22417 - Sociedad Inversora Forestal S.A

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Environmental Review Summary

Project Number

22417

Company Name

Lignum Forestry Fund

Date ERS Disclosed

Oct 19, 2004

Country

Chile

Region

Latin America and the Caribbean

Environmental Category

B - Limited

Status

Completed

Previous Events

Approved : Dec 14, 2004
Signed : Apr 12, 2006
Invested : Apr 12, 2006

Sector

Private Equity/Venture Cap Fund - Sector

Industry

other

Department

Regional Industry MAS LAC & EUR

Project Description

The Fondo Forestal Lignum (the Fund) is seeking IFC’s assistance for a forestry asset securitization project to monetize standing forests and unforested, eroded areas on small and medium rural properties in Chile.

The Fund is a scaling up of a successful pilot program carried out by Sociedad Inversora Forestal (SIF) with the support of Fundación Chile, the project sponsor. The pilot program started in 2000 with an investment of $4.1 million to acquire land use rights from small and medium landowners. As part of this project, SIF acquired 4,600 hectares of standing forests and planted 3,100 hectares of new forests. In November 2002, SIF issued a 10-year $13 million bond backed by the cash flows from these forestry assets.

The Lignum Fund Project is based on the same business model as the pilot program, with a proposed financial structure of a $34 million equity fund, to be contributed by IFC and 3-5 Chilean institutional investors. IFC is considering an investment of up to $6.5 million in the Fund.

Over an 8-year period, the Fund intends to:

- purchase approx. 20,000 hectares of standing radiata pine and
- plant approximately 30,000 hectares of eucalyptus globulus and radiata pine on properties held by small and medium landowners mainly in regions VII and VIII of Chile.

The cash flows from the future harvest of these assets will support a securitization or a forestry bond issuance in the Chilean capital markets. The Fund intends to use proceeds of the securitization or bond issuance to finance a second round of investments in standing forests and new plantations to support a second securitization. The Fund will target dry, eroded areas of little or no agricultural value. The average size of the standing forest or barren land that individual owners will cede usufruct to the Fund is expected to be approximately 130 hectares.

The project will be supported by Forestal Celco/Arauco (a subsidiary of Copec S.A.) and Forestal Mininco S.A. (a subsidiary of CMPC S.A.), the two largest forestry companies in Chile. These two companies (the Forestry Companies) will:

- carry out the operational activities during the forestry cycle (planting, fertilizing, thinning, pruning, measuring, guarding, harvesting, commercializing, transporting logs and building access roads needed to harvest);
- purchase the wood harvested from existing plantations and the afforested land;
- provide certain volume guarantees of standing forests at the time of the signing of the land use right agreements;
- comply with the minimum standard specified for new plantations by the Chilean government of a 90% survival rate and doubling the size of the seedling at the end of the first year (meeting these standards qualifies the plantation for planting subsidies); and
- provide forest fire combat infrastructure.

SIF S.A., a wholly-owned Fundación Chile affiliate, will be the forestry advisor to the Fund and, as such, will have the following responsibilities:

- locate, assess and negotiate land use contracts with current owners, after the forestry companies have pre-approved both the land location and projected future harvest volume;
- acquire insurance for forest fire;
- contract services to control biological damage and theft;
- market log volumes prior to harvest; and
- coordinate harvesting and log merchandizing through third party contractors.

Structuring and mobilization assistance are being provided by Asset Chile (an investment bank providing specialist corporate finance advice) and Independencia (a privately-owned fund manager specialized in real estate).

Environmental and Social

Fundación Chile has presented plans to address the potential adverse impacts of the proposed Project and to ensure compliance with the Chilean laws and regulations and the World Bank/IFC environmental and social policies and environmental, health and safety guidelines. Information regarding these plans and other aspects of the Project is summarized in the paragraphs that follow.

(1)- Regulatory Framework

Law 701 (Decreto Ley 701, passed in 1974) encourages the development of Chile’s forest resources and regulates forestry operations. Incentives under this law have resulted in a substantial increase in the land area of plantations, reflecting substantial investments by large, integrated companies and, to a lesser extent, medium and small landowners. At present there are about 2.24 million hectares of forest plantation in Chile, consisting of two primary species, radiata pine and eucalyptus globulus. Over 90% of Chile’s current industrial consumption of wood is grown on plantations.

In 1998, Law 701 was modified to favor small to medium-sized companies/landowners, to protect the environment, and to encourage the recovery of poor land. The effectiveness of the legal change has been mixed. The shift gave smaller landowners more opportunities, but most of them have not had the financial capacity to support the long planning cycle for plantations.

