UNLOCKINGFOREST BONDS
A HIGH-LEVELWORKSHOP ON
INNOVATIVEFINANCE FOR
TROPICALFORESTS
Workshop Report

Hosts

Financial Partners

Acknowledgements
Unlocking Forest Bonds was a workshop hosted by the WWF
Forest & Climate Initiative, Global Canopy Programme (GCP)and Climate Bonds Initiative on 25 February 2011 in London.
The hosts are very grateful to all those who attended for their
participation and to the organisations that supported theevent. The financial partners of the workshop were Goldman
Sachs and Fondation 1796 (Lombard Odier) and support for
GCP’s participation was provided by the Prince Albert IIof Monaco Foundation and British Airways. The hosts also
thank Simon Petley (EnviroMarket Ltd.) for providing atechnical review of this report, Melissa Tupper (WWF Forest& Climate Initiative) for providing an editorial review andNiki Mardas (GCP) for support in editing and designing thereport. Finally, a special thanks to Mandar Trivedi (GCP) for
his support in both organising the workshop and producing
this report.
For more information email m.cranford@globalcanopy.org
or ihenderson@wwf.org.hk
Citation
Cranford, M., Henderson, I. R., Mitchell, A. W., Kidney, S.
& Kanak, D. P. 2011. Unlocking Forest Bonds: A High-Level
Workshop on Innovative Finance for Tropical Forests,
Workshop Report. WWF Forest & Climate Initiative, Global
Canopy Programme and Climate Bonds Initiative.
Disclaimer
This document reports on the discussion that took place
during the workshop and does not necessarily represent
the views of the workshop hosts or financial partners. It
reports on the broad variety of presentations, experienceand views put forward by workshop participants. Some
additional background research was carried out to fill gaps in
information and provide a coherent synthesis of the workshop.
The workshop took place under the Chatham House Rule.
Note on terminology
The term “forest preservation” is used throughout thisdocument to collectively refer to the five types of activity tosustain forests: forest enhancement, avoided deforestation,
avoided forest degradation, sustainable management offorests and conservation of forest stocks.

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CONTENTS

5		 SCALING UP FOREST FINANCE
6		 EXECUTIVE SUMMARY
8		 INTRODUCTION
		WORKSHOP TOPICS
10 BUY-SIDE PERSPECTIVE
13 SELL-SIDE PERSPECTIVE
16 RISK MITIGATION
19 FOREST COUNTRY PERSPECTIVE
21 DONOR COUNTRY PERSPECTIVE
23 END NOTES
24 REFERENCES
		
25 PARTICIPATING ORGANISATIONSPhoto: © Roger Leguen/WWF-CanonSCALING UP FOREST FINANCE
STATEMENT FROM THE WORKSHOP HOSTS

Tropical forests contain more than half of all terrestrial life on
Earth. [ 1 ] The biodiversity and ecosystem services these forests
support are economically valued in the order of trillions ofdollars annually [ 2 ] and underpin climate, food, energy, water,
health and livelihood security for millions of people across theglobe. Yet the rate of forest loss “is still alarmingly high”. [ 3 ]The importance of forests has received increased
attention in recent years, particularly through international climate change negotiations and efforts to develop amechanism for reducing emissions from deforestation andforest degradation and conserving, sustainably managing
and enhancing forest carbon stocks (collectively referred
to as REDD+). One recent estimate suggests that the scaleof financing required to halve deforestation will increaseover the current decade, reaching US$30 billion annuallyby 2020. [ 4 ] Forest finance therefore must increase dramatically to achieve the goals of the UN Framework Convention
on Climate Change (UNFCCC) as well as those of the UN
Convention on Biological Diversity (CBD), Millennium
Development Goals (MDGs), and other national and international agreements. Donor countries are unlikely to havethe resources or political will to act alone and provide thefull level of finance required. Because of this, new strategies
are urgently needed to use the limited public funds
available to the greatest effect possible.
One such strategy could be the use of bonds to help
finance forest preservation. With large-scale investments incritical services, such as energy or transport infrastructure,a public-private partnership is often established to balance
the risks and rewards between the public and private sector
and finance the investment at least in part with a bond.
There are many common characteristics between thesetypes of built infrastructure investments and investmentsin ecological infrastructure such as tropical forests. In
particular, both require large upfront capital expenditures.
Recognising these similarities, for half a decade theDonald P. Kanak
Senior Fellow, Harvard Law School
Program on International Financial Systems
Former Chair,
WWF Forest & Climate Initiative

forest finance community has been developing the conceptof forest bonds as a tool for financing forest preservation. Lessons have been drawn from precedents set inother sectors that face similar funding challenges, such as
healthcare, where bonds have been successfully used toraise billions of dollars. [ 5 ] Although the idea has faced many
hurdles, the first rainforest bond is poised to be issued
soon. [ 6 ] If forest bonds prove successful, an urgent focus on
further developing this financing strategy will be required
to increase the scale of financing for REDD+.
Unlocking Forest Bonds was a high-level workshop
held to discuss the necessary conditions for bonds tobecome a useful large-scale financing mechanism in theeffort to save tropical forests. Hosted by WWF’s Forest &Climate Initiative, the Global Canopy Programme and the
Climate Bonds Initiative, the workshop brought together
international experts in forest finance and related areas
including government representatives, NGOs, forest project
developers, forest financiers and consultants.
Unlocking Forest Bonds set out to identify the issues,
obstacles and critical steps to making forest bonds work
for all stakeholders. This report synthesises the discussionthat took place at the workshop. Although bonds were thecore topic, a wide range of issues related to scaling up forest
finance was discussed. Accordingly, the workshop outcomesare not limited to forest bonds alone but are broadly relevant
to efforts to leverage private-sector finance for forests.
The need to scale up forest finance is unequivocallyurgent, not only to combat climate change and provide
a host of ecosystem services the world depends on, butalso to secure a prosperous future for the world’s forested
countries. We hope that this report helps communicate
some of the remaining obstacles and how to deal with them.
Though the challenges are great, they can be overcome, and
it is in all our interests to do so.

Andrew W. Mitchell
Founder and Executive Director,
Global Canopy Programme

Sean Kidney
Chair,
Climate Bonds Initiative

5

EXECUTIVE SUMMARY

To reach the scale of finance needed to combat climatechange, protect and manage forests, and maintain theworld’s natural capital, increasing engagement with theprivate sector is necessary. That engagement can come inmany forms, and bonds are one option. By using publicfunds to support private-sector investment in forests,
bonds could leverage additional finance from global capital
markets. Although forest bonds alone are not the solution
to saving the world’s tropical forests, they could play animportant role in catalysing the scale of financing needed totackle global forest loss.
Time is fleeting, scale is essential
Two fundamental issues for financing forest preservation
are time and scale. Time is a concern because the longer wewait, the more forest we lose. This increases greenhousegas emissions and biodiversity loss while degrading the
livelihoods of forest-dependent communities and reducing
the provision of other ecosystem services, vital on local to
global scales. All of these effects reduce the resilience offorests and the broader economic-ecological systems that
depend on them, increasing the risk of irreversible forest
loss and long-term damage to the global economy.
The scale of financing is important for three reasons.
First, the challenge itself is large and requires significant
levels of finance to overcome. Second, investing at scale
can reduce the risk of investing in one place and simply
displacing forest degradation across a given forest
landscape. Investing at scale can also target multiple typesof investment: multiple sectors that directly and indirectly
impact forests must be improved to protect forests fromwithin and reduce the external drivers of deforestation.
Third, the investment proposition needs to be large andliquid in order to attract the largest investors.
Why bonds?
Forest bonds can play a powerful role in financing forest
preservation as the policy landscape, globally and withincountries, takes shape. The issuance of bonds directly
addresses the concerns of time and scale, enabling issuers
to raise large-scale finance now that will be repaid byexisting and anticipated future income. Importantly,
bonds are also a familiar and proven mechanism forleveraging private-sector finance; they have been used6

