A FINANCIAL TOOLBOX

There are at least three types of financial tools, or more aptly put, finance and policy tools, that will permit the protection and development of environmental goods and services. They are:

1) those that help protect environmental areas as providers of "public goods or services;"

2) those that help protect environmental resources as providers of "private goods or services" (as businesses); and,

3) those aimed at correcting the incentive structure to encourage the conservation of biosystem resources.

The chart below provides a list of financial tools that might fall into each of these categories. In addition, there is a special sub-category related to creating markets for ecosystem services such as water filtration, carbon sequestration and so on. This subcategory is separated from the other three because many of these goods and services are currently treated as public goods, though with the proper mix of incentives and government regulation, they could become markets of their own.

Financing the Protection of World Heritage Sites

As Public Good

Taxation
Grants and Subsidies
Loans from MDBs
Debt-related Instruments
Loans from Capital Markets
Philanthropy

Changing Incentives
Tax incentives
Removing damaging subsidies
Environmental Fines
Tradable Permits / Development Rights / Extraction quotas
Performance Bonds
Deposit-refund schemes

As Business
Credits and loans to "Green Businesses" (Export Credit). +
Venture Capital (equity) for "Green Businesses" +
Investment Guarantees for "Green Businesses" +
Resource Extraction Rents and/or Severance Fees +
Entry fees / concessions +
Securitization

New Markets: Ecosystem services (e.g. carbon sequestration, water filtration, storm protection)

FINANCING ENVIRONMENTAL GOODS AND SERVICES AS A PUBLIC GOOD

Tax Revenues

Public goods such as roads, law enforcement and clean air, are generally financed through tax revenues. Such revenues are the oldest, largest, and most traditional source of funding for environmental or conservation sites. When a government allocates money to its National Parks Service or Ministry of the Environment and this entity in turn channels that money to an environmental purpose, it is the taxpayer who is financing the site's conservation.

Money from taxes, however, is anything but secured. It depends on the whims of those in charge of the political system and is usually decided upon in country capitals, far away from most environmental or conservation sites. Additionally, natural resource protection is not generally an issue with strong political allies. For this reason, conservation sites are often low on the priority list and at risk of having their budgets cut when there is a need for fiscal austerity.

Multilaterals

A less direct mechanism for financing environmental sites or services involves channeling funds through multilateral organizations. For instance, when the world's governments put money into the Global Environmental Facility (GEF), they are routing tax money to a multilateral institution that can channel the resources to projects or agencies that help protect environmental resources. Multilateral money can take the form of grants or even low-interest or concessionary loans.

The GEF is perhaps the most obvious example. The GEF was established in the early 1990s as an experimental facility for financing work in biodiversity, climate change, international waters, and ozone depletion. Following the Rio Earth Summit, it was restructured to serve as the main financing facility for the Convention on Biological Diversity and the Framework Convention on Climate Change. Recently, it has also undertaken to finance some projects called for in the Convention to Combat Desertification. Between 1991 and 1999, the GEF had allocated more than $991 million in grants for biodiversity, $884 million for climate change, $360 million for international waters, and $155 million for ozone depletion. In terms of World Heritage sites, GEF projects have helped finance the conservation of sites such as Galapagos and the Barrier Reef Complex in Belize. The Box below describes the GEF's program in Belize.

GEF Project: "Conservation and Sustainable Use of Barrier Reef Complex"

In 1998 the GEF council approved a grant of $5.355 million to finance the implementation of a Coastal Zone Management Act in Belize. This project follows on from a previous project funded during the GEF's pilot phase to conserve coastal and marine resources in Belize. The project will be completed in 2003 and it is expected that the project will be co-financed by government and private sector donors to the tune of $2 million. Total project costs are estimated at $7.37 million. The Barrier Reef complex in Belize is the longest such reef in the Western Hemisphere and five of the marine protected areas targeted through this program are World Heritage sites.

Source: GEF Project Status report, 1998.

In terms of loans from multilaterals, the governments of Colombia and Brazil have taken out loans from the Inter-American Development Bank (IDB) to help finance environmental funds (see information on environmental funds below and example of FNMA in box below) aimed at natural resource conservation.

