12 March 2009 | When Carlos Minc needed someone to set up a mechanism for disbursing funds to worthy environmental projects under Brazil's Compensação Ambiental (Environmental Compensation Law), he called the Brazilian Biodiversity Fund (FUNBIO), a non-governmental organization (NGO) set up in 1995 to support government action in support of biological diversity.
True to that mission, FUNBIO's financial mechanisms unit responded with the blueprint for a project that has since become the "Atlantic Forest Fund", an ambitious endeavor that goes well beyond Minc's goal of creating a support mechanism for the Compensação Ambiental and is best described as a statewide ecosystem marketplace that aims to channel private money into ecosystem development projects, regardless of whether that money comes from Payments for Ecosystem Services (PES) or from philanthropy.
"It's called a fund, but it's not really a fund in the legal sense of the word," says André Ilha, who is Director of Biodiversity and Protected Areas for the state's Instituto Estadual do Ambiente (INEA), which was formed through the merger of several state environmental agencies over the past two years. "It's more accurately described as a financial mechanism which will provide the means of applying more efficiently and with more control and transparency all of the money assigned to the creation and implementation of parks and reserves administered by the state government."
The mechanism recently launched in pilot form after Manoel Serrão, who heads FUNBIO's financial mechanisms unit, and his team spent two years surveying the environmental and regulatory landscape of the state's protected areas – a process that involved documenting the threats to protected areas and their current state of degradation, identifying potential and existing solutions, charting potential and current income flows, and compiling an analysis of the various laws and institutions impacting the areas. Making that data freely-available became the first step in creating a mechanism that Serrão believes will lead to a more transparent and liquid market for ecosystem finance across the state.
"It was during this research phase that we realized what a tremendous opportunity exists now for non-governmental organizations (NGOs) to play a role in administering significant resources for protected areas," he says.
The Compensação Ambiental came into force in 2000 and echoes other laws that promote species banking, wetland banking, and water quality trading – all of which are based on the premise that if you damage the environment, you should carry the cost of fixing it. In the case of the Compensação Ambiental, payments are directed towards protected areas equivalent to the International Union for Conservation of Nature (IUCN)'s Category One (nature reserve, free of development) or Category Two (limited protection) Protected Areas, and money collected under the law is earmarked for five specific uses: studies for the creation of new reserves, the creation of management plans, sorting out land-tenure issues, purchasing goods and services necessary for managing an area, and management-related research.
Unlike most PES schemes, however, the Compensação Ambiental doesn't establish a price tied directly to the market cost of replacing damaged areas, but instead requires the assessment of a licensing fee based on the un-mitigatable impact of the project development, the proceeds of which are then channeled to conservation projects in protected areas.
Because the fee was initially based on a percentage of the project's development cost, some companies fought the law in court, claiming the fee was arbitrary and not related to environmental impact. Last year, the Supreme Court agreed.
Now the compensation fee is capped at 1.1% of the industrial project's development cost, and the court is overseeing the creation of an impact-driven process for issuing licenses.
All parties have already agreed that a "Compensation Chamber" made up of representatives from industry, academia, government, and the environmental community should review projects submitted for funding, but the Court has still not passed judgment on how the final guidelines should deal with funds already collected, as well as a variety of other issues.
Once these issues are resolved and the guidelines clarified, the federal licensing agency will adapt its formula according to the ruling. Then, because licenses are issued by either federal or state authorities (depending on the type of project and whether its impacts cross state borders), each state will transpose the federal formula into its own system.
Regardless of whether the licensing agency is state or federal, the money will flow to protected areas administered by the state or even municipalities, depending on which areas are directly impacted or near the project – but companies paying the fees have some leeway in determining how the money is spent.
Under Compensação Ambiental, a company has three ways to spend the licensing fee, provided the money goes to one or more of the five activities specified by the law.
The first option is for a company to execute the payment itself, which theoretically leaves the door open to something akin to US-style mitigation offsets, but in practice means companies administer every detail of the project themselves.
"Companies don't like this, because it means they have to put a lot of effort into an activity that is not core to their operations," says Ilha.
So far, the only company to take this option is the private-public energy group Petróleo Brasileiro (PetroBras), which was able to sub-contract the environmental offset for a hydroelectric plant it purchased.
The next option is to deposit the fee into the responsible environmental agency, which Ilha and Serrão say would burden regulatory agencies with administrative tasks they are not designed to handle.
"You're taking money that's private and free and transparent and not burdened by administrative requirements imposed on governments and then putting it into that system," adds Serrão. "Plus, if the money doesn't get spent by the end of the fiscal year, it is absorbed into the larger government budget and is no longer earmarked for environmental purposes."
The final option is to put the money into a financial mechanism like the Atlantic Forest Fund.
Minc, who last year became Brazil's federal Environment Minister, had contacted FUNBIO because of the group's work in administering the Amazon Protected Areas Program (ARPA).
