Armando Cuichán / La Imagen Libre

 Photo: Armando Cuichán / La Imagen Libre. NJP Ecuador (Programa Nacional Conjunto ONU-REDD Ecuador).

perspectives  Fischer cropRemco Fischer, Programme Officer, Climate Change, UNEP Finance Initiative

There are grounds for cautious optimism as world governments intensify their efforts to achieve a global agreement on climate change at the UNFCCC Conference of the Parties 21 (COP21) which will be held at the end of this year in Paris. These efforts could lead to a global deal aimed at effectively tackling climate change and, with it, address not only greenhouse gas (GHG) emissions that result from the combustion of fossil fuels, but also emissions due to deforestation and forest degradation.

One reason for optimism includes the recent agreement between China and the United States, which heralds the importance of global decarbonization by the world’s two largest GHG emitters and ensures that both assume a leading role in these efforts. Equally encouraging is the current determination among rich countries to adequately provide capital to the Green Climate Fund (GCF), with a view of supporting developing countries in embarking on “climate-compatible” – meaning low-carbon and climate-resilient – development paths.

Ultimately, success in Paris will largely depend on progress and agreement on the issue of climate finance, as well as the prospect of mobilizing it at the pace and scale required. Equally, lasting, sustainable success in accomplishing REDD+ objectives will depend on the availability of financial resources required to effectively shift land-use behaviour from conventional, high-deforestation patterns towards smarter, more sustainable, low-deforestation patterns that support livelihoods and green growth.

In the financial arena, there is now more than ever a shared understanding that in order to tackle climate change – and with it REDD+ and sustainable land-use challenges – a major mobilization, or “re-channeling”, of private finance will be required. The underlying rationale is simple: tackling climate change, of which REDD+ is a significant component, requires a transformation of common business practices in the private sector. This in turn requires unprecedented investment at a scale which can and should only be financed privately.

It should, however, be noted that this does not make the role of public finance any less important. The misconception of a rivalry between public and private finance has inhibited progress in these discussions for a long time. Mobilizing private finance of the right scale requires bold public action, be it of a regulatory, legislative, and/or jurisdictional nature. All public action, in turn, requires both public investment and finance. However, as is often the case, public finance is scarce.

Therefore, for both the UNFCCC and GCF, a central question on REDD+ finance should be focused on how scarce public finance can best be used to achieve the greatest possible impact in terms of verified reductions or removals of forest carbon. For the reasons mentioned above, it is clear that the notion of unlocking private REDD+ finance will have to play a central role one way or another. The good news is that both the GCF’s mandate and its emerging design are explicitly geared towards this thinking. This is made clear by the existence of a Private Sector Facility as well as a Private Sector Advisory Group. The question again is “how?”. What are the “interventions” that the GCF should take, the instruments, facilities and mechanisms it should deploy, to achieve an unlocking of private REDD+ finance?

International negotiations have started to yield encouraging answers but many more are needed. In finding answers, the following aspects/questions should be taken into consideration:

Results-based payments are essential for a business case for private REDD+ investment

Private finance, mostly in the form of debt and equity, will always be available for activities that offer a competitive rate of risk and return. In fact, due to this reason, commercial land-use actors often have no difficulty in securing finance to implement such activities that contribute to deforestation or forest degradation. What is wrong then with the risk-return ratio of activities that reduce deforestation? One immediate impediment is that activities at the very core of REDD+, namely the simple act of leaving a forest standing (basic “forest conservation”), often generates no, or an unattractive, direct return compared to many alternative land uses (e.g. agriculture, mining, real estate development). There will never be “naturally occurring” financial revenues and with them a “naturally occurring” financial return associated with conserving forests. An exception may perhaps be found in business models based on ecotourism and non-timber forest products. The consequence is simple: “no revenue” equates to “no return”, which equates to “no entrepreneurial interest in pursuing the activity”, which ultimately equates to no demand for debt or equity investment. From the perspective of commercial land-use actors, no clear business case exists for REDD+ captured by traditional economic measures — at least for forest conservation REDD+ activities.