Debt-related Mechanisms

Recent developments permit other, more creative mechanisms for channeling tax money to protected areas. A prime example is the conversion of a country's national debt into money for conservation. This mechanism, sometimes referred to as a "debt-for-nature swap," can take one of two forms:

• Debt conversion: In a debt conversion (or swap), a third party (often an environmental NGO) buys a country's debt at a discount from a creditor on the secondary markets. The creditor is willing to sell because it does not think the developing country will repay the debt. (Some debts are sold for as little as ten cents on the dollar so that $1 million of debt can be bought for $100,000). After buying the debt, the third party sells it to the debtor government (also at a discount, though not as great as it obtained from the creditor) for local currency to be used for conservation. As an example, let's say that a conservation organization buys $1 million of Peruvian debt from a creditor for $300,000. It then sells the debt to the Peruvian government for $500,000 in local currency, which the organization uses to finance conservation activities in Peru. In this way, the government pays $500,000 in local currency for a debt worth $1 million (at the same time that it encourages conservation in the country), and the conservation organization pays $300,000 for $500,000 worth of conservation activities. The creditor gets $300,000 for a debt it didn't think was ever going to be paid back. When done correctly, these transactions can be real "win-win" situations. This sort of third-party debt conversion is usually used to convert a country's private, commercial debt (the debt it owes to private creditors such as banks)
  
  
• Debt forgiveness or debt buy-back: In a debt forgiveness, the creditor of a country's national debt (usually another government) agrees to forgive the debt in return for conservation activities in the creditor country. Often, this takes the form of a buy-back, where the debtor government agrees to purchase its debt for a fraction of its face value in local currency and to invest that local currency in conservation activities in its own country. As a general rule, debt forgiveness transactions are done for a country's bi-lateral debt.

In both these cases, the money to finance the debt conversion comes from the debtor country's tax revenues, so debt conversions are really only fancy ways of leveraging tax money for conservation.

Over the past 10 years there have been more than 100 debt-for-environment transactions worldwide, generating more than $1 billion in finance for conservation (some used to finance parks and protected areas) and reducing the debt of developing countries by more than $7 billion (see list of debt-for-environment transactions in Annex 1). However, this trend has recently slowed since most private commercial debt is no longer being sold at a discount in secondary markets.

Borrowing on Future Taxes

3 Innovating Environmental Finance March 20, 2001 www.milkeninstitute.org In addition to negotiating debt-for-environment swaps, some countries (notably the U.S.) have experimented with borrowing on future tax revenues to finance conservation. One way this can be done is by issuing state or municipal bonds at low rates of interest to pay for conservation activities. Ultimately, these loans are paid back using tax revenues that are collected at some future date, or via alternative sources of tax revenue (license plate taxes, taxes on cigarettes, etc.), so this too is just a way of earmarking future tax revenues for conservation. As a concrete example of this tool, The Nature Conservancy (TNC) has worked with several state governments in the U.S. to issue bonds that have raised more than $14 billion for the conservation of open lands. Examples of states in which these bonds were issued include California, Florida, New Jersey, and New York.

Using a similar principle, some developing countries (notably Brazil and Colombia) have borrowed money from multilateral development banks (the IDB in the cases below) for conservation, projecting to pay back the loans from future tax revenues or via environmental fines. The box below (taken from Bayon, Lovink and Veening, forthcoming) provides detailed information on how Brazil has borrowed on future tax revenues to finance conservation.

Brazil: National Environmental Fund (FNMA)

The Brazilian National Environment Fund (FNMA) was established by Brazilian law in 1989 to develop projects promoting the rational and sustainable use of natural resources, improving the quality of the environment, and raising the overall quality of life for the population of Brazil. The Law establishing the FNMA specified seven priority areas for projects: conservation of land, research and technology development, environmental education, forestry extension, institutional strengthening, environmental control, and rational use of flora and fauna.

In 1992, FNMA was supported by an IDB loan of $22 million in local currency at concessionary rates. A second loan was approved in 1998 to provide an additional $24 million to the FNMA, at similar concessionary rates. This makes the FNMA one of the few environmental funds that is capitalized via a multilateral development bank loan taken out by a government. The rationale behind this is that by strengthening civil society, the FNMA will help "create a demand" for environmental goods and help provide some of the public goods (e.g. clean air, clean water, access to open spaces) that markets tend to undersupply. It is expected that the loan from the Bank will be paid back by: (i) using future tax revenues, (ii) leveraging external grants (such as from the GEF, etc.), as well as (iii) through the collection of environmental fines and penalties. By late 1997, FNMA had financed over 500 small environmental projects.

The FNMA is housed in the Brazilian Ministry of the Environment (Ministerio do Meio Ambiente, Recursos Hidricos, e da Amazonia Legal) and controlled by a board of 14. In 1997, nine were from government and five were from civil society. The Board meets several times a year to decide on administrative and operational procedures and to select projects for final approval.

