Our Take: Global Credit Enhancement Facility

Written by Sean Penrith and Nathan Truitt

Without credit guarantees, countless potential ventures simply remain dreams on paper

Background

In late March 2023, the Intergovernmental Panel on Climate Change’s (IPCC) released the final installment of its Sixth Assessment Report (AR6), an eight-year long undertaking from the world’s most authoritative scientific body on climate change. Among many of the grim findings in the report, the IPCC found that still today, public and private finance flows for fossil fuels far surpass those funneled toward climate mitigation and adaptation. While annual public and private climate finance has risen by upwards of 60% since the IPCC’s Fifth Assessment Report, much more is still required to achieve global climate change goals. IPCC stated that climate finance will need to increase between 3 and 6 times by 2030 to achieve mitigation goals, alone.

The Climate Policy Initiative has stated that an increase of at least 590% ($630B in ‘19/’20) in annual climate finance is required to meet internationally agreed climate objectives by 2030 and to avoid the most dangerous impacts of climate change. The continual challenge in deploying climate finance to support carbon mitigation, renewable energy, water stewardship, and protection of biodiversity is to offer potential investors in climate solutions TLC; for transparency, longevity, and certainty. Investors respond to transparent processes that provide a reasonably certain rate of return over a given timeframe with a degree of assurance.

Under the Paris Agreement, 197 countries have agreed to limit global warming to well below 2 °C and make efforts to limit it to 1.5 °C. Meeting the 1.5 °C goal with 50% probability translates into a remaining carbon budget of 400–800 GtCO2. Staying within this carbon budget requires CO2 emissions to peak before 2030 and fall to net zero by around 2050. The IMF calls for between $3 and $6 trillion a year until 2050 to finance this transition to net-zero. An estimated 60% to 70% of this transition-to-net-zero capital must come from private capital.

Climate finance is an imperative for climate solutions, and specifically to leverage the potential offered by nature-based solutions. A 2018 study published in Science Advances offered that the U.S. could meet its Paris target using natural climate solution (NCS) pathways. This natural sequestration from the atmosphere using agriculture, reforestation, and other ecosystem-based approaches provided up to 21 pathways for the US to take advantage of without compromising human needs for pasture, cropland, and timber production. This suite of NCS measures has a maximum mitigation potential of approximately 1.2 billion tonnes of CO2e per year by 2025 representing 21 percent of the annual greenhouse emissions in the U.S. (5.8 billion tonnes in 2016). Plants and trees have the capacity of sequestering 63 percent of this carbon, soil carbon can capture 29 percent, and the avoidance of methane and nitrous oxides offer the remaining sequestration potential.

Examining the role of healthy forests as a natural climate solution for example, we note that forests house 80 percent of the world’s terrestrial biodiversity and support over 1 million jobs in the U.S. timber industry. Forests are the source of nearly two thirds of freshwater in the 48 contiguous states delivering fresh drinking water to 40 percent of the country’s municipalities and 180 million Americans. While forests absorb 15 percent of fossil fuel carbon emissions in the U.S., over 23 million acres of forestland is projected to be lost by 2030 due to conversion (urban and agriculture) pressure. This will reduce the carbon sequestration capacity of our nation’s forests by 36 million tonnes per year due to deforestation and degradation.

In summary, a lot of climate mitigation potential exists if we can unlock efficient and aligned financing to take advantage of those solutions.

The Challenge in Financing Natural Climate Solutions

Champions and developers of climate solution projects continually encounter obstacles when attempting to access private capital. These include the mismatch in timeframes, rates of return, and risk tolerance. Climate solutions inevitably need long timeframes to realize the mitigation benefits. As mentioned, this is out of sync with the typical time horizons for traditional debt and equity investments. Many solutions require upfront financing of costs before the positive climate outcomes can accrue and be monetized thus posing a perceived risk to potential investors. Furthermore, investors contemplating this space are challenged in assessing viability and the perceived risk in investing in climate solution projects. In short, impact investing in climate solutions struggles to meet the TLC framework mentioned earlier.

In order for developers of climate solutions to access impact capital, it is vital they secure the appropriate credit enhancement to assure investors that the investment is a safe one. Credit enhancement (guarantee) provisions are mechanisms used to improve the creditworthiness of a financial asset or investment, thereby reducing the risk of default for investors.

