Overview
Risk – whether real or perceived – is one of the most important barriers to accessing inance. Although risks vary across geographies, sectors and time, and can be categorised in many different ways, it is often observed that risk related to ‘green’ investments is higher than in ‘conventional’ investments. This can be due to a reliance on public policy for predictable revenue generation, the lack of an investment track record in embryonic sectors, or the result of a cash low proile often characterised by high upfront costs and long operating life-cycles.
It should be noted that the lack of private sector investment in REDD+ is not a generic aversion to exposure to forest-related activities. Indeed, the private sector has invested considerable sums in forest conversion and extraction in a market estimated to exceed US$ 1.2 trillion by 2015. This is an indication that there is a large pool of private capital that can be unlocked if the risk-adjusted returns are attractive.
This brieing note sets out an overview of one particularly promising type of risk mitigation instrument that has the potential to improve the inancial proile of REDD+ investments. It looks at loan guarantees in the speciic context of REDD+. Loan guarantees are a well-established instrument for de-risking investment, by using public funds to underwrite part of the potential losses on a loan, or portfolio of loans. Lowering the risk to a inancial institution should theoretically allow it to lend more to a sector at lower rates of interest. This lowers the cost of capital for any activity in that sector and in turn, increases the number of activities that are commercially viable given expected returns. By only covering a percentage of the potential risk, the loan guarantee limits ‘moral hazard’ and the selection of poorly designed or uneconomic activities, as commercial banks using this instrument share a portion of the inancial risk of a loan.
The process of review and due diligence required to establish a loan guarantee means this mechanism can be focused on
supporting only high-quality REDD+ initiatives that meet robust environmental and social standards, and can also be targeted to speciic geographic areas or types of initiative, or combinations thereof. The creation of a loan guarantee instrument for REDD+ would also be a strong political signal to the private sector in providing practical instruments and tools to support stated policy ambitions.
Fundamental principles, risks and safeguards
Loan guarantees are well known to the private sector, and are beginning to emerge in the area of sustainable land use. There is a wide range of forms they can take, and while some general principles can be established, the detail of the mechanism will need to be tailored to the speciic initiative and associated inancing arrangements that the guarantee is intended to support.We envisage establishing a “facility” within an existing fund or bank to issue loan guarantees. It would be expected to take 12-18 months for loan guarantees to be put in place, and they would likely need to have a duration of up to 5-10 years in order to align with the development phase for initiatives before they are able to generate income from REDD+ relevant activities or from sales of emissions reductions.
Key features of loan guarantees include:
• Funds are only expended if a borrower defaults. By only offering guarantees to well-designed and -managed initiatives, it is possible that only a relatively small percentage of allocated funds is disbursed, offering the potential for considerable leverage of private sector capital.
• We envisage loan guarantees focused on speciic jurisdictions or sectors, targeting areas embedded in national strategies or action plans.
• This mechanism does not attempt to stimulate demand for REDD+ emissions reductions directly. Instead it facilitates greater access to capital for REDD+ initiatives, to make a
An interim strategic
intervention for REDD+:
wider range of REDD+ initiatives commercially viable, and to send an important political signal about REDD+ in the post-2020 framework.
Options and examples
• Loan guarantees may be applied at the level of individual loans, or to an institution to guarantee against losses of a loan portfolio. A number of developed and developing countries have previously used loan guarantee mechanisms to support development of agriculture and rural enterprise, through guaranteeing lending to individual enterprises or cooperatives. The Alliance for Green Revolution in Africa (AGRA) has also used this type of support across ive African countries. UNDP and GEF operate Proyecto Cambio across Central America, which offers loan guarantees to rural and agri-businesses that aim to conserve biodiversity. There may be scope to expand existing facilities or replicate them, to focus on transition to sustainable land use.
• The European Investment Fund offers loan guarantees to institutions with a portfolio of loans to small-medium enterprises (SMEs) to provide cover across the portfolio. • USAID Development Credit Authority & Althelia Climate Fund. This loan guarantee was announced in May 2014, and covers loans up to a total value of US$133.8million to be issued by Althelia for up to 50% losses at portfolio level. Althelia will make commercial loans to a range of sustainable agriculture and REDD+ initiatives worldwide. It will then assist these projects to sell the carbon credits generated by their activities, creating a revenue stream that allows repayment of loans. A bond is being issued to raise capital for the loans.
Proposed steps
Establishing the terms of the scheme could be done most effectively through a focus group of industry associations and potential funders, drawing on expertise from similar arrangements.
An options analysis will be needed to identify organisation(s) who might administer the scheme. A government agency or a multilateral/regional development bank could be effective options. The selected organisation would then offer the loan guarantees to local inancial institution(s), which in turn can then make loans to speciic initiatives that are backed by the guarantee.
Key factors to consider are the criteria for investments that will be considered under the loan guarantee scheme. It is recommended to focus on initiatives linked to sub-national or jurisdictional-level frameworks, as well as those having widespread credibility for environmental and social factors as well as emissions reduction. Geographic scope should also be determined, focusing on countries where the government is interested and has 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 team, please write to [email protected].
1 http://www.prweb.com/releases/forest_products_paper/
wood_and_wood_products/prweb9190684.htm
2 Moral hazard describes the situation where actors could be incentivised
