Stimulating private investment in the forestry sector - Proparco

Stimulating private investmentin the forestry sector25Deforestation has devastating effects in developing countries. Managed sustainably, forestry projectsprovide solutions to economic, environmental and social problems by creating jobs, developinginfrastructure, etc. Through the financing of forestry projects, development finance institutionscan have a favourable impact on local legislation, as well as providing reassurance to investors.HANNA SKELLYHanna SkellyAssociate Director, FinnfundNatural forests are disappearing fastglobally. Every year global forest coverreduces by some 10 million hectares.The majority of this occurs in the Southernhemisphere and in developing countries.Forests serve as a natural carbon storage area– as a tree grows, it sequesters carbon. Deforestationis one of the key contributors to climatechange, and has farreachingimplications forthe environment in severalways – deforested areas areprone to drought, as thevegetative cover protectingwater sources is removed.They are also prone to erosionand depletion of soilHanna Skelly, Associate Directorat Finnfund Ltd, leads aninvestment team specialisedin forestry, renewable energy,energy efficiency and cleantechnologies with businessdevelopment responsibilitiesincluding origination andstructuring. In addition, she isresponsible for the managementof a dedicated portfolio of noninvestment-gradeemergingmarket investments (equity,mezzanine and loan). She hasover 10 years of experiencein emerging markets andforest industry sectors. Priorto joining Finnfund, she wasbased in Singapore as a seniorconsultant with Pöyry ForestIndustry Consulting, theleading global forest industryconsulting company, andwith Nordea Bank’s Singaporeoffice project finance team.minerals and significantlosses of biodiversity andecosystem services. Deforestedareas suffer more easilyfrom other catastrophessuch as flooding and landslides,and in the longerterm, deforested areas canundergo desertification, nolonger being able to providelivelihoods for localpeople. Measures to reducedeforestation have a positiveimpact in the fightagainst climate change.Beside climate change hasalready demonstrated devastatingimpacts in developingcountries. Mostare located in the tropicaland subtropical regionswhere even small changesin climatic conditionshave large consequences.The people in these countries are poor andhighly dependent on natural resources, agricultureand other such sectors that are sensitiveto climatic changes.In developing countries, especially in Africa, amajor contributor to deforestation is demandfor firewood, as well as shifting agriculturalpractices. Protecting existing forests aloneis not sufficient to fight deforestation.If alternative sourcesof firewood (or charcoal) andinputs needed for improvedagricultural practices are notprovided, the protection effortsmay become futile, as the people will moveto another location where protection is notenforced, and the deforestation will continue.Promoting the sustainable management anduse of forests by providing education and technicalsupport as well as developing new forestresources are equally important as conservation.Depending on the end use, new resourcescan be developed through rehabilitatingdegraded or badly managed forests or byplanting new forests. While plantation forestrymay in some stakeholders’ minds havea negative connotation, it can yield significantpositive environmental and developmenteffects when implemented appropriately.Forestry projects take time to developthough, and the attached community andsocial development issues require closemonitoring, time, support and effort.In developing countries where political andcountry risk issues limit the appetite of privatesector investors and financiers, the longtermcommitment required in these projectsmay further reduce the attractiveness of thesector. Further, infrastructure challenges inthese countries make these projects moreexpensive, lowering the yield. Thus, there isa clear need for development finance institutionsand multinationals to participate in thissector, as catalysts to other funding.“A major contributorto deforestation isdemand for firewood,as well as shiftingagricultural practices.”Private Sector & Development

26Stimulating private investment in the forestry sectorUtilising,developing andpreservingforests: findingthe balance.Forestry is one of Finland’s developmentpolicy themes, and regarding the sustainableuse and protection of forests, Finlandand the developing countries share thesame goals. Forestry offers economic opportunitiesand social and environmental benefits.By providing a framework for sustainableforestry, equitable economic growth iscreated, poverty is reduced, and threats tothe environment are prevented. Finnfundis one of the instruments for implementingFinland’s development policy, and ithas established a dedicated team to reviewopportunities in this area.Forestry and development impactsDevelopment finance institutions such asFinnfund require their investments to beboth profitable and to generate measurabledevelopment impacts in the project country.In addition to effectively mitigating climatechange, forestry projects also providea wide range of these development impacts.Forestry projects tend to be located in ruralareas where formal employment opportunitiesare few, they are labour intensive– a large project easily employs thousandsof people – and many tasks aremanual. Employment requirements rangefrom the performance of simple tasksto more demanding positions. Womenare equally easily employable. This largeemployee base supports the developmentof additional economic activities, providinglivelihoods for even more people.This potentially improves resilience andsupports adaptation to the effects of climatechange.Forestry projects require infrastructure,both in their immediate area and from theproject site to markets, and most projectsinvest heavily in developing and maintainingit. As the project sites tend to be verylarge, the whole region generally benefitsfrom this.While the land use and tenure regulationsof the relevant country determine whetherforestry projects will be based on land ownershipor other types of tenure, they typicallymake some form of payment either tothe government or to local agencies or communitiesfor the use of the land and wood.The projects also contribute to the localeconomy through direct and indirect taxesand in other ways. Wood products oftenhave significant export value, have welldevelopedglobal markets, and can providesignificant export revenues to the country.Well-managed, legally operating plantationforestry projects help battle illegal logging.They contribute to the development of officialand legal wood product markets, and meetthe demand that illegal logging attempts tosatisfy. They help officials and governmentsas well as local people to understand the benefitsof legally operating projects, and thusmake the operations of illegal loggers moredifficult and less profitable.Properly implemented plantation forestryprojects set an example of good governanceand may help host countries to develop sustainableforestry policies.In Finnfund’s experience, forestry projectshave provided the significant developmentimpacts expected of them. As an example,Finnfund has been an investor in a teakproject in Tanzania for more than ten years.This company supports the people within itsarea in many ways. For example,it has financed schoolsand health care, and now providesjobs for several hundredpeople in one of the poorestareas in Tanzania. When harvestingand processing get intofull swing, several thousandjobs will be generated directlyand indirectly. When the wood trade andprocessing are established, teak looks setto become an important crop plant for thearea and a major export product for Tanzania,providing over 130 million dollars ofexport revenues over a ten-year period.Unfortunately, where a business fails, thedevelopmental impacts are largely lost aswell. During its history of forestry projects,Finnfund has experienced one such failedproject. In that case, the failure was mainlycaused by changes in the political and operatingenvironment that made it impossibleto have staff on the ground and to continueto develop the project. In some otherprojects where the business has developedslower than expected, significant valuesare still captured in the growing biologicalassets, and while the overall returns ofthe project will be negatively impacted, thedevelopmental impacts are still significant.“There is a clear needfor developmentfinance institutionsand multinationalsto participate in thissector, as catalyststo other funding.”Finnfund’s investment criteriain forestry and forestry-related projectsDue to the significance of the forestry sector forFinland's economy 1 , its technical know-how 2 andthe expected development and environmentalbenefits delivered by the sector, it follows thatthis is also one of the focus sectors for Finnfund.Forestry projects to the end of 2011 accountedfor some 20 % of Finnfund’s portfolio.Finnfund’s investment criteria for forestryprojects do not, as a framework, differ fromwww.proparco.fr