In 2021, American Forest Foundation (AFF) issued an inaugural $10 million Series 2022A green bond under a Master Trust Indenture Agreement underwritten by Morgan Stanley; the first of its kind to be backed by the sale of carbon credits to corporate buyers. The 2022A Bond had 34 investor roadshow views and three management calls, ultimately receiving $23 million in orders across three different investors including $13 million of ESG-specific orders. Major actors like Blackrock were keenly interested in the bond but had a stipulated minimum of $100 million in bond ticket size.

**Figure 1 – Announcement of AFF’s Bond**

Since then, entities such as NE Wilderness Trust, Earth Shot, Mothers of the Amazon, Molpus Woodlands Group, Mad Ag, and Brightcore Quantum International (Norway) have approached Gordian Knot Strategies (GKS) to express the interest in exploring and pursuing a similar route of accessing green bond finance (~$1B) at affordable coupon rates and longer tenors that match project development parameters.

However, these groups are encountering the same issues that AFF did in terms of securing the third-party credit enhancement needed to guarantee the bond issued. Despite pursuing the
hope of securing credit enhancement from WIFIA (Water Infrastructure Finance and Innovation Act), USDA and the Clean Water State Revolving Fund (WSRF), AFF was forced to guarantee the issued bond using its own limited balance sheet. The ability for AFF to scale its Family Forest Carbon Program (FFCP) using green bond finance has been thwarted given the lack of available credit enhancement support they need to raise further green debt finance.

Credit Enhancement: Context

Credit enhancement and investment risk assessment are closely tied within the realm of financial markets, particularly in the context of fixed-income securities and debt instruments. Credit enhancement is a strategy used to mitigate credit risk, which is a type of investment risk.

The concept of credit enhancement has been employed in various forms throughout history, particularly in the context of lending and borrowing. A historical example of credit enhancement was the use of collateral in lending arrangements. Collateral, such as valuable assets or property, has long been used to secure loans and reduce the lender’s risk of default. This practice effectively enhanced the creditworthiness of the borrower by providing a tangible asset that serves as a form of credit enhancement. In ancient civilizations, such as Mesopotamia and Greece, collateral was often used as a way to secure loans and ensure repayment. For example, in Babylon, merchants could use land as collateral for loans, and failure to repay would result in forfeiture of the land. The concept of credit enhancement has evolved over time with the development of financial markets and instruments. In modern finance, credit enhancement encompasses a wider range of mechanisms beyond collateral, such as guarantees, insurance, and credit derivatives, all aimed at reducing credit risk and enhancing the credit quality of an investment.

Formed in January 1971, the Overseas Private Investment Corporation (OPIC) was borne out of the realization by U.S. policymakers that private investment was a powerful generator of economic development and that there was an appropriate credit enhancement role for government in encouraging private investment engagement. OPIC achieved its mission by providing investors with financing, political risk insurance, and support for private equity investment funds where commercial financial institutions often were reluctant or unable to lend. Impact investing was also a key priority for OPIC, supporting efforts that sought to produce positive social impacts while generating financial returns sufficient to make these projects sustainable. Established as an agency of the U.S. government in 1971, OPIC managed to operate on a self-sustaining basis at no net cost to American taxpayers.

In the words of Senator Jacob Javits (R-NY) during the Congressional debate preceding the establishment of OPIC back in 1969, OPIC was the “first really big initiative that has come along in the foreign aid field almost since it began, which goes back to 1948 and 1949 … this corporation will for the first time apply business methods and business accounting procedures to the business operations of project development, investment, insurance, guarantees and direct lending—that is, to private activities which are sensitively and directly geared into the development of the less-developed areas which we propose to help in the foreign aid program.”

OPIC of course was not without its critics from both sides of the political aisle. Conservative Republicans condemned what they saw as corporate welfare. Liberal Democrats complained that public resources were being used to support investors instead of projects that helped disadvantaged communities. Opposition came from those who were critical of government involvement in private sector activities abroad. These critics believed that the government should not be directly involved in promoting or supporting private investments overseas. They argued that the private sector should operate without government intervention, even in international markets. Others raised concerns about the potential environmental and social impacts of certain projects that received OPIC support. Overall, OPIC was generally viewed as having made a positive contribution to promoting U.S. investments in developing countries and supporting economic growth.

