reddy, set, grow - opportunities and roles for financial institutions in forest carbon markets

8/3/2019 REDDy, Set, Grow - Opportunities and roles for financial institutions in forest carbon markets

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REDDy SET

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Part 1

A briefng or fnancial institutionsOpportunities and roles or fnancial

institutions in orest carbon markets

A study by the UNEP Finance Initiatives

Biodiversity and Ecosystems Workstream (BEWS) and

Climate Change Working Group (CCWG)

May 2011


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REDDy

SETGROW

Part 1

A brieng or nancial institutionsOpportunities and roles or fnancialinstitutions in orest carbon markets

A study by the UNEP Finance Initiatives

Biodiversity and Ecosystems Workstream (BEWS) and

Climate Change Working Group (CCWG)

May 2011


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Disclaimer

The United Nations Environment Programme Finance Initiative (UNEP FI) is a

strategic public-private partnership between the United Nations Environment

Programme (UNEP) and approximately 200 fnancial institutions globally. For

the purposes o this paper, the term UNEP FI reers directly to the members

o the UNEP FI Biodiversity and Ecosystem Services Work Stream (BESWS)

and the UNEP FI Climate Change Working Group (CCWG) plus those UNEP FI

member institutions directly involved in the consultation process undertaken

during its development.

Unless expressly stated otherwise, the opinions, fndings, interpretations, and

conclusions expressed in the paper are those o the various contributors.They do not necessarily represent the decision or the stated policy o the

United Nations Environment Programme, nor the views o UNEP, the United

Nations, or its Member States. Neither do they represent the consensus

views o the member institutions o UNEP FI. The designations employed

and the presentation o material in this paper do not imply the expression

o any opinion whatsoever on the part o the United Nations Environment

Programme concerning the legal status o any country, territory, city or area

or o its authorities, or concerning delimitation o its rontiers or boundaries.

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Published in 2011 by UNEP FI

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Prepared or the United Nations Environment Programme Finance Initiative by


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Part 1 - A briefng or fnancial institutions 3

Forewordrom the United Nations Environment

Programme Finance Initiative (UNEP FI)

Forests are the natural treasure chests o the world, providing a host o ecosystem services that thisneeds to be said very clearly and up-ront - all economic progress and human well-being, even human

lie itsel, rely on. What orests give us is undamental in the strictest sense o the word: they stabilise the globalclimate system, regulate water cycles, provide habitat or biodiversity and people and host genetic resourceso unimaginable potential. Forests and their services remain, however, chronically undervalued by todayseconomic and political decision makers which results in their rapid destruction. One o the many consequenceso current deorestation is its contribution o approximately one th o global greenhouse emissions.

There is a glimmer o hope, though, as there is increasing consensus at national and international levelsand within the UNFCCC climate change negotiations or the need to include in a new climate change dealeorts to reduce deorestation and orest degradation as well as to accelerate reorestation, as what theymust be: a central component o the global response to the challenge o global warming.

Given the investment volumes, USD 17 33 billion per year, required to only hal emissions rom the orestsector by 2030, there is a clear, yet unaddressed, need to mobilise private sector nancing at scale, in additionto government investment. There are many important roles that nancial institutions and intermediaries can

play in this respect: Investment managers can invest their own equity directly into orestry projects, orestryproject development companies and orest unds or act as brokers or intermediaries or other investors.Debt nance can take the orm o lending to orest companies, leveraged unds or individual projects on anon-recourse basis. Insurance and guarantees are a crucial way to manage both conventional investmentrisk in the orestry sector, as well as such risks which are more specic to orest-carbon endeavours.

This brieng does not mark the end but the beginning o an eort by UNEP FI to work together with its

members, other UN agencies and stakeholders to help build regulatory rameworks and private sectorcapacity in order to scale up investment in emerging environmental markets, including orest-carbonmarkets. Part 1 o this study provides a brieng to the nancial world on current and emerging avenues

or business activity in orest-carbon, and highlights roles and barriers or nancial institutions to becomeinvolved. Part II develops recommendations to national policy makers and international negotiators on

what the international climate change architecture needs to deliver to eectively mobilise private nanceand investment or orests at the need scale.

We hope this brieng is inormative to you, and we look orward to working with you in the near uture.

Richard Burrett

Chair o the UNEP FIs Biodiversity

and Ecosystems Work Stream

Paul Clements Hunt

Head o UNEP Finance Initiative

Nick Robins

Co-Chair o UNEP FIs Climate Change Working Group


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REDDy SET GROW4

Contents

Abbreviations 5

1 Executive summary 6

2 Introduction 9

3 Current nancial opportunities in orest-based climate change mitigation 11 3.1 Background and scope o study 11 3.2 Where is the opportunity? 15 3.3 What are the potential benets? 15 3.4 Concretising the asset class: What are potential REDD and A/R activities? 17

3.5 Forests in the global carbon markets 17 3.6 Regulatory carbon markets 18 3.7 Voluntary carbon markets 19 3.8 Comparing the carbon markets 20

4 Roles, opportunities and risks or nancial institutions 22 4.1 Roles or nancial institutions in the orest-carbon market 22 1 Investors & Fund Managers 23 2 Lenders 26 3 Insurers/guarantors 27 4.2 Opportunities: why should nancial institutions be interested in the orestry sector? 29

4.3 Risks identied in orest-carbon market activities 30 4.4 Risk mitigation measures 31

5 Conclusions 33

Acknowledgements 35

Appendix 1: Bibliography 37


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Abbreviations

AFOLU Agriculture, Forestry and Other Land Uses

A/R Aorestation & Reorestation

BBOP Business and Biodiversity Osetting Programme (Katoomba Group)

CCB Climate, Community & Biodiversity

CCX Chicago Climate Exchange

CDM Clean Development Mechanism

CIFOR Center or International Forestry Research

COP Conerence o Parties

CSR Corporate Social Responsibility

EU ETS European Union Emissions Trading System

FCPF Forest Carbon Partnership Facility

FFI Fauna and Flora International

FIs Financial Institutions

GHG Greenhouse gas

GtC02e/yr Gigatonnes o carbon dioxide equivalent (1 Gt = 1 billion tonnes)

IFM Improved Forest Management

IPCC Intergovernmental Panel on Climate Change

JI

Joint ImplementationKP Kyoto Protocol

LULUCF Land use, land-use change and orestry

MtC02e/yr Megatonnes o carbon dioxide equivalent (1 Mt = 1 million tonnes)

NGO Non-Governmental Organization

NSW New South Wales (Australia)

OTC Over-the-Counter (transaction)

PCF Prototype Carbon Fund (World Bank)

PES Payment or Ecosystem Services

RED Reducing Emissions rom Deorestation

REDD Reducing Emissions rom Deorestation and Degradation

REDD+ Reducing Emissions rom Deorestation and Degradation in developing countries andthe role o conservation o orest carbon stocks, sustainable management o orests,and enhancement o orest carbon stocks

RGGI Regional Greenhouse Gas Initiative (North America)

SGER Specied Gas Emitters Regulation (Alberta, Canada)

t CO2e tonnes o carbon dioxide equivalent

UNFCCC United Nations Framework Convention on Climate Change

USD United States Dollars

VCS Voluntary Carbon Standard

WB World Bank


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REDDy SET GROW6

1 Executive summary

A50% reduction in deorestation is needed by 2020 i the orestry sector is to support, rather than undermine,global eorts aimed at holding global temperature rise below 2 degrees Celsius, the global climate target

that the worlds governments have set themselves in the international climate change agreements o the UNFCCC1.

