The REDD+ Acceleration Fund (RAF)...
aims to accelerate the use of market-based approaches to reduce tropical deforestation through an innovative finance approach to mobilize private investment to reduce tropical deforestation. The RAF combines private, mission-driven, philanthropic, and public capital to reduce risk for private investors, unlocking immediate demand for compliance-grade forest carbon credits (known as REDD+ credits) for prospective use in carbon markets in California and elsewhere. By catalyzing pre-compliance private investment into forest protection implemented at scale, the RAF aims to demonstrate the potential for market-based REDD+, bolstering confidence and support for “Reducing Emissions from Deforestation and forest Degradation” (REDD+) among regulators and regulated entities in key compliance markets. By attracting private capital into forest protection while compliance markets are developing, the RAF will also send a powerful demand signal and provide a critical finance “bridge” to sustain and encourage the development of REDD+ programs in key tropical forest jurisdictions.
The Problem: While forests disappear, private investment in REDD+ sits on the sidelines
To solve the global climate crisis, we must solve the deforestation crisis. Tropical forests, with their vast stores of carbon, are vital to a stable climate, while also providing crucial biodiversity and sources of livelihood to indigenous peoples and other forest-dependent communities. Yet, tropical forests are being decimated at such a rate that deforestation and forest degradation contributes up to 20% of annual global greenhouse gas emissions. Forests represent one of only a few gigaton-scale opportunities to tip the scales in the climate change fight and reverse rising global emissions within ten years, but the need for forest protection is urgent.
The root cause of tropical deforestation and degradation is the absence of economic incentives to protect and restore forests and the carbon they contain. Carbon credits for Reducing Emissions from Deforestation and forest Degradation (REDD+) can play a central role in realizing this vision, by creating durable, large-scale economic incentives for forest protection. To stop tropical deforestation, and address climate change, forests must be worth more alive than dead. Linking high-quality carbon credits for REDD+ to compliance carbon markets can play a central role in realizing that vision, by unlocking private capital at a scale sufficient to protect the world’s major tropical forests along with the carbon they contain.
The good news is that the critical components of a forest carbon market are coming into place. On the supply side, the Brazilian state of Acre is already generating verified reductions in emissions from REDD+. Other Amazon states, as well as over ten countries in the Forest Carbon Partnership Facility (FCPF) Carbon Fund pipeline, are ready to follow suit in the near term. On the demand side, the Paris Agreement explicitly recognized the role for REDD+ as a mitigation tool and the ability of countries to use international markets for achieving emissions reductions. California, an early mover, has recently initiated the first steps of a regulatory process that may lead to the acceptance of REDD+ credits into its existing compliance carbon market. Meanwhile, the International Civil Aviation Organization (ICAO) agreed in October upon a global Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). This market-based measure is part of a package of measures to cap the sector’s emissions at 2020 levels and allows air carriers to use credits for verified reductions from other sectors (possibly including REDD+) to offset their emissions.
The outcomes of these policy and regulatory processes are far from assured, however. In California, there is opposition from those who would prefer to see emissions reductions happen inside the state. In the ICAO context, there is uncertainty over future emissions unit criteria and opposition to forest carbon markets from some stakeholders. Despite Amazon states’ eagerness to access private investment for forest protection, there is also opposition at the federal level to allowing international compliance market transactions. To bring REDD+ into the California and aviation markets, officials will need to push for it, with the active support of regulated entities. Both officials and regulated entities must have confidence that REDD+ will “work”—i.e., that there is ample supply and sufficient demand for low-cost, high-quality credits. At the same time, forest jurisdictions sustaining and developing REDD+ programs need to know that compliance market opportunities are real and that successful efforts to reduce deforestation will be rewarded with private investment.