In 2019, under the BUILD Act the United States International Development Finance Corporation (DFC) was established as a development finance institution following the merging of OPIC with the Development Credit Authority (DCA) of the United States Agency for International Development (USAID). The Build Act transferred the Development Credit Authority from USAID to the DFC.

USAID’s use of the Development Credit Authority (DCA) to mitigate the perceived risks of lending to underserved clients abroad succeeded in mobilizing several hundred million in private financing to targeted sectors. USAID guaranteed cover up to 50% of a private lender’s risk in providing financing. USAID coupled the guarantees with training and technical assistance to both borrowers and lenders to maximize developmental impact.

USAID credit guarantees were backed by the full faith of the US Treasury and were structured in four different ways: through a Loan Portfolio Guarantee (LPG), Loan Guarantee (LG), Bond Guarantee (BG), or Portable Guarantee (PG). While each of these mechanisms varies in structure, all share the same goal of encouraging private investment.

USAID’s provision of this credit enhancement instrument offered a powerful signaling effect demonstrating to partner institutions that new sectors and products were now viable and profitable causing other financial institutions to often follow. USAID impressively leveraged an average of 30 dollars of private financing for each dollar spent by the US government.

Following the merger of OPIC and DCA, DFC now carries on the work of OPIC with a $60 billion agency portfolio (up from OPIC’s $29 billion) and also operates with the intention of achieving financial sustainability through the fees and returns generated by its investments and financing activities.

The DCA offers direct loans and guaranties (typically 50%, but as high as 100%) of up to $1 billion for tenors as long as 25 years. These guarantees are intended to encourage private lenders to extend financing to underserved borrowers in new sectors and regions. In 2014, the DCA guaranteed USD 134 million of commercial loans that the Althelia Climate Fund issued to support forest conservation and sustainable land use, helping to remove 100 million tons of carbon — the equivalent of 18.5 million cars — from our atmosphere. This guarantee enabled the flow of private capital to financing sustainable land use models that delivered livelihood improvements, ecosystem uplift, and climate change mitigation outcomes.

OPIC’s slice of the market had declined in recent years, with investors turning increasingly to the World Bank Group’s Multilateral Investment Guarantee Agency (MIGA) that has substantially less restrictive eligibility requirements.

MIGA is the other player in the credit enhancement field. As an international financial institution MIGA also offers political risk insurance and credit enhancement guarantees. MIGA promotes foreign direct investment by providing political risk insurance and credit enhancement to investors and lenders against losses caused by noncommercial risks. MIGA was established in 1988 as an investment insurance facility to encourage confident investment in developing countries. MIGA insures long-term debt and equity investments as well as other assets and contracts with coverage lasting up to 15 years with a possible five-year extension depending on a given project’s nature and circumstances.

MIGA too has faced some negative sentiment from those that argued its impact has been hindered by regulatory bottlenecks, corruption, and inadequate infrastructure. Others have voiced equity concerns coupled with transparency issues on the assessment of potential environmental and social impacts of projects. That said, MIGA has successfully managed to promote direct private sector investment in countries that might be considered riskier due to political or economic instability. MIGA’s guarantees have helped mitigate risks for investors, making investments in these regions in sectors that include infrastructure, energy, agriculture, and financial services which are crucial for economic growth and development. MIGA has also developed innovative products and tools to address emerging challenges in investment, such as environmental and social risks.

When we examine the deterrent that inhibits achieving a total investment in nature of $8.1 trillion between now and 2050 called for by the 2021 State of Finance for Nature report for us to have a chance at addressing our global climate, biodiversity, and land degradation challenges, it is imperative for companies and financial institutions to participate by sharing the risk and increasing investments in nature-based solutions. The mobilization of private capital for natural climate solutions is a key challenge over the coming decade. For context, the private sector delivered investment in nature-based solutions to the tune of $18 billion in 2018. The report found that using 2020 data, approximately $133 billion/year currently flows into natural climate solutions space, with public funds making up 86 per cent and private finance 14 per cent of that total.