In a recently passed Environmental Crimes Law for Brazil, the FNMA is mentioned as one of the main recipients of the proceeds collected via the environmental fines proposed by this new law. This could ensure a substantial contribution to the capital of the fund.

Source: Adapted from IDB 1997.

Private Philanthropy

In addition to taxes, the other source of money available to finance the protection of "public goods" is private philanthropy. In the U.S., Europe, and a number of other countries there is a long history of channeling money from philanthropy to the protection of natural areas. This money comes from individuals, organizations, or families who feel strongly about conservation and who are willing to donate money to ensure the protection of certain areas.

One example of the use of philanthropy to support the conservation of protected areas comes from the U.S., where the National Park Service has created a semi-autonomous National Parks Foundation whose role is to stimulate philanthropy and finance for the protection of parks. This Foundation has been instrumental in the creation of "Friends of the National Park" societies around the country who voluntarily help raise money for the protection of specific areas. The Foundation has been successful at raising money for conservation in part because it maintains a Board of prominent, and often wealthy, individuals who help make contacts and raise funds.

Like most areas of human endeavor, the process of philanthropy and fundraising is being thoroughly revised by the advent of the Internet. Recent years have seen the development of web sites involved in "click-through" or Internet philanthropy. These sites channel "internet surfers" to retailers in return for a percentage of the sales they help generate. Internet users are willing to go through these sites because (i) it doesn't cost them anything, and (ii) they are interested in helping out a particular cause. Three such outfits are GreaterGood.com, 4Charity.com, and iGive.com. All of these involve surfers going to a specially-designed web site, choosing their favorite philanthropic institution (whether it is the National Wildlife Federation, The Nature Conservancy, or the Red Cross) and then going through that site to shop at Amazon.com or any one of a long list of participating retailers. In return for this business, the retailers pay a percentage of the profits from each sale to the selected charity/philanthropy.

In 1999 the research agency of Craver, Matthews, Smith and Company issued a report detailing the prospects for online philanthropy and concluded that the potential was vast and mostly untapped. In addition, they found that the Internet could bring a whole new generation of users and donors to the traditional non-profit groups. Some of these findings have already been borne out. iGive.com, for instance, has apparently written checks totaling nearly $750,000 to more than 10,000 charities since going online in late 1997. And in 2000, a group called VentureFrogs pledged to donate up to $1 million to the American Red Cross ($1 for every unique visitor to their web-site). So far, they have collected more than $770,000 for the American Red Cross.

One of the first to use this form of "click-through" philanthropy was the World Hunger Program of the UN Food and Agriculture Organization. Several years ago FAO started a World Hunger site backed by a donor willing to give a small amount of money for every person clicking on the site. This site raised several million dollars for the World Food Program's activities and has since been integrated into the web site of GreaterGood.com.

FINANCING WORLD HERITAGE AS A PRIVATE GOOD

In addition to taxes, philanthropy, and other such "public" sources of finance, there are a number of potential "private" sources of finance for environmental conservation. These include sources that provide money to businesses that help protect an environmental site, sources that take a percentage of the profits made by companies that rely on environmental sites or resources for their business (e.g. tourism operators), or sources that raise money by charging for the use of the environmental resources.

In terms of finance for businesses that protect conservation sites, money can be channeled using a variety of traditional business finance mechanisms such as loans, equity investments, investment guarantees, and export credits. Some of these are discussed below.

Equity Investments in "Green Businesses" (Environmental Venture Capital)

Perhaps the best examples of a mechanism for channeling money to "green businesses" are the recent experiences with the use of venture capital tools to support environmental enterprises. The last five years have seen the creation of several "Environmental Equity Investment Funds," such as:

• Terra Capital Fund: Established by the International Finance Corporation (IFC) of the World Bank, the GEF, Banco Axial (Brazil), and an outfit called the Environmental Enterprises Assistance Fund (EEAF), the aim of the Terra Capital Fund is to help finance businesses in Latin America that are profitable and help protect biological diversity (see box below).
  
  
• Eco-Enterprises Fund: Established by The Nature Conservancy (TNC) and the Inter-American Development Bank (IDB), the Eco-Enterprises fund will finance businesses in Latin America set up by non-profit organizations working together with private companies and whose work is somehow related to environmental protection;
  
  
• IFC Solar Energy Fund: Financed, in part, by the IFC, this fund seeks to provide venture capital to businesses that promote the use of solar energy.

All of these are capitalized using money provided by multilateral development banks such as the IFC or the IDB, but they also include investments from private venture capitalists. Similar funds have been established or are being planned in Africa and Asia.

