the relevant impacts of Storm Desmond. However, all buyers asked for a ‘headline’ figure on the flood risk reduction, which the project team predicted was 10-15% based on early hydrological modelling and academic research (See Milestone 3 for more detail).

 

Ongoing buyer engagement

Around six months after discussions first began, and alongside these initial pitches, a ‘buyer consortium’ was formed between the buyers’ relevant representatives, the Rivers Trust and Triodos Bank – which was acting as a financial and commercial advisor for the project. The consortium met once a month for two hours, with frequent engagement over email, until contracts were signed.

The two objectives of the consortium were to ensure a consistency between buyer contracts, which would only vary by payment figures, and reach agreement over the hydrological modelling work and outputs to formally calculate the reduction in flood risk.

On the contracting side, United Utilities played a strong commercial role and drove most of the discussions, with oversight from Triodos Bank. Discussions on contracts included the liabilities accepted by buyers, ‘clawback clauses’, and decisions on inflation-linked payments. It also helped to overcome the issue of longer timeframes that the project required (see ‘Structuring payment schedules’ below).

On the modelling side, the project team took an ‘open book approach’ that showed the full extent of the modelling in order to maintain credibility and transparency with buyers and other stakeholders. Around three months after the buyer consortium began, a modelling sub-workstream was formed to undertake the full scope of modelling (See Milestone 3). This visibility also allowed each buyer to make their own calculations as to the value that the flood risk reduction would give to them (see ‘Modelling buyer benefits’ below)

 

Structuring payment schedules

Creation of a buyer consortium and an open book approach between all the parties allowed the project to successfully work through challenges and issues on the buyer side in a collaborative way. One issue that surfaced early on was the ability to enter into long-term contracts, as most of the buyers were government-linked entities with set funding cycles. For example, the Environment Agency and the Wyre Council have three- and one-year funding cycles respectively. This presented issues for the project that wanted to ensure payments of up to 50 years to monitor and maintain the interventions.

To overcome this, some middle ground was established and the project team managed to negotiate an initial nine year contract with each of the buyers. These contracts contained a steadily increasing payment obligation matched to delivery of the interventions in the catchment. The initial capital cost of implementing the interventions was borne by the external investors in the project and so the buyers were effectively transferring capital delivery risk to the investors which was attractive to them i.e. they only pay for what is in the ground.

In addition, the buyer contract contained a performance metric which became effective from the beginning of year six . The first five years of the contract were known as the “adaptive management phase” (see Milestone 3) whereby the CIC is able to monitor the effectiveness of the NFM interventions and make improvements and further investments where appropriate without risk of contract termination. From the beginning of year six however, this situation changes and buyers are able to reduce or terminate their contracted payments If the flood risk reduction data collected from two sub-catchment monitoring stations shows that the flood risk reduction hasn’t been delivered as planned..

The combination of staged payments during the implementation phase, transfer of delivery risk to investors and the incorporation of monitoring equipment, data collection and a performance metric was important in helping the buyers get comfortable with the nine-year timeframe of the project. If the project proves successful over this time (as intended), then the contracts can automatically be extended by the buyer group for up to 50 years in duration – effectively providing a more or less permanent natural flood management intervention in the landscape.

 

Modelling buyer benefits

Each of the buyers had their own internal business case and wider reasons for engaging with this project. The outputs from the modelling workstream were certainly useful, but the presence of a buyer consortium also generated a sense that each buyer would be securing 100% of the benefits of the scheme, in return for paying a proportion of its cost. A big challenge for the project team was the discussions and negotiation around the split of the required annual project revenue stream between each of the buyers because each buyer had their own internal economic return – and the project team could never fully know what this is.

For example, United Utilities have c.30 sites and assets in the catchment that have historically impacted when severe flooding occurred. These included drinking and wastewater treatment works, and network pumping stations.

To create a fuller picture of the cost saving benefits this project could deliver, United Utilities used several different sources of data.

Firstly, United Utilities accepted the project team’s view that these interventions could last for 120 years with appropriate maintenance. It then took the predicted number of severe flooding and storm events over the next 120 years, using rainfall data from the Environment Agency and the Met Office. Then, using its own data on historic costs from flood damage to its local assets and this expected frequency of flooding and storms, it modelled the likely asset repair and site rebuild costs that it would need to pay over 120 years to keep these in operation, used as the ‘business as usual’ scenario. Finally, United Utilities calculated the difference in its damage costs if these floods and storms were 5 – 15% smaller, based on the outputs from the project’s modelling workstream. This difference in cost, discounted to net present value, gave United Utilities an estimate of the direct monetary value that the project would deliver to it via reduced flood risk.