One cannot dismiss the financial risks facing the intrepid impact investor wanting to marshal the resources to support natural climate solutions. In contemplating mitigation solutions such as reforestation, afforestation, sustainable land management, soil carbon sequestration, and the preservation of ecosystems like wetlands and mangroves impact investors have to navigate long payback periods, uncertainty on returns, regulatory and policy risks, and the vagaries of emerging nature-based markets that don’t have the benefit of track records, clear monetization pathways, and transparent pricing mechanisms.

To succeed at our goal of tripling investments in nature-based solutions by 2030 with 60% – 70% coming from the private market, we need to venture where others won’t. Specifically, we need to learn from others that blazed a path in the field of foreign aid, such as OPIC, DFC, and MIGA but for nature this time.

Credit Enhancement: Definitions and Example

Credit enhancement is used by entities to reduce the credit risk associated with exposure. Credit enhancement can be funded or unfunded. One of the ways unfunded credit protection can be successfully secured is through a guarantee. This can be achieved through the obligation of a third party to pay out in the event of non-payment or default of a credit obligor.

The World Bank has been prominent in this space offering loan and bond guarantees to:

Provide access to international capital markets on more favorable terms;
Offer longer maturities and lower costs than achievable by the issuer on its own;
Mobilize larger volumes of development capital than the Bank can provide by itself; and
Help build a track record of credible performance for emerging market actors

Recently the World Bank utilized its capacities to help facilitate investment in the reforestation of degraded lands in Brazil through a $225 million bond issuance. The bond, which is the largest- ever “outcome” bond, provided up to $36 million in investment to Mombak, a project developer working on reforestation in Brazil.

Domestically in the U.S., the Farm Service Agency (FSA) of the U.S. Department of Agriculture offers guaranteed farm loans to help farmers and ranchers obtain financing. Furthermore, USDA offers credit guarantees to lenders who provide financing to rural America. In 2022, USDA was providing guarantees for 53,386 loans totaling over $17 billion. The U.S. DOE has more than $40 billion in loan guarantee capacity available to support clean energy projects. Loan guarantees have also been provided, albeit sporadically, through the Clean Water State Revolving Program. And the Small Business Administration partially guaranteed more than 57,300 loans worth $27.5 billion in FY 2023 alone.

Not all credit enhancement needs to come from the public sector. In February 2024, the Green Guarantee Company (GGC) launched on the London Stock Exchange (LSE). Touted as the world’s first climate-focused guarantee company, GGC aims to unlock $1 billion in climate finance for developing countries by providing guarantees for institutional investors buying green bonds issued and listed on the London Stock Exchange (LSE) and green loans issued in the private credit market. GGC will use guarantees to help borrowers in developing countries improve their credit ratings to access global capital markets like the LSE.

GGC plans to leverage an initial $100 million from its investors to provide up to $1 billion of guarantees underpinned by an investment grade rating of BBB/Stable from Fitch Ratings. GGC will prioritize green infrastructure, renewable resources, alternative energy, and clean transportation for issuers from African and Asian countries eligible for official development assistance, including India, Indonesia, Brazil, Bangladesh, Philippines, Egypt, Vietnam, and Kenya.

Philanthropic capital has sometimes been used as a form of credit enhancement as well. Many engaged philanthropic organizations are playing their part supporting climate solutions through a mix of grants, program related investments, and mission related investments. This approach however challenges philanthropies in that they have to equip themselves with enough domain expertise to conduct the appropriate due diligence on the NCS projects they are considering, which in turn slows down the rate of deployment. These philanthropic dollars are also missing out on the opportunity to deliver powerful leverage in attracting high volumes of private capital. In the face of needing urgent climate mitigation, we need to establish other avenues to attract and leverage private impact capital that include guarantee mechanisms, fund vehicles, green bonds, and increasing fiscal sponsorship that can accelerate the deployment of capital to the right solutions.

Expanding philanthropy’s engagement in the impact space would place it in good company with its colleagues. In recent years, organizations such as the Ford Foundation committed $1 billion of their $21 billion endowment to MRIs over ten years, and the Nathan Cummings Foundation has committed to aligning 100% of their investments with their mission, which amounts to approximately $415 million. As of October 2021, the McKnight Foundation invests 40% of its $3 billion endowment in mission aligned and impact investments, with $500 million committed to investments that provide ideas, technology, software and services to decarbonize the economy.