It should be noted that a robust business case articulated in a language that resonates with the relevant stakeholder is important to more than just commercial land-use actors. National governments of developing countries are likely to share this sentiment and their train of thought will be similar: that “no revenue” equates to “no jobs-creation”, and to “no tax generation”, and to “no poverty alleviation”. It is obvious that this local perception is in stark contrast to the more international perspective that an overwhelming economic case for effective climate change mitigation and the protection of tropical forests globally exists.

Tension does exist between the interests of the global community in a stable climate and the priority of developing countries to alleviate poverty by rapid economic growth through the full exploitation of natural resources including land surface. This tension, when coupled with the absence of a naturally occurring financial return on forest conservation, becomes quite telling with regards to interventions that the GCF should prioritize when aiming to unlock not only private financial flows of debt and equity for REDD+, but — even more importantly — private sector entrepreneurial initiatives. It becomes hard to conceive an international financial framework for REDD+ that is not built around a robust global mechanism for results-based payments. Such payments would then be funded by the wealthier countries in the Climate Convention and disbursed to developing forest countries that demonstrate positive REDD+ performance. Ultimately, they would provide the basis from which financial revenues for forest conservation (and the required lessening of agriculture- and commodity-related pressures on forest frontiers) could be derived, and financial returns for commercial actors generated, which, in turn, would unlock private-sector engagement and investment in REDD+.

Results-based payments are necessary but likely to be insufficient

This highlights the relevance and appropriateness of both theUNFCCC’s Warsaw Framework on REDD+ as well as the subsequent Logic Model for REDD+ Results-based Payments for the GCF, from the perspective of a mobilization of private REDD+ finance. But while it is true that a reliable and efficient system of ex-post results-based payments is a necessary condition for the required paradigm shift in commercial land-use patterns, it is unlikely to be a sufficient condition.

The reasons for this include, firstly, the risk side of the equation (given that performance-based payments only address the return side of the equation). Secondly, the fact that addressing, more systemically, commodity-related drivers of deforestation may require a greater array of public interventions to remove a greater and complex array of barriers in developing countries, beyond the mere prospect of there being results-based payments at the end of the tunnel. Lastly, one has to put into perspective the overall volumes of performance-based payments required in the REDD+ space. In the past, these have been estimated at roughly US$ 20 – 40 billion per year, which is several times the total capital that, for instance, the GCF has secured to-date from donor governments or the cumulative scale of REDD+ finance pledged to date (which is around US$ 9 billion).

Prohibitive risks associated with commercial REDD+ activities can easily inhibit private sector investment even in the presence of financial revenues associated with them. Examples of risks that are typical of investments in many developing countries are overall country and political risks, currency risks and, importantly, policy and regulatory risks, including those associated with land-use and REDD+ related policy frameworks nationally. The latter will be of particular potential detriment to private investment, given that it will be precisely through such national policy frameworks that international results-based payments will, in a second step, be passed on to the implementers of the underlying REDD+ activities on the ground, including private sector actors and financiers. If these frameworks are perceived to be opaque and risky, then private investment will not flow, whether an international system for results-based payments is in place or not. Therefore, helping mitigate, reduce and transfer such risks should be a complementary objective of the GCF, especially through its Private Sector Facility. This could occur by replicating, or by expanding and strengthening existing instruments such as those provided by the multilateral investment guarantee agency, and by tailoring those to the needs of land-use actors in the private sector and their investors.

The need for a nuanced discussion on financial needs for REDD+, barriers to private finance and the required public interventions

Lastly, there are, beyond risk and return, many other barriers that keep commercial land-use actors from changing behavior. These barriers also prevent the providers of capital from re-channeling investment from unsustainable to sustainable business models, and they will be different from one activity type to another. Barriers faced by the proponents of reforestation and afforestation activities are likely to be different from those faced by actors working towards land-efficiency gains in agricultural production, which are in turn likely to be different from those embracing sustainable approaches to forest management. Understanding and considering these nuances is important when designing public interventions aimed at removing barriers. One of UNEP Finance Initiative’s 2015 objectives in the REDD+ and land-use domain sheds light in this area, having developed a study on Demystifying private REDD+ finance — to be published later this year as a follow-up report to the first iteration titled Demystifying private climate finance launched at COP21 in Lima.