However, United Utilities also placed a value on the strategic element of this project. James Airton, the Natural Capital Strategy and Planning Manager at United Utilities who represented United Utilities in the project, comments on the strategic importance of this approach. “By using the whole 120-year period, we were able to increase this annual payment figure and improve the financial viability of the Project. Paying for a long-term benefit over such a short timeframe was worth doing in this instance due to the strategic value in demonstrating this alternative funding route.”  Airton adds, however, that type of approach is unlikely to be viable in the long term. “It’s therefore key that other beneficiaries for both flood benefit and wider ecosystems services are found, in order to reduce the cost impact on individual organisations.

 

Negotiating payment shares and reaching agreement

To calculate the payment figures from the buyer group, the project team took a ‘reverse-engineered approach’, where a detailed financial model was created which calculated the full costs of the project (including capital costs, annual operating expenditure, external financing costs and contingency) over its nine year duration (see Milestone 5). The output of the model was then presented to the buyer group in an open book manner and this led to an intermediated discussion and negotiation as to how the target annual revenue figure would be split between the buyers. This was largely achieved by the project team approaching each of the buyers individually and suggesting a share of the annual revenue requirement. This suggestion was based on commercial data available to the project team, but ultimately driven by the buyers’ willingness to pay. Turner says that starting with the costs instead of the revenues in this way prevented a ‘race to the bottom’ where the environmental outcomes may have been compromised in order to stretch the budget. The annual cost of the project was £220k, totalling £2m over the nine years.

During the discussions, the buyers themselves discussed how they thought the payments should be divided between them. For example, some of the buyers felt that as the Environment Agency had the scale and the clearest mandate for supporting this project, they should pay the largest amount. This was eventually agreed, along with the overall split of payments, after a negotiation period of about six months. Turner comments that these negotiations benefited greatly from having Dan Hird, at the time Head of Corporate Finance at Triodos Bank, in the room as a financial and commercial advisor to help these negotiations.

In October 2021, after nearly eighteen months since initial scoping on the project began, all buyers signed separate Memorandums of Understanding (MoU) with the project’s legal entity (see Milestone 6), which contained various information such as the background to the project, project objectives, high level details of what interventions would be delivered and the agreed payments schedule that would support this. As with the seller MoUs (see Milestone 2), all buyer MoUs were identical in content, other than the individual payments to which each buyer agreed. These MoUs were converted to legally binding buyer contracts and signed by all parties when the transaction formally achieved legal completion on 31 March 2022

 

Lessons Learned

For other projects considering how best to engage with buyers, Dan Hird offers the below lessons learned from the Wyre Catchment Natural Flood Management project:

• It is important to engage early with prospective buyers to test their appetite for being involved in the project, understand their corporate drivers, which ecosystem services are of interest to them, what evidence base they will require and find out how much involvement they would like to have in shaping the project. In other words – don’t develop the project in a vacuum if you going to be reliant on buyers to create a revenue stream – engage as early as possible.

• On first engagement with buyers, it is a good idea to produce and deliver an inspiring high level summary of the project and talk about the environmental (and social) benefits that it can deliver and what support you think you will need from buyers to achieve this. Suggest this is kept quite high level initially – because you also need to be in listening mode as to the response to this presentation (see point above), so you can shape your next meeting with that buyer.

• It may be that it takes one or two meetings and presentations to find the right person in a large corporate organisation. Discussions may start with a Head of Sustainability or ESG but may need to involve operational or data or commercial team members at some later point. It is worth making sure you tweak your presentation each time for what you think your audience needs to understand.

• Undertaking a financial modelling and reverse engineering exercise is useful in establishing what revenue stream a project needs. It is generally easier for a project team to start by building the estimated capital and operating cost base of the project and then considering what annual revenue is required and over what period to cover this. This piece of work can be explained to the buyers – who will then have an idea what is required of them to deliver the project.

• Be flexible when engaging with buyers – it may be possible to make a proposition more attractive by; creating a buyer consortium, creating a buyer modelling or data & evidence group, de-risking capital delivery by raising up-front repayable investment so that buyers only pay for outcomes not delivery, or by introducing performance metrics (as with the Wyre project).

• Buyers will want to understand what they are paying for and are likely to want to know who is else is buying ecosystem services to ensure there is a fair split. An open book, collaborative and solution focused approach appears key to delivering nature based investment projects.