to finance public-private partnerships around theworld that have invested in infrastructure, development
and health.
Carbon finance is a key opportunity, but demandis weak
Prospective issuers of forest bonds will need to convince
investors that the cash flows they plan to pay the bondback with are sufficiently secure and predictable. Carbon
markets are an important source of cash flows that could
be used to back a bond, but they are not yet reliable enough.
Lack of regulatory certainty within the UNFCCC and theabsence of demand from large compliance markets suchas the European Union’s Emissions Trading Scheme (EUETS) cast doubt on future income from regional or global
compliance carbon markets. Demand for forest carbon
through smaller markets, such as the California cap-andtrade programme or the voluntary carbon market, offerssome potential for return on forest investments now and isuseful in the context of a broader range of income streams.
A range of income streams could support a forest bondForest bonds should not rely solely on forest carbon
revenue and could potentially be linked to income fromother ecosystem service markets (e.g. water, biodiversity),sustainable timber and agricultural markets, regulation(e.g. taxes, liability regulation), and forest-friendly lending(e.g. to ecosystem-dependent small- and medium-sizedenterprises). Although some of these cash flows could comethrough voluntary markets and actions, support from thepublic sector through regulation or other commitments
will be needed to ensure that these cash flows materialise,
making forest preservation an attractive investment.
The investment proposition must be attractive
to investors…
Impact investors and other socially responsible financiers
target clear social and/or environmental returns alongside
financial returns. They may be willing to sacrificefinancial returns for social and environmental returns
and potentially compromise in other areas, like secondary
market liquidity. This could make these investors the ideal
pioneers in a new asset class like forest bonds. Larger insti-

tutional investors such as pension funds will generally
not be able to sacrifice financial returns for other formsof return due to their fiduciary duty. Yet, under the rightconditions, larger institutional investors could be interested
in forest bonds. Forest bonds should target impact andsocially responsible investors initially, while the market
develops, then begin to target institutional investors as
the forest bond market deepens. A tranche structure withdifferent risk/return profiles could also be used to simultaneously appeal to both groups.
…and equitable for all stakeholders
Forest preservation involves multiple stakeholders, including
private investors, public-sector funders, regulated businesses
and, importantly, the people whose livelihoods and well-being
depend on forests. To be successful, a forest-financing
strategy that leverages private-sector finance must ensurethat benefits are equitably shared amongst all stakeholders,rather than accruing as profits to the private sector alone.
Private investors that provide capital deserve an appropriate
return for the risk to which they are exposed, but if theyreceive a disproportionate return, the entire approach toforest finance could be undermined, particularly in the eyesof forest countries and communities.
Balancing risks and rewards among different actors isonly feasible with political will and a strong policy frameworkin place. Examples of these conditions are beginning toemerge, particularly at the sub-national level. Amazonian
states, such as the State of Acre, have developed or aredeveloping strong statewide frameworks to recognise themultiple values of their forests and to establish the policies,
institutions and public-private partnerships to secure thatvalue by investing in both forest protection and reducing thedrivers of deforestation.
Improved access to finance for eco-entrepreneurs
may be needed
In some cases, the first issue to resolve will be how to makeit possible for enterprises, communities and households toaccess the finance they need to shift towards more forestfriendly livelihoods and land uses. Such activities often
require greater upfront expenditures than non-sustainable
activities. So actors in forest countries that want to adopt
more sustainable land uses and access the associatedcash flows will not be able to if they do not have access toaffordable financing first. Forest bonds provide one avenue
through which the public sector could support the provisionof affordable financing to forest-friendly activities.

require this, even potential bond investors, since they are
motivated to invest (and potentially take lower returns)
because they want to make an investment that has environmental and social returns. Standards that are currently
under development for forest and other green bonds will
provide assurance of these sustainability benefits.
International donor finance has a catalytic roleto play
A primary role of the public sector is to find the appropriate
leverage point to make large-scale forest finance attractive
to both the investors that will provide finance and to theenterprises and communities that will carry out activities topreserve forests. To do this, international donors and multilateral institutions can support a bond by acting to:1	Ensure cash flows arise to reward investment in forest
preservation;
2	Make finance or capital expenditure more affordable forforest-friendly enterprises; and3	Become directly involved in structuring the bond by, forexample, providing credit enhancement.
The relative effectiveness of these strategies will depend
upon the context of the forest landscape or country where
the finance is to be delivered, but in all cases a combinationof approaches is likely to be needed. Multilateral institutions
could play an additional catalytic role by issuing a forest
bond themselves and helping to pump-prime the forest
bond market.
Demonstrations and dialogue will improveunderstanding
A disconnect remains between the international investor
community, from which finance would be leveraged, andthe projects on the ground that would use that finance. The
greatest catalyst to stimulating continued work in this area
would be the issuance of a forest bond to demonstrate howcapital from international markets can be funnelled down
to forest-level actions. Lessons from that experience would
highlight how to continue improving on the mechanism andhow to scale up forest finance in the future.
At the same time, dialogue between private- and publicsector actors must also be increased. There is currently a lackof understanding of each sector’s expectations and needs
for working together to leverage finance. Communication
between the private and public sectors must be increased if
public funding is ever going to catalyse a much larger scale offorest preservation than it can achieve on its own.

Risk mitigation is paramount
Potential investors are concerned about a number ofrisks, including security of future cash flows and failure ofenterprises, but they are particularly concerned about politicalrisk. Public-sector funds could ease such risk through a varietyof actions, including paying for or providing political risk
guarantees. However it is achieved, mitigating risk will be a
crucial factor in attracting potential investors to a forest bond.
Assurance of environmental and social benefits
is essential
As with any form of forest finance, safeguards will be
required to ensure the environmental and social integrityof forest bonds. All potential stakeholders in a forest bond
7

INTRODUCTION

The State of REDD+The UNFCCC’s 15th Conference of the Parties (COP-15)
held in Copenhagen in 2009 was largely seen as a politicaland diplomatic failure, which raised serious questions
about the appropriateness of this forum for dealing withclimate change negotiations. As a result, many observers
and participants entered COP-16 in Cancún the following
year with low expectations and the perception that Cancún
was the last chance for the UNFCCC negotiating process toprove its worth. Heading into the negotiations, agreementon mitigating climate change through forest protection(i.e. REDD+) was believed to be the issue on which there
was greatest consensus. Agreement on REDD+ was thus
seen as a litmus test for climate change diplomacy; it was
the last great hope of the last great hope. And with strong
leadership in Cancún, some agreement was achieved.
For forests, the Cancún agreement was generally
considered successful, although there is much left to be
decided. [ 7 ] Cancún did not specify what exactly is being paid
for under a REDD+ mechanism, how to pay for it or how tomeasure results. The metric of forest preservation under
the UNFCCC has been established as carbon emissions (ortheir absence), but while this commodification of forests
has benefits for scaling up efforts to combat climate change,
there is concern that negative effects may arise if forests
are valued only for their carbon. Debate continues on thesafeguards that must be put in place to prevent negative
impacts on biodiversity and people, respectively the fociof the CBD, and MDGs and UN Declaration on the Rights
of Indigenous Peoples. Some progress was made, however,on safeguards, reference levels, and monitoring, reporting,and verification (MRV) protocol during the Climate Change
Conference in Bonn in June 2011.[ 8 ]Carbon Markets and Forest Carbon
The existing market for forest carbon is largely driven
by demand from voluntary buyers of carbon offsets andis small, opaque and illiquid compared to compliancemarkets for carbon. As a result, compliance markets attract
much more capital. Although compliance markets havethe potential to generate large demand for forest carbon,
significant growth in trading volumes of forest carbon inthese markets appears unlikely in the near term.
The EU ETS, the world’s largest compliance market, is8

