Blended finance has the potential to address the climate financing gap – But the current grant-capital-return mix is standing in the way

Green finance is finally having its moment. $491 billion in sustainable bonds were issued in 2020, a jump from $200 billion in 2018, as reported by Environmental Finance. On 5 June 2021, the G7 committed to increasing finance for climate change adaptation and nature-based solutions and called on multilateral development banks and the private sector to do the same.

Brands including Olam, Nestlé, Barry Callebaut and Unilever have set science-based targets on reducing their carbon emissions and are preparing strategies for massive ‘forest positive’ campaigns. Significant investment capital, carbon finance and offtake commitments from these companies can enable financing of farm restoration and renovation, improve incomes and resilience, capture carbon, and protect remaining forests.

An investment of an estimated US$300 billion to US$400 billion is needed to preserve and restore ecosystems. However, only US$52 billion is being invested in such projects.

‘Blended finance’ has emerged to de-risk impact investments and thereby spur on the transition to a more sustainable agriculture system. In land use and agriculture projects, blended finance can address greenhouse gas emissions while improving biodiversity, soil quality and food security in developing countries.

But can it rise to the challenge of enabling the land use and land governance transition we need to meet the Paris goals?


Massive capital needed for sustainable production of tree crops

Smallholder farmers that grow tree crops, such as cocoa, coffee and palm oil, seem like prime candidates to benefit from the growth of blended finance and ‘forest positive’ carbon projects. Worldwide, over 7 million smallholder tree crop farmers, farming on an estimated 14 million hectares of land worldwide, need to replant their farms, and introduce more climate resilient and regenerative farming systems even to maintain their fragile farm income. Small-scale producers of coffee and cocoa are struggling with low productivity due to aging trees, depletion of soils, the effect of climate change and disease outbreaks like La Roya and swollen shoot.

Recent satellite analysis has shown that after decades of global deforestation caused by large-scale clear-cutting for plantations, patches of deforestation – often by smallholder farmers pushed into the forest frontiers to supplement their low incomes – are beginning to rival and even overtake commercial clear-cutting in the rate of deforestation.


Smallholder farmers debarked trees and cleared forests to plant new cocoa in West Africa© IDH

Ageing tree crops lead to farmer precarity and deforestation

How does this play out on the ground? In Cote d’Ivoire where cocoa production is dominated by small producers, 30% of the cocoa trees are over-aged, and their productivity is falling. Cocoa farming households’ incomes today are around the poverty line, far below targets IDH and cocoa companies have set towards a cocoa sector ‘living income’ roadmap, and it is projected that a farming household with aged trees and no means to invest will see its income drop by 43% over the course of the next ten years.

In Indonesia, 40% of the total smallholder oil palm area, amounting to 2.4 million hectares (5.9 million acres), is over-aged, according to Mongabay.

Without access to funds to replant their farms, farmers will have no other option but to clear new forests and peatland. The same fate looms for ageing oil palms in Malaysia.


Smallholder farmers: the Achilles’ Heel of blended finance

Is blended finance the solution these farmers – and their neighboring forests – are waiting for?

It’s not that easy. Today, close to 90% of global smallholder farmers do not have access to formal finance, and for female farmers this gap is even larger. Investors or financial service providers are not able to service smallholders due to a mix of factors, including limited aggregation, high transaction and physical costs of reaching the farmers, lack of creditworthiness, in some places over indebtedness, and insecure land tenure arrangements.

Replanting and transitioning to more regenerative and climate resilient forms of agriculture such as agroforestry, requires upfront investments that are often followed by a period of several years of reduced or no income as trees take several years before they come to fruition, dubbed the ‘Valley of Death’.

On top of that, in many rural regions, there is limited on-the-ground capacity to deliver services such as technical advice, inputs, and finance to smallholder farmers.

Looking into the financial needs that arise for smallholders as they progress through the transformation process, it is clear that this transition will require a range of funding solutions.

Financing needs of smallholder farmers to transition to sustainable agriculture© IDH

A different grant-capital-return mix is needed for smallholders and forests

Blended finance is not simply about mixing public and private resources into a fund. For blended finance and insetting projects to have the transformative impact on smallholders and ecosystems that is needed, it needs public and private partners to work together. Investment needs to fit in national and landscape level development plans, and new mixes of grants and investment capital to overcome hurdles including clear land tenure and land use zoning.

In IDH, we see the need for more innovation in the space where technical assistance and grant, carbon finance and investment vehicles in the agricultural and forestry sector come together and enable national climate agendas and community development ambitions.

We hope to hear ideas and see similar efforts from many partners and peers around the world, to capitalize on green investment’s moment, bridge the gap between blended finance and smallholders, and together, build a climate-proof future.

This article was first published in Responsible Investor.

IDH – The Sustainable Trade Initiative promotes sustainable landscape management through its Landscapes program, based on production, protection, restoration, and inclusion. The Landscape Finance team is dedicated to mobilizing investments and learning around innovative business and investment models for inclusive land and ecosystem restoration, and manages Technical Assistance Facilities (TAF) for Investment Funds that promote inclusive and sustainable land use, including the Land Degradation Neutrality (LDN) Fund, the AGRI3 Fund and the &Green Fund, as well as FarmfitFund managed by IDH Invest and dedicated to investing in smallholder inclusive business models.