Document of The World Bank FOR OFFICIAL USE ONLY ReportNo: 33228-MX PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN INTHEAMOUNT OFUS$45.00 MILLION AND A PROPOSED GRANT FROMTHE GLOBAL ENVIRONMENT FACILITY TRUST FUND INTHEAMOUNT OFUS$15.00 MILLION TO THE UNITED MEXICAN STATES FOR AN ENVIRONMENTAL SERVICES PROJECT February 15,2006 Environmentally and Socially SustainableDevelopment Sector Management Unit Colombia and Mexico Country Management Unit LatinAmerica andthe Caribbean Region This document has a restricted distribution and may be usedby recipients only inthe performance oftheir official duties. Its contents may not otherwise be disclosed without World Bankauthorization. CURRENCYEQUIVALENTS (ExchangeRate Effectiveas of January 15,2005) CurrencyUnit = Mexicanpeso (MXP) US$1 = 10.55pesos FISCALYEAR January 1 - December31 ABBREVIATIONS AND ACRONYMS APROMSA Promising areas for promoting environmentalservices (pilot sites), Areas promisoriaspara la promocidn de 10s sewicios ambientales CABSA Programto Develop Environmental Services Markets for Carbon Capture andBiodiversity and to Establishand Improve Agroforestry Systems, Programapara Desarrollar el Mercado de Sewicios Ambientalespor Captura de Carbon0y 10s Derivados de la Biodiversidadypara Fomentar el Establecimiento y Mejoramiento de SistemasAgroforestales CBD Convention on BiologicalDiversity, Convencid de Biodiversidad CDM CleanDevelopmentMechanism CNA National Water Commission, ComisidnNacional del Agua COINBIO Indigenousand Biodiversity ConservationProject ,Proyecto de Consewacidn de la Biodiversidad en Comunidades Indigenas de 10sEstados de Guerrero, Michoach y Oaxaca COLPOS PostgraduatesCollege, Colegio de Postgraduados CONABIO National Commission for Biodiversity Knowledge andUse, ComisidnNacionalpara el Conocimientoy Us0 de la Biodiversidad CONACYT National Committe for Science and Technology, ConsejoNacional de Cienciay Tecnologia CONAF National Forestry Council, ConsejoNacional Forestal CONAFOR National Forestry Commission, ComisidnNacional Forestal (Executor of the current Program) CONANP National Commissionfor Natural ProtectedAreas, ComisidnNacional deAreas Naturales Protegidas CPS Country Partnership Strategy,Estrategia de Colaboracidn EA Environmental assessment, Ancilisis ambiental EnvSAL I& I1 Environmental Structural Adjustment Loan, Prhtamo deAjuste Estructural Ambiental ES Environmental services FA0 Food and Agricultural Organization FFM Mexican ForestryFund, Fondo Forestal Mexicano GEF Global Environment Facility IBRD International Bank for Reconstructionand Development IMTA Mexican Water Technology Institute, Instituto Mexicano de TecnologiadeAgua INE National Ecology Institute, Instituto Nacional de Ecologia IPDP IndigenousPeoplesDevelopment Plan, Plan de Pueblos Indigenas GOM Government of Mexico, Gobierno de Mkxico LFD FederalRights Law, Ley Federal de Derechos (sets fees for national resources and services) MBC MesoamericanBiological Corridor, Corredor Bioldgico Mesoamericano MXP Mexican pesos NAFIN GOM's DevelopmentBank, Nacional Financiera, S.N.C. (Financial Agentfor the Project) NGO Nongovernmentalorganization, Organism0 No Gubernamental NPA Natural protectedarea, Area naturalprotegida OECD Organisationfor Economic Co-operationand Development Organizacidnpara la Cooperacidn y Desarrollo Econdmico PES Paymentfor environmentalservices, Pagopor sewicios ambientales PHRD Policy and HumanResourcesDevelopmentGrant POA Annual OperationalPlan, Plan OperativoAnual PROCYMAF Community ForestryManagement and ConservationPrograminMexico, partially funded with I&I1 WB resources. Loan 4137-ME,Programa de Desarrollo Forestal Comunitario Iy 11(Proyecto de Consewacidny Manejo Sustentable de Recursos Forestales en Me'xicofinanciado parcialmente con recursos del Banco Mundial. Prkstamo 4137-ME) PRODEFOR ForestDevelopmentProgram, Programapara el Desarrollo Forestal PRODEPLAN ForestPlantation Program,Programa de Plantaciones Forestales PROCOREF Programfor ForestConservationand Restoration,Programa de Consewacidn y Restauracidn Forestal PROFAS ReinforcementProgramfor ForestSelf-Management,Programa de Fortalecimiento a la Autogestidn de 10s Silvicultores PSA Costa Rica's Pagopor Servicios Ambientales program PSAH Payments for Hydrological Environmental Services Program, Programa de Pagopor Servicios Ambientales Hidroldgicos PSTyP Register of Technical andProfessionalServices, Padrdn de Sewicios Tkcnicosy Profesionales SAGARPA MinistryofAgriculture, Livestock, RuralDevelopment,Fisheries, andFood, Secretaria de Agricultura, Ganaderia, Desarrollo Rual, Pescay Alimentacidn SEMARNAT Ministry of Environment andNatural Resources, Secretaria de Medio Ambiente y Recursos Naturales SHCP Ministry of Finance and Public Credit, Secretaria de Hacienday Cridito Pziblico SINAP National System ofNatural ProtectedAreas, SistemaNacional de Areas Naturales Protegidas PST Technical service provider, Proveedor de servicios te'cnicos Vice President: Pamela Cox Country Director: Isabel Guerrero Sector Director: Laura Tuck Sector Manager: Abel Mejia Sector Leader: Ethel Sennhauser Task Team Leader: Mark Austin MEXICO ENVIRONMENTAL SERVICES PROJECT PROJECT APPRAISAL DOCUMENT LATIN AMERICA AND CARIBBEAN LCSEN Date:February 15,2006 Team Leader: Mark A. Austin CountryDirector: Isabel M. Guerrero Sectors: Forestry (90%);General agriculture, SectorManager/Director: Laura Tuck fishingand forestrysector(10%) Project ID: P087038 Themes: Biodiversity (P);Other environment and LendingInstrument: SpecificInvestment Loan natural resourcesmanagement (S) Environmental screeningcategory: Partial Assessment Global SupplementalID: P089171 Team Leader: Mark A. Austin LendingInstrument: SpecificInvestment Loan Sectors: Forestry(100%) FocalArea: B-Biodiversity Themes: Biodiversity (P);Otherenvironment and DEVELOPMENT GLOBAL ENVIRONMENT FACILITY 15.00 0.00 15.00 LOCAL SOURCESOF BORROWING 15.90 0.00 15.90 COUNTRY Total: 156.56 0.00 156.56 Borrower: Ministry of Finance and PublicCredit (Secretaria de Hacienda y CreditoPublico, SHCP) Responsible Agency: National Forest Comission (ComisionNacional Forestal, CONAFOR) Annual 10.35 10.65 12.70 11.30 Cumulative 10.35 21.00 33.70 45.00 2007 2008 2009 2010 I I I I Annual 3.00 5.50 3.00 3.50 Cumulative 3.00 8.50 12.00 15.00 Project implementationperiod: Start June 15,2006 End: December 31,2010 Expected effectivenessdate: June 15,2006 Expected closingdate: December 31,2010 Does theproject depart from the CAS in content or other significantrespects?Ref. PADA.3 [ ]Yes[X] No Does the project require any exceptionsfrom Bank policies? Ref. PAD D.7 [ ]Yes [X]No Have these been approvedby Bank management? ]Yes 1No Is approval for any policy exceptionsought from the Board? [ ]Yes [1No Does the project include any criticalrisks rated "substantial"or "high"? Ref. PAD C.5 [ ]Yes [X]No Does the project meet the Regional criteriafor readiness for implementation?Ref. PAD D.7 [X]Yes [ ]No Project developmentobjective Ref. PAD B.2, TechnicalAnnex 3 Theproject development objectiveis to enhance the provisionof environmental servicesof national and global significanceand secure their long-term sustainability. Thiswould be done by strengthening and expandingthenational PSAH andCABSAprograms and supportingthe establishment of local payments for environmentalservices(PES) mechanisms in selectedpilot areas. The objectivewill be achievedthrough the followingkey outcomes and outputs:(i) strengtheningthe capacity of CONAFOR, community associations,andNGOs to increaseflexibilityand improve efficiencyof existing serviceprovisionto support long-termdevelopment ofthe PSAH program in Mexico; (ii) establishingand securing sustainablelong-termfinancingmechanisms; (iii) establishing legal, institutional,and financial arrangementsto pilot market-basedmechanisms forpayment for I environmentalservices; (iv) documentinglinksbetween land use changesand water services improvementsand biodiversity conservation; and (v) defining good practicesto replicate, scale up, and sustainmarket-basedPES programs. Global Environmentobjective Ref. PAD B.2, TechnicalAnnex 3 The global environment objective ofthe project is to enhanceand protect biological diversityand preserve globally significantforest and mountainecosystems. This objectivewill be achievedthrough the followingkey outcomesand outputs:(i) improvingthe targeting of the existing PSAH program; (ii)piloting a market-based system tocontractenvironmental services;and (iii) establishingan endowmentfund forbiodiversity conservationto provide long-term financingforpayment for environmental services.The project will ensurethat only siteswith globally significantbiodiversity will receive GEF fundsunder the national or local programsin the project area. InI addition,these sites are recognized aspart of thenational protected areas system. Furthermore,all land management systemswith PES supportunder the project (from anyfundingsource)will be biodiversity- friendly. 1 Project description[one-sentencesummay of each component] Ref. PADB.3.a TechnicalAnnex 4 Component 1 focuseson developingsustainablefinancingmechanisms. Component2 activities supportthe developmentand strengtheningof PES delivery mechanisms. Component3 supportsenvironmental serviceproviders. Component4 focuses on the actual flow of paymentsto participantsand the ongoing operationalcosts of the program. Component5 focuses on project and programmanagement mechanisms,includingmonitoringand evaluation. Which safeguard policies are triggered, if any? Ref. PADD.6, Technical Annex10 EnvironmentalAssessment (4.01) Natural Habitats (4.04) IndigenousPeoples (4.10) Forests (4.36) Significant,non-standardconditions,if any,for: Ref. PAD C.7 Disbursementconditions: Disbursementsof the endowment fund seedcontributionunder Component 1 willbe subject to(a)the fund being establishedand operationalin form and substancesatisfactoryto the Bank (b)responsibility establishedand entity assigned for financialand asset management, and (c)Bank approval of fund operatingrules and manual. Disbursementsof each of the three types of local financingmechanisms for environmental services (water,biodiversity,and carbon)under Component4 will be subjectto the Bank's approval ofthe respective operatingrules developedunder the project. Disbursementsof matching grantsunder component4 willbe subjectto the Bank's approval of the operatingrules for such financingmechanismto be developed underthe project. Covenants applicableto project implementation: No later than sixmonths after the date of the loan agreementCONAFORmust enter into cooperation agreementswith CNA and at leasttwo Technical SupportAgenciesto assist in the development of Water EnvironmentalServicesand BiodiversityEnvironmental Servicesrespectively underterms and conditions satisfactoryto the Bank. Each year CONAFORmust furnishto the Bank for its commentsthe proposed revisionsto the operatingrules for PES mechanisms or any othersrules that may be proposed asper therequirements of theproject. MEXICO EnvironmentalServices CONTENTS Page A. STRATEGIC CONTEXT AND RATIONALE ................................................................. 1 1. Country and sector issues.................................................................................................... 1 2. Rationale for Bank involvement ......................................................................................... 5 3. Higherlevel objectives to which the project contributes .................................................... 5 B . PROJECT DESCRIPTION ................................................................................................. 7 1. Lending instrument............................................................................................................. 7 2. Project development objective and key indicators.............................................................. 7 3. Project components .............................................................................................................. 8 4. Lessons learned and reflectedinthe project design.......................................................... 12 5. Alternatives considered and reasons for rejection............................................................ 14 C. IMPLEMENTATION ........................................................................................................ 14 1. Partnership arrangements (ifapplicable) .......................................................................... 14 2. Institutional and implementation arrangements................................................................ 14 3. Monitoring and evaluation o f outcomeshesults ................................................................ 18 4. Sustainability and Replicability ........................................................................................ 19 5. Critical risks and possible controversial aspects............................................................... 21 6. Loadcredit conditions and covenants............................................................................... 22 D. APPRAISAL SUMMARY ................................................................................................. 22 1. Economic and financial analyses...................................................................................... 22 2. Technical........................................................................................................................... 24 3. Fiduciary ........................................................................................................................... 24 4. Social................................................................................................................................. 25 5. Environment...................................................................................................................... 26 6. Safeguard policies............................................................................................................. 27 7. Policy Exceptions and Readiness...................................................................................... 27 Annex 1: Country and Sector or Program Background ......................................................... 28 Annex 2: Major RelatedProjects Financed by the Bank and/or other Agencies .................41 Annex 3: Results Framework and Monitoring ........................................................................ 45 Annex 4: Detailed Project Description ...................................................................................... 60 Annex 6: Implementation Arrangements ................................................................................. 77 Annex 7: FinancialManagement and DisbursementArrangements ..................................... 89 Annex 8: Procurement Arrangements ...................................................................................... 98 Annex 9: Economic and FinancialAnalysis ........................................................................... 102 Annex 10: Safeguard Policy Issues .......................................................................................... 111 Annex 11:Project Preparation and Supervision ................................................................... 