Kresge Foundation commissioned the Global Impact Investing Network (GIIN) to examine the application, benefits and scalability of financial guarantees in impact investing. GIIN’s report titled, “Scaling the Use of Guarantees in U.S. Community Investing,” shows how some impact investors are using guarantees as a credit-enhancement tool to stimulate increased private- sector investment in solutions to social and environmental problems.

Following this study Kresge led the establishment of the Community Investment Guarantee Pool recognizing that to boost investments in areas deemed too risky by most traditional financial entities, foundations and other like-minded impact investors should unite to unlock available capital to catalyze community development finance in such areas as small business, climate and affordable housing. In the words of Joe Evans, Kresge’s portfolio manager: “Using the guarantee helps us leverage our balance sheet to create impact today without using cash reserves…..we’re removing a layer of risk that will catalyze investment from other sources.”

Another example of using guarantee mechanisms is from the Delaware River Watershed Revolving Fund (“Fund”) in the U.S., which aims to protect the Delaware River Basin by offering temporary financing for projects when available capital is insufficient. This $2.6 million pilot loan fund, supported by initial seed funding from the William Penn Foundation and managed by the Open Space Institute, is intended to attract additional public and private investment. The Fund focuses on projects that safeguard and restore the watershed, expand and enhance the trail network, and broaden support for watershed protection. The Fund offers loans and financial guarantees at between $100,000 and a $1 million at 1.5% annual interest rates.

Credit Enhancement: Challenges and Gaps

Despite the existence and development of credit enhancement facilities mentioned above, reliable sources of credit enhancement are few and far between for natural climate solutions developers. This is because natural climate solutions and the outcomes they produce (such as carbon credits) are seen as ineligible for many of the various sources of credit enhancement detailed above, for a variety of reasons, including:

The geography of the activities, where U.S.-based projects often have less access to the varieties of credit enhancement offered by the federal government.
The lack of clear guidance from entities offering credit enhancement on applicability of natural climate solutions as an eligible activity.
The relative uncertainty of carbon and other ecosystem services markets.

We propose three potential pathways to addressing this gap:

First, innovation on the part of project developers and financial institutions to access existing credit enhancement vehicles under innovative structures.
Second, advocacy to establish guidance for existing programs and / or new programs that would be authorized to offer credit enhancement to natural climate solutions.
Third, the establishment of a Global Credit Enhancement Facility which would serve as a trusted intermediary between different providers of credit enhancement, investors, and project developers in a way that would drastically reduce transaction costs and allow the market to scale.

Pathway One: Innovative Structures to Access Existing Facilities

Developers of Natural Climate Solutions have in general not been successful at accessing existing third-party credit enhancement. In part this is due to the design and restriction on those existing facilities. It is also possible, however, that innovation in the way that Natural Climate Solutions projects are structured or defined could enable them to access credit enhancement from federal or other sources. For example, what would it take for a developer of Natural Climate Solutions in the U.S. to access loan guarantees from the Small Business Administration? Or for nature-based solution to benefit from some of the authorities possessed by the Department of Energy, by positioning nature-based projects as a solution for the temporary storage of CO2 that will eventually transfer to longer-term, geologic storage? Could U.S.-based projects benefit from some of the guarantee programs aimed at improving export markets to the extent they concentrated on producing credits for sale to other countries or to international companies based abroad?

Knowledge about the various avenues for credit enhancement and the innovative ways they might apply to NCS is lacking in the sector, for a few reasons:

Generally, project developers work in isolation from one another, pursuing bespoke and proprietary financial solutions within an opaque market. There have not been historical efforts to share learnings or establish a joint policy agenda.
Project developers are generally under-resourced, and to the extent that they have explored credit enhancement at all it has been in their spare time, and without the concentrated focus required to identify breakthrough solutions.
Because the capital requirements of Natural Climate Solutions projects have (to date at least) been modest, they have not drawn the kind of sustained partnership from the financial sector that would enable the design of robust new structures that could provide reliable access to credit enhancement.