The land use agreements planned as part of the Project (see section 3 below) will facilitate the conversion of eroded land within small and medium farms into forestry plantations. Under these agreements, small and medium landowners will receive regular payments from the Fund for the use of the land during the forestry cycle, instead of making direct investments and having to wait many years for the returns.

(2)- Forest Management Plans

Forest Management Plans will be prepared for each of the Fund’s plantations. Prior to their implementation, these Plans must be reviewed and approved by the National Forestry Council (Corporación Nacional Forestal--CONAF), the government agency that regulates natural forest and plantations.

Management plans must be submitted to CONAF for approval prior to each intervention such as planting, thinning, pruning and harvest. The plans must be accompanied by a technical study of the land qualified for forestation under the local norms, and prepared by a licensed forestry engineer. The request for approval must include the area of intervention and cover the activities to be executed, as well as the measures for preservation and protection as established by Chile’s forestry regulations. No interventions are allowed on properties before CONAF has accepted the management plans. Lignum will use external forestry engineers for the preparation of management plans for planting and obtaining incentives. Plans for interventions such as harvests will be prepared by the Forestry Companies, as well as third party engineers. In order to grant certification, CERTFOR requires additional information upon which its certification decision is based.

CONAF monitors the implementation of Forest Management Plans through the Audit Department of the Regional Offices of CONAF. This Department carries out inspections of forestry operations and receives complaints related to forest mismanagement or violations of the law. When such violations occur, CONAF’s investigation is much deeper and requires explanations from the owner. If appropriate, CONAF files suit in the courts seeking monetary compensation.

(3) - Land Use Agreements

As indicated above, over an 8-year period, the Fund intends to purchase land use rights over approx. 50,000 hectares of land (approx. 20,000 hectares of standing radiata pine and approx. 30,000 hectares of eroded land to be afforested). The land use rights will be acquired from small and medium landowners who will retain title to the land.

The compensation to the landowners will vary according to the type of investment. In the case of existing forests, the landowners will receive a lump-sum payment from the Fund for the use of the land and the acquisition of the forest. The value will be determined by the Fund and will be specified in an agreement between the landowner and the Fund. The forest will be administered by the Forestry Company specifically named in the contract. Under Chilean forestry regulations, the landowners must reforest their land within 2 years of the harvest date.

In the case of eroded land to be afforested, the landowners will receive an annual payment from the Fund for the future use of their land. The payment will be negotiated based on the potential growth rate of the timber, the forecasted harvest value, the date of harvest, and the cost to prepare soil for planting, fencing fertilizing, and building roads. SIF S.A. will reforest the land within the 2 years required under Chilean regulations.

All landowners who have already sold land use rights to land to be afforested as part of the pilot project are receiving annual payments. Future contracts are likely to be more flexible with respect to the payments, depending on the specific situation and needs of the landowners participating in the Lignum Project. Monthly payments may be offered as an additional option. Also, the payment period is likely to vary depending on the age of the landowner (younger landowners may want to receive payments over a long period of time, while older persons may prefer a shorter period).

The areas targeted by the Fund are dry, eroded areas without irrigation, which are primarily used for extensive livestock production. Land is also used for limited crop cultivation, but the income potential is low. In 1998 Fundación Chile prepared a study of income derived from lands similar to those in the SIF project and determined that the great majority of alternative uses such as livestock production (cattle and sheep) and agriculture (wheat and lentils) yielded less than US$40 per hectare returns to the owners. Based on that data, the SIF project paid US$40 per hectare planted. The majority of landowners on the properties in the SIF project generally had pre-project monthly incomes of $500.

The land use agreements will indicate that any remnants of native forest within the areas under usufruct will be protected and will not be converted to plantations as required under the management plans submitted to CONAF. When CONAF determines that areas of protection or native forests fall within the area for planting submitted in the management plans, the protected areas or native forests are excluded from the area approved for planting. Forestry companies do their own analysis and can reduce the area to be planted even further for technical reasons (too shallow soils, areas where machinery cannot operate, watershed protection, etc.).

The Fund intends to purchase land use rights in Chile’s VII and VIII regions and does not intend to operate in areas where there are conflicting claims to land, such as those in the IXth Region where the Mapuche Indians have claims to land titled in the name of other parties.

SIF S.A. and the Lignum Fund intend to develop formal procedures for acquiring land use rights by November 2004.