118 Annex 12: Documents inthe Project File ............................................................................... 119 Annex 13: Statement of Loans and Credits ............................................................................ 121 Annex 14: Country at a Glance ............................................................................................... 124 Annex 15: IncrementalCost Analysis ..................................................................................... 126 Annex 16: STAP Roster Review .............................................................................................. 133 Annex 17: Pilot Site Selection Criteria .................................................................................... 137 Annex 18: DetailedLessons Learned ...................................................................................... 142 Annex 19: Payment for Environmental Services-Water Program (PSAH) ........................ 147 Annex 20: Payment for Environmental Services-Carbon and Biodiversity Program (CABSA) .................................................................................................................................... 156 Annex 21: Biodiversity Endowment Fund .............................................................................. 162 MAP IBRD33447 A. STRATEGIC CONTEXT AND RATIONALE 1. Country and sector issues 1. Since the 1994 economic crisis Mexico has undertaken impressive reforms that have lead to a major political and economic transformation. The government's National Development Plan includes a substantial agenda for further progress, including very important goals in poverty reduction, improved competitiveness, environmental management, and institutional change. 2. Water qualityhupply and deforestation are two important environmental challenges facing Mexico, which i s experiencing rapid environmental degradation, including some o f the region's most extensive deforestation. This degradation i s aggravating already severe water quality, reliability, and contamination problems, threatening current and future economic activity and the welfare o f Mexico's people, and leading to loss o f globally important biodiversity. 3. Water. Water consumption patterns in Mexico are unsustainable. According to the National Water Commission (CNA), although less than 16 percent o f Mexico's 653 aquifers are considered overexploited, 66 percent o f all groundwater used comes from only 188 o f those aquifers, and 57 percent of all groundwater used is from overexploited aquifers. In addition, the UN considers Mexico a country under high water stress as measured by the amount o f mean natural water availability used. While water scarcity i s not directly related to deforestation, forest conservation may help ameliorate water scarcity pressures by improving the quality o f available water. There is also evidence that forests and other vegetation cover may help regulate seasonal flows (and seasonal availability) o f water in certain cases and increase rates o f aquifer recharge. 4. Deforestation. In the 1990s only four countries (Brazil, Zambia, Indonesia, and Sudan) accounted for more deforestation than Mexico, according to the FAO's 2005 Forest Resources Assessment, While the amount o f deforestation in Mexico (631,000 hectares per year) was only one- quarter of that in Brazil, it was more than twice as much as the next nearest country inthe Americas, and its annual rate o f deforestation (1.1 percent) was nearly four times greater than in Brazil. Various assessments indicate that both the amount and rate o f deforestation in Mexico i s highest in tropical forests, including areas o f high biodiversity value. According to one analysis, between 1993 and 2000 about 3.1 million hectares o f forest in Mexico were converted to agricultural uses and 5.1 million hectares were converted to pasture, with only 1.7 million hectares beingreforested or regenerated. 5. Rapid deforestation has adversely affected water quality and resulted in sedimentation o f reservoirs. Scientific work highlightsthe role that montane cloud forests play in providing surface water flows during the dry season in Mexico's Veracruz watersheds. There i s also evidence that dry tropical forests provide the environmental service o f reducing the risk of floods during storms inwestern Jalisco and that the Sierra Gorda's forests are fundamental for water recharge in the aquifers that supply the cities o f Queretaro and San Juan del Rio. 6. Critical Ecosystems and Globally Significant Biodiversity. Mexico is one o f the mega- biodiversity countries in the world, with second place in reptilian diversity, third in mammal diversity, and fifth in both amphibian and plant diversity. Its plant diversity exceeds that o f the United States and Canada combined. Mexico i s regarded as one o f the world's most important centers o f genetic diversification in plants and one o f the areas where agriculture originated. Some 120 cultivated plant species (belonging to 39 families) originated in Mexico, including cocoa, kidney beans, maize and tomatoes. 1 7. Land use change i s eroding Mexico's extraordinary biological wealth. One-third o f birds and nearly two-thirds of amphibian, reptile and mammal species are at risk. In total, 2,582 species and subspecies are at risk (161 more than under the previous 1994 standard), o f which 41 are already extinct in the wild, 1,215 endangered or threatened with extinction, and 1,326 subject to special protection. Although the 154 federally administered natural protected areas (NPAs) cover almost 19 million hectares, many areas with important biodiversity do not have protected status. 8. Rural Poverty and Forests. Mexican forests are located almost entirely in common property lands, the owners of which are among the poorest in the country. Nearly 85 percent o f localities in forested areas have a "high" or "very high" marginality index. This has two important implications. First, poverty is one o f the driving forces in deforestation. Second, poor households are highly dependent on forest resources, so degradation o f these resources hinders their ability to sustain their livelihoods. The indigenous people of Mexico have an important presence in forested areas. Indigenous households account for a large majority of households inthe 20 percent o f ejidos or communities that have more than 100 hectares o f forest, but are the majority in only 2 percent o f the ejidos without forests. 9. Government Strategy. The Government o f Mexico (GOM) has taken a number o f legislative, institutional, and budgetary actions to address daunting environmental challenges. For example, in 1986 the government created the National System o f Protected Natural Areas (SINAP) to safeguard some o f Mexico's richest habitats and most important biological diversity. With help from the GEF and World Bank, an endowment fund was created to provide long-term financial support for SINAP. The Mexican government i s also committed to a "zero deforestation" target and in April 2001 it created the National Forest Commission (CONAFOR) to support sustainable production and conservation o f forest resources based on the Strategic Forestry Program for 2000-2025, which articluates specific priorities, goals, and strategies in areas such as community forestry, commercial forestry, soil conservation, forest management, and reforestation. This forest strategy i s part of an overarching approach to national development that also includes formal sector strategies for water, rural development, and biodiversity. To helpsupport and implementthese strategies, the government recentlypassed or extensively modifiedlaws on water resources, forests, and sustainable rural development. These sectoral initiatives are complemented by the Sustainable Development Program, which seeks to build synergies and coinpleinentarities among different government policies and instruments. The introduction o f a fiscal instrument (the water fee) and the PSAH and CABSA environmental services programs are further examples o f the government's serious commitment to conservation and sustainable use o f natural resources. 10. PSAH. The Payments for Hydrological Environmental Services Program (PSAH), started in October 2003, was designed to complement other initiatives by providing economic incentives to avoid deforestation in areas where water problems are severe, but where in the short- or medium-term commercial forestry could not cover the opportunity cost o f switching to agriculture or cattle ranching. PSAH consists o f direct payments to landowners with forests in a good state o f conservation. Payments are made for watershed conservation, management, and restoration aimed at preserving temperate and tropical forest lands (and in particular, highmontane cloud forests) associated with the supply o f water to communities. Part o f its innovative approach is that it is funded through a portion o f the water fees collected under the Federal RightsLaw (LFD). 11. The PSAH gained rapid acceptance from the outset, despite the very short time between its creation and the implementation o f its first year o f environmental service contracts. In2003, the first year of operation, 200 million pesos (US$18.2 million) were allocated from the LFD for the PSAH, and for 2004 and 2005 the annual allocation was increased to 300 million pesos. The program pays 300 pesos (US$27.3) per hectare for forest conservation and 400 pesos (US$36.4) per hectare for cloud forest conservation. In 2003 more than 900 applications were received offering a total o f almost 600,000 hectares for inclusion in the program. From these applications, 271 were selected, covering 127,000 hectares. In2004 the PSAH received 960 applications o f which 352 were chosen, covering about 184,000 2 hectares. In 2005 there were 688 applications, 256 applications accepted, and 169,03 1 additional hectares included inthe program. Intotal, there are currently 879 contracts covering about 480,000 hectares under the PSAH program. 12. Despite these achievements, there is room for improvement. In particular, the PSAH program needs to address the fact that (i)the majority of the contracted area is outside the priority conservation areas-less than 14 percent of the area enrolled in 2003 and 2004, for example, was located in areas with overexploited aquifers; (ii)less than 20 percent o f the area enrolled in 2003 and 2004 was in areas with high or very high risk of deforestation, while 62 percent was in areas of low or very low risk of deforestation; (iii)most contracts have gone to better organized, more developed communities and ejidos and to private owners, even though they tend to require stronger incentives to participate because their opportunity costs are higher; (iv) there is a 5-year limit on payments to any one participant, putting conservation beyond that period at risk; and (v) there i s a lack o f training and capacity building (on both the supply and demand sides) to develop local markets. 13. CABSA. In 2004, as a complement to the PSAH, Mexico created CABSA (Program to Develop Environmental Services Markets for Carbon Capture and Biodiversity and to Establish and Improve Agroforestry Systems). CABSA supports reforestation activities and land use changes in Mexico and links them to national and international markets/financing for carbon capture and biodiversity. Like the PSAH, contracts for environmental services under CABSA have a duration o f up to five years. In 2004 CONAFOR received 830 proposals for CABSA and approved 216 (57 in agroforestry, 71 in reforestation for carbon sequestration, and 91 in biodiversity conservation). The area covered by the 216 proposals i s 537,360 hectares. In 2005 CONAFOR received 955 proposals for CABSA and approved 51 (17 in agroforestry, 11 in reforestation for carbon sequestration, and 23 in biodiversity conservation). The area covered by the 51 proposals i s 68,535 hectares, but only 20,000 will be receiving direct payments while the rest represent proposals accepted for further development. While the initial success in attracting proposals reflects a strong potential for the program, several important limitations were identified in an assessment made by the Colegio de Postgraduados (COLPOS): (i)sustainability is limited by the 5-year payments, (ii)international carbon and biodiversity markets are new and lack well-established prices and rules, (iii)transaction costs may be high, and (iv) there is not adequate information and clarity on how communities will benefit from CABSA. 14. Market-Driven Payments for Environmental Services (PES). Because farmers, forest dwellers, and landowners often profit from land uses that adversely affect the environment but do not benefit directly from environmentally friendly ones, the PES approach i s to recognize the value o f those services and create markets through which the users o f environmental services compensate the providers of those services. These environmental services may include global benefits such as biodiversity preservation and carbon sequestration, or national and local benefits such as improvement in water quality, control o f land degradation, reduction o f erosion and sedimentation, prevention or attenuation o f landslides and flooding, and scenic preservation or enhancement. While local actors can often be convinced to pay for national environmental services, global services are likely to require funding from the GEF, international NGOs, and the financial mechanisms created by the UN Framework Convention on Climate Change (UNFCCC) inthe case o f carbon sequestration. 15. Market-driven PES programs are more likely to be sustainable because they depend on the self- interest of the affected parties rather than on taxes, tariffs, philanthropy, or the whims o f donors. By providing payments on an ongoing basis, such PES programs avoid the pattern o f short-term adoption followed by rapid abandonment that has characterizedpast approaches. They can also help reduce poverty because the areas that provide environmental services (and receive payments) correlate highly with areas of rural poverty. The project builds on previous experience with the use o f PES approaches or schemes, including a successful nationwide program in Costa Rica that i s supported by the Bank and GEF, and a wide range o f small-scale initiatives throughout the region, including El Salvador and several in Mexico itself. 3 16. Market-driven approaches are harder to implement in the case o f biodiversity conservation services because, with some exceptions, it is hard ifnot impossible to identify and charge service users. PES based on financing from water users and carbon buyers will make an important contribution to biodiversity conservation needs, as will payments from the tourism industry, but areas o f globally significant biodiversity will remain where such payments are insufficient. Funding for biodiversity conservation, such as GEF grants, is typically only provided for a limited time, making it hard to use for PES, which requires long-term funding flows. An endowment fund will be establishedto help fill this gap and convert short-term funding into the long-term funding flows necessary to finance PES payments for conserving globally significant biodiversity in cases where other payments are insufficient. Fundingfrom this Fund will be targeted at areas of globally significant biodiversity in the buffer zones o f protected areas and the corridors that connect them, thus helping to ensure the sustainability o f the national protected area system and the Mexican portion o f the Mesoamerican Biological Corridor. 