The Terra Capital Fund

In late 1998, a consortium made up of the Environmental Enterprises Assistance Fund (EEAF), a Brazilian bank (Banco Axial) and Sustainable Development Inc. (SDI), working with the World Bank's International Finance Corporation (IFC), announced that they had secured the capital necessary to establish a private, for-profit, environmental venture capital fund for Latin America called the "Terra Capital Fund." The fund obtained money from a variety of sources, private and multilateral (including the IDB, the Swiss government and private investors), in order to invest in small, private businesses that meet a set of environmental criteria. In addition to money for its capitalization, Terra Capital received grant money from the GEF ($5 million) to:

• establish the technical and managerial capacity needed to operate such a fund,
• monitor and evaluate the environmental impact of investments, and
• cover any additional costs that will be incurred by the fund when screening projects for their biodiversity/environmental value.

Initially capitalized at $15 million, the fund will make investments of between $500,000 and $3 million (with an average investment of $2 million) in projects related to sustainable forestry, agriculture, ecotourism, and other biodiversity-based businesses.

Source: Adapted from Bayon, Lovink, and Veening, Forthcoming.

The Eco-Enterprises Fund

Also in 1998, The Nature Conservancy (TNC) and the Multilateral Investment Fund (MIF) of the InterAmerican Development Bank (IDB) created an environmental venture capital fund known as the EcoEnterprises Fund (or Fondo EcoEmpresas). When fully capitalized, the fund will be a $10 million dollar operation designed to provide venture capital and technical support to environmentally responsible business projects in Latin America and the Caribbean. In its own words, the fund will help "spur the growth of small and medium-sized companies, which is key to the economic future of Latin America and the Caribbean, and promote the conservation of one of Earth's most biologically important regions."

In addition, the EcoEnterprises Fund aims to foster the development of socially and environmentally responsible enterprises, generate revenue for biodiversity conservation, and enhance the long-term sustainability of non-profit environmental organizations in Latin American and the Caribbean.

Target sectors include alternative agriculture (including organic agriculture, apiculture and aquaculture), sustainable forestry, non-timber forest products, and nature tourism.

The fund has two components: a $6.5 million venture fund to invest in enterprises at all stages of development and a $3.5 million technical assistance fund to provide business advisory services to help new ventures succeed. TNC serves as Fund Manager. Over a 10-year period, the fund will provide between $50,000 and $800,000 (with an average of $150,000) to as many as 25 ventures. Revenues generated by the ventures will contribute to the long-term financial sustainability of the participating environmental organizations, demonstrating ways to integrate economic growth and environmental protection.

A key difference between the Terra Capital Fund and the Eco-Enterprises Fund is that the latter requires the ventures it finances to be a collaboration between private enterprises and non-profit organizations. This criteria was included to help build capacity within the NGO community in Latin America.

Source: Adapted from Bayon, Lovink, and Veening, Forthcoming.

Loans to "Green Businesses"

In addition to equity investments in green businesses, it is also possible to stimulate the creation of these businesses by providing them with concessionary or low interest loans. The best example of the use of this mechanism is the Small and Medium Enterprise (SME) program of the IFC and the GEF. The idea behind this program is that it makes loans to intermediary organizations (around $1 million at low rates of interest), who then on-lend to small and medium enterprises that help protect the environment (in smaller amounts and at higher rates of interest). So far, organizations like the World Wildlife Fund (WWF)-U.S. and Conservation International (CI) have participated in the program as intermediaries, but the success of the program has been mixed. Recently, some of the intermediaries have said that they have found it exceedingly difficult to channel funds to "bankable" businesses that also help protect the environment. At least one intermediary, WWF, has indicated that it might actually return unspent money to the IFC because of difficulties in finding suitable investments.

Export Credit and Investment Guarantees

Other mechanisms that might help stimulate "environmental businesses" include investment guarantees and export credit. The principle behind these mechanisms is simple: since many private investors shy away from investment in green businesses because they are perceived as being "excessively risky," why not set up a mechanism that will help diminish these risks and thereby encourage "environmental" investment? Some of the mechanisms that have traditionally been used to provide this form of incentive to investment include export credits and investment guarantees. In the U.S., Europe, Japan, and at the global level, these kinds of investment guarantees and export promotion tools have been used by organizations such as the Export-Import Bank of the U.S. (Ex-Im), the Overseas Private Investment Corporation of the U.S. (OPIC), the Japanese Export-Import Bank (Jexim), and the Multilateral Investment Guarantee Agency (MIGA) of the World Bank. Guarantees generally come in two forms:

• Guarantees against commercial risk that cover businesses against risks such as nonfulfillment of contracts, non-payment of loans, fluctuations in the exchange rate, among other things; and
• Guarantees against political risks, which cover businesses against events like wars, civil disturbances, inconvertibility of currency, and the expropriation of goods.