Previous research suggests that slowing down, and ultimately even reversing, emissions rom orestryactivities requires a combination o three distinct approaches: (i) withdrawing the current drivers odeorestation, particularly through shits in the production o agricultural commodities, (ii) mobilisinginvestment into the pro-active protection o standing orests, (iii) mobilising investment into the creationo new, sustainably-managed orests. The ocus o this study is on areas (ii) and (iii).

In these two areas, considerable investment is needed to realise the climate change mitigation potentialo orests: roughly USD 17-33 billion per year are needed to halve emissions rom deorestation by 2030

(Eliasch, 2008); UNEPs Green Economy Initiative comes to the conclusion that annual investment inthe order o USD 40 billion is needed to both halve global deorestation by 2030 as well as to increasereorestation and aorestation by 140% by 2050 relative to business as usual. Investment is needed bothup-ront or capacity building and preparatory work as well as on an ongoing basis or implementation,

which entails compensation or opportunity costs as well as the costs o orest protection.

Investment at this scale is unlikely to come rom governments alone. Hence active investment rom privatesector investors is essential, including nancial institutions (FIs) and intermediaries o dierent kinds,

particularly or implementation activities. This will depend on making the protection and enhancemento natural orests, and the creation o new orests, a competitive investment opportunity.

The international carbon market oers an avenue or increasing the nancial competitiveness o orest

protection and creation. While investment in orest-carbon has been limited to date with an estimatemarket value o only USD 37 million in 2008 in the regulatory and voluntary markets combined utureinvestment opportunities in orest-carbon promise to be o great interest to the private sector in general, in

particular investors and other nancial intermediaries, or a variety o reasons:

1. Proft:Aside rom traditional orest gains, such as through timber and non-timber orest products, newprots can be made in the sector through the generation and export o carbon credits. In the orest sectorthis is at present largely limited to voluntary carbon markets which are small in size and weak in prices.The potential is expected to signicantly increase, however, i carbon credits rom avoided deorestation arerecognised in regulatory markets post-2012. At present, only such credits rom the creation o new orests(aorestation and reorestation) are tradable on ocial, regulatory markets.

2. Diversifcation: Forest-based climate mitigation investments can constitute a viable opportunityor risk management by diversiying investors portolios, including such portolios with an exposure tothe orestry sector. Forest carbon prices are unlikely to be highly correlated with (or example) pulp ortimber prices (at least initially as there is more competition or limited resources, prices could becomeincreasingly correlated).

3. Compliance: Financial institutions or their clients may have emission reduction targets that they need tomeet (or example in Kyoto Protocol Annex I countries), or they may expect such targets to be imposed in the

uture (or example in the case o a number o states in the USA). Investing in orestry can help meet such targets.

4. Corporate social responsibility (CSR): Financial institutions or their clients may be

interested in demonstrating CSR through a nancially competitive investment which, in addition, yieldsenvironmental and social returns. Such non-nancial returns can be capitalised on via marketing and

1 This target was recently conrmed in the Cancun Agreements 2010


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institutional positioning. Forestry projects can have especially interesting characteristics as they oten resultin a wide variety o signicant sustainability benets alongside reductions in greenhouse gas emissions.

5. Broader sustainability: Forestry investments can indirectly lead to the provision o a variety o ecosystemservices and sustainability benets next to emissions reductions. These include enhanced water-cycle management,the retention o valuable soil, and landscape protection. Despite the current lack o systems o payments or ecosystemservices and resulting revenue streams, these could lead to additional returns in the uture, once such systems

are established. The overall market value o payments or water-related ecosystem services and other ecosystemservices were estimated at USD 5.2 and USD 3 billion in 2008, respectively (TEEB, 2010).

Despite the commercial promise o these benets, activities and investment in orest-based climate changemitigation have to date been slow and modest, especially when compared to other types o emissionsreduction eorts. A variety o reasons or this can be identied:

n There is at present no mechanism under the ormal international climate change architecture to capitaliseon emissions reductions rom avoided deorestation. Such activities are possible only on voluntary carbonmarkets. There is at present no guarantee that such a mechanism will be put in place in the uture; althoughthe current UNFCCC agreements speciy the set-up o an international REDD+ mechanism, it remains

undecided how the implementation o concrete REDD+ activities will be nanced and whether the mechanismwill be based on a system o tradable credits. Part 2 o this two part series, will make suggestions on suchdesign options o the uture international REDD mechanism that will ensure eectiveness in mobilising

private nance and investment.

n Despite the act that the generation and trade o carbon credits rom reorestation/aorestation projectsis possible under the Clean Development Mechanism (CDM) o the Kyoto Protocol, such projects remain

ar rom being competitive with other types o CDM projects. The carbon sequestered by new orests isnot captured permanently as, at some point in the uture, orests will cease to exist and will release thecarbon back into the atmosphere. The modalities o the CDM address this issue by allowing reorestationand aorestation projects to generate only such carbon credits which are temporary and which need to

be replaced by additional credits at predened points in time. The temporary nature o orestry credits isa clear disadvantage when compared with conventional CDM credits, and the result is a price discount aswell as only marginal demand on international carbon markets.

n Trade with orestry credits is banned rom the European Emissions Trading Scheme (EU ETS) and otherdomestic carbon markets, which ultimately alienates reorestation and aorestation projects rom the mainsources o global demand or CDM-derived osets.

n Voluntary carbon markets allow activities in the area o avoided deorestation to generate tradable carboncredits, and also address the issue o non-permanence through a system o buers and insurance ratherthan through a solution o temporary credits; this makes orestry credits equivalent to and competitive

with other types o osets. The result is that on the voluntary carbon markets orestry credits play a much

greater role, relative to other emissions reduction eorts, than in the regulatory markets. Voluntary marketsare, however, limited in demand and size and have thereore only mobilised relatively modest volumes oinvestment into emission reduction activities.

n There has to date been only limited eort in inorming and educating relevant commercial actors with potentiallyimportant roles in these markets. This Brieng and subsequent activities by UNEP FI address this barrier.

n In addition to broader barriers, investments or both the creation o new orests, and especially the protectiono standing orests, are exposed to a variety o distinct and very unique risks; these exacerbate the alreadychallenging risk landscape inherent to such developing countries and emerging economies where most,i not all, opportunities in orest-based mitigation are ound.

n In the domain o policy and political risk, or instance, overall governance risks at the domestic level aswell as the general lack o law enorcement, are compounded by the risk that a specic country might notbe eligible or the participation in ocial conservation projects and or the generation o orestry credits.Furthermore, a country may be ormally eligible but de acto unable to put in place the operational


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REDDy SET GROW8


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2 Introduction

The protection and enhancement o orests, especially in the tropics and sub-tropics, is an essential

part o the international eort to stabilise the global climate. Previous research suggests that a 50%reduction in deorestation is needed by 2020 i the orestry sector is to support, rather than undermine, globaleorts aimed at holding global temperature rise below 2 degrees Celsius. On average, 13 million hectareso tropical orests are disappearing annually (FAO, 2010), which is equivalent to about six billion tonnes ocarbon dioxide being released into the atmosphere. Deorestation also damages crucial ecosystem services suchas soil stability, aects watershed production and destroys habitats and livelihoods. The potential o oreststo mitigate climate change is vast. In terms o their ability to reduce greenhouse gas emissions, stoppingtropical deorestation and planting new orests could represent the equivalent o doubling current globalnuclear energy capacity, or the construction o two million new wind turbines (Pacala & Socolow, 2004).