17. A recent study commissioned by the World Bank and CONAFOR conducted a rapid assessment of 40 experiences related to payment for environmental services in Mexico. The cases involve water supply and hydrological services, biodiversity, carbon capture, risk mitigation, and landscape (ecotourism) values. They include a range o f stakeholders and participants, from local communities and civil society organization to the federal government and international agencies. All the cases affect local watershed and ecosystem management in some way and usually involve more than one kind environmental service. 18. Although most PES systems reviewed are still under development or negotiation, there are a handful o f decentralized PES systems that are already under implementation. For example, the Parque de la Joya-La Barreta (Queretaro) and Municipio de Coatepec (Veracruz) PES systems channel public and private money through municipal trust funds to the owners o f land in the watersheds that provide water regulation, quality, and supply services to municipal water users (as envisioned in Component 1A o f the proposed project). The landowners are rewarded for including new areas under formal conservation commitments or for improving conservation and land use practices in areas that have been degraded. The source of funds may include money from municipal and local government budgets, fees to urban users o f water services, or earmarking o f a share o f money spent on urban construction projects. 19. Country GEF Eligibility. Mexico ratified the Convention on Biological Diversity (CBD) on March 11, 1993. It is also a signatory to the Convention on International Trade inEndangered Species o f Wild Flora and Fauna (CITES) and the Cartagena Protocol on Biosafety. The project's objectives are fully consistent with guidance from the Conference o f the Parties (COP) o f the CBD regarding conservation and sustainable use o f biological diversity. The project i s consistent with the guidelines and decisions o f a number o f CBD Conference o f the Parties in particular. For example, the project contributes to Practical Principle 12 (on the equitable distribution o f the benefits for indigenous and local communities) o f the Addis Ababa Principles and Guidelines adopted by COP VI1 Decision 12, by promoting economic incentives to generate additional benefits to indigenous and local communities and stakeholders involved inthe management o f biodiversity. Furthermore, the project contributes to COP VI1 Decision 14 (Biological Diversity and Tourism) and Decision 16 (Article 8j and related provisions) by creating appropriate mechanisms to capture the economic benefits o f ecological services, and i s also consistent with COP VI Decision 15 (Incentive Measures). 20. The proposed project will address weaknesses in Mexico's existing PES programs by seeking to (i)ensure the long-termsustainability ofthe PES programbydevelopingnew, sustainable long-term financing mechanisms based on payments from service users; (ii)increase the program's efficiency and cost-effectiveness by focusing on the areas at greatest risk o f deforestation and on areas with water quality or regulation problems; (iii)improve its contribution to poverty reduction; and (iv) increase its contribution to the conservation o f globally important biodiversity by focusing it on critical ecosystems. 4 2. Rationale for Bank involvement 21. Mexico has requested World Bank assistance to strengthen the PSAH and CABSA Programs because o f the Bank's knowledge and experience in the design, implementation, and support o f PES programs in developing countries. Four Bank-financed projects that use PES are under implementation with GEF cofinancing, and others are under preparation (see Table A1-5 in Annex 1). In parallel, the Bank has been undertaking research on PES and providing the results to practitioners through capacity building efforts. No other institutionhas the same depth of experience in implementing PES approaches. 22. GEF support is warranted because the project would (i)help conserve globally significant biodiversity, including critically endangered endemic species, (ii)enhance the Mexican portion o f the MBC, (iii)pilot PES as a sustainable, long-term conservation instrument that could be scaled up and replicated in Mexico and serve as a model for other countries, (iv) research links between land use change and environmental services; and (v) increase carbon sequestration and knowledge about biocarbon sinks. Without the GEF increment, environmental services payments might not provide sufficient iiiceiitive to adopt land uses that would yield global benefits in addition to local and national benefits. 3. Higher level objectives to which the project contributes 23. The environmental objectives o f the Mexican government are to increase sustainable development as a shared responsibility; facilitate decentralization o f environment management and increased public participation; promote payment for environmental services programs; decrease loss o f temperate and tropical forests; conserve biodiversity; and increase sustainable water resource management (200 1-2006 Mexico Environment and Natural Resources Program). 24. The 2005-2008 Mexico Country Partnership Strategy (CPS) addresses four core issues: (i) poverty reduction; (ii)environment management; (iii)increased competitiveness; and (iv) improved governance. It builds on the positive experience o f the EnvSAL-a development policy loan (DPL) for the environment sector-in its review o f existing programs and incentive structures to address the implicit short-term tradeoffs between social protectionand environmental protection. 25. The CPS recognizes that Mexico's natural environment is under tremendous pressure and that failure to reverse some o f the most damaging trends may not oiily act as a brake on continued economic growth, but could even contribute directly to decreasing social welfare and increasing poverty. The CPS addresses the need to consolidate the regulatory and legal framework for environment issues and to support implementation of measures aimed at watershed recovery, reforestation, decontamination, clean production, management o f ecosystems, and biodiversity conservation. The CPS notes that vulnerability to natural disasters i s closely related to rural poverty and that low productivity and high population pressures have depleted natural resources in many rural areas, caused soil erosion and land degradation, led to loss o f habitat, biodiversity, and natural forests, and exacerbated problems in water management and conservation. In response, the CPS supports development o f markets for environmental services and strengthening o f protected areas management. 26. The project i s consistent with the Bank's 2002 rural and environment strategies for Latin America. The rural strategy aims to reduce poverty and promote growth within the context o f sustainable natural resources management and calls for better integration o f environmental issues into rural development to build consensus around possible "win-win" opportunities. The environment strategy promotes sustainable, integrated management o f natural resources and ecosystems with a focus on highly degraded and disaster-prone areas. The project would support both strategies by developing PES markets that generate win-win opportuiiities for poverty alleviation, economic growth, and environmental protection. 5 27. The project also takes into account the Bank's 2002 Forest Strategy, which is built on (i) harnessing the potential of forests to reduce poverty, (ii)integrating forests in sustainable econoinic development, and (iii)protecting global forest values. The strategy notes that addressing these three aspects together i s complex and multifaceted-not merely about growing trees but rather supporting a complex interaction of policies, institutions, and incentives. It focuses on economic policies and rural strategies that embrace both sustainable use and conservation o f vital environmental services, seeking to build markets and financial instruments in support of private investments in sustainable natural resources management. 28. The GEF operational program goal supported by the project. The proposed project supports the GEF Biodiversity Focal Area by protecting natural habitats and biological diversity through forest conservation, reversion o f marginal agricultural areas to forest, and promotion o f sustainable practices in agriculture. It supports Operational Programs 3 (Forest Ecosystems) and 4 (Mountain Ecosystems) by promoting conservation o f biodiversity in key forest and mountain ecosystems. Within the Biodiversity Focal Area, the project particularly fits with two Strategic Priorities: Catalyzing Sustainability of Protected Areas (SP 1) and MainstreamingBiodiversity in Production Landscapes and Sectors (SP2). 29. Under SP1, the project would help ensure sustainability o f the national protected areas system by providing a mechanism for long-term financing o f biodiversity conservation in the buffer zones of protected areas and the corridors that connect them, including the Mexican portion o f the Mesoainericaii Biological Corridor. 30. The project would complement the SINAP I1Protected Areas Project, a GEF cofinanced project to strengthen protected areas management. The goal o f SINAP I1 is to promote conservation and sustainable use o f biodiversity in Mexico through consolidation o f the National System o f Protected Areas (SINAP). Its specific objectives are to (i)conserve globally important biodiversity in selected areas of SINAP; (ii)promote the economic, social and environmental sustainability o f productive activities in selected protected areas; (iii)promote social co-responsibility for conservation; and (iv) promote the inclusion of biodiversity conservation and sustainable use criteria in development projects and other practices affecting selected Protected Areas. The proposed project would complement the SINAP I1 objectives by improving habitats on private lands in buffer zones and corridors around and between protected areas, thereby improving the viability and biodiversity conservation value o f the protected areas themselves. Developing PES markets will also foster and strengthen partnerships between local and national government, NGOs, community organizations, and the private sector and will help promote an integrated ecosystem approach to watershed management. 3 1. Under SP2, the project will focus on two types o f activities: (i)facilitating the mainstreamingof biodiversity within productive landscapes, and (ii)developing market incentive measures, as described below. 32. Facilitating the mainstreaming of biodiversity withinproductive landscapes. Through this type o f activity the GEF seeks to support development o f the institutional capacities o f government agencies and other stakeholders that would help secure biodiversity conservation. This could be achieved through enabling legislation, removing barriers to conservation, reforming or creating policies, institutional structures, and management procedures, generating relevant knowledge, and building partnerships between agencies, local communities, and the private sector. Activities o f this type under Component 2 of the project include strengthening the capacity o f national institutions such as CONAFOR, community associations, NGOs, and academic institutions to support development o f PES markets in Mexico. Component 1 activities will help create an enabling environment for development o f a PES market in Mexico and generate financial resources for the PES program. 33. Developing market incentive measures. Through this type o f activity the GEF seeks to support innovative market incentive structures (such as demand and supply side interventions, certification of suppliers, purchasing agreements, and codes o f conduct) that would catalyze market forces. In doing so 6 the GEF seeks to develop partnerships with private sector stakeholders, small- and medium-size enterprises, and others to catalyze the development o f innovative processes and activities that improve market efficiency and the ability to provide biodiversity and productive system gains. Activities o f this type under Component 1 of the project will support the development o f PES financing mechanisms that generate payments to land users for adopting and/or maintaining land use practices that generate valuable ecosystem services. The mechanisms will be piloted in eight priority areas that provide eiiviroiiinental benefits at the local, national, and global levels. These mechanisms will support land use practices such as forest conservation and management, reforestation, and sustainable agroforestry systems that improve water quality, increase base flows during the dry season, help regulate groundwater and surface flows, and maintain or enhance biodiversity both on-site and by protectingcritical ecosystems. B. PROJECT DESCRIPTION 1. Lendinginstrument. 34. Fixed-Spread Loan (FSL). The proposed project would be financed through an IBRD loan o f US$45.00 million, a GEF grant of US$15.00 million, government counterpart funds o f US$80.66 million, project beneficiary contributions o f US$l5.00 million, and other funding o f US$0.90 million for a total project o f US$156.56 million. 2. Project development objective and key indicators 35. The project development objective i s to enhance the provision o f environmental services o f national and global significance and secure their long-term sustainability. This would be done by strengthening and expanding the national PSAH and CABSA programs and supporting the establishment of local payments for environmental services (PES) mechanisms in selected pilot areas. 36. The objective will be achieved through the following key outcomes and outputs (i) Strengthening the capacity o f CONAFOR, community associations, and NGOs to increase flexibility and improve efficiency o f existing service provision to support long-term development o f the PSAH program in Mexico; (ii)establishing and securing sustainable long-term financing mechanisms; (iii)establishing legal, institutional, and financial arrangements to pilot market-based mechanisms for payment for environmental services; (iv) documenting links between land use changes and water services improvements and biodiversity conservation; and (v) defining good practices to replicate, scale up, and sustain market-based PES programs. 37. The global environment objective o f the project is to enhance and protect biological diversity and preserve globally significant forest and mountain ecosysteins. 