not planning to accept international forest carbon credits
for compliance in Phase III (2013-2020). Current rhetoric in
Brussels implies it is unlikely that forest carbon credits will
be accepted in Phase IV either. That implication is supported
by increasing requirements for the quality of all international
carbon offsets and a tightening of the limits on their use forcompliance in the EU ETS. In contrast, the State of California
looks set to become the first compliance market in the world
to accept international forest carbon credits. Based on current
proposals, however, California’s entire annual demand could
be satisfied by the supply from just one of the states withwhich it is partnered (e.g. the State of Acre in Brazil).
There is still potential for the US to establish acompliance carbon market. If the US were to establish acompliance trading-scheme that includes international
forest carbon credits, it is likely that significant demand
would be created and that other major economies, suchas the EU and Japan, would be pushed to include international forest carbon credits as well. There is no expectation,
however, of any movement by the US until after the nextpresidential term begins (in January 2013) at the earliest.
So, in the short to medium term, REDD+ faces a
sizeable finance gap [ 9 ] with no imminent market or othermechanism that could generate large-scale demand forforest carbon and provide a meaningful price signal forinvestors to fill that gap. Even if such a proposal were to
emerge, uncertainties exist as to how long it might take fora REDD+ mechanism to become fully operational. [ 10 ]If progress is to be made at the scale required and within
the time required, alternative, complementary approaches
to forest finance are needed.
Securing Forest Friendly Development
While demand for forest carbon is slow to grow, donor
countries are looking for ways to stimulate forest preservation now, particularly by reducing the drivers of deforestation. In addition to payments for forest carbon, otherpayments for reductions in deforestation and unsustainable
land use are emerging. Achieving sustainable land uses,
however, requires transitioning of livelihoods to moresustainable activities, which in turn requires significant
upfront investment to make that shift. In many tropicalforest countries, the cost of capital and difficulty accessing
it is a significant barrier to that transition.
In these circumstances, catalysing successful preser-vation of tropical forests will first require support fordeveloping and financing alternatives to forest-degrading
activities. Once a strong platform for a forest-friendly,
low-carbon development is in place, a pay-for-performance mechanism can then be used to enhance and sustain
a country’s trajectory along that path. To do this on thescale of a country requires large-scale upfront investments.
Similar investments are familiar to those involved in infrastructure and economic development finance, which use
financing mechanisms such as bonds and public-private
partnerships. Under the right enabling conditions, thesemechanisms could also be used for financing forestfriendly development, offering a significant opportunity for
donor countries—looking for new ways to deliver official
development assistance (ODA) in a catalytic approach—to
leverage private-sector financing and ensure the large-scale
investment that is needed is delivered.

Photo by Olivier H, Creative Commons on Flickr
9

TOPIC 1
BUY-SIDE PERSPECTIVE

Key Points
To access the deepest pools of capital managed by institutional investors, forest bonds will need to be simple,
transparent, comparable and liquid, and must hold an
investment-grade credit rating.
The first forest bonds should target investors with a socially
responsible investment mandate that may be willing tocompromise on some financial aspects of the investment inreturn for assured environmental and social returns.
Adopting a tranche (i.e. segmented) structure would enable
forest bonds to attract multiple types of investors at the sametime, each with different requirements for risk, financial
returns, and social and environmental returns.
Governments of donor countries can incentivise investors
by providing tax breaks on forest-friendly investments suchas forest bonds.

Looking to Capital Markets
The bond markets are a large pool of finance that forest
bond issuers could potentially tap into: outstanding global
bond issuance totals around US$100 trillion. Some multilateral institutions investing in sustainable development
have already begun to target that source of finance, with
US$3.5 billion of green bonds issued in 2010. [ 11 ] The green
bonds issued so far help finance climate change mitigation
and adaptation, including renewable energy and water
infrastructure. Whilst they can include forest investmentsin the portfolio of projects they finance, to date, forests
represent only a small portion of such a portfolio and areincluded only for their value in mitigating and adapting
to climate change. A forest bond would focus specifically on forests and recognise the multiple benefits offorests in securing climate, food, water, energy, health andlivelihoods.
Core considerations for prospective investors in forest
bonds will mirror those for any other bond: returns, risk
and liquidity. Different types of investors, however, will
have different requirements in relation to those considerations, and some will include requirements for socialand environmental returns on their investment in forest
10

bonds. Ultimately, forest bonds should be mainstream andattractive to institutional investors. The early forest bonds,
however, will need to target more niche investors.
Impact Investing
Impact investing is an emerging asset class that describes
investors seeking to create positive social and/or environmental impact beyond financial returns. [ 12 ] There arearound 100 active impact investment funds, [ 13 ] catalysing
a market that could grow to US$500 billion or more ofassets under management (AuM) in the current decade, [ 14 ]which would provide a significant pool of finance that forest
bonds could attract. As opposed to other investors, impact
investors are often willing to compromise on the financial
attributes of an investment in return for the social orenvironmental return they seek to create.
A brief survey [ 15 ] of private investors’ perceptions ofgreen bonds indicated that when considering investing insuch bonds, they might be willing to compromise on the
return, risk and liquidity of that investment compared to abenchmark (Table 1). They are not willing to compromiseon their preferred maturity or the assurance of environmental benefits. Reaching this type of investor will
require overcoming some barriers (Figure 1). The twomost important barriers for private investors’ involvement
in impact investing are low awareness of the investment
opportunities and the short track-record of such products,
Table 1: Private investors’ desired features of a green bond and willingness
to compromise on those features.
FEATURE

PREFERENCECOMPROMISE?

Maturity≤ 10 years

No

Credit Rating

≥ A–

Yes

Interest Rate

Comparable
to benchmark

Yes

Liquidity

Narrow daily spreads

Yes

Environmental
Benefits

AssuredNo

Figure 1: Barriers to private investors’ involvement in impact
investing (percent of respondents that ranked the importanceof a given barrier as 4 or 5 on a 5-point scale).

HIGH SPECIFIC RISKS
CLIENTS ARE NOT INTERESTED IN THESE INVESTMENTS
UNPROVEN RETURNS, PRODUCTS ARE TOO NEWLOW RETURNS COMPARED TO PERCEIVED RISKLOW LIQUIDITY
LOW AWARENESS OF INVESTMENT POSSIBILITIESDISAPPOINTING PREVIOUS EXPERIENCES

meaning the asset class is unproven in their eyes. The
third most important barrier is high specific risks, such as
emerging market risk.
Socially Responsible Investment
Not far removed from impact investing, the socially
responsible investment (SRI) market is composed of a heterogeneous collection of investors that have all agreed to
uphold certain principles for responsible investing, and they
are another class of investor to which forest bonds could
cater. If the SRI market is defined by asset managers that are
signatories to the UN Principles of Responsible Investment(UN PRI), globally there are approximately US$20 trillion
of SRI AuM, [ 16 ] of which nearly US$10 trillion is allocatedto fixed income. Although some SRI asset managers may
act like impact investors by being willing to compromise on
the financial aspects of their investment, 73% of SRI AuM
are held by pension funds, which are strict institutional
investors that cannot make that compromise.
Institutional Investors
Institutional investors hold roughly US$70 trillion in assets
under management. [ 17 ] As opposed to impact and somesocially responsible investors, institutional investors generally
operate under a strict fiduciary duty to maximise risk-adjusted
financial returns and are not typically in a position to sacrificefinancial performance for social or environmental returns.
Institutional investors are similarly unlikely to compromise
11

TOPIC 1: BUY-SIDE PERSPECTIVE

on other characteristics of a product—such as credit rating or
liquidity—even if the risk-adjusted returns are comparable toother investments in their portfolio. [ 18 ]Institutional investors with long-term liabilities could,
however, be attracted to long-dated forest bonds, provided
they are relatively easy for investors to understand, compare,trade and book into their risk management systems. The more
standardised and commoditised a forest bond is, the more
attractive it will be to institutional investors.
A forest bond must also be transparent in its environmental integrity to attract institutional investors that rarely
have the time or sector-specific expertise to carry out due
diligence on the environmental benefits associated with aninvestment product. To address this need, the Climate Bonds
Initiative launched the International Standards and Certification Scheme for Climate Bonds in December 2010. By
adhering to a known and agreed set of standards, the processof certification outsources the responsibility of environmental
due diligence to a third party, which gives investors greatercertainty of the environmental integrity of green bonds.
Conclusion: Targeting Multiple Types of Investors
To reach institutional investors and the deep pools of capital
they manage, forest bonds must be simple, transparent,
comparable and liquid and hold an investment-grade credit
rating. As with most new environmental markets, however,forest bond markets will need something to pump-prime themarket and help reach a critical mass before it can become
mainstream and easily accessible to those investors. The
first forest bond issuances should target impact and socially
responsible investors that have a specific interest in environmental returns and may be willing to compromise on thefinancial aspects of an investment in return for tangible andassured environmental returns. Multilateral developmentbanks could also become more active in stimulating themarket, not only through their capacity to guarantee or
issue [ 19 ] green bonds, but also in their own role as investors
through their own treasury.
Early forest bonds could offer a lower-than-benchmark
guaranteed return, but with a carbon or ecosystem service
upside should the proper policy framework be put into
place. [ 20 ] Such products could possibly raise a few hundred
million dollars and, importantly, get the market started.
To continue pushing the market to scale, other strategies
could also be implemented. Policymakers could incentivise
12

investors through, for example, tax breaks on forestfriendly investments. [ 21 ] Forest bonds could initially bedesigned in partnership with the governments of donor
countries that have relatively high tax rates but are
motivated to undertake environmentally friendly actions.
Although it is likely that impact and socially responsible
investors would be the pioneers in a new market for forest
bonds, as the market developed, the use of a tranche (i.e.
segmented) structure could be used to appeal to multiple
types of investors at one time. Impact investors, forexample, could invest in a riskier tranche of the bond inorder to support the overall funding structure. An institutional investor could in turn invest in a different tranche
offering lower returns but increased security. Throughtranching, the pool of investors for any given bond issuancecan be spread across multiple investor classes (the tranche
structure is revisited below in Table 3).