However, considerable investment is needed or this potential to be realised estimated at a minimum oUSD 17-33 billion per year to halve emissions rom the orest sector to 2030 (Eliasch, 2008). Reducingdeorestation and orest degradation can mitigate climate change at considerably lower costs than manyother technology-based abatement options, and with immense potential co-benets such as biodiversityconservation and watershed protection - ree services with an estimated annual value o up to USD 45billion by 2050 (TEEB, 2010). These services are central to human well-being and economic progress in themedium to long term: estimates show that on a business as usual path, the deorestation-related impactso climate change on the world economy could reach USD 1 trillion/year by 2100 (Eliasch, 2008).2 UNEPsGreen Economy Report concludes that, on average, the global climate regulation benets o reducingdeorestation by 50 per cent exceed the costs by a actor o three (UNEP, 2011).

Nevertheless, investment on the scale o USD 17-30 billion per year is unlikely to come rom governments

alone, and thus active participation o private sector investors, including nancial institutions (FIs) andintermediaries o dierent kinds, is essential. This in turn depends on making the protection and enhancemento natural orests, and the creation o new orests, a competitive investment opportunity.

There are many reasons why orest-based mitigation should be interesting to FIs, as shown below in Figure1, and discussed urther throughout this study. However, in order to mobilise this private sector capital atthe required scale, it is paramount that policy-makers increase the nancial competitiveness o orest-basedclimate mitigation investments, and minimise the risks involved.

2 Please note this is an estimate o the orestry-related impacts o climate change, additional to the climate change impacts underpinned by other industrial emissions ogreenhouse gases.


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REDDy SET GROW10

Figure 1: Overview o why fnancial institutions should be interested in the orestry

sector

While a global ramework or REDD+ is now a top priority in the international climate negotiations, thereis no guarantee that a ramework agreed at this political level will be investor-riendly. However, policy andregulatory initiatives designed to attract or guide capital are evolving at both international and nationallevels. In broad terms these seek to (a) improve potential returns, through support or new markets, and(b) decrease risk, either directly through access to risk mitigation products, or indirectly through policydesign and implementation.

It is thereore essential that:

(a) Financial institutions ully understand the nature o the commercial opportunities, potentialinvestment mechanisms and risk mitigation instruments available within the orestry sector, and;

(b) Policy-makers understand the needs o private sector investors, lenders and insurers in relationto the specic characteristics o orest sector emissions abatement opportunities.

Improving the understanding o both stakeholder groups is the undamental objective o this two part series.

Why should fnancial institutions be interested in the orestry sector?


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3 Current fnancial opportunities in orest-based

climate change mitigation

This section explains the current rameworks within which investments in orest-based climate changemitigation occur, in particular through regulated and voluntary carbon markets.3.1 Background and scope o study

Forests have been managed as protable investments or hundreds o years. Today, managed orests worldwidegenerate around USD 100 billion/year in wood removals alone, plus at least a urther USD 18.5 billion/yearin non-wood orest products (FAO, 2010). An estimated USD 64 billion is invested in the orest sector every

year, with USD 18 billion o this being or orest management and USD 46 billion in orest product processingand trade (Tomaselli, 2006). The majority o this is domestic investment (90%), mainly concentrated indeveloped countries and associated with plantations and processing acilities or pulp, paper and biouel.Ocial development assistance accounts or only around 7% o the total investment in orestry worldwide;However, it is a signicant actor in orestry investments in poorer developing countries (Tomaselli, 2006).Overall, the picture or developing countries is that, apart rom ocial development assistance, nancingis primarily domestic and relies heavily on internal cash fows, as lending and equity capital is dicult toaccess (Strecket. al., 2010).

When taking a step back and providing the broader context or this study, the interactions o the privatesector (and nancial institutions in particular) with orests and the orestry sector become more complexand multiaceted. As much as there is a key role or private actors and investors to play in mobilisinginvestment or the protection and creation o orests, private investors and nancial institutions today play

a central role in and contribute to current deorestation and orest degradation trends.

Figure 2 gives an overview, in red, o the areas where the private sector and capital markets today underpinand benet rom deorestation, particularly in areas such as timber extraction, agricultural commodities(especially soy beans, palm oil and meat), as well as inrastructure. Figure 2 urthermore highlightshow the economic use o orests can be shited to a more holistic and sustainable approach and how theycan become a pillar o the Green Economy; this can happen through a combination o eciency gainsand more undamental step changes, particularly by:

(i) Increasing eciency and inducing step changes in the sectors that drive deorestation (higher land eciencyin agricultural production, greater exploitation o already deorested land, and shits rom conventional

agriculture to agro-orestry and a greater ocus on tree-crops);(ii) Enhancing land eciency in the production o conventional orest products, such as timber, bre and

other non-timber products.

(iii) Establishing markets or and create monetary value o such orest-based ecosystem services that, despitetheir tremendous value to societal and economic well-being, remain ormally unvalued.

While private actors, investors and nancial institutions have undamental roles to play in re-thinking theirown behaviour patterns and shiting via all three avenues above - the way todays orests are exploited, thisstudy ocuses exclusively on the third category, and particularly on the ecosystem service o carbon storage.In the near uture, UNEP FI will urther explore the current roles o private nance and investment with

regards to the sectors driving deorestation and the avenues to rapidly shit behaviour patterns.


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REDDy SET GROW12

Figure 2:

Framework o

links between

orests, orestry

and fnancial

institutions

Source: Prabhu

ater Aulisi et al

(2008), Personal

Communication


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Eorts are currently underway at a variety o levels with the aim o incentivising orest-based climate changemitigation. The global market can be roughly segmented by location (e.g. orests in developed or developingcountries) and activity (with the main opportunities being to reduce deorestation and degradation, knownas REDD+3, or to plant new orests, known as aorestation/reorestation, or A/R). 4 This report ocusesexclusively on REDD+ and A/R opportunities in developing countries. The level o orest-based climatechange mitigation investment in developing countries is currently low (the value o orestry credits in the

global carbon markets amounted to USD 37.1 million/year in 2008 see Table 1), but i scaled up tothe USD 17-33 billion necessary to halve deorestation, this would become a major category o investmentin the orest sector as a whole, rivalling traditional land use and land-use change or timber products andagricultural expansion.