(4)- Environmental management capacity

Fundación Chile, Forestal Celco/Arauco and Forestal Mininco S.A./CMPC each have experienced and dedicated management committed to achieving high environmental performance. Fundación Chile has implemented a number of successful environmental management initiatives such as the creation of the CertforChile program (Chile’s national forest certification system) and the introduction of management and planting techniques for eroded lands in the VII and VIII regions of Chile. Arauco has introduced ISO 14001 Environmental Management Systems in all its forestry operations, which involved defining an environmental policy for the company’s forestry operations, establishing a forestry environment unit, training more than 15,000 workers and implementing procedures for preventing and mitigating potential environmental impacts of its forestry activities. CMPC/Forestal Mininco has also certified its environmental management system under the ISO 14001 protocol, formalizing its commitment to minimize the impact its activities may have on the environment at any point in the forestry cycle. The company has also completed the first stage of the Work Health and Safety certification process known as OHSAS 18001.

(5)- Sustainable forestry management

The Fund’s plantations will be managed according to the principles and requirements of the CertforChile certification program. The forest management policies of the two Forestry Companies that will manage the Fund’s plantations (Forestal Celco/Arauco and Forestal Mininco S.A.) contain an explicit commitment to comply with the CerforChile standard in all Forest Management Units (FMU) they own or administer, including the Fund’s plantations. Thus, all of the Fund’s plantations will be independently certified as meeting CertforChile’s set of forest management and chain-of-custody standards.

CertforChile is a national standard created under the leadership of Fundación Chile and the Instituto Forestal (the Chilean government agency for forest research and official statistics). The mission and purpose of CertforChile is similar to the certification program sponsored by the Forest Stewardship Council (FSC), with the main difference being their geographic scope. FSC is an international program supported by national initiatives, while CertforChile focuses solely on Chilean plantations. Like FSC, CertforChile seeks to improve forest management practices through the application of sustainable development principles, taking into account environmental, social and economic dimensions of sustainability and explicitly protecting special and unique forest areas, including sites of cultural or ecological significance. CertforChile also encourages the forestry products market to reward exemplary forest management through the labeling of wood products coming from “sustainable forests”, which should be independently certified as meeting a set of forest management and chain-of-custody standards. The requirements of CertforChile are comparable to those of FSC. CertforChile is also expecting to receive endorsement of its plantations standard by PEFC, the Program for the Endorsement of Forestry Certification, an international body which endorses national standards which conform to its principles.

- Anticipated Impacts of the Project

The Project will have positive environmental and social impacts. It will result in the afforestation of eroded land with little or no agricultural use and will generate income-earning opportunities for small and medium landowners. The vast majority of the landowners participating in the pilot project retained some land for their own use and were able to increase their annual income as a result of the sale of land use rights by 25% to 300%. In addition, the structure, sale and operation of the Fund will offer Chilean institutional investors alternative means to invest in the country’s forestry sector.

Fundación Chile estimates the Lignum Project will on average employ 275 forest workers daily over 25 years.

Potential adverse impacts of the project (such as invasion of native forests, damage of protected areas, forest fires, contamination resulting from the inappropriate use of chemicals, reduction of the quantity and quality of water resources, etc.) will be avoided or minimized through the application of the principles and practices required by the CertforChile standard for sustainable forest management. CertforChile is based on nine overarching principles that are consistent with IFC’s policies and guidelines and that cover the following areas: management of forest resources, protection of biodiversity, protection of forest resources from fires and other damaging agents, soil and water conservation, rights of local communities and indigenous peoples, rights of forest workers, monitoring of forest resources, and compliance with the laws of Chile, international agreements and legally binding treaties.

Conclusion & Monitoring

IFC will evaluate the project’s compliance with the applicable environmental and social requirements during the lifetime of the project by reviewing the annual monitoring reports (AMRs) prepared for the project covering:

- progress towards CertforChile certification of the Fund’s plantations;
- approval by CONAF of Forest Management Plans prepared for the Fund’s plantations; and
- ongoing environmental, social and health and safety performance of the Fund’s plantations as reflected in the results of regular evaluations of the condition of the forest resources and of the environmental and social impacts of forestry operations.

Periodic site supervision visits will also be conducted.

This Environmental Review Summary (ERS) is prepared and distributed in advance of the IFC Board of Directors' consideration of the proposed transaction. Its purpose is to enhance the transparency of IFC’s activities, and this document should not be construed as presuming the outcome of the Board of Director’s decision. Any documentation that is attached to this ERS has been prepared by the project sponsor or in conjunction with the project sponsor and authorization has been given for public release. IFC has reviewed this documentation and considers that it is of adequate quality to be released to the public but does not endorse the content. The following ERS is disclosed in accordance with IFC's Disclosure of Information Policy that went into effect September 1998.

The map is for illustrative purposes and does not imply the expression of any opinion on the part of the World Bank, concerning the legal status of any country or territory or concerning the delimitation of frontiers or boundaries. Country borders or names do not necessarily reflect the World Bank Group's official position. In some cases, available project location information is limited to the country of the project's activities. Locations are approximate.

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