Photo by Gavin White, Creative Commons on Flickr
13

TOPIC 2
SELL-SIDE PERSPECTIVE

Key Points
Policymakers and financiers should avoid relying solely on
future carbon market revenues and consider a mix of cash
flows to back a forest bond. A broader range of cash flows
potentially makes a forest bond more feasible to structure
and more attractive to potential investors.
Funding multiple initiatives inside and outside the forest
enhances a forest protection strategy by both increasing
forest resilience and reducing the pressures on them.
Public policy can create a price signal to stimulate early
investment in forest preservation through demand-pullmechanisms such as advanced market commitments or
through supply-push mechanisms such as subsidising thecost of capital for forest-friendly enterprises. The choice ofthe proper mechanism will be context specific, but either
type of support should be reduced as forest preservation
becomes familiar to investors and the economy.
A first forest bond is urgently needed to demonstrate how
to link on-the-ground activities in forest preservation withinternational capital markets and also to demonstrate whattypes of policies are needed in the given context.

Structuring and Issuing a Forest Bond
Forest bonds allow an issuer to borrow from the international markets to fund forest preservation and a transition
to sustainable livelihoods. There are a number of organisations that could do this, including private-sector financial
institutions; supranational institutions and multilateraldevelopment banks; and state-, regional- or national-levelgovernments. The challenge for any potential issuer of aforest bond is to generate cash flows that will repay thebond’s principal and interest, manage associated risk(see Topic 3), and ensure social and environmental integrity(see Topic 1).
The first component of structuring a forest bond will be
to determine how to pay it back. A bond could be issued on
the basis of future cash flows from a suitable forest preservation project or programme. Alternatively, a forest bond
could be issued to refinance loans made by local institutions to forest-friendly projects or activities carried out by
14

individuals, communities or businesses. In this case, thecash flow required to pay back the bond would come fromfuture repayment of these loans. Finally, if the issuer werea public-sector entity, a forest bond could be structured
on the basis of cash flows generated through policy-based
mechanisms such as natural capital taxes, user fees orenvironmental liability legislation. [22] Although these formats
are presented as separate, a bond could be developed that
integrates these models (depending on who the issuer is).
In addition to generating cash flows, the issuer will haveto decide how best to manage forest bonds. That could bedone through an earmarking procedure, in which revenues
flow back into the issuing entity and are kept on the issuer’sbalance sheet before being used to pay back the bond. If for
any reason those earmarked cash flows did not arise, theissuer would draw on other financial resources to meet its
obligations. In this case, potential investors would primarily
consider the balance sheet and risk level of the issuing
institution before deciding to invest in the bond.
Alternatively, cash flows could be ring-fenced by having
them flow into a separate legal entity [ 23] that would be
responsible for paying back the bond using those cash
flows. In this case, if the cash flows failed, there would be
limited recourse on the sponsoring institution, so potential
investors would primarily be concerned with the risk
inherent in the cash flows before deciding whether to buy aforest bond.
A key issue in attempting to structure and issue a forest
bond is that whatever structure is used, cash flows thatwould pay it back are often variable and/or difficult toaccess. In many cases, forest preservation is competing withdestructive land uses, such as palm oil, cocoa, soya, biofuels
and cattle ranching, all of which have less variable and/or
more easily accessible cash flows and so are often consideredless risky and attract more investment. Public-sector
support is needed to reduce the risks related to cash flows
for forest preservation, making the investment proposition
more attractive. How exactly to do that, however, is still
under discussion.
Demand-Side Policies for REDD+
The clearest way to secure investment in forests is toimplement regulation that ensures significant demand forthe outputs of forest preservation, such as forest carbon
services or sustainable timber. The REDD+ mechanism

TOPIC 2: SELL-SIDE PERSPECTIVE

under the UNFCCC is the largest attempt to do this,and although progress has been made to pay for forest
preservation on a global scale, the mechanism is not yet
established. In the interim, lack of demand for forest preservation, such as seen with compliance carbon markets, meansthat crucial near-term investment in forest preservation is
not occurring. To scale up forest finance earlier, potential
suppliers of REDD+ credits (or other outputs of forest
preservation) need to be encouraged to invest now, whilst
regulation is still being designed and implemented.
One way for public-sector entities to do this is via
advanced market commitments (AMCs) that would
provide sales or price support for REDD+ credits whilst
the UNFCCC mechanism takes shape. AMCs have beensuccessfully used in other sectors such as health and energy
and come in four basic forms, namely those that increase
sales, increase price, improve certainty of sales or improvecertainty of price. [ 24 ] In the context of tropical forests,
such an approach should focus on states or nations thatare further along in their development of REDD+ supply.
In these places, a relatively small amount of public-sector
funding could support a carefully designed AMC, whichshould be scaled back as the REDD+ mechanism develops.
Three types of AMC are receiving particular attention for
use with REDD+ credits:1	Performance Agreement: The public sector agrees topurchase a predetermined volume of verified REDD+
credits. At its core, a performance agreement is intended
to increase quantity of sales. The price can, however,be fixed, indexed (against e.g. a carbon price or othereconomic variable) or indexed with a combination of aprice floor and ceiling, and each option would provide a
different level of price certainty. A REDD+ performance
agreement would be a variation of an Emissions
Reduction Purchase Agreement (ERPA) commonly usedin the broader carbon markets.
2 REDD-Credit Option: The public sector sells (orallocates) the right, but not the obligation, to sell credits
at a minimum price to the public sector (i.e. a forest
carbon put option), thus improving price certainty.
The option would be exercised when the market price
was below the price designated by the option. As witha performance agreement, the price promised by the
public sector could be fixed, indexed or indexed with afloor, each providing a different level of price certainty.
3	Subsidy: The public sector would pay a guaranteed

price subsidy for every REDD+ credit generated, notnecessarily improving price certainty, but aimed atincreasing the price.
Advocates of forest carbon markets and the interim use of
AMCs argue that providing direct payments and publicsector demand-pull mechanisms are the most effective ways
to stimulate private-sector investment in preserving tropicalforests. It is also the approach that most easily aligns withthe concept of payments based on performance.
Supply-Side Policies for Forest-Friendly Development
A direct approach that pays for delivery of forest preservation
ex post is clearly a useful policy tool. Yet questions remainaround how to bring that approach to scale and how to makeforest preservation sustained in the long term, such as:–	What policy support can be provided in the absence offorest carbon or other ecosystem-service compliancemarkets?
–	How can the high transition costs to establish forestfriendly development and deliver forest preservation be
overcome?
–	How does the public sector ensure that the next
generation does not convert forest that a previous
generation has invested in preserving?
One possible answer to these questions is the use of supply-pushpolicies. These interventions make it easier and/or cheaper tostart a forest-friendly enterprise. For example, the public sector
could lower the cost of financing forest projects. Shifting tomore sustainable livelihoods and activities, generally involves
high upfront capital expenditure (capex), [ 25 ] and there may be
a significant time lag before positive returns are generated. In
contrast, unsustainable uses of land often require less capex andgenerate short-term cash flow more rapidly, [ 26 ] meaning they areeasier to finance. Access to a relatively cheap source of long-term
funding is therefore important for sustainable development.
Generally speaking, supply-push policies may be preferredover demand push-policies (e.g. AMCs) when there areconstraints that do not allow firms or households to accessthe start-up resources they require. [ 27 ] That scenario often
exists in tropical forest countries where demand for affordable
capital from individuals, communities and businesses in thosecountries that want to act sustainably is not satisfied. The
projects are often too small to be attractive to investors, and alack of access to financial and business expertise can also be a15hindrance. There are three primary strategies to dealing withthis mismatch:
1 Provide cheaper capital directly at ground level.
2	Help aggregate projects so that combined they reach ascale that is of interest to larger investors that provide
cheaper capital.
3	Reduce capex costs through subsidy or technology/
services transfer.
The barriers to cheap capital for forest-preservation capex inforest countries have significant implications. In the extreme,
activities that could potentially help preserve forests either do
not take place or are financed by institutions or individuals
in industrialised countries that do have access to financial
expertise and cheaper funding from capital markets. Thus,
even with robust demand for forest preservation in place,the combination of high capex costs and high cost of capital
could keep actors in tropical forest countries from being able
to capitalise on the full benefits of a forest carbon (or otherecosystem service) market or interim guarantee mechanism.
Therefore, reducing the initial financing barrier should beconsidered alongside any pay-for-performance mechanism.
Advocates of supply-side interventions also point out
that forests will come under increasing pressure as the
populations of forest countries grow and increasingly demandhigher standards of living. The approach of supporting thefinance of forest-friendly enterprises could not only support
enterprises that are directly forest related (e.g. sustainable
forest management, ecotourism, non-timber forest products,etc.), but could also reach outside of the forest. It could help
ensure that as forest countries develop, people have opportunities for work that do not depend on unsustainable forest
extraction and that outdated enterprises transform and newenterprises emerge that are based on sustainable use of forest
resources, reducing the external pressures that forests face.
Although forests can be preserved in this generation, without
the concurrent improvement in people’s livelihoods andopportunities for work that do not depend on unsustainable
forest extraction, there will always be pressure in the future
to return to short-term thinking that leads to conversion ofnatural capital (i.e. tropical forests) into financial capital.
Conclusion: Diverse Policies and Diverse Cash Flows
Since interest in forest bonds began, it has been argued thatthey can and should draw on a mix of forest-friendly cash
16