It would be possible to address these shortcomings by resourcing a dedicated exploration of existing facilities for credit enhancement that seeks to, first, map all the potential sources of credit enhancement and their associated requirements; and second, identify mechanisms/structures for NCS projects to access those sources of credit enhancement. This could be done through a single lead organization or through a coalition model.

Pathway Two: Advocacy to Establish Guidance for Existing Programs and/or New Programs Authorized to Offer Credit Enhancement to Natural Climate Solutions Providers

As discussed above, in the American context, the U.S. federal government is not averse to using the balance sheet of the U.S. Treasury to guarantee loans and/or bonds in areas where it sees a compelling public interest. A coordinated advocacy campaign to either influence administrative processes or to encourage the adoption of legislation might empower agencies to either expand existing programs to cover NCS, or to establish new programs specifically for NCS.

One example of this kind of effort is the Rural Forests Market Act (RFMA). Introduced in the U.S. on a bipartisan basis by Senators Casey, Braun, and Stabenow and Representatives Pingree an Timmons, RFMA established a pilot authority for U.S. Department of Agriculture (USDA) to issue up to $150 million in loan or bond guarantees to eligible NCS projects, to enable them to attract private capital at sustainable rates.

Other examples of policy changes such an effort might promote in the U.S. include:

Utilizing existing authorities such as the SUSTAINS Act, a facility that allows USDA to accept donations from corporates to leverage investments in traditional programs, to be used as a credit enhancement facility
Leveraging the Regional Conservation Partnership Program (RCCP) Alternative Funding Arrangements (AFA) program which allows for Natural Resources Conservation Service (NRCS) to leverage federal investments in conservation with private financial tools environmental market access
Expand the Department of Energy’s Carbon Dioxide Removal program to include nature- based projects.

Based on insights from Pathway One, a proactive policy agenda could be created aimed at:

Adjusting existing programs to make NCS projects eligible; and
Establishing new programs specifically for NCS

Key to this pathway would be coordinated policy advocacy by the various actors (buyers, investors, project developers, landowners and others) with a clear stake in environmental markets in general and carbon markets specifically.

Pathway Three: A Global Credit Enhancement Facility (GCEF)

Even in the event the above Pathways are successful, they could result in a patchwork quilt of authorities and facilities that are confusing to navigate and difficult to bring together at the pace and scale required by the climate crisis. Therefore, parallel to the above Pathways, we see the opportunity to establish a global credit enhancement facility (GCEF) established in phases beginning with the U.S. The GCEF would be a global turn-key guarantee facility that offers credit enhancement to support a variety of financing instruments and vehicles at scale. This facility, which would rely on the creation of a common guarantee pool by foundations, agencies, impact investors, corporate buyers, and others with a clear stake in the success of NCS, would allow climate solution developers to focus on delivering impact using impact capital and a credible operator of the NCEF to scale the level of private market engagement in climate solutions.

The successful creation of such a Facility should establish a blueprint for federal/international agencies to step into the credit enhancement role thereby rolling off the need for continued enhancement provision by the participating philanthropies, agencies, or corporate partners.

The Facility would be structured with the following elements (Figure 2):

Credit enhancement commitments on a pari passu basis from forward thinking philanthropic, agencies, or corporate organizations.
Mechanism to issue regular RFPs to solicit proposals from the market seeking credit enhancement provisions.
Technical assistance provision to selected projects
A rigorous investment guarantee screening tool to filter out the top proposals
A robust due diligence framework to vet each of the selected top proposals to ensure among other aspects that impact investment opportunities and vehicles have successfully lined up the payor streams with off-takers for the environmental outcomes and commodities delivered and beneficiaries (leisure, hospitality, fisheries, tourism, government, homeowner associations, etc.) for the environmental uplift as appropriate
Management by the Facility for:
- The allocation of guarantee provisions to approved investment opportunities and vehicles
- The servicing of nominal returns to credit enhancement partners

With the creation of the Facility, any climate solutions developer or impact capital entity that wishes to deploy cash to fund its climate-friendly interventions could apply to the Facility. Each applicant would be screened, shortlisted, and subjected to thorough due diligence before approval for an allocation of the credit enhancement provision.

