EIB intermediated lending cannot see the wood from the trees

The European Investment Bank (EIB) has invested in equity funds whose forestry projects in Ghana, Sierra Leone and Paraguay have sparked forced evictions and conflict with local communities since 2018. Yet, the bank has taken few measures to avoid this.

The EIB, just like every public bank, must regularly evaluate how it can get the most out of the capital it employs. This issue is often mistakenly framed as trying to achieve the highest level of investment in desirable sectors with as little public banking capital as possible. Since mitigating the climate crisis requires major investments, a default solution for the EIB is leveraging - using public money to trigger more private investments than the amount initially invested. As the adage goes, you turn billions into trillions.

Since the EIB typically doesn't cover more than 50% of the total cost of a project, all EIB operations include leveraging to some extent. Senior loans for infrastructure projects (e.g. a loan to a government for building a new hospital) typically have lower leverage, while equity products and intermediated operations have greater catalytic effect - being an attractive finance solution for the EIB. The latter includes funding through public or private intermediaries, such as on-lending to national development banks or direct equity participation in investment funds. Intermediated lending makes up about 30% of the bank’s total lending. One of the reasons the EIB lends to other financial institutions is to indirectly finance smaller projects, since the EIB itself only directly finances projects over €30 million.

However, using intermediaries weakens the bank’s ability to direct its investments in line with set objectives and to monitor compliance and performance. There is a trade-off between policy steer and leverage. Yet, financing climate solutions needs focused policies and projects - not diffuse spending.

This is not a forest

Take forestry as an example. In 2018, the EIB took direct equity participation in two private investment funds committed to reforestation efforts - the Mirova and Arbaro funds. The bank then conducted environmental and social assessments of the funds’ activities. Both funds then in turn invested in Miro Forestry, which manages industrial tree plantations in West Africa.

The company’s forestry efforts went badly. They reported losses on biological assets because of droughts, fires and conflicts with local communities. In Sierra Leone, the company is accused of having broken promises of building new infrastructure for local communities in exchange for leasing their lands - lands for which Miro Forestry pays only US$2 per hectare a year. In Ghana, the company has been taken to court for the forced evictions of local farmers without compensation. The Arbaro fund also invested in forestry projects in Paraguay, where the bulk of their revenues from industrial eucalyptus plantations is actually expected to come from charcoal production. Demand for charcoal in Paraguay mostly comes from agri-businesses for grain-drying purposes, Paraguay being a major soybean exporter.

The EIB has also directly financed forestry projects over which it had more control and learning opportunities. Between 2009 and 2020, the EIB invested €1 billion in forestry projects in China, all of them loans to local governments for specific projects. China’s experiment with tree planting has long been mired with failures. Projects have faced devastation by pests and droughts resulting in ‘forests’ with not one surviving tree or hydrological stress in water-scarce regions. However, in the environmental assessment of the EIB’s latest project in China, it acknowledged that previous efforts and foreign interventions, including by them, were impaired by ecological instability due to single species tree-planting and suggested several mitigation measures.

When dealing with financial intermediaries, the EIB lacks monitoring capacity over the final projects. Not only does this make enforcing the bank’s regulations harder, but improving the impact of future climate financing becomes unlikely. In the forestry projects in China, adjustments were possible because the EIB had the opportunity to learn from its mistakes.

Then again, it is doubtful that these projects were the best available options for the EIB. The previous efforts were afforestation projects, which means that trees were planted where there were none previously. On the contrary, reforestation or regeneration implies the renewal of deforested areas. Studies showed that natural forests can hold as much as 40 times more carbon than commercial monocultures. Moreover, afforestation projects in China sometimes included objectives not related at all to the just transition, like ensuring China’s strategic supply of timber.

When less is more

Effective and efficient climate finance and policy steer not only need more monitoring, but also a narrower focus. If the EIB really wants to do more with less, climate finance should be better planned to make sure only projects driven by effective, sustainable and science-based policies get funding. Policies which allow for the financing of suboptimal projects or make extensive use of intermediaries which don’t have effective policies themselves occur in other sectors as well as forestry. For instance, bioenergy and green hydrogen technology do not currently justify an EIB spending spree. If the EIB is really preoccupied with getting the most out of its capital, it must avoid diverting limited resources to ‘solutions’ that might actually be of little use.

The well-designed use of financial intermediaries can be useful. Funding for SMEs can be easier with decentralised financial structures. However, it should go through public bodies like national and regional development banks and local governments instead of opaque private equity funds. These public bodies are better equipped to impose conditionalities and monitor compliance of environmental and social regulations. Yet the EIB should not blindly use financial intermediaries on the basis that its capital is limited - public banks have a lot more resources than we would think.

Then there is the transparency issue. The EIB, unlike many other development banks, does not disclose its sub-investments made through intermediaries. This makes tracking the real impact of the EIB’s climate finance remarkably tricky.

The EIB should be laser-focused on making genuine climate investment. Crowding in private investments will not help the just transition if the money is spent on inefficient projects or captured by private interests. To do more with less requires a qualitative effort as much as a quantitative one.

Olivier Lessard is a Masters Student in International Law at Université du Québec à Montreal and an intern at Counter Balance.