flows. [ 28 ] Although carbon markets can provide a source ofrevenue for forest preservation, the scale of the opportunity
remains uncertain. Given the current policy landscape, it isclear that more forest needs preserving than carbon markets
appear willing to pay for.
Forest bonds could in theory be structured around cash
flows from a wide range of forest-friendly activities andpolicies including mechanisms for ecosystem service andbiodiversity provision, sustainable forest management,sustainable agricultural commodities and in some cases
revenues from fiscal policies. Creating forest bonds in thisway enables prospective issuers to develop larger deals
and to reduce reliance on future carbon revenues alone to
pay the bond back. The ability to evaluate and potentiallyblend different forest-friendly cash flows enables institutions structuring forest bonds to manage overall risk more
effectively, making the bond increasingly attractive topotential investors. It also inherently means that the bondis used to finance a broad forest protection strategy, bothincreasing forest resilience and reducing the pressureson them.
Work to understand how cash flows related to ecosystemservices might link to forest bonds is nascent. A demonstration is urgently needed to show how capital from international markets could be funnelled down to forest-level
actions. Similarly, more thinking and demonstration
activities are needed to understand how other cash flowsthat do not depend on carbon credits could be used toincentivise forest preservation and even back a forest bond.
With water scarcity poised as the next great global environmental challenge, there is particular interest in developing
models where long-term support for forest preservation isconnected to the water, food and energy sectors that are
currently benefiting from water services provided by large
areas of intact forests.
Finally, it is clear that some form of public support isneeded to stimulate investment in forest preservation.
Whilst regulation that values the ecosystem services
provided by forests is still being negotiated, public funding
can be used to foster the foundation for the private sector
to finance forest projects and forest-friendly development.
Whether that support is best provided through demand-side
mechanisms, such as securing a minimum price for REDD+
credits, or through supply-side mechanisms, such as
reducing the costs of capital, is a context-specific question.
In some cases, the answer may be that both are needed.

TOPIC 3
RISK MITIGATIONKey Points
Forest preservation in the tropics entails high market andcommercial risk, but political risk is the dominant concern
for potential investors; forest bonds will require somedegree of political risk insurance (PRI).
The Multilateral Investment Guarantee Agency (MIGA)
is a logical provider of PRI and, with recent changes to its
convention, is in a strong position to take on that role. Even
if MIGA does not provide PRI for forest bonds, evaluating
its case provides lessons on what characteristics a PRI
provider for forest bonds needs to have.
Insurance and other external risk mitigation measures, forall types of risk, will not make a bad deal good; it will only
make a good deal better. Existence of external enabling
conditions and a strong underlying bond structure thatis designed to mitigate risk are equally important to thesuccess of a forest bond.

Table 2. Overview of risk mitigation mechanisms that could be used fortropical forest investment, and the risks they mitigate. Mechanisms are
qualitatively ranked first by their level of effectiveness, then breadth ofusefulness. C = Commercial Risk, M = Market Risk, P = Political Risk
(adapted from Gaines & Grayson, 2010).
MECHANISM

DESCRIPTIONDiversification

M

P

Invest in a portfolio that +++includes diverse cash
flows and projects

+++

+++

Credit Guarantees

Guarantors insure
against default of abond (or other debt
payback) for any reason

+++

+++

+++

Commercial Insurance

Insure against losses
due to specific risk
events, such as natural
hazard+++––Political Insurance

Insure against losses
due to specific risk
events, such as
expropriation

–

–

+++

Securitisation
and Tranching

Revenues are isolated++
from the original entity,
so less risk ofmismanagement, andtranching allows different
investors to take different
levels of risk.

++++

Technical Assistance

Provide business or
financial management
expertise to actively
manage risks that arise

++

++

–

Due Diligence

In-depth research toensure project risk is
known

++

–

–

Derivatives

Financial products used
to minimise volatility of
cash flows

–

++

–

Fund Enhancement

An ‘enhancing’institution takes thefirst loss on any
business failure

+

+

+

Risk Mitigation Tools
The first step in mitigating risks inherent in a forest bondshould be to fully understand risks associated with theunderlying assets and/or relevant cash flows. That will
determine the best risk mitigation strategy. There are three
primary categories of risk in forest investment that need tobe addressed: commercial risk (e.g. natural hazard or theft),market risk (e.g. currency exchange risk or interest raterisk) and political risk (e.g. expropriation risk). [ 29 ]Two key approaches that can be used to mitigate risk, orat least to apportion it appropriately, have been discussed
earlier in this report. First, diversifying cash flows by type(e.g. carbon or other ecosystem service credits, forestfriendly loan repayments, natural capital taxes, etc.) andgeography is the best way to lower overall risk. Second, a
tranche structure can be used to allocate more or less risk
to different target investors.
There are a number of other mechanisms, however, for
reducing various risks associated with a forest bond (Table
2). Unfortunately, awareness of some of the mechanisms is
low, and the total cost of mitigating relevant risks can often
be prohibitive. Innovative ways of the public sector raisingawareness, subsidising the costs or otherwise supportingC