"With ARPA, FUNBIO managed to distribute R$55 million among several NGOs without raising legal disputes or challenges," says Ilha. "That indicates that they work competently and in a way that keeps all stakeholder happy, which is quite an accomplishment."
Under the scheme, FUNBIO opens a bank account in the company's name, and the company deposits its compensation fee into the account. FUNBIO then acts as the permanent administrator of the funds – but only under the watchful eyes of regulators and contributing companies.
"We and the companies are free of the burden of having to do this directly, while FUNBIO – which has the structure to administer the fund – does what it is good at," says Ilha. "Every step is registered in the system, so that the environmental sector of the government has instant access, as do external organs such as courts and public ministries. You have absolute transparency, and projects are developed more efficiently than they have been so far."
The mechanism is divided into several components, chief among them being the compensation fund for administering money collected under the Compensação Ambiental and the donation fund for administering money from philanthropic donors. Within the compensation fund, an endowment fund is to be maintained to cover recurring expenses such as maintenance and repair of facilities on protected areas.
"Money coming into the compensation fund for compliance purposes can only be used for a limited number of activities laid out by the law, while money coming into the donation fund can be used according to the donor's own specific criteria," says Ilha.
"When we talk about a fundraising strategy, we're not interested just in the volume of funds, but in the diversity of the funding sources," adds Serrão. "That's because the source determines what can be done with compensation money. If it comes from the compensation scheme, it is limited to five uses, but if you have a diversity of donor sources, it's possible for us to expand beyond these five things."
That makes it easier for donors and NGOs with compatible but narrow mandates to find each other. The donation fund is even flexible enough to channel carbon payments and biodiversity payments – but individual states have to decide whether they want to recognize payments REDD.
"You have some donors that only want to support family farming around protected areas, for example," says Serrão. "When we receive a request from the protected area to support family farms, we have the ability to point them in the right direction – even if we're not administering the money."
Indeed, Serrão believes that the overall transparency generated by the fund's existence will have knock-on benefits that resonate well beyond the money it directly disseminates.
"Money doesn't have to flow through the mechanism, but the mechanism has to know what is out there," he explains.
That, he says, not only encourages NGOs across the state to communicate with each other and focus on common goals, but also creates the kind of transparency that private-sector donors increasingly demand.
Then there's the matter of focus: the fund's existence has forced the development of a more coherent vision for all protected areas.
"It's requiring the creation of a medium-term planning process, and forces us to take stock of what's available on the resource front and what demand exists from the protected areas," says Serrão. "We can design the fund with a clear idea of what the state of the protected areas should be in four years."
That vision, and the promise of a concentrated pool of capital to help carry it out, is already providing an incentive for NGOs and others active in the protected areas to draw up detailed proposals designed to meet specific targets. What's more, because projects proposed for compliance purposes have to be approved by a governance council comprised of representatives from industry, government, and the environmental community, there should be more pre-vetted projects for non-compliance donors to choose from.
Early on, FUNBIO decided to design the fund's scope based on the most conservative estimates of the amount of money the compensation mechanism might deliver. That meant beginning with roughly $R(Brazilian Real) 75 million already sitting in escrow for Compensação Ambiental, and putting out word that roughly $R100 million more should be available for conservation projects over the next four years from the Compensação Ambiental.
But there could be more cash in the kitty. While charting the landscape, FUNBIO found that protected areas in the state of Rio tend to attract significant amount of investment for environmental projects.
"It's an interesting perspective," says Serrão. "When you talk to a mayor, they're likely to say that protected areas cost money and take away jobs, but we've found the opposite: places with protected areas are getting investment because of compensation and complementary investments, such as royalty payments from petroleum – and environmental investments are the 10th largest economy in the state of Rio."
Because of its scope, the test of the fund's effectiveness will lie not in the achievement of individual projects, but in the state of the protected areas four years down the road.
"We will be able to evaluate how areas have progressed from no infrastructure in place to plenty of infrastructure to fully functioning protected areas. We will know if a protected area has progressed from being a paper park to a truly consolidated protected area."
Like the larger fund, the pilot project involves two mechanisms: one using the rules from the compensation fund, and one using rules from the donation fund.
The R$3.1 million compensation payment comes from German steel and engineering giant Thyssen-Krupp, while the donation of R$510,000 comes from Germany's KfW Bank Group (formerly the Kreditanstalt für Wiederaufbau, or Reconstruction Credit Institute).
"It's like hiring an architect to create a blueprint for house," says Serrão. "We've given the state of Rio a blueprint for the mechanism, and now we've offered to build a scale model – the pilot project – to put that into practice to show you what it will look like."
If the mechanism takes hold, you can bet it will spread to other states as well. At least four other Brazilian states have already begun the process of adapting the process to their own needs.
Steve Zwick is Managing Editor of Ecosystem Marketplace. He can be reached at SZwick (at) ecosystemmarketplace.com.
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