IMM has published a new scoping study on forest sector investment in VPA implementing (including Viet Nam and Honduras) and FLEGT-licensing VPA partner countries. The study is intended to provide a baseline for monitoring potential impacts of FLEGT VPA implementation and FLEGT-licensing on investment decisions in the forest and timber sector.

Forest sector investments are realized by a diverse set of investors. They all have the common aim to generate returns from economic activities related to forest management and wood processing. The underlying assumption of the study is that implementation of FLEGT VPAs attracts legal and sustainable forest sector investments, while reducing informal and illegal economic activities in the sector.

The study aims to:

• assess the quality, accessibility and regularity of existing data on the value of domestic and international forest sector investment flows, and the suitability of this data for long-term monitoring of the impact of FLEGT licensing; 
• provide a baseline assessment of the views of key international investors and the content of financial sector guidelines on the role of FLEGT licenses as a current or potential mechanism to mitigate investment risk; 
• draw on the previous two aspects, to make recommendations for refinements to the IMM indicators and long-term strategy for monitoring of forest sector investment flows.

The scoping study is based on combination of analysis of quantitative data on forest sector investment flows in the selected countries and an interview-based survey among investors in the forest sector. All types and sizes forest sector investors were approached for the survey.

To establish the baseline dataset of forest sector investments in VPA countries, the following data sources were reviewed and analysed:

• Meta-studies and publications on forest investments;
• Strategies and publications of international investors (i.e. TIMOS and specialized forest funds);
• National statistics on FDI flows and capital stock increase in economic sectors.
• A first summary of insights and recommendations provided to IMM by mid-year 2019 allows for some initial conclusions.

Data availability found to be a major constraint

Data availability is a major constraint when assessing investment volumes for FLEGT VPA countries. Among the countries reviewed by the IMM study, Viet Nam, Indonesia, Ghana and Cameroon provide historical data on investment flows and only data for Viet Nam, Indonesia, and possibly Cameroon is of adequate quality and regularity to allow for monitoring of investment flows. 

Table 1 shows the availability and suitability of data identified to date. For the other countries, the consultant was unable to identify sources of reliable data on investment flows in the forest sector. Publicly available data does not provide the detail or regularity required. 

Table 1: Forest investment data availability by country

Investors recognise risk mitigating potential of FLEGT 

Emerging economies, including VPA countries, are becoming of more interest to international investors. The focus of this interest is Asia and Latin America, while Africa is still maturing. Investments by TIMOs/institutional investors in VPA countries mainly target plantations and related industries. Natural tropical forests are mainly targeted by domestic and international industry investors. 

Investment in forestry depends on a set of factors. Each of these factors is tested by investors for opportunities and related risks before taking an investment decision. If the risks outweigh opportunities, an investment will not be realized. From the perspective of an investor in the forest sector, risks are typically grouped into three categories :

• Project risk: These are risks directly related to technically operate an asset in the forest sector and generate the expected returns. These include site conditions and productivity, production costs, financing requirements (volume, tenor, CAPEX or working capital type investment), cash flow profile, overall complexity, presence of off-takers, product prices, natural hazards, etc.
• Forest sector risk: sector specific policies, taxes and incentives, competition, level of differentiation, level of formalization and legality, access to land/forests and tenure security, environmental and social safeguards and requirements, etc.
• Country risk: all other factors “surrounding” project and sector risk, i.e. maturity of the market, economic stability and growth, terms of trade, incentives for investment, taxes, ease of doing business, regulatory frameworks, national security, etc.

In theory, FLEGT hosts an array of activities and tools that enhance forest sector attractiveness for investments by reducing typical risks. All investors interviewed for this study recognised this risk mitigating potential of FLEGT. However, according to the study, most of these risk-mitigating characteristics only materialise when a VPA becomes fully operational and the majority of market participants in a partner country comply with the TLAS requirements. Moreover, the importance of risks associated with weak law enforcement and governance structure is rated lower by investors than more specific technical and economic project risks. 

The study concludes that, to date, a FLEGT VPA is not considered a criterion for any investor type to rate partner countries as preferential investment locations for the following reasons:

• Long duration of the VPA implementation processes and lack of trust that processes will be completed.
• Relevance: Indonesia is the only country with an operational timber legality assurance and FLEGT-licensing system. In all other countries, the scope of reforms implemented and the number of actors complying with reforms is still perceived to be too low. Investment decisions are based on the status of the investment enabling environment at the time the decision is under consideration.
• Lack of information: some respondents assume that, for example, timber legality assurance systems will only apply to exports to the EU and are therefore of relatively limited importance to the wider industry. As a consequence, the scope of reforms of law and governance structures undertaken as a part of VPA implementation were underestimated and respondents saw no risk mitigation potential of FLEGT at country level.

The report makes several recommendations, including:

• Targeted awareness-raising in the financial sector. Materials informing about the scope of VPAs and their risk-mitigating potential with reference to specific investment risks would be of particular interest. Industry investors in natural forest-based value chains rated VPAs risk-mitigating potential more important than financial investors. 
• Assess how the FLEGT VPA process can better embrace the risk perceptions of institutional investors and TIMOs and prioritise investment-related reforms.
• Further monitoring of correlations between the FLEGT VPA process and forest sector investment should be limited to countries with an operational licensing system.
• Due to limitations in data availability a panel survey to assess the attractiveness of VPA countries for investors – with a specific view of VPA implementation activities – should be established.
• Results of such a panel survey could be used to establish an investment attractiveness index of VPA countries, ideally disaggregated by investor types (domestic SMEs, international forest industries, TIMOs and institutional investors). 

To read the full report, click here.