17

the use of risk mitigation should be explored.
Political Risk and Tropical Forest Investment
Even with all of these risk mitigation tools, in the context
of forest bonds, country risk—specifically political risk—
remains the dominant concern for potential investors.
Under the Clean Development Mechanism, country risk was
reduced because a letter of approval from the host country
was required and the UNFCCC was intimately involved. For
now, it does not appear that a REDD+ mechanism would
follow the same path, so other avenues must be explored.
It is no surprise that potential investors in tropical forests
are concerned about political risk; investors perceive suchrisk as the greatest constraint to foreign direct investment
generally. [ 30 ] What is surprising is that one of the simplest
means of addressing that risk, political risk insurance (PRI),
is only used by 21% of investors that invest in developing
countries (Figure 2). Although PRI will clearly not hedge
every risk and other methods of reducing political risk are
more popular, PRI is broadly considered a necessary featureof a successful forest bond. The Multilateral Investment
Guarantee Agency (MIGA, a member of the World Bank
Group) is often recommended as the most logical provider of
PRI when investing in tropical forest countries, [ 31 ] due to its
remit to support sustainable development.
PRI and Forest Bonds: The Case of MIGAMIGA provides insurance for investors investing acrossborders into developing countries. The Agency’s coverage
insures against currency transfer restrictions and inconvertibility, expropriation, war and civil disturbance, breachof contract, and non-honouring of sovereign obligations.
Breach of contract is particularly important when
considering REDD+: one envisioned structure of REDD+
is a nested approach that would involve project developers
or states/regions generating forest carbon credits for which
the national government would reward them. Failure of thenational government to pay could be considered a breach ofcontract, the resolution of which would require involvement
by a PRI provider such as MIGA. Similarly, if a national
government offered an AMC (see Topic 2), but was unable orunwilling to honour it, that would also constitute a breachof contract that PRI could insure against.
MIGA has a strong record of success in resolving issues
18of political risk. [ 32 ] Based on this history, MIGA’s politicalleverage with host countries and a strong capital position,
the Agency has an implied triple-A credit rating and isnamed in the Basel II framework as a highly rated multilateral. Thus, PRI from MIGA enhances the credit ratingof the investments insured against, often from just below
investment grade to potentially as high as MIGA’s triple-A
rating. Further, PRI through MIGA is affordable, equivalent
on average to approximately a 1% annual premium on
investments, depending on the risk of the host country.
MIGA has experience with forestry as an insurer of
equity investments and loans for timber and some re- andafforestation investments, but the opportunity for MIGA to
become involved in forest bonds has only just opened up.
Changes to MIGA’s convention in late 2010 now allow it toinsure 1) stand-alone debt and 2) existing assets. MIGA’s
insurance of capital market bond issuance or asset securitisation is done on a case-by-case basis. The changes in the
Agency’s convention, however, mean that MIGA is now
technically allowed to insure a stand-alone forest bond thatwould invest, at least in part, in already existing forests.
Importantly, beyond these technical necessities, MIGA
is suited to insure forest bonds. The Agency has the financial
scope to insure large amounts of forest investment [ 33 ] andcan offer insurance up to 15-20 years maturity, matching
the long-term nature of forest investment. The Agency also
applies a comprehensive set of social and environmental
performance standards to all projects, which at minimum
provides a baseline from which to build in safeguards andassurance of the environmental integrity of a bond. Perhaps
most importantly, there is good alignment between tropicalforest countries and MIGA’s focus countries.
Conclusion: PRI and More
As often suggested, MIGA could be a strong project partnerin structuring and issuing a forest bond. MIGA’s global
diversification and strong record of resolving issues toavoid the need for claims permit the Agency to offer strong
leverage. MIGA also has good partnerships and can workwith other public- and private-sector entities to jointly
insure and bring attention to an investment. Together, thesepoints mean MIGA could insure investment on the scale offorest bonds.
MIGA is also now in a good position to engage withall types of forest intervention, not only new forest assets

TOPIC 3: RISK MITIGATION

Figure 2. Percentage of investors that use specific mechanisms
to mitigate political risk when investing in developing countries.
From the MIGA-EIU Political Risk Survey 2010 (p. 24-25 of
MIGA, 2010).

43

CONSULTANTS

18

OPERATIONAL HEDGINGJOINT VENTURES45

RISK ANALYSISDON'T USE ANY TOOLS5SCENARIO PLANNINGCDS
ENGAGEMENT WITH LOCAL GOVERNMENTENGAGEMENT WITH NGOs

20
16

PRI
ENGAGEMENT WITH LOCAL COMMUNITIESOTHERDON'T KNOW

generated under reforastion and afforestation projects,
since its new convention permits the Agency to insure
pre-existing assets. The Agency is also well placed to insure
the mechanism of a bond, particularly a forest bond, since
it is now able to insure stand-alone debt and has always
offered long-term insurance. Further, the Agency’s socialand environmental performance standards could help
in the implementation of safeguards and assurance ofthe environmental integrity of a forest bond. Finally, andperhaps most importantly, there is good alignment between
tropical forest countries and MIGA’s focus countries.
Exploring the case of MIGA does not mean that itshould be the sole provider of PRI for forest bonds, but
understanding the potential of the organisation helps

clarify the qualities that a forest bond issuer should look forin a PRI provider. The costs of PRI and any other externalrisk mitigation mechanisms will vary, and subsidisingthese costs could be a role the public sector can play inencouraging investment. Although external risk mitigation
is an important component, it alone is not sufficient toensure the success of forest bonds. Insurance will notmake a bad investment good; it can only make a commercially viable proposition better. Portfolio diversification,a tranche structure, proper ex ante risk analysis, andengagement with government and local communities are
all internal risk mitigation measures that will be necessary
to help make forest bonds work.
19© Edward Parker / WWF-Canon
20

TOPIC 4
FOREST COUNTRY PERSPECTIVE

Key Points
The burdens and benefits of forest preservation must be
appropriately balanced among all stakeholders, from international investors to rural communities.
Only if that balance is achieved can forest bonds, or any
effort to leverage private-sector finance for forest preservation, be deemed legitimate.
Sub-national experiences are demonstrating how toestablish effective policy frameworks and public-private
institutions that strike this balance.
These experiences demonstrate that a key strength of
sub-national action is strong ground-level engagement andgovernance, whilst a key weakness is lack of expertise.
With appropriate technical support, sub-national
governments could be early issuers of forest bonds.

Engaging the Private Sector
Donor countries are seeking ways to engage the private
sector in forest preservation, and the private sector iswilling to invest, provided returns on those investments arecommensurate with the associated risk. How to catalysesuch investment, however, is still under debate.
Tropical forest countries have a mixed view of the way
forward for financing forest preservation: some forestcountry governments are wary of linking it to international
carbon markets. The concern is that finance will be highly
uncertain and risky if it is primarily dependent on the
single commodity value of carbon, which some worry could
be volatile. Additionally, some forest-country governments
do not like the idea of depending on the private sector tosave their forests, which could result in the associatedbenefits of that investment (i.e. profitability, rents)
flowing out of the country to wealthy outside investors.
Understandably, forest countries want to maintainsovereign control over how forest finance is used within
their borders and want to ensure that a good portion of
the potential profitability goes to support their economic
development. In short, if the onus of saving forests falls on
forest countries, they should receive an equitable share of

the bonus too.
The solution is to ensure that the burdens and benefitsof forest preservation are distributed appropriately
between the forest countries and forest-dependent peoples
attempting to balance development and forest preservationand the donor countries and private-sector providing
finance. Public-private partnerships can be establishedto deal with such investments and ensure that burdens
and benefits are appropriately allocated between
different entities.
A Sub-National Case: The State of Acre, Brazil
While national governments are still working out the details
of international agreements on climate change and forest
finance, sub-national governments are developing theirown policies for maintaining their natural capital. Thesestate-level initiatives provide lessons and models uponwhich national and international policymakers can build.
The State of Acre in Brazil is a forested state in
the Amazon basin that has already developed a policy
framework for recognising the value of ecosystem services
provided by the forest and incentivising land practices tomaintain those services. Acre’s framework is increasingly
recognised as an example to be followed and expanded
upon. The state’s efforts to foster its carbon programme
include establishing the necessary institutions, particularly
an ecosystem service regulatory agency and a public-private
partnership agency. The role of the latter is to attract direct
investments in forest-friendly activities and facilitate
the purchase of ecosystem service credits issued by theregulatory agency.
An important aspect of the Acre policy, as well as othersimilar policies in the Brazilian Amazon States, [34 ] is thatthey recognise the multiple ecosystem services provided
by forests. The carbon value is the starting point because
it is the most readily monetisable value, but these policies
also explicitly recognise the forest’s contribution to theregulation of water resources, conservation of biodiversity and regulation of local climate, and importanceto traditional and local livelihoods. Acre’s policy is thus
designed to foster the development of multiple funding
sources related to those different values, including state andfederal government resources, philanthropy (e.g. throughSky Rainforest Rescue), private investment, and carbon
credit trades (for which they have already secured some
21

TOPIC 4: FOREST COUNTRY PERSPECTIVE

demand through an agreement with the State of California).
That is the first step to aggregating diverse cash flows thatthe state could then use to back a forest bond.
Acre has also been hailed as a strong model becauseof its broad engagement with all relevant government,
community and private-sector organisations and representatives throughout the development of the policy framework.
That engagement led to these groups having a real stake inthe success of the policy and indicates one of the potentiallylarge benefits of sub-national programmes: better
ground-level engagement and governance. With years ofengagement and structural policy development to support
their ecosystem services policy, Acre is in a strong position
to effectively implement a sustainable development path.
The Acre experience also highlights one major difficultyat the sub-national level: the need for more expertise.
Compliance markets and increased demand for certification of voluntary ecosystem service credits or sustainableproducts mean that environmental and social standards
are increasingly strict and more expertise is needed to meetthose requirements. Financial and private-sector expertiseis also needed to ensure that the strong policy framework,
which includes economic incentives and a public-private
investment agency, is used most effectively to stimulate
investments in forest-friendly development in the state.
Conclusion: Balancing Burdens and Benefits
In one sense, the discussion on tropical forest preservation
is primarily about who should pay. But whether investors,
businesses, national governments or any other parties pay,
it is important to make sure that those that take on theburden of forest preservation — financial, economic, social
or political — also reap their fair share of the benefits. The
problem of forest finance is not so much about choosing
which policy is best (e.g. REDD+ credit price subsidy vs.
lowering the cost of capital), but about implementing
a framework that permits a mix of policies to support
different groups contributing to sustainable development.
For example, this could include domestic governments
implementing a tax on forest-degrading activities to raisefinance for co-investment in forest-friendly enterprises,
which profit in part from ecosystem service credits forwhich donor countries have provided a price floor.
For any policy mix, a bond could provide a method toraise large-scale financing up front. Domestic governments
22