38. This objective will be achieved through the following key outcomes and outputs: (i)improving the targeting o f the existing PSAH program; (ii) piloting a market-based system to contract environmental services; and (iii)establishing an endowment fund for biodiversity conservation to provide long-term financing for payment for environmental services. The project will ensure that only sites with globally significant biodiversity will receive GEF funds under the national or local programs inthe project area. In addition, these sites (see Annex 17) are recognized as part o f the national protected areas system. Furthermore, all land management systems with PES support under the project (from any funding source) will be biodiversity-friendly (see Annex 10 for details). 39. As detailed in Annex 17, all eight o f the pilot sites where local PES systems would be established, strengthened, or continued under the project were chosen to overlap with at least two of the following high-priority biodiversity conservation designations: (i)existing Natural Protected Areas; (ii) Priority Terrestrial Ecoregions established by CONABIO; (iii) Important Bird Areas that are vital to the 7 survival o f endemic species or to protecting key bird breeding, feeding, and migration areas; and (iv) Ramsar Wetlands of International Importance. 40. Key performance indicators related to the project development and global environment objectives are: 0 At least 600,000 additional hectares under environmental service contracts o f which, (a) fiiianced from existing sources: at least 500,000 additional hectares under environmental service contracts that contribute to increased hydrological, biodiversity conservation, and carbon sequestration services; and (b) financed from new financing sources established under the project: 100,000 additional hectares under environmental service contracts aimed at increasing hydrological services, biodiversity conservation, and carbon sequestration; 0 Stand-alone local PES mechanisms designed for at least two pilot sites for contracting (buying and generating) environmental services in priority areas, including functioning M&E systems by end of project (EOP); 0 At least 15 proposals for carbon sequestration projects submittedto potentialbuyers; 0 Institutional arrangements for facilitating management and learning o f PES mechanisms established, properly staffed, and resourced to continue beyond the EOP to replicate and scale up market-based PES programs; 0 CONAFOR and INE use (a) state-of-the-art techniques and procedures to monitor data on implementation and impacts o f boththe national PES program and local pilot PES mechanisms (such as vegetation cover, land use practices, ecosystem and habitat conservation, indicator species of conservation interest, water discharge, sediment production and transport, biochemical oxygen demand (BOD), and total suspended solids); and (b) information to evaluate and draw conclusions on (i)the links between land use changes and environmental services, (ii)buyers' responses, (iii)community acceptance o f the PES mechanism, and (iv) sustainability o f the mechanism, as measured by the ratio o f payments from local buyers o f environmental services (ES) and CONAFOR's operational costs; 0 The new areas enrolled include 200,000 additional hectares o f forests and other natural ecosystems o f global biodiversity significance placed under effective conservation (protection and sustainable management) by landowners before EOP inthe buffer zones o f protected areas and the corridors that connect them, includingthe Mexican portion o f the MBC. 3. Project components 41. The proposed project would substantially enhance the provision o f environmental services and secure their long-term sustainability in Mexico by (i) developing new, sustainable financing mechanisms for environmental services, which could be channeled either through the existing PES programs or through new, stand-alone local PES mechanisms; (ii)strengthening and improving the efficiency o f existing PES programs (PSAH and CABSA); (iii)stimulating the development o f stand-alone local PES programs; and (iv) assisting local communities in service provision. Component 1 focuses on developing sustainable financing mechanisms. Component 2 activities support the development and strengthening o f PES delivery mechanisms. Component 3 supports environmental service providers. Component 4 manages the actual flow o f payments to environmental serrvice providers and for the ongoing operational costs o f the program. Finally, Component 5 focuses on project and program management mechanisms, including monitoring and evaluation. (See Annex 4 for detailed component description.) 8 Table 3: Proiect ComDonent Costs and Financina fmillion US$) I. Developing Sustainable Financing Mechanisms 14.47 ' 9 ' 7.68 '53 1.26 ' 9 ' 5.54 ' 38I - a Development of financing mechanisms from water users 181 1 0.73 40 076 42 0.33 18 b. Development of financing mechanisms from biodiversity 11.78 8 6.60 56 0.12 1 5.05 43 users - Local PES Program for Biodiversity 1.53 1 1 38 90 0.11 7 0.05 3 - Development and capitalization of biodiversityendowment 10.25 7 5.23 51 0.02 0 5.01 49 fund c. Development of financing mechanisms from carbon users 0.88 1 0.35 40 0.37 42 0.16 18 II. Developing and Strengthening PES Delivery Mechanisms 3.51 2 1.30 37 1.55 44 0.66 19 a. Strengthening of existing PES programs 2.52 2 0.88 35 1.15 46 0.49 20 b. Support development of stand-alone local PES programs 0.94 1 0.37 40 039 42 0.17 18 c. Establishing Matching Funds Mechanismfor Local 0.05 0 0.05 90 7 .. 3 Financing Mechanisms 111. Supporting Environmental Services Providers 9.56 6 3.70 39 4.04 42 1.82 19 a. Community organization and capacity diagnostic 0.43 0 0 17 40 0.18 42 0.08 18 b. Community promoters 0.57 0 0.23 40 0.24 42 0.10 18 c. Organizational assistance 4.46 3 1.66 37 1.90 43 0.91 20 d. Technical assistance and TA grants 4.09 3 1.64 40 1.72 42 0.74 18 IV. Payment to Services Providers 127.00 81 1.58 1 37.23 29 72.29 57 15.90 13 a. Paymnents to PSAH participants 100 00 64 3403 34 6596 66 b. Payments to CABSA participants 9 52 6 320 34 6.32 66 c Local fin mech from water users (est under comp IA) 1065 7 1065 100 d Local fin mech from tourism ind (est under comp. IA) 180 1 180 100 e Payments from carbon buyers (proj. dev under comp IC) 3.45 3.45 100 f GEFGrant 1 58 1.58 100 V. Project and Program Management 1.90 0.74 39 0.81 43 0.35 18 Front End Fee 0.11 0.11 100 .. Less than $10,000 Component 1: Developing Sustainable Financing Mechanisms ($14.47 million, of which $7.68 million porn GEF) 42. The main objective o f this component is to develop new, sustainable financing sources based on payments from service users, which could then be channeled either through the PSAH or through stand- alone local PES mechanisms, as appropriate. To achieve this objective, this component will help develop financial mechanisms based on the main types o f environmental services: water quality and regulation, biodiversity conservation, and carbon sequestration. These financial mechanisms would be piloted in eight promising sites identified by CONAFOR (see Annex 17). Some sites might focus on a single financing mechanism while others include multiple financing mechanisms, depending on the services being generated and the interests o f users. A biodiversity endowment fund would be established and capitalized to provide long-term financing for PES that conserves globally significant biodiversity in the buffer zones o f protected areas and the corridors that connect them in cases where other sources o f funds are insufficient. 43. Component 1 will be implemented by CONAFOR in coordination primarily with the relevant agencies, states and municipalities. The major federal and technical support agencies involved would be: 9 for water services CNA, IMTA, and NE; for biodiversity services CONABIO, SECTUR, CONANP, and INE; and for carbon sequestration SEMARNAT, NE, and SAGARPA. CONAFOR will enter into cooperation agreements will all such agencies as required for implementation o f the activities but not later than six months from the date of the loan agreement. CONAFOR shall, not later than six months from the date o fthis Agreement, enter into an agreement (a) CNA; and (b) at least two Technical Support Agencies to assist in the development o f Water Environmental Services and Biodiversity Environinental Services respectively under terms and conditions satisfactory to the Bank. 44. The capitalization o f the endowment fund will occur only upon completion o f all the preparatory work for the establishment o f such fund. Disbursement o f the GEF allocation will be subject to Bank's approval o f the establishment o f such funding mechanism, i.e. a separate fund or a sub account o f the existing forestry fund managed by CONAFOR, the appointment o f the financial agent to manage the fund, and the operatingrules o f the fund. The GEF contributionto the Fundwould be matched on at least a one-to-one basis by other sources. 45. Key outputs from this component include (a) pilot financing mechanisms developed for local water services in at least eight sites, including some mechanisms that channel payments through the PSAH and others that channel payments through stand-alone local PES programs; (b) pilot financing mechanisms for local biodiversity users (primarily the tourism industry) in at least four sites; (c) development and initial capitalization o f an endowment trust fund for biodiversity conservation to ensure the availability o f long-term funding for cases where water-based payments would be insufficient to ensure conservation o f biodiversity; (d) pilot financing mechanisms for carbon buyers in at least two sites; and (e) develop replication strategies to expandthe use o f these mechanisms beyond the pilot sites. 46. Key inputs for the success of this component include (i)providing the necessary resources for CONAFOR to implement the activities; (ii) providing adequate resources to design and implement the local operational manuals; and (iii)providing resources to design and capitalize the biodiversity endowment fund. Component 2: Developing and Strengthening PES Delivery Mechanisms ($3.51 million, of which $1.30 nzillionfiom GEF) 47. The objectives o f this component are to strengthen the existing PSAH and CABSA delivery mechanisms and to support the development of new, stand-alone delivery mechanisms for local PES markets. Having financing i s not sufficient; mechanisms are needed to act as intermediaries between service users and service providers. These mechanisms must undertake functions such as determining how best to generate the services that users are paying for, identifying critical areas and land use practices to be targeted, negotiating with and contracting service providers, monitoring compliance, making payments, and monitoring impacts. CONAFOR has already created the PSAH (and on a smaller scale CABSA) to undertake this role. However, both PSAH and CABSA are young mechanisms that require considerable strengthening and improvement to increase their efficiency and their capacity to handle the greater and more complex demand generated through Component 1 (see Annex 6 on institutional arrangements). 48. This component will be implemented by CONAFOR in cooperation with CNA, CONANP, and INE.Before finalizing any changes to the operating rules of CABSA and PSAH, and in particular those revisedas per this component, CONAFOR will furnishthe proposed changes to the Bank for comment. 49. Key outputs from this component include (i)stronger capacity in CONAFOR and other national institutions, market intermediaries, community associations, and NGOs to undertake the functions necessary to implement PES programs, (ii)greater efficiency and effectiveness o f the PES programs o f PSAH and CABSA, including the introduction o f revised rules and location-specific operational manuals using a more targeted and differentiated system o f payments in which the eligible areas and payment levels offered are defined by region rather than nationwide (and perhaps also by subregion if appropriate) 10 on the basis o f objective technical criteria, (iii)improved compliance and impact monitoring to increase the credibility and sustainability o f PES programs, (iv) better promotion to foster broader support and participation in the programs, (v) development o f stand-alone PES programs closely attuned to local conditions and separate from existing delivery mechanisms, and (v) a matching fund system to help local financing mechanisms get started and transition to self-sufficiency. 50. Key inputs for the success o f this component include (i)financial resources and technical assistance to help existing PES mechanisms carry out the activities and capacity building envisioned, (ii) equipment, training, resources, and technical assistance to improve compliance and impact monitoring, (iii)resources, TA, training, and study trips to help local stakeholders develop their own customized stand-alone PES mechanisms, and (iv) resources to design rules and arrangements for a program o f matching funds. Component 3: Supporting Environmental Service Providers ($9.56 million, of which $3.70 millionfiom GEF) 5 1. This component would focus on removing obstacles that may prevent cominunities from participating in either national PES program or local PES mechanisms with a particular focus on problems faced by poor communities. 52. CONAFOR in cooperation and CONANP, N E and NGOs will carry out the strengthening o f the eligible ejidos and/or indigenous communities (prospective providers o f environmental services). The assistance to the communities may be provided directly to the communities and ejidos by consultants contracted by CONAFOR, or in the form o f grants to the ejidos or communities to finance the technical assistance to be contracted by the concerned ejido or community. The contractual arrangements made between CONAFOR, the communities, and technical service providers follow standard forms contemplated inthe operating rules o f CONAFOR's programs and inthe project Operational Manual. The subcomponent o f support for Community promoters (chosen by the community to act as liaisons in the preparation and implementation o f environmental services proposals) will pay stipends and provide training and knowledge sharing opportunities for community promoters that will help them identify and contract needed technical assistance. 53. Key outputs from this component include (i)identification andresolution o f technical issues that constrain potential environmental service producers from participating in PES programs, (ii)greater capacity o f service providers to fulfill contract commitments, (iii)more equitable distribution of the costs and benefits o f participation in the program, and (iv) greater transparency in decisionmaking and greater participation o f vulnerable and marginalizedgroups. 