IFF Loan guarantees 07 1
An interim strategic
intervention for REDD+:
loan guarantees
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
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.
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).
1
2
http://www.prweb.com/releases/forest_products_paper/
wood_and_wood_products/prweb9190684.htm
Moral hazard describes the situation where actors could be incentivised
to lend to riskier counterparties than they would under normal
conditions as someone else will pay for the costs of any defaults
• 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.
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 iffmanagement@globalcanopy.org.
intervention for REDD+:
loan guarantees
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
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.
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).
1
2
http://www.prweb.com/releases/forest_products_paper/
wood_and_wood_products/prweb9190684.htm
Moral hazard describes the situation where actors could be incentivised
to lend to riskier counterparties than they would under normal
conditions as someone else will pay for the costs of any defaults
• 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.
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 iffmanagement@globalcanopy.org.