The Solution: The REDD+ Acceleration Fund – kick-starting a virtuous cycle
The RAF is a multi-stakeholder, blended finance strategy designed to spur private investment in to tropical forest protection by providing a source of demand (rather than project or program development finance) for REDD+ credits on a pay-for-performance basis. The RAF will contract for current and future volumes of REDD+ credits (on a forward basis) and will pay for verified emissions reductions from REDD+ upon delivery. The RAF will combine public, private, mission-driven and philanthropic capital to kick-start a virtuous cycle of finance and policy intended to create desirable conditions for first movers to engage in the nascent market for REDD+ from jurisdictional (state or national scale) programs that meet potential requirements for compliance carbon markets.
How the RAF works
The RAF is designed to take advantage of emerging compliance carbon markets that may soon accept REDD+ credits. The Paris Agreement has recognized a role for REDD+ as a mitigation tool and encouraged countries to use international markets for achieving emissions reductions, thereby spurring international demand. California Air Resources Board has indicated that REDD+ credits may be accepted as early as Spring 2018. In addition, pending regulation from the International Civil Aviation Organization (ICAO) may unlock long-term demand on a much more significant scale under ICAO’s new global Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). On the supply side, the Brazilian state of Acre is generating verified reductions in emissions from REDD+ at a jurisdictional scale. Other Amazon states and many countries in the World Bank’s Forest Carbon Partnership Facility’s Carbon Fund pipeline are ready to follow suit.
The RAF structure involves the interplay of four distinct parties, each with their own incentives and risk / reward profile. The relationships and contracts among the parties are arranged so risks are distributed efficiently, and so rewards in the base and upside scenarios are equitably shared.
The “REDD+ Acceleration Fund” would be structured as follows:
· Corporate pre-compliance investors (for example companies with current or prospective compliance obligations under the California cap-and-trade program ) or other public or private investors (e.g. trading companies) interested in off-taking credits that would be valid under a future compliance market) would invest in an option to purchase jurisdictional REDD+ credits representing verified emissions reductions to be delivered at a future date certain (e.g., 2020) if a compliance market for REDD+ exists at such time;
· Mission-driven investors (for example, impact investing funds, family offices, or philanthropies) would provide up-front funding (equity or debt), motivated both by the prospect of a return and by the potential to catalyze policy and REDD+ market developments;
· Public investors or other funders motivated by forest conservation or climate goals (for example, bilateral donors, philanthropies, or corporate social responsibility programs) would offer (in return for a fee) a price guarantee in the form of an advance purchase commitment of the credits at a fixed price, should a compliance market fail to materialize.
Mitigating Risk: The Backstop Purchase Guarantee
As noted above, the Fund will seek to mitigate the risk of purchasing REDD+ credits at this early stage by obtaining a minimum price guarantee (i.e., a put option), potentially provided by the public sector, in order to bolsters investor confidence. If no compliance market for REDD+ emerges, the price guarantee would act as a backstop, partially compensating investors and reducing policy risk. The World Bank is currently piloting such a guarantee approach for methane reductions with its Pilot Auction Facility for Methane and Climate Change Mitigation. A price guarantee would also enable the fund to deliver more attractive terms (both in terms of up-front price and later potential upside) to the REDD+ programs.
The RAF will source REDD+ credits from jurisdictional programs (or projects nested within them) based on the criteria established for REDD+ under the UNFCCC and potential requirements from future compliance markets. In 2013, the more than 190 nations of the United Nations Framework Convention on Climate Change (UNFCCC) adopted, by consensus, a globally agreed framework for REDD+, and in 2015 these nations adopted the Paris Agreement on Climate Change, which specifically identifies forests as the only sector meriting special mention. There is now more than a decade of experience with programs to help tropical and subtropical developing countries get ready to participate in REDD+ at scale – i.e., adopting national or state/provincial-level REDD+ strategies; developing reference emission levels (RELs); designing measurement, reporting, and verification (MRV) systems; and setting up REDD+ management arrangements, including proper environmental and social safeguards.