The market can be urther segmented according to the type o incentive mechanism: broadly, into carbonmarkets (which in turn can be broken down into regulatory and voluntary markets) and a wide rangeo other mechanisms, such as ocial development assistance (aid unding), over-the-counter markets,other multilateral and bilateral unding initiatives, debt-or-nature swaps, philanthropic donations,national orestry budgets, premiums paid by consumers or certied orest products, etc. This reportemphasises carbon markets as a primary mechanism likely to drive investment in orest-based climate

change mitigation over the long term (Eliasch, 2008), despite some o the likely shortcomings o currentcarbon markets in unlocking private investment at scale which are discussed in more detail in Part 2o this study. It should be noted that carbon markets may take many dierent orms, and could includeresults-based inter-governmental payments as well as more conventional private-sector led investments inemission reduction projects. Besides carbon, there are other orest ecosystem services that hold signicant(economic) value, and which may be capitalised on a bigger scale in the uture.

3 While this is a handy way o categorising orestry-based mitigation activities, it may be simplistic: REDD+ activities namely include more than reducing emissions romdeorestation and orest degradation and may very well include also reorestation activities, as well as orest restoration.

4 Opportunities to reduce emissions or enhance storage o carbon also exist in a range o other orest-related areas, such as increasing the longevity o wood products andsubstituting or more carbon-intensive construction materials, but these are outside the scope o this report.


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3.2 Where is the opportunity?

Land use, land use change and orestry (LULUCF) currently contributes close to one th (17.5%) o globalemissions, which puts the sector as the third largest greenhouse gas (GHG) emitter worldwide. Emissions inthe orestry sector occur primarily as a result o deorestation activities in countries in the tropics and sub-tropics, where Indonesia (33.6%)5, Brazil (18%), Malaysia (9.2%), Myanmar (5.6%) and the DemocraticRepublic o Congo (DRC) (4.2%) have been identied as key players in terms o REDD (Verchot & Petkova,

2009). Opportunities or A/R are more widely distributed in a larger number o developing countries.

Hope and Castilla-Rubio (2008) estimated that the net present value o benets in terms o reducedclimate-change damage associated with reducing deorestation and hence emissions by 50 per cent each

year rom 2010 to 2100 would be US$5.3 trillion (mean) with a 90 per cent condence interval (CI) oUS$0.6 to US$17 trillion (UNEP, 2011).

The global benets o annually mobilising roughly USD 30 billion o investment, rom 2010 to 2050, intoavoiding deorestation as well as increasing sustainable reorestation and aorestation, are not limited tothe avoided damage that would otherwise result rom climate change. Modelling done or UNEPs GreenEconomy Report urther suggests that as a result o such investment the global added value, or additional

return on investment, in the orestry sector would reach USD 0.6 trillion in 2050 (UNEP, 2011).

3.3 What are the potential benefts?

Forests can generate large emission reductions at relatively low cost. Studies have shown that orestrymitigation options can contribute to reductions o 1.3 to 13.8 billion tonnes o carbon dioxide emissions

per year (GtCO2e/yr) in 2030 (IPCC, 2007)6. According to the Stern Review (Stern et al, 2006), emission

savings rom avoided deorestation could yield reductions in CO2

emissions or under USD 5/tonne CO2,

and possibly or as little as USD 1/tCO27, while planting new orests could result in increased absorption o

CO2

at between USD 5 and USD 15/tCO2. This is considerably cheaper than achieving emission reductions

in many other sectors (though not cheaper than energy eciency, which can potentially be achieved at

negative cost).

The extent to which the dierence betweenactualorest sector abatement costs and the price paid orabatement can be exploited will be a key determinant o the attractiveness o the sector to private investment.This is because the dierence translates into rent or potential prot. It should be noted that the potential

or uture prot is what drives present investment, and the level o expected prot must be high enough tocompensate or expected risk: a scheme that aimed perectly to compensate or actual costs, without takingrisks into account, would ail to attract private investment.

Forest-based mitigation, and REDD+ in particular, can deliver attractive co-benets. These include:

n Biodiversity conservation and environmental protection (UNEP & WCMC, 2009); (see Box 3); and

n Improved livelihood standards and sustainability or stakeholders that directly and indirectly depend onorests (CIFOR, 2010).

5 Percentages show proportion o total deorestation emissions.

6 This wide range is a result o the act that the carbon mitigation potential o the sector varies greatly depending on the region and activities being undertaken and the pricethat one is prepared to pay.

7 This range is a result o dierent opportunity costs o land which would no longer be available or agricultural activities i deorestation was avoided.


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3.4 Concretising the asset class: What are potential

REDD and A/R activities?

Measures that could contribute to reduce emissions rom orest destruction, thus reducing carbon lossesrom standing orests, are diverse: selected examples are provided in Figure 3. These areas o activity canbe interpreted as potential targets or investment and could be delivered by a range o actors companies,government agencies, environmental NGOs or community groups each with unique nancing requirements.

Figure 3:

Example

ventures that

could be part o

REDD+ projects

Figure 4 provides examples o activities that can be undertaken as projects in the areas o aorestationand reorestation:

Figure 4:

Example

ventures that

could be part oA/R projects

3.5 Forests in the global carbon markets

Global carbon markets can be divided into two segments: the regulatory (compliance) markets and the voluntary markets. Regulatory markets include countries and organisations that have to reduce theiremissions as a result o a binding regulatory ramework, most notably as a result o emission reductiontargets established under the Kyoto Protocol. On the other hand, voluntary markets include all carbon credittrades that are not required by regulation, but which are driven by organisations or individuals voluntarilyseeking to oset their emissions.

Todays global carbon market is a patchwork o regulatory and voluntary markets. Table 1 provides anoverview o the size (in terms o both volume and value) o regulatory and voluntary markets, and thesame data or orestry-based transactions in those markets.

Large-scale,

industrial

plantations

Biomass

plantations

energy

production

Jatropha

curcas

plantations

Enrichment

planting

Small-scale

plantations by

landowners

Woodlots on

communal land

Assisted

natural

regeneration

Rehabilitation

of degraded

areas

Introducing

trees into

agricultural

systems

Restoration of

marginal areas

with native

species

Fruit orchards Coffee or cocoa plantations

Direct

compensation

payment

for less

deforestation

Community

development

and

environmental

education

Enhance

alternative

income

sources

Agricultural

extension

Improve land-

use planning

Restrict

transportation

infrastructure

Establish

protected

areas

Police against

encroachment

and illegal

logging

Reduce Impact

logging

Enhance

productivity

of forests and

agroindustry

Provide

alternative

sources of

timber

Extend rotation

age

Timber market

restrictions

Forest law-

enforcement

Introduce

improved treevarieties (e.g.

fast-growing

species


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REDDy SET GROW18

Table 1: Volume and value o voluntary and regulatory markets in general and

specifc to orestry in 2008 (adapted rom Hamilton et. al., 2009 and

Hamilton et. al., 2010). Data is provided or 2008 rather than 2009 as no

comparable data is currently available or orestry beyond 2008.

3.6 Regulatory carbon markets

Regulatory (compliance) carbon markets have emerged in response to a regulatory commitment oremission reductions that a government or other regulatory body imposes on the emitters. Market playersare primarily entities that are legally obliged to reduce emissions, although brokers, exchanges, speculatorsand a variety o supporting service providers also play important roles. Regulatory markets include thosedirectly linked to the Kyoto Protocol such as:

(1) The Clean Development Mechanism (CDM), one o the fexible mechanisms under the Kyoto Protocol. Ithas experienced signicant investment with thousands o projects under development and a market volume

exceeding USD 20 billion in 2009 (Kossoy & Ambrosi, 2010).