Participating philanthropic or corporate organizations contributing a portion of their balance sheet for the credit enhancement would sit on the Facility’s Investment Committee (IC). Only on approval by the IC would the due diligence be undertaken for any one applicant to lock in the corresponding level of credit enhancement from the Facility’s pledge pool. The guarantor organizations will derive an annual fee (1% – 1.5%) for the provision of such a guarantee from the Facility.

This credit enhancement commitment from participating philanthropies, foundations, agencies, or corporations would be treated similarly to the use of a letter of credit (LC) for a business transaction, viz. an off-balance sheet disclosure. Under Generally Accepted Accounting Principles, assets, liabilities, revenue and expenses are only recognized when they actually happen. Since the credit enhancement guarantees a future liability, there’s no actual liability to recognize. As a result, such a credit enhancement commitment would be disclosed as a footnote to the respective balance sheets of the guarantee partners.

Also noteworthy is that any fees earned by the guarantor partners for offering the pledged credit enhancement are generally not considered unrelated business income tax (UBIT) for tax-exempt organizations like foundations. Guarantee fees are typically treated as interest income or fees for services, rather than as income from an unrelated business activity. So, they are not considered equivalent to operating an active trade or business that is unrelated to the organization’s tax- exempt purpose. Further, Section 512(b)(1) of the U.S. tax code specifically excludes “amounts received or accrued as consideration for entering into agreements to make loans” from UBIT. While guarantee fees are not explicitly mentioned, they are not clearly included in this definition of UBIT. Unrelated debt-financed income (UDFI) is a separate concept from UBIT that can apply when a tax-exempt organization incurs debt to acquire property. However, guarantee fees alone do not trigger UDFI.

In summary, while there is limited direct guidance, the available authorities suggest that fees earned on guarantees are not considered UBIT for tax-exempt organizations like foundations. The fees are more akin to interest, fees for services, or excluded loan-related income rather than income from an unrelated active business.

As the financing supported by the Facility is serviced and the need for the credit enhancement diminishes over time, the Facility’s credit enhancement commitment pool can be recycled for other applicants, providing greater leverage once again. Again, the aspiration is that the Facility paves the way for federal/international agencies or intermediaries to step into the credit enhancement role.

Recommendations

In summary, we provide the following recommendations:

Market stakeholders, including but not limited to project developers, investors, credit buyers and NGOs, should establish coordinated efforts to:
- Complete a thorough scan of existing sources of credit enhancement and an analysis of how those sources could potentially be applied to NCS projects.
- Based on that exercise, create a proactive policy agenda aimed at broadening the use of existing programs and/or establishing new programs such that NCS projects can be included. Once such an agenda is completed, market stakeholders should devote energy to advocating for needed administrative or legislative changes.
Market stakeholders should provide resources – both human and financial – to support the coordinated efforts above via a single organization or through coalition efforts.
In parallel to the above, private donors should make investments to help create a Global Credit Enhancement Framework which offers credit enhancement secured by a community guarantee pledge pool. Once such a Framework is established, market stakeholders should consider participating in this pool to the extent they are able.
Develop the credit enhancement offering of the Facility on a phased basis beginning with a pilot in the U.S. and then expanding globally.

About Us

At Gordian Knot Strategies, we are expert climate finance consultants. Drawing on two decades of experience, our clients rely on us to devise high impact solutions that are innovative and implementable. Over 80% of the impact investors, corporations, and developers that we serve are repeat clients. They trust us to provide clarity as they mobilize and deploy capital in a complex and rapidly evolving market. With our proprietary frameworks and deep industry knowledge, our clients are equipped to unlock and optimize environmental impact and returns. See our recent article, “Venturing where others won’t” for additional context on credit enhancement referenced herein.

The American Forest Foundation and its flagship program, the Family Forest Carbon Program, have been working to solve challenges in the Voluntary Carbon Market since 2018. In that time, AFF has enrolled over 100,000 acres in FFCP, issued the world’s first bond backed by carbon credit revenues, co-authored the world’s first carbon credit methodology to use a dynamic baseline as a solution to the market’s over-crediting problems, launched the market’s first Permanence Fund to extend the durability of NCS, and engaged in many other innovations to support a market that delivers highly credible climate mitigation while also supporting the economic health of rural communities.