The LDN Advisory Investment approach

Navigating the complexity: Costs and Challenges of Restoring Forest Ecosystems and Land Degradation

Restoring degraded landscapes and land, especially in forest ecosystems, encompasses a complex set of outcomes that include positive impacts on climate resilience and mitigation, livelihoods, food security, biodiversity, and other economic and social benefits. This endeavor comes with a cost that far surpasses the simplistic marketing notion of $1 per tree for global forest restoration.

In 2021, a white paper titled “Defining the Real Cost of Restoring Forests” outlined various price ranges based on three types of interventions in the tropics and subtropics:

1. Assisted Natural Regeneration: Implementation costs range from $12 to $3880 per hectare, with maintenance costs ranging from $2 to $213 per hectare.
2. Agroforestry: Implementation costs range from $125 to $1240 per hectare, with maintenance costs ranging from $5 to $720 per hectare.
3. Planted Forests: Implementation costs range from $105 to $26,830 per hectare, with maintenance costs ranging from $107 to $2,401 per hectare.

LDN Advisory, drawing from its own experience and accounting for ecological conditions and the severity of land degradation, estimates that a comprehensive sustainable restoration project would incur an average cost, including maintenance, ranging from $1,000 to $5,000 per hectare.

Recently, Global Forest Watch highlighted in its annual report on tree cover loss that deforestation rates are persisting at levels similar to previous decades. In 2023, total tropical primary forest loss reached 3.7 million hectares, resulting in 2.4 gigatons (Gt) of carbon dioxide emissions, roughly equivalent to almost half of the United States’ annual fossil fuel emissions.

The Bonn Challenge, a global initiative launched in 2021 aiming to restore 350 million hectares of degraded and deforested forest landscapes by 2030, is projected to require an investment exceeding $1.5 trillion.

However, the 145 countries that pledged at COP 26 in Glasgow to halt and reverse forest loss by 2030 are facing significant challenges in fulfilling their commitments, especially in two key areas:

1. Mobilizing the necessary funding from public budgets to combat deforestation effectively.
2. Addressing the lack of engineering and technical capacity within public administrations to implement robust strategies for reversing forest and land degradation, particularly in tropical and sub-tropical regions.

The private sector, equipped with human resources, technical expertise, and funding capabilities, must collaborate closely with the public sector to develop science-based and practical solutions. While it is in the private sector’s long-term interest to maintain a sustainable environment, the path forward is not without complexities and challenges that need to be navigated effectively.

What are the challenges impeding progress?

Tropical and sub-tropical countries, often situated in emerging or developing regions like Africa, face several hurdles that can be categorized into three main areas:

1. Technical Challenges: These are related to determining the most effective methodologies for building sustainable projects.
2. Financial Constraints: Many countries in these regions struggle with high levels of debt and chronic budget deficits. Additionally, their financial markets are still in early stages, limiting both public and private borrowing capabilities. Although wealthy OECD countries pledged to provide $100 billion annually in financing from 2021 onwards, this target has not been met. This reliance on external financing creates vulnerabilities.
3. Duration and Risk Perception: Restoration projects for degraded landscapes and land, which typically span 10 to 20 years, present a country risk issue for investors. Local financial institutions, too, are hesitant due to concerns about political stability, legal enforcement over the project’s duration, and weak sovereign ratings affecting borrowing terms. Basel criteria, linking banks’ capital requirements to external ratings, further hinder the mobilization of significant funds over extended periods. Addressing the lack of engineering and technical capacity within public administrations to implement robust strategies for reversing forest and land degradation, particularly in tropical and sub-tropical regions.

Despite these challenges, projects are still progressing, utilizing diverse financing models to navigate the complex landscape.

Existing “Green finance” products’ spectrum:

The existing financial tools are designed to tackle climate issues. However, as is clear from the descriptions below, few are specifically dedicated or adapted to the restoration of degraded land:

• green bonds. Green bonds have become the investment vehicle of choice for the private and public sectors to finance projects with environmental benefits. But it particularly targets low-carbon transport, clean power, and energy efficient buildings. While there is much debate around issues such as greenwashing whether green bonds are better than conventional bonds, this product has now become a highly recognized asset base attracting ever-increasing amounts of institutional capital and is likely to be a mainstay of the green finance revolution.
• green equity. A green equity fund is a structured investment vehicle that selects investments based on a commitment to a green investment strategy. This structure enables different investors to pool their capital with qualified investment managers to pursue an agreed investment strategy. This type of investment structure has been used extensively to support investment in renewable energy over the past 15 years and is now a well-accepted investment tool.
• transition and sustainability bonds. These are used by companies in carbonintensive sectors such as oil and gas or heavy industry, where green bonds may not be accessible due to the specific criteria.
• green securitization. The bundling of green loans into securities can unlock additional capital to finance the transition to a decarbonized and climate-resilient economy. Securitization enables the aggregation of multiple small-scale loans and helps to attract a different investor base. Importantly, securitizing existing loans also gives banks and other primary lenders an opportunity to refinance existing loan portfolios and recycle capital to create fresh portfolios of green loans. Different structures such as collateralized loan obligation and asset-backed securities transactions can be utilized.
• green leasing. Leasing is one of oldest and most popular financing structures
  available to finance the acquisition of planted equipment; however, it is still only
  at a nascent stage when considering the potential for funding green assets.
  Emerging areas where green leasing has been used include:
  • Green property leases
  • Green car leasing
  • Energy efficiency
  • Green mortgages.
• Islamic finance. Climate mitigation strategies are consistent with the principles of Islamic (or Sharia) finance. Islamic finance offers a broad range of instruments that can be used for climate mitigation and importantly draws on a completely different universe of investors.
• blended finance. In new and challenging markets, blended concessional finance (the combining of concessional funds with other types of finance, on commercial terms) is increasingly used to mobilize capital and accelerate highimpact private sector investments. There are several instruments in use:
  • Senior debt, when concessional, can address cost issues, e.g. the high start-up costs for pioneering technologies, or the high costs of providing loans to SMEs.
  • Sub-debt and equity mitigate senior debt risk by improving coverage ratios (e.g. the expected cash flows compared to the required senior debt interest payments).
  • Grants can address high initial capital or start-up costs that occur with new technologies or markets.
  • Performance grants can provide incentives to encourage project sponsors to meet development goals.
  • Guarantees and risk-sharing facilities, especially when on-lending through financial intermediaries to riskier segments such as smallholder farmers’ cooperatives or SMEs, can address underlying portfolio risks. Typically, these are used when liquidity is either not a problem, or to indirectly address the cost of local currency funding.
  • A relatively new approach for the provision of concessional capital for use by development finance institutions is emerging—the “returnable capital” model. With this new model, principal, interest, and other amounts are repaid to the original provider of funds (usually a government) on a regular basis. Because this can reduce the impact on donor government budgets, more government funds could become available for collaboration with the private sector.
• carbon credit/carbon offsets. Carbon credits and carbon offsets play distinct roles in addressing greenhouse gas (GHG) emissions:
  • Carbon Offsets: These involve the removal of GHGs from the atmosphere, contributing to a net reduction in emissions. When a carbon offset is purchased, it represents the elimination of one ton of carbon emissions. Once utilized, that offset is retired and cannot be resold or reused.
  • Carbon Credits: In contrast, carbon credits signify a reduction in GHGs released into the atmosphere. Like offsets, one carbon credit equals one ton of carbon emissions. However, carbon credits are typically generated by governments and traded in the carbon compliance market, while carbon offsets, often produced by independent companies, are traded in the voluntary carbon market.

McKinsey estimates that annual global demand for carbon credits could reach up to 1.5 to 2.0 gigatons of carbon dioxide (GtCO2) by 2030 yearly and up to 7 to 13 GtCO2 by 2050. Depending on different price scenarios and their underlying drivers, the market size in 2030 could be between $5 billion and $30 billion at the low end and more than $50 billion at the high end.

This increase is expected to be driven by activities across four main categories:

1. Avoided nature loss, encompassing efforts to prevent deforestation.
2. Nature-based sequestration, such as reforestation projects.
3. Avoidance or reduction of emissions, including methane mitigation from landfills.
4. Technology-based methods for removing carbon dioxide from the atmosphere.

On paper, as mentioned earlier, there are numerous financial instruments available to mobilize funds for “green projects.” LDN-A has favored a multiapproach strategy using these instruments to finance nature-based solution projects in a traditional manner. However, these tools are somewhat inadequate for developing countries due to several challenges:

1. Market Spread: Developing countries with lower credit ratings face significant market spreads when trying to secure long-term funding in hard currency. This can hinder their ability to raise capital at favorable terms.
2. FX Availability and Cost: The limited availability of foreign exchange (FX) coupled with high costs further complicates funding for naturebased solution projects in developing countries.
3. Grant Dependency: While grants can support such projects, they are inherently limited in amount, constraining the scale and scope of initiatives that can be undertaken.

These challenges highlight the need for innovative financing solutions tailored to the specific circumstances of developing countries to ensure the successful implementation of nature-based solution projects.

LDN Advisory’s Innovative Approach:

1 – Pre-condition Assessment:

Before initiating financing, LDN-A prioritizes assessing the quality of the naturebased solution project. This involves defining parameters crucial for certification and investor attraction, such as a bottom-up project design approach, comprehensive Operational Due Diligence (ODD) coverage, economic sustainability, and influencing parameters.

2 – Phased Project Implementation:

LDN-A breaks down the project lifecycle into phases, identifying significant investment opportunities and determining suitable financing options for each phase:

• Developing a new offset type: Grants and subsidies are preferred, with potential tech funds for technology development. LDN-A plans to launch a returnable capital model green equity fund to finance pre-feasibility studies.
• Selecting an offset methodology and project planning: Working capital expenditures are covered by LDN-A’s treasury or concessional capital, reimbursed during implementation.
• Implementation, verification, and offset issuance: Traditional financing tools from LDN-A’s toolbox are used in countries with no borrowing challenges. However, for developing countries:
  • De-risking carbon offsets: LDN-A proposes double-level risk mitigation—local state guarantees backed by insurance from groups or multilateral organizations.
  • Equity raising: LDN-A seeks sovereign fund and private actor investments. These steps are crucial for offset purchaser assurance, project implementation, and ensuring quality of proposed naturebased solutions.
  • Maximizing ROI and Managing Risks: LDN-A strategically pre-sells carbon credits to minimize borrowed funds. The remaining borrowed amounts, if any, are structured with forward FX-sales to mitigate FX risks. Management and sale of carbon credits are carefully scrutinized to optimize returns for shareholders and local communities.