(2) Joint Implementation (JI), another fexible mechanism under the Kyoto Protocol. While substantiallysmaller than the CDM, it saw transactions in excess o USD 350 million in 2009 (Kossoy & Ambrosi, 2010).


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(3) The EU Emissions Trading System (EU ETS) established in 2005 as a means to help EU Member Statesmeet their Kyoto Protocol targets. Allowance trading values totalled USD 118 billion in 2009 (Kossoy &

Ambrosi, 2010).

(4) New Zealands Emissions Trading Scheme, which has covered domestic orests since 2008. However, importso orest carbon credits rom CDM or JI are not allowed.

Regulatory markets also include a series o markets which are not directly linked to the Kyoto Protocolbut to alternative regional or national compliance regimes. Most o these markets are small compared tomarkets linked to the Kyoto Protocol. They include:

(1) The Australian New South Wales (NSW) GHG Reduction Scheme;

(2) Emerging markets in North America, such as the Regional Greenhouse Gas Initiative (RGGI), and themarket linked to the Alberta-based Specied Gas Emitters Regulation (SGER).

(3) The Caliornia Global Warming Solutions Act (AB 32); passed in 2006, this Act sets the 2020 greenhousegas emission reduction goal into law, and it is likely that international REDD+ credits could be importedinto the AB 32 cap-and-trade system by 2015 (see Box 4). The Caliornian emissions trading scheme will

be established in early 2012.

3.7 Voluntary carbon markets

These have emerged as a result o organisations and individuals voluntarily deciding to oset theirown emissions. Forest-related carbon credits have played a more prominent role in voluntary markets(Box 5) than they have in the Kyoto markets. The demand on voluntary markets is driven by:

(a) Environmental concerns, as in the case o individual air travel, or a sense o corporate social responsibility. In2009, purely voluntary reasons were the driver behind at least 48% o voluntary carbon market transactions.

(b) The expectation o a uture regulatory market, with an emission reduction commitment i.e. i companiesexpect to be assigned an emissions cap under a uture market, or are speculating on that possibility. In

2009, around 23% o transactions had pre-compliance as a stated objective (EcoSecurities, 2010).


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REDDy SET GROW20

Voluntary carbon markets can be divided into:

(a) Voluntary over-the-counter (OTC) markets, which transacted 51 MtCO2e in 2009 (Hamilton et al.,

2010); and

(b) Voluntary exchange-based markets, primarily the Chicago Climate Exchange (CCX), which transacted41 MtCO

2e in 2009 (Hamilton et al., 2010).

3.8 Comparing the carbon markets

A number o reasons can be ound, both on the supply and on the demand side, to explain why orestryprojects play such a dierent role in the compliance and voluntary markets.

Supply Side:

n The scope o the CDM is limited to only allow or tree planting (A/R) activities, while the voluntary marketoers a much broader range o activities, including orest establishment (A/R), management (IFM) andconservation (REDD+);

n Transaction costs or orestry CDM projects are particularly high due to the complexity o pertinent

methodologies (Nee & Henders, 2007). The ten approved methodologies or large-scale A/R projects arehighly complex, requiring a high level o expertise and signicant amounts o data that are oten notavailable. This makes developing A/R projects under the CDM cumbersome, time consuming and expensive.These eatures cause a major bottleneck on the supply side o CDM A/R projects.

Demand Side:

n CDM rules address the non-permanence risk o carbon stored in standing trees through the issuance otemporary, rather than permanent, carbon credits; i.e., they expire ater 5 years. This was one o the reasons

why CDM orestry credits were excluded rom the EU ETS, thereby eliminating an important potentialsource o demand. Few actual transactions o carbon credits rom orestry CDM have taken place; and

prices o these have only reached ractions o the prices enjoyed or permanent CERs (USD 3-4). In act,

there are ew actual buyers apart rom the World Banks BioCarbon Fund (see Box 8), which renders pricedynamics virtually absent (Nee & Henders, 2007). In Part 2 o this study we suggest avenues to improvethe commercial viability o A7R projects under the CDM.

n A consequence o the above, and a urther challenge to A/R project developers, has been the need orsubstantial upront unding and the diculty to identiy investors or project donors at an early stage o

project development. There is a major challenge o developing innovative nancing mechanisms (e.g.private-public partnerships) or A/R CDM projects.

Voluntary markets have taken a broader and more fexible approach both to supply and demand o orestryprojects than regulated markets. Alongside the numerous eligible project types, voluntary carbon standardsavoid the concept o temporary credits and are instead testing alternative ways o insuring the permanence oemission reductions, mainly through the creation o reserve buers o carbon credits that cannot be tradedto hedge against the risk o a reversed carbon sink. The ability to generate permanent credits is a distinctmarket advantage or orestry under the voluntary compared to the CDM markets (Nee & Henders, 2007).


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This explains why orestry CDM, unlike the voluntary market, so ar has not proven very successul or asinteresting an investment opportunity or the private sector (see Boxes 4 and 5). However, several market

players see a uture role or A/R CDM post 2012 - mainly in the context o a broader land use approach,or within integrated projects complementing emerging orestry activities like avoided deorestation andmanaging soil carbon (Hamilton, 2008). A continuation o CDM A/R is only realistic, however, i a majorsimplication and streamlining o project requirements can be achieved, and demand can be created. A

sounder and more cost-eective ramework or carbon sink projects under CDM can contribute alongsideREDD+ to promote sustainable management o tropical orests through constituting a payment or theimportant ecosystem services provided by them.


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REDDy SET GROW22

4 Roles, opportunities and risks or fnancial

institutions

Using case studies, this section provides an overview o the opportunities or private nancial institutions(investors and und managers, lenders and insurers) to play a key role in the emerging orest-carbonmarket, outlining the potential risks involved and how these could be mitigated.

4.1 Roles or fnancial institutions in the orest-carbon

market

A notable eature o carbon market mechanisms is that they typically provide ex-post revenue support viathe generation and sales o some kind o carbon credit, rather than up-ront investment or climate changemitigation activities. In other words, while the mechanism can provide a new potential uture revenuestream or emission reduction or carbon sequestration activities, it is up to the private sector to source theup-ront investment and to implement the project successully over a certain period o time; only then willthey start to receive a return on their investment. In addition, generally the revenue support originates indeveloped countries with mandatory emission reduction requirements, while the investment needs are indeveloping countries.

Financial institutions (FIs) can play a vital role in overcoming the spatial and temporal mis-matchesbetween investment needs and available capital. The diagram below (Figure 5) provides a highly simpliedrepresentation o the major potential roles or FIs in the orest-carbon market.

Figure 5:

Overview o the

major potential

roles or FIs

in the orest-

carbon market


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An essential requirement or any private sector investment proposition is that the risk-adjusted returns (onthe right hand side o the diagram) should more than compensate the risk-adjusted costs (on the let handside). Thereore one o the most important drivers o success is the amount o demand rom end userso carbon credits especially governments, industry and individual consumers (FIs themselves can alsobe end users, but their demand is small relative to the whole). I there is sucient demand, then FIs can

play various roles to move capital rom developed to developing countries through brokerage and trading

unctions and rom larger to smaller scale via micro-nance structures; to bring orward capital in timethrough orms o debt and equity investment and to reduce risks through o-take agreements, guaranteesand insurance. These roles are discussed in urther detail in the sections below.