54. Key inputs include (i)consultancies to identify key technical issues and constraints to participation and to identify the organizations most capable o f providing appropriate technical assistance, (ii)resourcestocontracttheappropriatetechnicalassistance,and(iii) hnding to train and support local community promoters to work with communities in developing customized capacity building strategies and act as liaisons between communities and the project. Component 4: Payment to Service Providers ($127.00 million, of which $1.58millionfiom GEF) 55. The objective o fthis component is to finance and make actual payments to environmental service providers and ensure that they are being compensated properly. This component will channel payments from the financing mechanisms developed in Component 1, through the delivery mechanisms developed and strengthened under Component 2, and to the service providers supported through Component 3. While the bulk o f project financing i s allocated to this component, most o f the activities to actually arrange, structure, and monitor this flow o f financing are carried out under other project components. 56. Environmental services for water, biodiversity and carbon sequestration will be financed by government resources and out o f the proceeds o f the loan and grant subject to the Bank's approval o f the 11 operating rules for such payment mechanisms, prepared under Component 1. The matching grants will be financed out o f loan and grant proceeds subject to the Bank's approval o f the operating rules for such matching grants, includingthe contractual arrangements to be made with the beneficiaries. 57. The key output of this component is delivery o f payments from financing sources to environmental service providers via the Mexican Forest Fund (FFM)-which currently channels payments for PSAH, CABSA, and other programs-or via stand-alone delivery mechanisms. 58. Key inputs include the resources generated by the full range o f PES financing mechanisms and funding sources already in existence or developed under Component 1, including: 0 Share of water tariffs from the Ley Federal de Derechos (LFD)that are directed to PES. 0 New financial resources from water users generated by mechanisms developed under Component 1A. 0 Tourism industryfees and contributions developed under Component 1B. 0 GEF and Biodiversity ConservationEndowment Fundresources. 0 Carbon sales from programs supported under Component 1C. 0 World Bank resources to help finance the PSAH and CABSA programs, including both the national programs and the matching fund for pilot areas. Component 5: Project and Program Management ($1.90 nzillion, of which $0.74 millionfioni GEF) 59. This component focuses on project management mechanisms including planning and monitoring and evaluation (M&E). It would help new and existing entities and mechanisms in the national government conduct project coordination and supervision and strengthen the effectiveness and quality of project operations. 60. Key outputs include (i)establishment o f a group o f staff within CONAFOR to inanage the project, (ii)overall financial management and control o f financial flows, (iii)project planning, and (iv) project and program monitoring and evaluation. 61. Key inputs include (i)CONAFOR staff to work on the project, (ii)office equipment, vehicles, and hydrological and biodiversity monitoring equipment, and (iii)resources to create and maintain performance monitoring and evaluation systems and modules and to train project staff in project related functions. Loan and grant proceeds would be available for the financing o f the staff o f the implementation team. Key core staff which include project coordinator, three subcoordinators (strengthening environmental service providers, financing mechanisms and PES demand, and PES operations), 6 technical staff (promotion and contracts; statistics and data bases; water markets, biodiversity, and carbon markets specialists; and technical support specialist), an administrative assistant, a financial management specialist, a procurement specialist, and 25 regional promoters; would be in place within three months after loan and grant signing, and all other project implementation staff would be in place within six months after loan signing. 62. All components will be carried out following the procedures of an Operational Manual o f the project. A draft o f such manual will be available by negotiations and will require no objection by the Bank. Any changes to the Operational Manual and the PSAH/CABSA program operating rules will also require the no objection o f the Bank. 4. Lessons learned and reflected in the project design 63. Design o f the proposed project has been enriched by lessons and recommendations from several initiatives, including relevant projects cofinanced by the GEF and/or other donors (listed inAnnex 2) both within Mexico and in other countries. The main lessons, detailed in Annex 18, are from three broad sources: (i) Mexico's current Payments for Hydrological Environmental Services Program (PSAH) and Biodiversity, Carbon, and Agroforestry PES Program (CABSA); (ii)other payment for environmental 12 services initiatives, including in particular Costa Rica's Pago por Servicios Ambientales (PSA) program and the Ecomarkets Project that supports it; and (iii)other GEF-supported biodiversity and sustainable use projects, including the Biodiversity Conservation and Sustainable Use in Productive Landscapes Project in Chiapas and the Consolidation o f the ProtectedAreas System Project (SINAP 11) in Mexico. Need for sustainable, long-term Jinancing mechanisms. To ensure the sustainable provision o f environmental services there must also be a sustained flow o f prograin funding and sustained payments to landholders to maintain the desired land uses over the long-term. Currently, funding for Mexico's PSAH and CABSA programs comes from the government, and is thus subject to political decisionmaking. `To increase the sustainability of funding for the program, the proposed project will help the Government of Mexico to implement new financing mechanisms that directly correspond to users o f the services being generated, both nationally and globally. At the national level, the proposed project will develop new financing mechanisms that draw funding from water users and the local ecotourisin industry. At the global level, the proposed project will help CONAFOR access emerging global carbon markets. Since no method has been developed for generating sustained payment streams specifically for biodiversity conservation, the proposed project will establish and capitalize an endowment fundthat will allow time-limited biodiversity conservation funding to be converted into a sustainable long-term funding stream. Preparation o f the SINAP I1project was particularly valuable in analyzing lessons related to conservation trust funds, such as the importance of structuring government commitments and incentives for capitalization to avoid having government funding decrease as a result o f the fund, matching such funds to the type o f need (short- versus long-term), and having a clearly defined mission and goals that are relevant to donor interests. Needfor robust monitoring and evaluation. The credibility o f environmental service programs relies not only on fiduciary monitoring but also on quantification o f the impacts o f environmental services: financing will only be sustainable if service users are satisfied that they are receiving the services for which they pay. Therefore, monitoring and evaluation must be an integral part o f project design and implementation. It must include the establishment o f a baseline, and the socioeconomic and environmental impacts o fthe proposed project. Needfor differentiatedpayments. Both the value o f environmental services and the cost o f providing them vary tremendously from case to case. Current targeting efforts have not succeeded in concentrating conservation payments in priority areas. There i s considerable scope for improvement in targeting. Linking"buyers" and "sellers" o f environmental services directly (as will be done with the new financing mechanisms) will help in this regard. The proposed project will also help implement a differentiated payment scheme. The current approach under the PSAH and CABSA programs o f paying the same amount nationwide results in significant inefficiencies, paying more than would be necessary to induce participation in some areas, while offering insufficient amounts to induce participation in others. Increasing efficiency requires that eligibility rules and payment levels be based on both the magnitude o f the benefits to be achieved through conservation and the costs o f that conservation.' Need to remove barriers to participation by the rural poor and marginalized groups: Environmental service programs are not specifically designed to be poverty reduction programs, and targeting them purely on the basis o f poverty reduction objectives risks undermining their primary objective o f generating valuable environmental services. However, they can often contribute to poverty reduction, because many potential service providers are poor and marginalized groups. Lack o f training and capacity-building activities in PSAH Programs for both the supply and demand sides have created a barrier for less-organizedand marginalized ejidos to participate in the program. 1. Differentiated payments does not imply that each individual participant would be paid a different amount, an approach that would be vulnerable to corruption. Rather, payments would be differentiatedon a regional basis, based on expected costs and benefits in that region. If appropriate, they may be further differentiated within regions based on objective and observable criteria (the current PSAHprogram already does this to a limited extent by a paying more for conservation of cloud forests). 5. Alternatives consideredand reasonsfor rejection 64. Land acquisition. Land acquisition, particularly from individual landowners, can be a useful tool for establishing, expanding, or consolidating protected areas when (i) the landowners inquestion are more interested in selling their land for a reasonable price than in managing it for long-term conservation and (ii)the entitymanagingthe landafter acquisition would protectandmanage the landbetter thanthe original landowners. However, most o f the lands eligible for PES under this project (80 percent o f Mexico's forest land) are owned collectively by communities and ejidos. With a modicum o f technical assistance and the financial incentives provided by PES contracts, many Mexican communities and ejidos are willing and able to protect and manage their lands effectively from a long-term conservation standpoint, In any case, the outright sale and purchase o f community and ejido land i s not currently permitted under Mexican law; even if it were, it would likely be problematic from a social and political standpoint. 65. Eco-labeling.Even when eco-labeling or certification schemes promotes adoption o f improved land used practices and recognition of good forest practices or management among buyers o f forest products, this alone would not be enough to increase public awareness of environmental services or effectively target priority areas. Most o f the time the direct beneficiaries o f environmental services are not themselves the direct buyers o f goods from certified forests, which limits the potential o f eco-labeling to help develop local markets for environmental services. An advantage o f this approach is the possibility o f obtaining funds from people interested in good forest management. C. IMPLEMENTATION 1. Partnershiparrangements(if applicable) 66. There are a number o f related donor activities that are currently under execution or preparation. A detailed list o fthese initiativesas they relateto this project are includedinAnnex 2. 2. Institutionalandimplementationarrangements 67. Inaddition to the three main institutionalactors with a direct responsibility to the Bank-the loan and grant recipient, financial agent, and executing agency-the Mexico Environmental Services Project will involve a wide range o f other institutions and actors that are important to effective implementation and achievement o f project objectives. These actors and their roles are described indetail in Annex 6. The institutional framework for the project will be legally defined by an agreement between the SHCP, CONAFOR, and NAFIN. Main Responsible Institutions 68. The Ministrv o f Finance and Public Credit (SHCP) is the official recipient o f the loan and grant. SHCP is the only entity o f the Federal Government that has the capacity to obtain external loans and receive donations from international financing agencies and it also assigns the financial agent for the project. 69. The National Forestrv Commission (CONAFOR) will execute the project and have responsibility for all technical and fiduciary matters, monitoring, and evaluation o f the project as well as overall management and supervision o f the grant and loan. Direct implementation will be undertaken by staff in CONAFOR's Department o f Production and Productivity, Office o f Forestry and Management (GSM), which operates the existing PES programs in Mexico (PSAH and CABSA). CONAFOR's administration department will provide financial management and procurement support. Inaddition to the project staff at CONAFOR's headquarters in Guadalajara, key functions will be carried out by program coordinators and 14 regional promoters in CONAFOR's regionallstate offices. Community promoters, selected by the communities themselves to facilitate interactions with CONAFOR, will receive stipends from the project but are not employed by CONAFOR. 70. Nacional Financiera (NAFIN), a federal development agency responsible for managing the administration o f many different projects receiving both national and external financing, will provide overall financial management o f the project and the Special Accounts, if utilized, for the loan aiid grant. NAFINwould also be responsible for all formal correspondence with the Bank, including prior review for consultants and other procurement pertaining to the Loan and Grant Agreements. Structure of CONAFOR andResponsibilities of Project Staff 71. The highest decisionmaking body for the project will be CONAFOR's Governing Board, which will approve the Annual ImplementationPlans and Quarterly Project Reports. It includes representatives from the National Water Commission and the ministries of National Defense, Finance and Public Credit, Social Development, Environment and Natural Resources, Economy, Agriculture, Agrarian Reform, aiid Tourism. 72. Implementation o f the project will also benefit from the guidance o f an Advisory Committee that was formed informally at the outset o f the PSAH program in 2003 and will be formally constituted before project execution begins. The committee usually meets every six to eight weeks to review program activities, achievements, implementation schedules, and national and international experiences in PES programs. The committee has 17 members from government, the private sector, NGOs, and academic bodies. This committee includes institutions with technical oversight for biodiversity aspects o f the PES programs. Before project implementation begins, representatives o f local PES schemes will be invited to join the Committee. The Advisory Committee will also include a subgroup called the Scientific aiid Technical Advisory Group (STAG) which will provide guidance for the PES monitoring program. This would be an interinstitutional group of specialists with members from participating institutions, science and research groups, and international advisor. As part o f the advisory committee, the STAG will meet at least once a year to review the latest monitoring reports, interact with scientific and technical personnel collecting and analyzing field data, provide comments and suggestions, and schedule international workshops on subjects relevant to better understandingthe production of environmental services. 