could potentially use it to overcome the transitional costs ofestablishing governance structures and investing in forestfriendly enterprises and pay it back from cash flows basedon forest-extraction tax revenues, sales of forest carbon
credits, or any number of other regulatory or normal
market cash flows.
The experience in the State of Acre is one of a small
but growing number of sub-national models that areleading the way in establishing a policy framework on
which forest-friendly development can be built. In addition
to demonstrating how to design the policy framework,
these experiences are also illustrating that sub-national
governments are generally willing to engage with theprivate sector. Action by sub-national governments islikely only to strengthen under initiatives such as theGovernor’s Climate and Forests Taskforce. [ 35 ] Considering
their potential strength in ground-level governance and the
movement to develop multiple revenue streams for multiple
forest values, state governments could be prime candidates
for issuing forest bonds.

TOPIC 5
DONOR COUNTRY PERSPECTIVE

Key Points
Donor countries are increasingly exploring bilateralarrangements to use climate, biodiversity and development
aid as catalytic finance, leveraging private-sector
investment in forest preservation.
There are three basic approaches to doing this for a forest
bond: 1) Use demand-side mechanisms to secure the cash
flows that pay back investment in forest preservation; 2)
Use supply-side mechanisms to reduce the costs of thatinvestment; and 3) Provide direct risk mitigation in the
structuring of a forest bond.
To understand how best to leverage private-sector finance,
more dialogue between the public and private sectors is
required to understand what each expects from and iswilling to do to support such a public-private partnership.
Dialogue needs to expand to other public-sector actors
as well, specifically to treasury departments and financeministries that are familiar with private-sector engagement.
This dialogue will be essential to the success of forest
bonds, particularly if issued by the public sector.

Catalysing Forest Preservation
Approximately US$7.2 billion in forest finance has been or isimminently expected to be pledged from donor countries. [ 36 ]As donor countries increase their pledges, they havegrowing concerns about how to use that finance effectively.
Although dominant in the history of ODA, the project-based
approach appears to have failed in many cases. That has led
donor countries to look for more careful uses of aid that cancatalyse systemic changes needed for development.
Although there is a role for funnelling ODA throughmultilateral institutions, those institutions are not the
only means of managing and delivering international
finance for tropical forest preservation. Countries trying
to move fast on forest preservation and climate change
are starting to look at bilateral deals whereby public funds
can catalyse a sustainable development path and leverage
private-sector finance to support it. Forest bonds offer amechanism for doing just that: using donor country
funds to leverage private finance and reach a large scaleof funds that can be used to invest in a forest country’s
economic transition.
Many Potential Roles
There are three basic roles that donor countries can take toleverage private-sector finance:1	Demand-side: Secure the cash flows that pay backinvestments in forest preservation.
2	Supply-side: Reduce the costs of investing in forest preservation.
3	Structuring: Become directly involved in forest
investment through, for example, providing third-party
risk mitigation.
An argument could be made that the second option,
supply-side interventions, should be slightly prioritised
above the other options. The goods and services that
donors expect forest-friendly activities and development
to produce will simply not be produced on a large scale if
there are constraints on financing the upfront transition
costs [ 37 ] which may occur in some contexts in tropicalforest countries. Further, providing finance can play somerole towards that transition in the absence of certain
regulatory changes to boost demand for forest preservation (e.g. through compliance carbon markets). Cashflows for forest-friendly activities can come from a numberof sources without regulatory intervention, such as cash
flows arising from increasing global demand for green
commodities such as sustainable timber or cash flows
from activities that locally make economic sense, suchas paying for watershed services or intensifying beef
production, both of which are seeing increased implementation globally. Policy support for these types of activities
is needed to stimulate broader and larger economic shifts,
but at least there is a starting point to profit from forest
preservation without much policy intervention.
Assuming no constraints to investment exist, donor
countries should focus on implementing policies to promotedemand for forest preservation and secure cash flows thatwould pay back a forest bond. Although AMCs for REDD+
have received a lot of attention, other demand-side interventions to help secure other cash flows are already ineffect and should not be forgotten, specifically interventions
promoting sustainable products (e.g. laws combating illegal
timber, such as the US Lacey Act or EU’s FLEGT). A range
of demand-side policies could be linked to forest bonds or
23

TOPIC 5: DONOR COUNTRY PERSPECTIVE

Table 3: Stylised comparison of a normal tranche structure (top)to a potential
forest bond tranche structure (bottom) where public sector finance is used toleverage private sector investment.
INVESTORINVESTMENT

RETURNRISK

Investor 1

Debt: Senior Tranche$+

Investor 2

Debt: Junior Tranche$$++

Investor 3

Equity Investment

$$$

+++

INVESTORINVESTMENTFINANCIAL SUSTAINABILITY RISKRETURN
RETURN

Institutional

Debt: Senior Tranche $$+ImpactDebt: Junior Tranche$$++

PublicSectorEquity /Concessional Debt

Maybe $+++

countries from which a forest bond is issued, reducing risk
associated with the cash flows that would pay back the bondand improving investor demand for it.
Donor countries can also become more directly involvedin the structuring and issuing of a bond. One way is to
reduce the risk associated with the bond by underwriting thebond directly, paying insurance premiums (e.g. for PRI) or
providing some other mechanism that directly improves thebond’s credit rating.
A similar role would be to design the bond with donor
countries taking a stake in the bond and providing a first-loss
facility. [ 38 ] In some ways, this is like the donor taking anequity stake in the forest investment but with a return inthe form of public goods rather than a financial return,
although some financial return may be realised (Table 3).
That structure deploys public funds to provide public goods,
the primary purpose of those funds, but in a manner thatleverages much larger amounts of finance.
Conclusion: Dialogue and Engagement
A great challenge left for donor countries and the private
sector is that they do not yet speak the same language anddo not understand one another’s needs and motivations.

Policymakers that support carbon markets have usually
done so on the basis that providing a price signal for the
output of an environmental externality would change theeconomic landscape and force the private sector to change
its behaviour. That logic works in some cases, specificallywhen the externality is one-dimensional, there is an easy
technological fix and financing that fix is relatively cheap.
The case of forests is different. A price signal from carbon
markets, or other markets such as biodiversity andwatershed markets, can be a strong policy tool. The lossof tropical forests, however, is a multidimensional issue
in which some fixes may be simple, but in many cases
donors are asking households to transition to alternative
livelihoods and that transition can be costly, or even
unaffordable for many poor people living in forests andrural areas in tropical countries. The process is more
complex and requires much greater engagement with thosethat will finance this process.
Engagement with the private sector is also different for
the global issues of forests, biodiversity and climate change.
It is not simply a matter of making the polluters pay, as
was the case with many environmental issues in the past.
Instead, it is also about engaging the private sector to help
finance the large shift to sustainability that economies needto undertake.
If donor countries expect to leverage private-sector
finance, the two sides need to speak the same language tobegin better understanding one another. That engagement
can be difficult in international forums where ideological
opposition to markets has disproportionate power. As aresult, that engagement is starting to emerge at the levelof national governments between like-minded countries
and private-sector organisations. Moving forward, it would
also be useful to engage treasury departments and financeministries. These government groups are not only familiar
with private-sector engagement, but are essential to thesuccess of any large-scale financing strategy, including
forest bonds and the role they may play in stimulating
forest-friendly development.