Based on the agreements in the UNFCCC, REDD+ must be implemented at the national level, or, on an interim basis, at the subnational level. California has indicated that international offsets must come from “sector-based” (i.e. jurisdictional scale) programs, with the potential for smaller projects nested within these. Countries, states, and provinces have already made great progress on formally implementing REDD+ in a manner consistent with the 2013 Warsaw Framework. Brazil has submitted all elements to the UNFCCC, and is the first country to be included in the REDD+ information hub. Other countries are close behind. Fifteen countries have submitted their forest reference (emission) level, and 6 countries have had their reference levels technically assessed by a committee of experts.
Many states and provinces are also developing and implementing REDD+ programs, taking action on reducing emissions from deforestation while their national governments prepare country-wide programs. States and provinces would have to show that their forest reference levels and monitoring systems are consistent with national measures, and that their emissions reductions are not being double-counted, in which case they could be nested within national programs. The Forest Carbon Partnership Facility (FCPF), a multilateral program coordinated by the World Bank, is financing 47 tropical forest countries to prepare national REDD+ programs and has received financing from 15 donor countries. Twenty-nine states and provinces representing a quarter of the world’s tropical forests are building or supporting jurisdiction-wide REDD+ programs under the Governor’s Climate and Forest (GCF) Task Force.
The Payoff: Possible scenarios
We estimate that the initial purchase price (e.g. $2-5) would be funded by the private, mission-driven, and philanthropic investors. Funds from the pre-compliance corporate investors are combined with mission-driven equity capital into the RAF (in the center of the diagram in Figure 2 above) where they will then be used to purchase compliance-grade REDD+ credits from eligible tropical forest jurisdictions and REDD+ programs. Once the fund has acquired a portfolio of credits, it will hold those credits until a pre-determined “strike-date”.
· At the strike date (i.e, December 31, 2021), if a compliance carbon market has emerged (e.g., in California), the corporate investor would have the option to pay a predetermined exercise price, discounted to an index of the highest prevailing allowance price in any compliance market, and receive a credit that could be used for compliance with a regulatory obligation (or resold in the market). Depending on the market price, the proceeds from the exercise payment would be used to repay and provide the mission-driven investors with a return on investment; and provide an additional revenue-sharing payment to the originating jurisdiction to support forest communities and sustainable development.
· If the compliance carbon market fails to materialize, the option might be extended for an additional payment. There might also be some cost recovery by selling credits in the voluntary market. As a last resort, the advance purchase commitment would be exercised. Even a nominal price guarantee (e.g. $1-2/ton) would be sufficient to allow each of the fund participants to recover a portion of their investment —providing some “downside” protection to each of them.
· An equitable and balanced distribution of any gains and losses among the different parties is a central principle of the RAF design. The jurisdictions receive a guaranteed up-front payment. In return, they give up some of the potential appreciation in the value of credits, but receive capital up front and transfer the risk that the credits may lose value. In the event that there is an appreciation in the price of the credits, relative to the fund’s acquisition cost for the credits, that gain will be shared between the corporate investor (in the form of the right to purchase credits at a discount to the market price), the mission-driven investors, and the jurisdiction according to a predetermined profit sharing arrangement. The share accruing to the jurisdiction will also ideally rise, once the other participants have earned a reasonable return to compensate for their level of risk. Similarly, in the event that the credits lose value, there will be a predetermined split for benefiting from any partial cost recovery from market sales or the exercise of the price guarantee.
In Conclusion: The Opportunity
RAF presents a unique opportunity to bridge the policy uncertainty surrounding global compliance markets by a) significantly reducing the risk of investing in REDD+; and b) bolstering confidence in REDD+ among regulators and regulated entities.
RAF will ensure that REDD+ programs quickly go to scale by:
· Spurring adoption of jurisdictional REDD+ protocols in key compliance markets, including California and the international aviation sector;
· Providing vital bridge finance in the years leading up to the emergence of compliance demand;
· Reducing corporate exposure to climate policy risks (future price uncertainty);
· Providing mission-driven and philanthropic investors with a mechanism to help prevent global deforestation;
· Creating and communicating a replicable model for early-stage REDD+ investment.
· We are actively seeking private, philanthropic, mission-driven, and public funding partners to help design and ensure the success of this fund.