1. Investors & und managers

One option would be or nancial institutions to invest their own equity directly into orestry projects, orinto orestry project development companies or orest unds. An example o this is Bank o America MerrillLynch investing in the Ulu Masen REDD project (see Box 6), possibly a model or what may increasinglyhappen as the policy outlook or REDD+ becomes clearer.

Financial institutions can also act as intermediaries between third-party investors (whether government orprivate sector) and orestry projects, managing unds contributed by investors and nding and managingorestry projects in which to invest those unds (see example o the World Banks BioCarbon Fund as amodel or private-public partnerships in this area in Box 7 and Macquarie Banks REDD unds in Box 8).


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REDDy SET GROW24

Financial institutions can also act as intermediaries between third-party investors (whether government orprivate sector) and orestry projects, managing unds contributed by investors and nding and managingorestry projects in which to invest those unds (see example o Macquarie Banks REDD unds in Box 8).

Financing potential o orest bonds

Issuing orest bonds or nancing REDD+ and A/R would oer institutional investors a major newsustainability themed asset class. To date institutional investors have made direct investment in oreststhrough specialist orestry unds, albeit at a relatively small scale. However, while buying the shares andbonds o orest-rich pulp and paper companies oers indirect exposure at a larger (nancial) scale, it doesnt

provide the same long term investment characteristics. Increasingly, xed income institutional investors arealso looking or ways to proactively address climate change; against this background traditional allocation


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strategies are being re-examined and new products sought. Bonds markets could undoubtedly oer thescale and tenor o capital required; investor appetite or project/inrastructure, corporate and governmentbonds ar exceeds that or private equity style orest unds.

However, while most agree that orest bonds are a promising option, key stakeholders express concernsincluding how the bonds will ultimately pay o and what their value will be i there is no political agreementon the uture o REDD+ (OSullivan et. al., 2010).

Research is ongoing; over the medium to long term, material progress is closely tied to enabling conditions,in particular the uture shape o carbon markets and/or perormance related payments or REDD+, andthe role o governments in mitigating regulatory risk connected with these schemes.

One model envisages developed country governments or a multilateral institution issuing orest bondsto mobilise unds which they then pass on to developing countries in the orm o loans. To be attractivethese would clearly need to be on better terms than a beneciary could access themselves under normal,commercial borrowing market circumstances, given their credit rating. Repayment options or such abond could include a levy on insurance premiums, the auctioning rom cap and trade schemes or levieson aviation and shipping uels (OSullivan et. al., 2010). A second model under discussion would see orest

bonds issued directly by developing orest nations, either at national or sub-national level.Financing orestry through securitisation

Securitisation is another way to provide up-ront nancing or REDD+ pilot projects. Key advantages o thesecuritisation model are the possibility o raising unds through an instrument other than REDD+ credits,and to do so within an already regulated and transparent ramework. Securitisation diers rom bondissuance in one important respect; investors buying asset-backed securities (the product o a securitisationdeal) directly invest in the asset or group o assets nancing the repayment. By contrast, bond investors arecreditors o the issuer and they are not necessarily repaid rom the cash-fows o the underlying, nancedasset. The advantage o using asset-based rather than, or instance, themed sovereign bonds is that the

ormer could be packaged by any investors, or project sponsors themselves in a fexible, decentralised,

disperse and needs-driven ashion

The disadvantages and barriers o securitisation in this context relate to the question o whether investorswould be prepared to take on the risk associated with REDD+ securities which are not issued by a sovereigncountry. Investors such as pension unds may not be allowed to invest in such high-risk instruments. Asa result o this risk, it is likely that securities would be listed at a highly discounted price, which wouldrepresent considerable value lost or REDD+ given the high cost o capital or the provision o uprontnance (OSullivan et. al., 2010).

Securitisation can be attractive i an asset or group o assets can be structured to operate successullyindependent o their originating entity. Underlying security and cash fow oered by the assets (and correlationbetween individual assets) are undamental considerations in determining the viability o a securitisation.

An eco-securitisation o uture REDD+ carbon revenue or perormance based payments would likely involveassigning rights to a third party special purpose vehicle, which would in turn issue a series o REDD+ notesor orest-backed securities tradable in national or international capital markets.


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REDDy SET GROW26

2. Lenders

Banks and other lenders may be involved in lending to orest companies, leveraged unds or individualprojects on a non-recourse basis, where the returns and expected cash fows are commensurate with theirlending criteria. Debt nance can be particularly important or A/R projects, where most o the capital isrequired up-ront (or planting and establishment) and returns are spread over long periods o time (asthe trees grow). Many dierent sorts o debt instrument can be oered, rom conventional senior debt

secured over assets such as land or a uture stream o carbon credits (see Box 9 below), to more innovativemezzanine products such as convertible loans which revert to equity under certain conditions.

Microfnance

One o the key challenges or REDD, in particular, is how to set up a sustainable, long-term ramework ormaking small compensation payments to thousands o individual orest dwellers. Similarly, orest protectioneorts may depend on extending small amounts o credit to smallholders to help them establish alternativelivelihoods that do not involve deorestation or orest degradation. Micronance institutions could play animportant role in providing the necessary micro-payment and micro-credit inrastructure to support REDD.

As yet, there are relatively ew examples o this occurring in practice, but a pioneering model o how thiscould be achieved is described in Box 10.


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3. Insurers/guarantors

Financial institutions can play a crucial role in improving the viability o orestry projects by providinginsurance products to cover, or example, the risk o physical damages resulting in increased emissions orreversals o carbon storage, or to back-up a credit buer set aside or a similar purpose.

As previously noted, the CDM deals with the risk o non-permanence o carbon sequestered in A/R projects

by issuing temporary credits which require periodic renewal. This characteristic o CDM A/R credits severelydepressed demand, whereas demand has remained strong or voluntary market A/R credits such as those

rom the Veried Carbon Standard (VCS), which issues ully ungible, permanent credits, but requires sellersto put aside a buer o credits which goes into a global shared insurance pool. The advantage o this buerapproach - over temporary crediting - lies in its simplicity and ecacy in attracting investment, such asthe NedbankWildlie Works REDD project described in Box 11. Alternatively, the insurance provided by acredit buer could be provided perhaps ar more eciently by nancial products issued by insurers. The

Veried Carbon Standard Association is currently investigating the potential to allow the use o insuranceproducts to back up a credit buer system in this way - see Box 12. Forest insurance is thereore a largelyuntapped opportunity, and the climate change challenge creates a very strong stimulus or the insuranceindustry to unleash innovation in this emerging market8.

8 UNEP FI. 2008. Making Forests Competitive: exploring insurance solutions or permanence. UNEP FI Climate Change Working Group and UNEP FI Insurance Working Group.