END NOTES

1 The Royal Society, 2003
2 TEEB, 2009
3 FRA, 2010, pp. 3
4 The Commission on Climate and Tropical Forests, 2010
5	The IFFIm has raised more than US$ 3 billion for the
GAVI Alliance’s immunisation programmes. Read more
online at: www.iff-immunisation.org
6	A multilateral finance institution seems poised to issue
the first ‘rainforest bond’, which is being structured by
Bank of America Merrill Lynch. Reported in Carbon
Finance (4 May, 2011) and Environmental Finance (6May, 2011) with the article ‘“Rainforest bond” aiming tomonetise REDD+ credits’ (subscription required).
7	To read more on REDD+ under the Cancun Agreement, go
to The REDD Desk and follow links to many major NGOs’
analyses: www.theredddesk.org/conference/cop16/news/
blogcop_16_and_the_cancun_agreements_agreements_
what_did_it_all_mean_for_forests
8 For more on progress in Bonn see Parker and Almassy, 2011.
9	It was recently estimated that financing needed toreduce deforestation will increase over the current
decade, reaching US$30 billion annually by 2020,
averaging US$16 billion during that period (TheCommission on Climate and Forests, 2010). Current
and imminent pledges of REDD+ financing total about
US$7.2 billion (Simula, 2010), but these are multi-year
amounts; forest finance remains far short of the annualsums required.
10 Under the Kyoto Protocol, it took seven years fromagreement of the Protocol before the first issuance ofcarbon credits under the Clean Development 				Mechanism—the portion of the carbon market that 		developing countries could participate in.
11 Wood & Grace, 2011
12 O’Donohoe et al., 2010
13 GIIN, 201114 Monitor Institute, 200915	Lombard Odier surveyed 47 private banking clients
about their views on green bonds.
16 PRI, 2010
17 The City UK, 201018	E.g. the need for a liquid secondary market in any
product included in their portfolio. Ensuring enoughliquidity to attract institutional investors would
probably require a forest bond issuance of at least
several hundreds of millions of US$.

19	International financial institutions have issued over
US$5 billion in green bonds as of early 2011. For more
information on green bond issuance see
www.climatebonds.net/resources/bonds-issued
20	This structure is similar to the “Green Sectoral Bond”
proposal of the International Emissions Trading Association(IETA), whereby if emissions reductions were achieved, partof the payback to investors would be in the form of carbon
credits, which the bondholders could likely sell on.
21	A popular example is the Dutch Groenregeling, a set oftax incentives designed to stimulate investments that areimportant for the environment, including nature and forests.
22	See Parker & Cranford, 2010.
23	i.e. a special purpose vehicle
24 Vivid Economics, 200925	E.g. securing land tenure, legal fees, etc.
26	In some cases this may be due to environmentally
harmful subsidies.
27 Vivid Economics, 200928	Forum for the Future & EnviroMarket, 2007
29 Gaines & Grayson, 201030	MIGA, 201031	Forum for the Future & EnviroMarket, 2007; Gaines &Grayson, 2009; O’Sullivan et al., 201032	Of over 600 projects insured, more than 80 cases ofpossible claims have arisen with only five resulting in
actual claim payments.
33	MIGA is currently only directly exposed to US$4.8
billion, but its capacity is in excess of US$9 billion
before reinsurance. There is a current limit of US$180
million of exposure MIGA can take on its own books
for any one investment project, and US$600 million in
any one country, but those amounts can be leveraged by
as much as 10 times with the help of reinsurance andcoinsurance. The limits are reviewed annually.
34	E.g. the recently approved Ecosystem Service law in theState of Amazonas.
35	A collaboration between 15 states and provinces in
Brazil, Indonesia, Mexico, Nigeria, and the US, on
implementing REDD. See www.gcftaskforce.org
36 Building on Simula, 201037	Demand-pull interventions are ineffective if the market
is restricted and cannot supply what the intervention isdemanding (Vivid Economics, 2009)38	For further discussion on a first-loss facility see Forumfor the Future & EnviroMarket, 2007
25

REFERENCES–	Commission on Climate and Tropical Forests, 2010,
Protecting the Climate Forests: Why reducing
tropical deforestation is in America’s vital
national interest. Online at: www.climateforestscommission.org/the-report–	Forest Resource Assesment (FRA) 2010. ‘Key Findings’,
Global Forest Resource Assessment 2010, Foodand Agricultural Organization of the United Nations,Rome. Online at: foris.fao.org/static/data/fra2010/
KeyFindings-en.pdf–	Forum for the Future & EnviroMarket, 2007, Forestbacked Bonds Proof of Concept Study, International Finance Corporation, Washington DC. Online at:www.forestbonds.com/reports/ifc-proof-of-conceptstudy#more-99–	Gaines, A. & Grayson, J. 2009, ‘The potential of risk
mitigation mechanisms to facilitate private sector investment
in REDD+ projects’, Chapter 4 in Forest Investment
Review, Forum for the Future, London. Online at:www.forumforthefuture.org/files/Chapter4_FIR.pdf–	MIGA, 2010, World Investment and Political Risk,
MIGA, Washington, D.C. Online at: www.miga.org/
news/index_sv.cfm?aid=2855–	Monitor Institute, 2009, Investing for Social andEnvironmental Impact: A design for catalyzing
an emerging industry, Monitor Institute, New York.
Online at: www.monitorinstitute.com/impactinvesting–	O’Donohoe, N., Leijonhufvud, C. & Saltuk, Y. 2010,
Impact Investments: An emerging asset class,
JP Morgan and the Rockefeller Foundation. Online
at: www.jpmorgan.com/pages/jpmorgan/investbk/
research/impactinvestments–	O’Sullivan, R., Streck, C., Pearson, T., Brown, S. &Gilbert, A. (2010) Engaging the Private Sector
in the Potential Generation of Carbon Credits
from REDD+: An Analysis of Issues, Report to
the UK Department for International Development(DFID). Online at: www.climatefocus.com/documents/
engaging_the_private_sector–	Parker, C. & Almassy, A. 21 June 2011, Policy Brief:
SBSTA Makes Incremental Progress on REDD
in Bonn, Global Canopy Programme. Retrieved 21 June
2011 from http://www.globalcanopy.org/updates/blogs/
policy-brief-sbsta-makes-incremental-progress-redd-bonn

26–	Parker, C. & Cranford, M. 2010, The Little Biodiversity
Finance Book: A guide to proactive investment innatural capital (PINC), Global Canopy Programme,
Oxford, UK. Online at: www.globalcanopy.org/
materials/little-biodiversity-finance-book–	Principles for Responsible Investment (PRI), 2010,
Report on Progress 2010: An analysis of
signatory progress and guidance on implementation, PRI Secretariat, London. Online at: www.unpri.
org/files/2010_Report-on-Progress.pdf–	Royal Society, 2003, Measuring biodiversity forconservation, The Royal Society, London. Online at:www.royalsociety.org/Measuring-biodiversity-forconservation-Main-report–	Simula, M. 2010, Analysis of REDD+ financing gaps
and overlaps. Prepared for the REDD+ Partnership.
Online at: www.reddpluspartnership.org/en–	TEEB, 2009, TEEB Climate Issues Update.
Online at: www.teebweb.org/InformationMaterial/
TEEBReports/tabid/1278/Default.aspx–	The City UK, 2010, Fund Management 2010, The
City UK, London. Online at: www.thecityuk.com/
media/188154/fund%20management%202010.pdf–	Vivid Economics, 2009, Advanced Market
Commitments for low-carbon development: an
economic assessement, UK Department for International Development, London. Online at: www.vivideconomics.com/index.php/publications/low-carbon-amcs–	Wood, D. & Grace, K. 2011. A Brief Note on
the Global Green Bond Market, Initiative for
Responsible Investment at Harvard University,
Cambridge, Massachusetts. Online at: www.hausercenter.org/iri/wp-content/uploads/2010/05/
IRI-Green-Bonds-note.pdf

PARTICIPATING ORGANISATIONS– Bloomberg New Energy Finance– BNP Paribas– Canopy Capital– Clifford Chance–	Climate Bonds Initiative–	Colombian Embassy to the UK–	DeRisk–	Nicholas Institute for Environmental Policy Solutions,
Duke University–	E2 Group–	Earth Capital Partners–	EKO Asset Management–	EnviroMarket–	Global Canopy Programme–	GLOBE International–	Goldman Sachs–	Eco System Services Limited–	Harvard Law School Program on International
Financial Systems–	Lombard Odier Investment Management–	London School of Economics–	Multilateral Investment Guarantee Agency–	Norton Rose–	Norwegian Environment Ministry–	PwC–	SEB–	State Street Global Advisors–	Terrestrial Carbon Group–	UK Committee on Climate Change–	UK Department for International Development–	UNEP Finance Initiative–	Vivid Economics–	WWF Forest & Climate Initiative–	WWF-International–	WWF-UK

27

www.panda.org/forestclimate
www.globalcanopy.org
www.climatebonds.net