73. The CONAFOR staff responsible for project implementation will include a program coordinator, three subcoordinators (strengthening environmental service providers, fiiianciiig mechanisms and PES demand, and PES operations), 12 technical specialists (social strategies and organization, performance aiid monitoring, promotion and Contracts, payments aiid committees, water markets, biodiversity markets, carbon markets, environmental services evaluation, technical support, management control, impact monitoring aiid control, statistics and data bases), an administrative assistant, a financial management specialist, a procurement specialist, 8 pilot-area liaisons, 13 regional liaisons, 16 regional promoters for pilot areas, and 50 regional promoters for the national program. The regional promoters, based in the regional/state offices o f CONAFOR, will maintain close links with local communities and leaders and play a key role in addressing community problems and concerns and tailoring the program to local conditions. The work of the regional promoters will be facilitated by Community promoters selected by the communities themselves from among their own members. The community promoters may receive stipends from the project, but are not considered staff o f CONAFOR. More detailed descriptions o f these functions, responsibilities, aiid associated procedures are contained in Annex 6, the Project ImplementationPlan (PIP), and the Operations Manual. 74. The CONAFOR staff will be responsible for processing environmental service contracts with private landowners, signing environmental services purchase agreements with the private and public sector, monitoring contract compliance, and preparing project reports. Some o f these functions will be carried out or facilitated by the staff in the regional offices (with assistance from the community promoters), as well as by federally recognized Technical Service Providers, NGOs, and other actors 15 contracted by CONAFOR. CONAFOR will maintain satisfactory financial management and procurement procedures duringproject implementation. Project Documentation, Planning, and Reporting 75. All components will be carried out following the procedures o f an Operational Manual o f the project. A draft o f the manual will be available by negotiations and will require no objection by the Bank. The Operational Manual will detail the rules and regulations for implementing each component and the responsibilities of project staff in CONAFOR (planning, monitoring, evaluation, institutional arrangements, environmental review, reporting, communication, human resources, risk, coordination, procurement, and financial management). An annex o f the manual will set out rules governing operation o f the PES mechanisms. The manual and any changes to it will require no objection from the Bank. 76. Such manual will also contain (a) financial management, disbursement, and procurement requirements o f the project and the action plan for capacity strengthening PSAH and CABSA that was developed during appraisal; (b) criteria provided in CONAFOR's operating rules for eligibility o f communities, beneficiaries, and technical assistance to communities, as well as any revisions that might be needed to those criteria to comply with Bank environmental and/or social requirements; (c) model forms of agreement between CONAFOR, technical assistance providers, and the ejidos, communities, or associations that will be the beneficiaries o f the technical assistance; (d) description o f the organizational structure o f the staff within CONAFOR that will be responsible for implemeiiting the project; and (e) applicable safeguard documents, including the indigenous peoples plan and the environmental management plan that includes sections for natural habitat protectionand forests. 77. A Project ImplementationPlanwill be prepared by CONAFOR and submittedto the Bank for no objection prior to project launch. Annual Implementation Plans (AIPs) will be submitted for no objection prior to the start o f each year and will include (i)description o f project activities; (ii)Gantt Chart showing the timing o f activities and responsible entities; (iii)budget plan; and (iv) procurement plan. The AIPs will be the principal tool for project execution and supervision by the Bank. Annual and quarterly implementation progress reports to the Bank will analyze execution and lessons learned and will recommend adjustments ifnecessary. Financial Management and Procurement 78. Disbursements will be transaction-based against statements o f expenditure (SOEs), full documentation, direct payments, or special commitments, but may later become based on Financial Monitoring Reports (FMRs). A special account in U.S. dollars may be maintained and operated by NAFIN. Accounting and financial reporting will be done by the project staff in CONAFOR and NAFIN under Bank rules spelled out in the Operational Manual. Separate accounts will be opened for each source o f financing (IBRD, GEF, private sector payments). The project includes financing for audits that will be carried out under TORS and by firms acceptable to the Bank. Main capacity constraints and plans to address them are detailed in the procurement and financial management assessments. Annexes 7 and 8 contain more detailed descriptions o f the project's financial management, disbursement, and procurement arrangements. Administrative Structure and Responsibilities in the National and Local PES Mechanisms 79. CONAFOR implements the PSAH and CABSA programs. An Advisory Committee with 17 members from government and private institutions, NGOs, and academic institutions provides review and guidance for the program, while two Technical Committees (for PSAH and CABSA) composed o f representatives from CONAFOR, SEMARNAT, and other federal agencies make the final selection o f subprojects and contracts to be financed. Actual payments under the existing programs are made through the Mexican Forest Fund (FFM), which also includes the financial accounts of several other forest programs. Environmental services payments using project resources and the Biodiversity Trust Fundwill also be channeled through the FFM (see Annex 21 for more details). The administrative structure and 16 flow o f funds for local, demand-based mechanisms developed under the project will be determined individually for each case. 80. CONAFOR's Office of Forestry and Management (GSM) also contracts program promoters for the regional offices, reviews contract proposals from ES providers for eligibility, completeness, and conformity with the program rules, and prioritizes the list of eligible proposals for final review by the Technical Committees. The promoters inthe regionallstate CONAFOR offices will give technical support to local environmental services providers and helpthem put together proposals, enter submitted proposals into the CONAFOR system, monitor contract compliance, geo-reference the areas included in the program, and compile data for project monitoring and evaluation. The regional/state offices sign the actual commitment letters or contracts with the service providers when they have been selected as beneficiaries o f the programs. Other Actors 81. The project has identified the current roles of key federal government institutions and technical support agencies in PES systems and the role they could play to make these mechanisms more effective and sustainable (see Annex 6 for details). Participating agencies will receive training to facilitate coordination, increase understanding o f the PES system, and help them assume the desired role. CONAFOR will enter into cooperation agreements will all such agencies as required for implementation of the project activities. CONAFOR shall, not later than six months from the date o f this Agreement, enter into an agreement (a) CNA; and (b) at least two Technical Support Agencies to assist in the development o f Water Environmental Services and Biodiversity Environmental Services respectively under terms and conditions satisfactory to the Bank.The main federal agencies involved would include: Federal Government Institutions: Ministry o f Environment and Natural Resources (SEMARNATCfoster cooperate and coordination between other agencies and actors. Ministry o f Agriculture, Livestock, Rural Development, Fisheries, and Food (SAGAMA)-provide information on use o f ES, coordinate programs, raise awareness, mainstream environmental concerns, and negotiate local mechanisms with private actors. Ministry o f Tourism (SECTUR)-information 011 demand for environmental services in tourism sector, mainstream environment in sectoral strategies, negotiate PES mechanisms and payments from commercial actors, promote awareness o f environmental services. Technical Support Agencies: National Water Commission (CNA)-promote PES, generate data, disseminate information, raise awareness, increase demand, and negotiate ES payments. National Ecology Institute (NE)-provide scientific and technical support and studies to help define policies, strategies, and decisions related to environmental services. National Commission for Biodiversity Knowledge and Use (CONABI0)-scientific and technical support and studies, specifically related to biodiversity and agroforestry. National Commission for Natural Protected Areas (C0NANP)-provide technical assistance to producers in protected areas, monitor compliance with contracts. 82. Municipal governments currently have limited participation inPES programs by developing some local strategies (such as in Coatepec, Veracruz) and by operating some drinking water and sewerage systems that collect fees that are used inpart to provide payments for environmental services. The project will seek to increase the role o f municipal governments by having them participate actively in the development and implementation of local PES mechanisms, provide funds from municipal sources to match federal and multilateral financing, help negotiate PES contracts with local stakeholders, improve 17 Table 4: Monitoringand Evaluation Costs (million US$) Component cost 1A.Development of financing mechanisms from water users 0.3 1 1B. Development of financing mechanisms from biodiversity users 0.23 1C. Development o f financing mechanisms from carbonusers 0.20 2A. Strengtheningof existing PES programs 0.63 2B. Supportdevelopment of stand-alonelocal PESprograms 0.06 3B. Organizational Assistance 0.71 3D.Technical Assistance 0.15 5D.Project and ProgramMonitoringandEvaluation 1.20 Total 3.49 payments mechanisms based on water fees and other services, and help monitor contract compliance and program impacts. 83. Private and nongovernmental actors are expected to play a critical role in implementing the PES programs, in large part by providing services and informationthrough consultancies and contracts, and by representing stakeholder interests and liaison in the case of producers organizations. CONAFOR maintains a register (padron) o f nearly 160 officially recognized "Technical Service Providers" (TSPs) for contracting and consultancy purposes. These consultants will help federal government agencies, municipal governments, and other actors by promoting PES programs, providing technical assistance services to producers in writing PES proposals and complying with commitments, helping develop projects, and participating in monitoring and evaluation o f contract compliance, project results, and impacts. Other actors not in the directory, such as NGOs, academic and research institutions, and individuals, are also expected to compete for consultancies and provide services under the project, as well as provide training and capacity buildingto the service providers on CONAFOR's registry. 84. Nongovernmental organizations, education and research institutions, and producer organizations currently play an important role in the PES programs and are expected to increase their participation under the project (Annex 6). Their roles will include providing technical assistance to environmental service providers, monitoring contract compliance, evaluating project performance, helping develop and promote local PES mechanisms, developing demand for environmental services, supporting negotiations, gathering and disseminating local information, identifying barriers to program participation by poor and marginalized populations, and acting as intermediaries between government agencies and local stakeholders. 3. Monitoring and evaluation of outcomes/results 85. One o f the objectives o f the project i s learning. PES programs are by nature country specific and site specific. Therefore about two percent of the project budget is dedicated to monitoring and evaluation. Monitoring and evaluation has been mainstreamed into almost all project components and will be conducted at three levels: (i)contract compliance, (ii) impact monitoring, and (iii)project implementation. Table 4 shows monitoring and evaluation costs by subcomponent. 86. The project staff in CONAFOR will be responsible for overall project monitoring, includingthe activities o f both the new and existing PES mechanisms. CONAFOR will aggregate M&E inputs for project-level decisionmaking and reporting. The baseline, beneficiary assessments, and impact evaluation studies will be contracted out, and the CONAFOR staff will be in charge o f coordination and technical 18 supervision o f the studies. CONAFOR will provide overall project oversight, NAFIN will provide financial and procurement oversight, and World Bank staff and consultants will conduct periodic supervision missions (see Annex 3). 87. Duringproject implementation special semiannual reports will be prepared on the lessons learned duringthe previous semester, and year, and on plans for incorporating those lessons into future activities. Learning workshops are planned semiannually to coincide with Bank supervision missions. It i s critical to understand for each project site the causal links between specific land uses or land use changes and environmental services, and the amount o f change needed to produce specific quantities o f those services. A critical weakness o f many PES programs is that these links are poorly documented. In addition, site- specific indicators will be defined in each area as part o f the environmental service contracts themselves. While causal linkages are site specific, the results and learning from the eight initial pilot sites will provide valuable guidance and insights for replication within Mexico and for PES programs in other countries. Key lessons learned will be incorporated into the programs' operating rules on at least an annual basis. 