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REDDy SET GROW28


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Insurance is a potentially useul tool or mitigating investment risk in the orestry sector. A number oorestry insurance providers exist (see or example Forum or the Future & EnviroMarkets (2007)), thoughthey have so ar primarily ocused on known and measurable risks such as natural events, as opposed toREDD-specic risks (such as the risk o leakage and credits not being issued to a particular project dueto an increase in emissions elsewhere in the country). Experience in dealing with risks specic to REDD+activities and mechanisms is still limited and insurers will nd it dicult to put together actuarial models

or this due to a lack o inormation (OSullivan et. al., 2010). As scale is important to insurers (the largerthe scale, the easier it is to insure because it becomes more straightorward to balance risks and probabilitiesand hence to budget appropriately or payouts), it is likely that insurers will ocus on larger areas, or even

whole countries and regions. Insurance companies currently engaging with REDD+ include ForestRe,MunichRe and SwissRe (OSullivan et. al., 2010).

Guarantees

Guarantees can orm a valuable tool or mitigating risks and encouraging FI involvement in orestry projects.Guarantees can cover a number o risks and are especially useul or managing government-related risks(such as government implementation risk and country risk). Guarantees can range rom unconditional

perormance guarantees to limited guarantees that cover specic events, are limited by time and/or

capped at a certain amount (OSullivan et. al., 2010). Guarantees are typically provided by host countrygovernments (sovereign guarantee) and/or multilateral institutions such as the World Bank, MIGA andregional development banks. An example o what REDD+ guarantees can look like is provided in Box 13.

One o the key disadvantages o guarantees is that they only deal with the symptoms, rather than tacklingthe root causes o the risks and as such cannot constitute a viable long-term solution (OSullivan et. al.,2010). Another shortcoming is that the scope or guarantors to issue guarantees is limited by their abilityto cover the potential liability i those guarantees are called upon (Nee and Ascui, 2009).

4.2 Opportunities: why should fnancial institutions be

interested in the orestry sector?

The orestry sector, and REDD and A/R in particular, could be o interest to FIs or the ollowing reasons(OSullivan et. al., 2010; Strecket. al., 2010):

1. Proft. Aside rom traditional orest gains, such as through timber and non-timber orest products, newprots can be made in the sector through the generation and export o carbon credits. In the orest sectorthis is at present largely limited to voluntary carbon markets which are small in size and weak in prices.

The potential is expected to signicantly increase, however, i carbon credits rom avoided deorestation arerecognised in regulatory markets post-2012. At present, only such credits rom the creation o new orests(aorestation and reorestation) are tradable on ocial, regulatory markets.


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REDDy SET GROW30

2. Diversifcation. Forest-based climate mitigation investments can constitute a viable opportunityor risk management by diversiying investors portolios, including such portolios with an exposure tothe orestry sector. Forest carbon prices are unlikely to be highly correlated with (or example) pulp ortimber prices (at least initially as there is more competition or limited resources, prices could becomeincreasingly correlated).

3. Compliance. Financial institutions or their clients may have emission reduction targets that they need

to meet (or example in Kyoto Protocol Annex I countries), or they may expect such targets to be imposedin the uture (or example in the case o a number o states in the USA). Investing in orestry can help meetthese targets now (through A/R projects), or in the uture i REDD+ is recognised in compliance markets.

4. Corporate social responsibility (CSR). Financial institutions or their clients may beinterested in demonstrating CSR through a nancially competitive investment which, in addition, yieldsenvironmental and social returns. Such non-nancial returns can be capitalised on via marketing andinstitutional positioning. Forestry projects can have especially interesting characteristics as they oten resultin a wide variety o signicant sustainability benets alongside reductions in greenhouse gas emissions.

5. Broader sustainability. Forestry investments can indirectly lead to the provision o a variety o

ecosystem services and sustainability benets next to emissions reductions. These include enhanced water-cycle management, the retention o valuable soil, and landscape protection. Despite the current lack osystems o payments or ecosystem services revenue streams, these could lead to additional returns in the

uture, once such systems are established. The overall market value o payments or water-related ecosystemservices and other ecosystem services were estimated at USD 5.2 and USD 3 billion in 2008, respectively(TEEB, 2010).

4.3 Risks identifed in orest-carbon market activities

Forest-based mitigation activities are exposed to a number o risks which have acted and can continue toact as deterrents to nancial institution involvement and investment. Key risks can be grouped into three

main categories (Forum or the Future & EnviroMarkets, 2007):

1. Political risks (P), including:

(1) International policy risk For example, the risk that an international REDD+ agreement does notenter into orce and as such there is no compliance market (at least at the UNFCCC level) or REDD+credits. While this policy risk would not directly aect the voluntary markets, the latter is tightly linked tothe compliance market and demand therein will also likely all i there is no international agreement onREDD+ (OSullivan, Streck, Pearson, Brown, & Gilbert, 2010).

(2)Eligibility risk The risk that a country, region or project type is not allowed to participate in a REDD+scheme as a result o an international or bilateral agreement (OSullivan, Streck, Pearson, Brown, & Gilbert,

2010).

(3) Government implementation risk The country does not successully implement a REDD+ strategy andas such the ramework conditions or REDD+ project implementation are not in place (OSullivan, Streck,Pearson, Brown, & Gilbert, 2010).

2. Market risks (M), including:

(1)REDD+ credits traded at a very low price - This could happen i, or example, too many REDD+ credits areallowed to enter the market, or i emission reduction targets are not set suciently high (Streck, Lehmann,Rau, & Coren, 2010).

(2) Carbon market specic regulatory risks Any perormance-based payment system where both demand

and supply are created by government regulation will inevitably be subject to a number o unique regulatoryrisks, much like the risks currently aecting investments in the CDM (Ascui & Moura Costa, 2007). Theexperience o CDM A/R suggests that the way in which the potential non-permanence o orest carbon is


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dealt with rom a regulatory and carbon accounting perspective can make or break investment in thesector (Nee and Ascui, 2009). An equivalent challenge or REDD could be what has been termed nationalbaseline risk i.e. the risk that a well-perorming sub-national project will not receive credits due to poor

perormance elsewhere in the country aecting the national baseline (Nee and Ascui, 2009).

Other REDD-specic risks might be associated with the rules or establishing (and possibly updating) national,regional or project-level baselines, the rules or measurement, reporting and verication, international

rules or the transer or use o credits and liabilities or error, raud or other actors ater transer o credits.

3. (General) business risks (B), including:

(1)Natural events or example re, wind, pest and disease;

(2) Country risk or example, political stability and security, non-carbon specic regulation and taxation,nancial markets, quality o inrastructure and human resources (Forum or the Future & EnviroMarkets,2007).

(3)Social risk Forest-based mitigation activities involve new relationships and nancial fows that are likelyto change the lives o some o the worlds poorest smallholders and orest dwellers. This may lead to unique

risks associated with social conrontations.

4.4 Risk mitigation measures

A number o risk mitigation measures can be taken by both FIs and policy-makers to make orest-basedmitigation activities investable, as illustrated in Table 2 below.


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REDDy SET GROW32

Table 2:

Risks and risk

mitigation

options to make

orest-based

mitigation more

attractive to FIs

(OSullivan et.

al., 2010).

P Political risks

M Market risks

B General business risks


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5 Conclusions

This report provides an analysis o the opportunities, risks and roles or nancial institutions (FIs) inthe area o orest-based climate change mitigation. The orest-carbon market is attractive to both

private sector actors, including nancial institutions, and policy makers due to its large potential or abatingcarbon emissions in a cost-eective way, while providing an opportunity to achieve substantial co-benets

or biodiversity conservation and human development.

