Overview
This brieing note sets out a strategic
payment-for-performance approach to stimulate private sector investment in REDD+. The approach presented is a form of “put option contract” issued by a purchasing facility, using public funds. This contract gives the seller the right, but not the obligation, to sell REDD+ emissions reductions veriied to an agreed standard at an established price, at a given point in the future. Two key features of this approach are (i) it directly creates demand, and (ii) that uncertainty over variables such as price and demand for carbon is reduced. This approach has been successfully used to rapidly scale up activities in a number of geographies and sectors outside the ield of REDD+. The ability to select from a wide range of geographical and methodological criteria and stipulate these within the put options contract means this approach can be focused on improving the incentives speciically for initiatives that meet robust environmental and social standards, and can also be targeted to speciic geographic areas or types of activity.
In the absence of large-scale, long-term demand and price signals for REDD+ emissions reductions, implementation of REDD+ has been signiicantly below what is required to avoid dangerous climate change. This is in part due to the absence of a clear economic incentive for either forest countries or the private sector to shift from business as usual activities to land use policies that have REDD+ at their core. In this context, a “put option” reduces uncertainty and makes more REDD+ activities commercially viable by offering a guaranteed buyer for a certain value or volume of emissions reductions. The visibility over future revenues that this incentive structure creates is a precondition for unlocking the vast pools of private capital managed by large, responsible money managers. Securing a guaranteed price in advance will help scale up REDD+ activities, as inancing available from investors and lenders can be more easily accessed and secured on more favourable terms.
The value of the “put options” contracts is in using public funds to provide a credible assurance of future sales, which creates the incentive for activities to go ahead and can help leverage associated investment, rather than simply using public funds to purchase emissions reductions. Even a modest amount of public money could send a powerful signal of the long-term credibility of REDD+ and so can be expected to have a much wider impact on investment in the sector.
Fundamental principles, risks and safeguards
Put options contracts are relatively simple and widely used. Irrespective of what they are being applied to, robust conditions or safeguards are an integral part of the contract. The private sector has for a number of years expressed broad support for this type of intervention.It is envisaged that a “facility” is established within an existing fund, bank or organisation, which would be capable of selling put options contracts. If the options were ‘exercised’, or used, by the owners, emissions reductions would be bought by the facility and retired. The facility would be quick to establish, and offers a high degree of lexibility.
Key advantages of put options contracts include:
• Funds are only used to pay for results (emissions reductions)
rather than upfront. This is aligned with a core principle of REDD+.
• This approach creates the conditions required for private
sector investment: being of suficient timeframe to allow effective planning (“Long”); a clear commitment that will directly affect the bottom-line of investments (“Loud”); a legally binding and enforceable contract (“Legal”) and still simple to understand and engage with (“Light”). By providing an assured revenue stream for REDD+ emission reductions, the private sector will have an incentive to invest in and operationalise REDD+ initiatives.
An interim strategic
intervention for REDD+:
• Cost effectiveness – using existing institutions keeps costs
low, and technical features of the product will allow multiples of private sector capital to be mobilised per dollar of public funding.
• ‘Proof of concept’ is developed along with an investment
track record which is of great importance to the private sector and in scaling up REDD+.
• Creating the mechanism will send strong political signals
about the commitment to REDD+ in the post 2020 framework.
Options and examples
How will recipients be determined? The speciic criteria for emissions reductions to be purchased would be determined by national circumstances. The process might involve features such as an open tender with clear eligibility criteria and a due diligence process for applicants.
How will price be determined? There are a range of well-established techniques for ensuring value for money and price discovery. A common process is the reverse auction which can be employed in a variety of different forms to suit a range of requirements. A reverse auction is a process by which the purchaser announces the highest offer price they are willing to accept and then the sellers underbid each other for the right to sell, driving the inal clearing price down below the original offer. This approach has been widely used when setting renewable energy tariffs and found to be eficient and effective.
Design features. There are many ways to structure the contract; the preferred option will ultimately also be a function of national circumstances. Options contracts have been used for many years and the permutations and trade-offs are well understood. Features that can vary include the ability to trade the permit (‘fungibility’), the price or premium paid for the contract, the length of the contract and the conditions under which it can be used (or ‘exercised’).
Proposed steps
A range of organisations could administer the scheme, including multilateral/regional development bank or even a public-private partnership. Establishing the terms of the scheme could be done most effectively through a multi-stakeholder process, drawing on expertise from similar arrangements in renewable
energy, health care or climate change sectors. Key factors to consider include:
a) The scale of funds available.
b) The duration of the commitment and sequencing of the transactions. It is recommended that the mechanism has a minimum term of ive years, based on clear private sector feedback that medium to long term signals are most needed, as well as the timeframe for new REDD+ initiatives to start producing emissions reductions veriied to speciic standards.
c) The criteria for emissions reductions that will be purchased. It is recommended to focus on credits certiied by VCS + CCBA, linked to sub-national or jurisdictional-level frameworks. Geographic scope should also be determined, focusing on countries with a well-developed national REDD+ strategy, and also responding areas of interest for the private sector on REDD+ (i.e. ease of doing business considerations).
The Interim Forest Finance (IFF) project is a collaborative initiative of the Global Canopy Programme (GCP), the Amazon Environmental Research Institute (IPAM), Fauna & Flora International (FFI), the UNEP Finance Initiative (UNEP
FI), and the United Nations Ofice for REDD+ Coordination
in Indonesia (UNORCID).
The IFF project advocates a strategic intervention by donor country and tropical forest country governments, and public
inancial institutions, to scale up public and private sector demand for REDD+ emission reductions, in the interim
period between 2015 and 2020. To read more about the IFF project, please visit http://www.globalcanopy.org/projects/
interim-forest-inance. To contact the IFF management