An example of the use of investment insurance to finance a project with environmental components is found in the box below.

MIGA and the Rainforest Tram

An example of the use of guarantee instruments to encourage environmental activities is the case of two guarantees provided by the Multilateral Investment Guarantee Agency (MIGA) of the World Bank. In 1995, MIGA supported the construction and operation of 1.3 km. aerial tram, a restaurant, and a visitor research center located on a 338 hectares site of rainforest bordering Braulio Carrillo National Park in Costa Rica (50 km. north of San Jose). MIGA issued guarantee contracts covering foreign investment in Dosel S.A., a special purpose company set up to run the Rain Forest Aerial Tram (RFAT). One contract guarantees the equity invested by Conservation Tourism, Ltd., of the United States against currency transfer risk; the other guarantee contract covers the Bank of Nova Scotia's (Canada) non-shareholder loan to Dosel against Transfer Restriction, Expropriation, War, and Civil Disturbance. The idea behind the Rainforest Tram is that it will help educate visitors about the imp ortance of the rainforest, as well as serve as an example of how Costa Rica can make the best use of its rainforests in a non-destructive way. Finally, the company concerned, Dosel, hopes to work closely with the Costa Rican government to reduce illegal hunting activities in the area. Source: Adapted from Bayon, Lovink, and Veening, forthcoming.

Source: Adapted from Bayon, Lovink, and Veening, forthcoming

Another interesting possible use of guarantees as a way of stimulating conservation has been proposed by the U.S.-EPA (1997), which recommended the establishment of guarantee mechanisms that enhance the availability of credit for environmental activities to municipalities in the U.S. Generally, the guarantees discussed by the EPA are used to finance environmental infrastructure (i.e. wastewater treatment plants and solid waste facilities) and not to support activities directly related to biodiversity conservation, but there is no reason why these mechanisms could not be applied to biodiversity-based businesses. The EPA refers to these guarantees as "tools for enhancing credit" and defines them as "assurances to lenders or bondholders that credit is available and that they will be repaid if the debtor government or private party should default or delay payment." What is interesting in the EPA's approach to guarantees is that they are used to help environmental projects obtain money through capital markets via the issuance of bonds (Bayon, Lovink, and Veening, forthcoming).

Although guarantees can serve as promising tools for stimulating biodiversity-based businesses, it is important to note that they can also carry considerable financial risk. An institution providing guarantees needs to ensure that it has enough capital to cover the guarantee should it be called upon to do so. Existing investment guarantee agencies have considerable expertise in this regard, (in fact, OPIC has found that if done correctly, providing investment guarantees can be an extremely profitable business), so this is an obstacle that can be surmounted.

Problems with "Green Business Finance"

Although there has been much recent interest in channeling money to businesses that somehow help protect the environment, certain problems with this approach require careful consideration. They include:

• The difficulty of determining whether the businesses concerned really do have a positive impact on the environment. Part of the problem is that not enough work has been done in monitoring the long-term impacts of these businesses on the resources they are intended to help conserve or on the communities in which they are created. To be fair, many of these businesses have not been in operation very long, but nevertheless, monitoring of "environmental businesses" would be a useful area for further research and investment.
  
  
• The difficulty of finding enough businesses that meet both the environmental and financial criteria of the funds set up to finance "green businesses." Until a broader and deeper pipeline of green businesses is developed, many of these programs will have trouble finding willing customers and investors. And, in order to build that pipeline, there is a need for training of environmental entrepreneurs, the provision of micro-credit to these businesses, and further development of the markets in which these businesses operate (e.g. eco-tourism or organic agriculture);

While protecting the environment can mean reducing pollution or decreasing the use of fertilizers and pesticides (which can be clearly demonstrated), having a positive impact on conservation sites is a much more nebulous concept. Has it really led to decreased pressure on the site? And how can this decrease be demonstrated?

These are but a few of the hard questions that "green businesses" will need to answer before support for green businesses becomes a major form of finance for environmental conservation. This does not mean that investment should not be made in businesses that may have beneficial effects on such sites, but rather that it is important to have a clearer idea of what those impacts might be, and how they will be measured/demonstrated before any such investments are made.

Finally, when making investments i