While the orestry sector presents new business opportunities or the private sector, a lack o both nationaland especially international regulation, as well as modalities that are not particularly riendly to the privatesector, has meant that nancial institutions and other private actors have been slow to get involved; high

perceived levels o risk and a general lack o awareness o the opportunity have also added to the problem.However, with the right actions, regulations and modalities, policy makers and the private sector can ensurethat orests and their services are attributed their true value and that investment at the needed scale is rapidlymobilised or meaningul reductions in deorestation and orest degradation and increases in reorestationand sustainable orest management.

Key messages and conclusions or nancial institutions

n Currently, orestry projects are underrepresented in the CDM market (only 1% o the pipeline). This isrelated to the scope o orestry being limited to A/R activities in the CDM, the temporary nature o carboncredits that orestry projects can generate and the limited demand or them, due to their current exclusion

rom the EU ETS. In the voluntary market, on the other hand, orestry projects are well represented (24%o 2009 transaction volume) and there is high demand or them.

n There is still uncertainty about the orm o a uture REDD regime, which will depend on an international

agreement being reached in the context o post-2012 climate negotiations. However, a number o activities(mainly REDD-readiness and pilot activities) are underway across the developing world and are beingnanced primarily through multilateral and bilateral public sources. It can be expected that - other than

or capacity-building, preparatory and pilot activities - public unding will not be sucient to implementREDD+ projects and programs at the needed scale and speed.

n Financial institutions can take and are already taking important roles in getting orestry projects o theground. Key roles that FIs can assume include or investment managers to invest their own unds into

orestry projects, orestry project development companies and orest unds or act as brokers or intermediaries.Debt nance can take the orm o lending to orest companies, leveraged unds or individual projects on anon-recourse basis. Insurance and guarantees are a crucial way to manage both conventional investment

risk in the orestry sector, as well as such risks which are more specic to orest-carbon endeavours.

n FIs interest in the opportunities oered by REDD+ is due to the potential or prots, portolio diversication,compliance, CSR, broader sustainability and political imperatives.

n Key risks that FIs will need to ace when investing in REDD+ include political risks, such as internationalpolicy risk, eligibility risk, government implementation risk; market risks, such as a low price or REDD+credits and carbon market-specic regulatory risks; and other more general business risks such as naturalevents, county and social risks

n There are a number o tools are available to FIs that can help mitigate the risk associated with orestryprojects. These include guarantees, insurance, (orest) bonds and securitization.

n In order to be interesting to FIs, orest-based mitigation activities need to contain elements that guarantee:


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REDDy SET GROW34

n Return on investment commensurate with the risk.

n Transparent and ecient procedures or gaining government approval o REDD+ initiatives, projectsand activities.

n Clarity on ownership, acquisition and transer o orest carbon asset rights, including the potential toseek leases, concessions, or other recognized interests or securities in land or orest that are consistent

with REDD+ project lie periods.n Investment laws or guarantees granting assurance that REDD+ credits or investments will not be subject

to expropriation by host countries.

n Decisions on government levies or taxes on REDD+ credits or prots, or any de minimus nationalrequirements on benet sharing.


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Acknowledgements

About the UNEP FI

The United Nations Environment Programme Finance Initiative (UNEP FI) is a global partnership betweenthe United Nations Environment Programme and the private nancial sector. UNEP FI works closely withthe nearly 200 nancial institutions that are Signatories to the UNEP FI Statements, and a range o partnerorganisations, to develop and promote linkages between the environment, sustainability and nancial

perormance. Through regional activities, a comprehensive work programme, training activities and research,UNEP FI Carries out its mission to identiy, promote, and realise the adoption o best environmental andsustainability practice at all levels o nancial institution operations.

About the Biodiversity & Ecosystem Services WorkStream (BESWS)

The Biodiversity & Ecosystem Services Work Stream (BESWS) is based on the need to engage the nancialservices sector in identiying and addressing the challenges arising rom the loss o biodiversity and thedegradation o ecosystem services.

About the Climate Change Working Group (CCWG)

UNEP FI channels its work on climate change through the Climate Change Working Group (CCWG). TheCCWGs membership is diverse, ranging rom banks, over insurers and re-insurers, to capital market actors,

with a wide array o knowledge and expertise and open to all regions o the world.

This study was commissioned to EcoSecurities.

Authors: Marianna Doria and Francisco Ascui, with inputs rom Robert Tippmann, Jan Fehse and SabineHenders.

Project Team at the United Nations Environment

Programme Finance Initiative (UNEP FI)

Head o Unit: Paul Clements-Hunt

Project Lead: Remco Fischer and Ivo Mulder

Project Team: Jessica Boucher and Jenny Lopez

The study was independently reviewed by

EnviroMarket.

Project Manager: Simon Petley


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REDDy SET GROW36

UNEP FI would like to thank the ollowing individuals or actively contributing

to the success o this publication: Martin Ewald and Katharina Lati - Allianz ClimateSolutions, Matt Hale Bank o Americal Merrill Lynch, Christian Delvalle BNP Paribas, Ravi Prabhu UNEP, Daniele Welsh VicSuper Pty Ltd.

The ollowing fnancial institutions are members o UNEP FIs BESWS: ANZ,ASN Bank, Bank o America Merrill Lynch, Banque Fdrale des Banques Populaires, Barclays, Bayern LB,

Calvert, Citigroup, Connexis, Credit Suisse, Development Bank o Southern Arica (DBSA), Earth CapitalPartners (Chair), F&C Asset Management, HypoVereinsbank / UniCredit Group, ING, JPMorgan Chase & Co.,KW Bankengruppe, KPA Pension, Nedbank Ltd, Nikko Asset Management Co. Ltd., Rabobank Netherlands,Sustainable Development Capital, LLP, Sumitomo Trust, VicSuper Pty Ltd.

The ollowing fnancial institutions are members o UNEP FIs CCWG: AccessBank, Allianz, Aviva, Axa, BoA Merril Lynch, Calvert, CarbonRe, Chartis Insurance, Deutsche Bank (Co-Chair), Development Bank o Southern Arica, Ecobank, HSBC (Co-Chair), IL&FS, ING, JBIC, KW, LaCompagnie Benjamin de Rothschild, Munich Re, Pax World, SAM, Societe Generale, Standard Bank,Standard Chartered Bank, Swiss Re, UBS.


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Appendix 1: Bibliography

Ascui, F., & Moura Costa, P. (2007). CER Pricing and Risk. Equal Exchange: Determining a Fair Price or Carbon. G. Hodes &

S. Kamel (Eds.), Roskilde, Denmark: UNEP Risoe Centre.

Aulisi, A., Sauer, A., & Wellington, F. (2008). Trees in the Greenhouse: Why Climate Change is Transorming the Forest ProductsBusiness. World Resources Institute (Figure 3).

Bendana, M. (2010). What does Copenhagen mean or the private sector in REDD+?. Available at: http://www.ecosystemmarketplace.com/pages/dynamic/article.page.php?eod=1&page_id=7398&section=news_articles

Betts, R., Gornall, J., Hughes, J., Kaye, N., McNeall, D., & Wiltshire, A. (2008).Forests and Emissions: A contribution to theEliasch review. Available at: http://www.metoce.gov.uk/climatechange/policymakers/policy/eliaschreport.pd

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