Where Impact Investors Shy Away from Impact.
I recently met a Brazilian NGO in the Amazon supporting local producer cooperatives. The producers, many of them Indigenous Peoples, collect or produce products from the forest, like cacao, açai or Brazil nuts, and sell them in bulk through a cooperative structure. Yet, their sales were low, as was their income. What little profit they made was not sufficient to grow their business. Most of them were quite poor. They had no access to credit. And no one had seen a dime from either carbon credits, Payment-for-Ecosystem services (PES), Impact Investments or Sustainable Finance initiatives, these trendy buzzwords that you often hear at seminars and conferences that usually take place far away from the forest.
There are incredibly many reasons why a producer in the Amazon struggles: distances and complicated logistics, insufficient warehouses, no standardised quality of product, low volumes, lack of certifications (and premiums), limited access to markets – and credit, just to name a few. Working capital in the central Amazon region is often provided through "aviamento" -- frequently an abusive practice in which an off-taker will provide a loan in exchange for a substantial share of the production. In many cases, the smallholder ends up heavily indebted, and forced to continue to work to pay their debt.
Yet people continue living in the forest, in poverty, trying their best to make a decent living.
We all know that forests, especially tropical ones, are crucial for maintaining the global temperature increase below 2 degrees Celsius. But the harsh reality is that the economic value of forests is greater when they are cut down, rather than preserved. The reason is mainly due to unsustainable production of commodities such as soy, beef, wood and palm-oil. Yet there are alternatives to this type of production, and not necessarily at the cost of profits.
Local people, many of them indigenous, living and producing in forests, are crucial to protect remaining forests. But rural credit to smallholders, including many Indigenous Peoples, is severely insufficient. And negative impacts from climate change further aggravate the problem.
Smallholder cooperatives, even those that are profitable, often struggle to accumulate reserves, leaving their businesses significantly undercapitalized and lacking access to financial services. Without capital, cooperatives cannot invest to improve their production, market their products and improve sales.
Where is the private sector? Where are the much-needed investments?
ESG and impact investments
Meanwhile, there is a booming global trend on ESG and impact investments. The former is intended to enforce “Do No Harm” regulations such as the EU Directive on corporate sustainability and due diligence and the recent EU Deforestation Regulation. The latter is about intentions to “Do Good” by including social and environmental targets, in addition to financial return. It has become very fashionable, and most institutional and professional investors globally plan to increase their impact investments.
It’s great, really. Yet, few of them dare to invest in smallholders’ production due to high transaction costs and perceived risks. Moreover, the banking sector in rural areas is often undeveloped, requiring substantial collateral from clients – which many cannot provide. It is seen as risky and expensive, especially for loans between USD 50,000 and USD 1 million, which are hard for smallholders to secure. This range constitutes the missing middle: it is too large for microcredit, but too small for typical impact investors. For the cooperative I met in the Amazon, it means they cannot invest in machinery, warehouses and marketing required to improve sales and prices.
Carbon markets
The long-awaited carbon market holds the promise to make standing forests profitable. Voluntary carbon markets trade in units of carbon, and corporations can use them to offset their emissions and deliver additional carbon savings. Guardians of the forest shall be rewarded! It could potentially provide a much-needed subsidy for fostering sustainable production of smallholders.
Carbon credits amount to a kind of magical thinking. The product is invisible, and only made into a commodity and payment through complicated methodologies and verifications undertaken by professional – and often extremely costly – consultancies. There’s also the issue of potential greenwashing. Many Indigenous groups report that "carbon pirates" have taken advantage of them.
Without going into the whole discussion around future carbon markets, the fact remains that few local communities and producers are benefitting. Local producers continue to struggle to get working capital for their businesses.
Future money?
Despite the billions invested in impact investments and carbon markets, these efforts do little to help smallholders in the Amazon today. While they might see benefits in the future, it doesn't address their immediate needs or help them grow their businesses today.
The lack of private investments and limited appropriate public incentives to de-risk such investments is striking, especially in view of all the nice buzzwords circulating on ESG, impact investments, and carbon schemes.
Deforestation is driven by economic forces, and only by creating economic opportunities for sustainable production can we change the current destructive practices. Smallholders represent a triple kinder egg: scaling sustainable production, improving livelihoods, and protecting natural forests and biodiversity.
But that would require a lot more in terms of making high-level financial mechanisms more tailored to suit the needs of local people who live in and by the forest.
The views and opinions expressed in this blog are those of the author and do not necessarily reflect the opinion or position of Future Horizons.