88. By project launch an M&E system and methodology will be put in place to track project implementation, compliance o f land users with services contracts, and progress in attaining results. The system will have six modules: (i)a Management Information System to track results and financial indicators and provide feedback for decisionmaking; (ii) environmental services contract compliance; (iii) aniiual beneficiary assessments to report target groups' perceptions; (iv) site-specific monitoring and globally significant biodiversity and hydrology evaluation studies to quantify land use changes/impacts and environmental services produced, with baseline assessments for each site and each contract and both inidterm and final project studies; (v) data collection to better understand causal links between types o f lalid use changes and environmental services; and (vi) standard auditing and supervision missions at least twice a year to review the technical, fiduciary, and safeguards aspects o f the project. 4. Sustainability andReplicability 89. Ensuringlong-term sustainability of the PES program is a major objective o f the project. Current funding is only guaranteed for five years at a time, and the future o f the existing program is entirely dependent on continued government s u ~ p o r tThe project will pilot the development o f new financing . ~ mechanisms based on demand from water users, the local tourism industry, and carbon buyers. Once established, these mechanisms have the potential for being highly sustainable because they depend on the mutual self-interest o f service users and service providers. For this to occur, it i s important that the program actually generate the services desired by the service users. Thus the project devotes considerable attention to both ex ante technical studies (to ensure that payments are carefully targeted to generate the desired services) and ex post monitoring (to demonstrate that services are being generated and to make program adjustments if they are not). The project also supports considerable capacity building to ensure that there are credible and effective institutions acting as intermediaries between service users and services providers, which i s essential for program sustainability. Efforts to improve efficiency and cost- effectiveness will also help improve sustainability. 90. Conserving biodiversity benefits through PES poses particular challenges. The project addresses these in part by piloting the development o f financing mechanisms based on demand from the local nature-based tourism industry.It also supports the creation and capitalization o f an endowment trust fund that will provide sustainable long-term financing to PES targeted at biodiversity conservation in the buffer 2 The project assumes that the Congress will continue to allocate funding to the PSAH throughout the course of the project and beyond at levels similar to the current anunual allocation. These funds will continue to be placed in the FFM, as i s done currently, so that each annual allocation finances five years of payments (the length of a standard contract). Should the government end or reduce allocations to the PSAH, future contracts would be reduced correspondingly but signed contracts would not be affected. 19 zones o f protected areas and the corridors that connect them, thus helping to ensure the sustaiiiability o f tlie national protected areas system and of the Mexican portion o f the MBC. The financing for biodiversity conservation will be in areas where payments for local water or tourism services or carbon sequestration services are insufficient. Replicability: 91. The pilot efforts to develop new financing mechanisms at pilot sites will provide inputsto prepare a replication strategy being developed for the development o f additional such mechanisms throughout the country. Tlie experience accumulated under the project should allow such replication to occur rapidly and on a large scale by identifying conditions conducive to their development as well as flagging potential pitfalls. It will also lead to the development o f an array o f standardized instruments that could easily be usedin new settings with appropriate adaptations to local conditions. 92. Tlie Mexican PSAH i s only tlie second effort in any emerging economy to develop a nationwide PES program (tlie other being Costa Rica's PSA program). Tlie lessons learned here, in a context much inore complex than Costa Rica, will also provide valuable lessons for the many other countries conteinplating this approach. At the same time, the parallel effort to stimulate the development o f stand- alone local PES mechanisms will also provide valuable lessons to countries opting for a more decentralized approach. Although a wide variety o f such stand-alone local PES mechanisms has emerged spoiitaneously throughout the region, this is one o f the first efforts to attempt to systematically encourage and support their development (the other beingthe recently approved El Salvador Environmental Services Project). The proposed project includes a strong replication element. A replication strategy will be developed along with evaluation o f the project and analysis o f lessoiis annually, at the mid-term, and at the end of the project. These lessons and the replication strategy will be widely disseminated in Mexico, the region, and globally through workshops, seminars, training, publications, and CONAFOR's website. 20 5. Critical risks and possible controversial aspects Risk to PDO/GEO Rating Risk mitigation measures Politicalpressure to shape the PES LIM This has alreadybeen observedto some degree inthe current programto achieve nonenvironmental PSAHprogram.The moveto a more targeted systembasedon goals objective targetingcriteria will reduce this risk. This risk would not affect payments made with financing by local service users and GEF, as these payments would be made under rules agreedto by the users. Unwillingness to pay for services by M A variety of experiences inMexico and inthe region show that service users there can be willingness to pay. The project will provide technical information to demonstrate likely benefits and establish a strong monitoring framework. The project will also provide short-termincentivesfor the creation of local financing mechanisms through the matching fund. Lack of capacity of national and local L Mexico has severalstrongnational institutions that have already institutions to support the long-term built up experienceinPESby examining other countries and, developmentof environmental service since 2003, operating the PSAH(CONAFOR). The project will markets support hrther capacity building inboth national and local institutions. Risk to component results Rating Risk mitigation measures Low participation rates of landusers L Experienceto date ofthe PSAHshows ahighwillingness to participate, with applications far exceedingavailable funds. In areas with higher opportunity costs, the project will support the provision of higher payments. The project also includes a componentto provide direct support to poor communities that might encounter difficulties inparticipating. Difficulty inidentifyingthe landuses M Mexico has alreadyundertakenconsiderable efforts to compile that generatethe desired and review available data. The project will support targeted environmental services technical studies at pilot sites to fill gaps inthe data, and a strong impact monitoring system to verify that services are being generated or indicate what changes may be needed. Willingness to pay by service users is L Ifwillingness to payis too low, thenPESwill notproceedat that insufficientto offer paymentsthat site. PES discriminatesbetweenthings worth doing and those not induce land user participation worth doing. Politicalopposition to differentiated M Differentiated paymentsto be introduced gradually, initially in payments by areas that would receive conjunction with new financing mechanismsthat provide lower relative payments objective reasons for the differentiation. Implementation impededby M With retroactive financing, the project will have atrack record of presidentialelections andpotential one year of executionbefore anew administration takes office. personnelchanges inCONAFOR. The PSAHand CABSA programs are being strengthenedwith technical staffthat should not be affected be changes associated with anew administration. Overall risk rating M 21 6. Loadcredit conditions and covenants 93. Effectiveness: 0 Satisfactory agreement signed between the United Mexican States as Borrower, NAFIN as financial agent, and CONAFOR as executing agency in respect o f the Bank loan. 0 Satisfactory agreement signedbetween NAFIN as financial agent and CONAFOR as executing agency in respect o f the GEF grant. 94. Disbursement Conditions: 0 Disbursements o f the endowment fund seed contributionunder Component 1will be subject to (a) the fund being established and operational in form and substance satisfactory to the Bank (b) responsibility established and entity assigned for financial and asset management, and (c) Bank approval o f fund operating rules and manual. 0 Disbursements o f each o f the three types o f local finalicing mechanisms for environmental services (water, biodiversity, and carbon) under Component 4 will be subject to the Bank's approval o f the respective operating rules developed under the project. 0 Disbursements o f matching grants under component 4 will be subject to the Bank's approval o f the operating rules for such financing mechanism to be developed under the project. 95. Dated Covenants: 0 N o later than six months after the date o f the loan agreement CONAFOR must enter into cooperation agreements with CNA, and at least two Technical Support Agencies to assist in the development o f Water Environmental Services and Biodiversity Environmental Services respectively under terms and conditions satisfactory to the Bank. 0 CONAFOR financial management and procurement experts responsible for the project must be in place no later than three months after the date of the loan agreement, and all other staff responsible for project implementation must be in place no later than six months after the date o f the loan agreement. 0 Each year CONAFOR must furnishto the Bank for its comments the proposed revisions to the operating rules for PES mechanisms or any others rules that may be proposed as per the requirements o f the project. D. APPRAISAL SUMMARY 1. Economic and financial analyses 96. D e m a n d for services. PES programs depend on service users paying for the services they receive. 0 Water services. The main national service the PES program is expected to help generate is improvements in water services. Depending on the nature o f local service users, this may take the form of improving water quality (by reducing contamination and/or improving natural filtration), reducing sediment loads, increasing dry season water flows, or reducing the risk of flash flooding. Existinglocal PES initiatives inMexico have demonstratedthat there is a willingness to pay for water services. In Costa Rica, a number of hydropower producers, bottlers, hotels, irrigation systeins, and municipal water supply systems, generate more than US$0.5 million a year in financing for PES. As an example o f the potential for financing from water users, in the town o f Saltillo (pop.584, 000) a fee of 50 pesos per cubic meter o f domestic water use would generate about US$1.8 million a year in PES financing at a cost to consumers o f only US$3 per person. There are three other towns with 22 populations o f more than 200,000 in the pilot sites. While the many smaller towns in the pilot areas could only generate smaller funding flows, they would also have correspondingly smaller environmental services needs. Fees for other water uses, such as irrigation, could also contribute to PES financing. 0 Local biodiversity services. The localtourism industry often relies heavily on natural ecosystems for scenic beauty and/or recreational activities. Damage to these ecosystems could result in fewer tourists or lower prices. The project will pilot new financing mechanisms based on use o f ecosystem services bythe growing, nature-based tourism industry. 0 Carbon sequestration services. Selling carbon sequestration services could help finance costly reforestation indegraded areas. 97. Supply of services. In theory, the payment required to induce land users to adopt practices that provide benefits to other actors must equal, at a minimum, the foregone profits they could have earned through the most profitable alternative use o f the land. Studies by INE estimate the average opportunity cost at the pilot sites to be between US$30 and US$l50 per hectare, with wide variation even within sites. At Cerro Grande, for example, the mean opportunity cost is about US$l50 per hectare, but 20 percent o f producers have opportunity costs of US$50 per hectare or less. The areas that would need to be conserved at each site have not yet been determined. This is a process that will be undertaken during implementation, based on detailed diagnostics o f precise problems facing local service users and technical studies to identify the sources o f these problems. As a very crude, order-of-magnitude estimate, it would cost about US$10 million to conserve about 5 percent o f current forest area at the sites. However, for a number o f reasons this estimate is probably high, and the actual cost o f conserving the forest area needed to protect the targeted environmental services would be somewhat lower. 98. Increasing PES efficiency. The current PSAH program has a one-size-fits-all approach, with a single activity being supported (conservation o f existing forest) and a single price being offered nationwide (except that cloud forests are paid slightly more). Experience worldwide has shown this approach to be inefficient, potentially leading to considerable "conservation" o f forest that i s at little risk o f being lost or that provides few benefits and failing to conserve forests at high risk o f deforestation or with high benefits. The PSAH's initial experience bears out these lessons. The more targeted and differentiated approach to be introduced under the project will help substantially increase efficiency. This will be reflected most obviously in a greater area being conserved per dollar spent. Indicators are being developed to attempt to derive estimates o f environmental services generated per dollar spent. 99. Financial analysis. Expansion o f PES beyond the area supported by current financing will only occur as additional resources come on line through development of new financing mechanisms. All financing mechanisms that channel their funds through the PSAH will also have to contribute to the administrative costs o f the PSAH (including the cost of monitoring). Stand-alone PES mechanisms would have to cover their own administrative costs; technical assistance would be provided to such mechanisms to help them achieve financial sustainability. 