27those of other sectors. Key criteria includeprofitability, private sector participation,environmental and social sustainability,development impacts, good governance andthe integrity of other project parties. However,in forestry projects and in projects whichhave similar land use issues (such as biomassprojects), certain aspects of the projectreceive in-depth scrutiny in due diligenceLand procurementand land use plansand practices receiveespecially detailed andin-depth analysis.”and on-going monitoring, dueto their complex and sensitivenature. Typically, the due diligencefollows the requirementsset out in the IFC PerformanceStandards and forestry certification,and preferably the ForestStewardship Council criteria.Especially in new, greenfield plantation forestryprojects, economic sustainability requirementsmay, for example, entail that land use permits,be they concession agreements or other suchpermits, be valid for a long enough period, andalways cater for the replanting of the areas afterthe wood resource has been harvested. A forestmanagement plan that is based on the sustainabledevelopment and use of the resource isalso required. Social sustainability, on the otherhand, may require the project to provide alternativesources for firewood, charcoal or otherecosystem products and services, or educationand technical assistance in developing agriculturepractices that will eventually provide thecommunity with an alternative to, for example,slash-and-burn practices.Land procurement and land use plans andpractices receive especially detailed and indepthanalysis. This includes legal due diligenceof the land procurement and usebut also an analysis of the overall land tenureissues, from a legal but also cultural andcustomary points of view. Land use is alsoassessed from an alternative land use pointof view, to make sure that the project will notjeopardise or restrict food production andfood security, or otherwise negatively impactit, e.g. in water use. Especially in greenfieldprojects that are located in less-developedcountries with complex land tenureissues (e.g. many African countries), increasingemphasis is given to community consultationand NGO co-operation. The underlyinggoal is to ensure that the projects aredesigned to respect areas and resources thatare important for communities.While the environmental and social aspects ofthe project assessment tie closely in with landuse issues, conservation should be highlightedseparately. The assessment includes identifyingand maintaining environmental and socialvalues that are considered to be highly significantor critically important (defined as highconservation-value forests in the IFC performancestandards). Finally, projects areassessed from the point of view of the equitableuse and sharing of benefits.Finnfund has participated in both direct andindirect forestry investments in 15 countries.The average size of the investment in the forestrysector varies from 7 to 10 million dollars.Direct investments have been in both existingprojects and greenfield developments aswell as in the industrial components of thebusiness, largely in frontier markets (at leastas defined at the time of making the investment),where purely commercial fundingis not readily available and the regulatoryframework is still being developed.Finnfund strongly believes that it is a keypart of the role of development finance institutionsto go into situations where the regulatoryframework has not been finalised andto help improve them, both through interactionwith regulators and by showing thepotential of responsible long-term privatesectorinvestments for various stakeholders.This is particularly true in forestry.1In the past couple of years, it has con tributed 4-5 % of Finland’s GDP, whichis very high for the EU. More important, it generates some 18 % of Finland’sexport revenue.2Finland has state-of-the-art scientific and techno logical knowhow infor estry, and is home to many large multinational companies in the industry.The players in the sector, including research insti tutes, universities andthe large corporations, have been busy develop ing new technologies andproducts catering for new markets (bioenergy, other wood-based products)which will generate half of the sector's additional value created by 2030.F O C U SFinnfund is the Finnish development finance institution, majorityowned by the Finnish state. Its mandate is to provide long-termrisk capital for private sector projects in developing countries,with an emphasis on the poorer countries. It seeks to promoteinvestments that are profitable and environmentally and sociallysound, and focuses on certain sectors, including renewable energy,forestry and the environment. Apart from co-investing withFinnish companies Finnfund can finance ventures that use Finnishtechnology, cooperate with Finnish partners on a long-term basisor generate major environmental or social benefits. Finnfund alsoco-invests with other similar development finance institutions.Private Sector & Development