100. Incremental cost. The baseline project would focus on areas o f national importance-primarily water services. This project would also provide some global benefits, but they would be limited. The GEF alternative boosts the global benefits provided by the project considerably. It supports the conservation and sustainable management o f natural ecosystems in Mexico by developing new sustainable financing mechanisms explicitly targeted at paying for conservation in critical ecosystems that would not have been covered (or covered to a much smaller extent) in the baseline project. The difference, or incremental cost between the estimated baseline scenario (US$236 million) and the GEF alternative (US$267 million) is US$31million, o f which only US$l5.0 million i s beingrequested from the GEF. 23 2. Technical 101. PES markets are an innovative approach with few operational examples. Lessons learned from the state-of-the-art system in Costa Rica, the preparation o f the El Salvador Environmental Services Project and other cases have been incorporated into the project design (see Section B4). Eight primary pilot sites (promising sites) have been selected and project preparation is now focusing on in-depth analysis o f demand for environmental services in each area. Additional work to finalize pricing structures, targeting, and the establishment of local mechanisms for collection and payment of fees will be done duringproject implementation. 102. The project is consistent with the government's needs and will address constraints in environmental conservation, including financing. If successful, the project will demonstrate that a local, market-driven PES system can function in Mexico and provide the framework for sustainable sources o f local financing for environmental protection. From the experience with the PSAH, local communities have indicateda highwillingness to participate as purchasers o f environmental services. 103. Currently, the PSAH's only contract modality i s for the conservation o f existing forests. Expectations that this modality would improve water services are based 011the view that forests are always beneficial to water services. This view is well entrenched in Mexico, as in most o f the region. In fact, the evidence on the links between land use and forest i s far from clear, and monitoring has not been undertaken on the impact o f PSAH-supported forest conservation on water services. 104. Notwithstanding this lack of precise data, the PSAH Program's forest conservation activities are likely to generate benefits interms of avoiding degradation o f water quality and the higher treatment costs such degradation could cause; reducing sedimentation o f reservoirs and water intakes thereby avoiding the need for costly de-silting operations; and reducing flood risk. It may also help improve dry season water flows (an important issue in several areas), though data on this point are particularly uncertain. It is unlikely, however, to increase total water availability, which i s an issue in the drier parts o f the country. On the contrary, forests may reduce total water availability in these areas, except in the case o f cloud forests (for this reason, the PSAH programpays more for conservation of cloud forests). 105. However, because water services are highly site-specific, these benefits will only be produced if forests are conserved in the right place. This means targeting conservation payments to areas at high risk of deforestation and in areas where water services are threatened. The current PSAH Program scores poorly in this regard: less than 14 percent o f the area enrolled in 2003 and 2004, for example, was located in areas with overexploited aquifers and less than 20 percent was in areas with high or very highrisk o f deforestation (62 percent was in areas o f low or very low risk o f deforestation). 3. Fiduciary 106. Financial Management. The Bank has carried out a Financial Management Assessment (FMA), which involved ensuring that the project design allows for an appropriate level o f transparency that facilitates oversight and control while also supporting smooth implementation. Based on this analysis, the regional financial management team (LCOAA) has concluded that (i)CONAFOR has experience with Bank projects and with the types o f activities to be carried out in this operation, and its record to date on financial management matters has been satisfactory; (ii)certain actions will be required to strengthen program financial management prior to launching the Bank-financed project, especially in terms o f written procedures, reporting formats and assignation o f new responsibilities to staff; and (iii) Nacional Financiera (NAFIN) will provide implementation support and oversight based on its many years o f experience as financial agent. The written procedures and reporting formats should reflect the simplifications proposed in the Financial Management/Disbursements section o f the Bank's Review o f Country Systems in Mexico, which was delivered to the federal government in July 2005. Financial management risk for this project i s high.The identified risks will be mitigated by (a) usingCONAFOR's 24 resources to strengthen the internal control environment, (b) NAFIN's supervision, and (c) closely supervising project implementation to allow earlier detection o f financial management issues and ensure the proper use o f project funds. 107. Procurement. CONAFOR as implementing agency will be responsible for bidding contracting and paying consultants, for producing adequate procurement reports, and for preparing and submitting annual procurement plans and periodic reports as required by the Bank. A project procurement plan has been prepared and a specific procurement plan for the first 18 months will be agreed upon before negotiations. The Bank carried out a procurement capacity assessment o f CONAFOR and found that its implementing capacity i s in the average range and that with the measures agreed in the CONAFOR Action Plan it will be able to improve its capacity and comply with the Bank's rules. See Annex 8 for further details on procurement arrangements. 4. Social 108. A participatory social assessment was completed during project preparation. The social assessment (a) identifies the key stakeholders who should participate during project design and project implementation; (b) identifies the main project beneficiaries, including indigenous and nonindigenous people; (c) describes their decisionmaking processes and organizational structures; (d) identifies the main natural resources management activities-both actual and potential-of the project beneficiaries; and (e) identifies possible risks associated with social impacts and provide recommendations for mitigating such risks aiid impacts. Participatory social assessment activities will continue during project execution as the specific local PES mechanisms are designed and implemented. 109. Risks and mitigation. The risk of negative socioeconomic impacts on both service users aiid service providers i s substantially mitigated by the very dynamic that underpins local, market-based environmental service payments-that these systems, and their long-term sustainability, rely on voluntary participation grounded in the perceived self-interest and well-being o f the participants. In addition, provisions for ongoing consultation and participation are included throughout the project components to ensure relevancy, feedback, and compliance. 110. Conceriis about social and political risk are greater on the side o f environmental service providers because these ejidos and comunidades agrarias in forest areas vary widely in their organizational capacity and processes for decisionmaking, and also correspond to some o f the poorest communities in the country, with large shares o f indigenous people and some o f the highest marginalization indexes and migration rates. 111. However, while there are risks related to overcoming obstacles to participation and equitable distribution o f benefits, the PES payments are expected to have positive socioeconomic impacts by providing additional income and encouraging land uses that yield greater long-term benefits and security. In addition, the participatory action plan outlined below will build capacity and strengthen community cohesion and social capital. 112. Social assessment process. A participatory social consultation included (i) extensive interviews at pilot project sites which included ejido and indigenous community leaders, NGO representatives, community/ejido technical field workers, and local managers and staff o f the protected areas and CONAFOR, and (ii)participatory workshops with diverse stakeholders and participants, including three workshops specifically for women. 113. Participatory action strategy. These consultations helpedcraft a project design that emphasizes strong indigenous community and ejido participation in a strategy that integrates the following pillars of action: 25 Making environmental services a source of income for the ejido/community by paying for conservation activities. This is clearly preferred by local inhabitants to payment for mere ownership o f the forest. Promoting reestablishment o f collective administration and control o f common property and reactivating ejido/community assemblies and the assertion of collective rights under specific cultural and sociopolitical conditions. Providing technical assistance in sustainable management o f both ejido/community lands and individual agricultural holdings. Strengthening social capital and local capacity for ejido/community planning, land and forest management, and design of development subprojects. Building local capacity to attract public programs and funding for specific environmentally friendly subprojects. Establishing and strengthening local participatory committees with a range o f local stakeholders in potential PES areas to represent social and community concerns in the negotiation o f PES arrangements and commitments. 114. Ongoing community liaison and consultation arrangements. Participants in the consultations made clear that they value knowledge and capacity building and that they demand regular face-to-face communication and outreach, with clear rules, on a long-term basis, with stable technical personnel who are directly accountable to them. 115, Regional promoters hired by CONAFOR would maintain close interaction and consultation with local communities and leaders and play a key role in addressing community problems and concerns and defining how to tailor the strategy to local conditions. In addition, indigenous ejidos and communities would select community promoters from among their own members to serve as liaisons with the project in general and with the regional promoters in particular. These community promoters would facilitate follow-up on activities agreed with the regional promoters, serve as translators at community meetings, and help disseminate technical knowledge. They would receive stipends or scholarships and would participate in regional seminars several times a year for training and knowledge sharing. CONAFOR would also provide training and facilitate peer-to-peer learning and knowledge sharing between the regional promoters. 116. Project beneficiaries include indigenous people. An Indigenous Peoples Development Plan was completed and disclosed prior to project appraisal. The IPDP specifies activities to be carried out with Indigenous communities participating in the national PSAH and CABSA programs. An Area Specific IPDP before ES contracts with local private financing are signed in each pilot area (see Annex lo). Indigenous Action Plan (IAP) will be prepared for each o f the eight pilot areas in accordance with the 5. Environment 117. Positive Environmental Impacts. The project i s expected to be overwhelmingly positive from an environmental standpoint, by using PES to induce rural landowners to maintain the forests or other natural vegetation on their lands, thereby (i)conserving globally significant biodiversity, (ii) maintaining or improving hydrological functions, and (iii)reducing greenhouse gases by storing carbon. The eight proposed pilot sites all contain substantial areas o f forests and other natural vegetation that i s important for all these types o f environmental services. In addition to supporting the national-level PSAH program, the project would promote establishment o f local-level PES systems at sites o f conservation interest, either for water users interested in improved upstream watershed management, or for tourism operators and others interested in maintaining biodiversity and scenic beauty. 26 118. Project Expenditures. The majority o f project funds (including the IBRD loan, GEF grant, and Mexican counterpart funds) would be dedicated to providing direct payments to landowners for environmental services, either duringproject implementation or (in the case o f the project-supported trust fund) on an ongoing basis after the end o f the project. The remaining project funds would go mostly to technical assistance, consulting services, training, promotional campaigns, and institutional strengthening needed to establish and strengthen PES programs and their long-term funding mechanisms. N o civil works are expected to be procured under the project. The main on-the-ground environmental impacts associated with project expenditures would thus be the maintenance o f desired vegetative cover on the rural landholdings of PES recipients. 119. Environmental Management Plan. The only possible adverse environmental impacts would be strictly unintended; they could possibly involve (i)tradeoffs between different environmental objectives (such as biodiversity and improved water flows); (ii)misallocation o f PES funds (such as landowners who have not complied with their contracts, or environmentally inappropriate land uses); or (iii) perverse incentives (such as new people moving onto lands so they can apply for PES benefits). The Environmental Management Plan (EMP) for this project i s intended to prevent these types o f unintended negative impacts by incorporating within the project's Operational Manual and the PSAH and CABSA operating rules (i)eligibility and prioritization criteria for the types o f lands and landowners that could receive PES contracts and (ii)review procedures and specific responsibilities within CONAFOR to ensure that all contracts are awarded, administered, and supervised in accordance with these criteria. The PES eligibility criteria are expected to require, inter alia, (i) no clearing o f forests or other natural habitats to establish new agricultural systems; (ii) any reforestation must be with species native to the site; and (iii)alleligiblelandowners(whethercommunities, ejidos,orindividuals) willneedtopresentevidenceof legally secure land tenure and long-term residence in the PES-eligible area. Within any watershed selected for PES support, the prioritization criteria will tend to favor the conservation o f native forests (or other natural habitats) over the maintenance o f agro-ecosystems (such as shade coffee), although the latter could receive PES contracts insites where there is an insufficient area o f original natural ecosystem. 6. Safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.01) [XI [I Natural Habitats (OP/BP 4.04) [XI [X 1 [I Pest Management (OP 4.09) [I Cultural Property (OPN 11.03, being revisedas OP 4.11) [XI Involuntary Resettlement (OP/BP 4.12) E11l [XI IndigenousPeoples (OP/BP 4.10) [X 1 [I Forests (OP/BP 4.36) [XI [I Safety o f Dams (OP/BP 4.37) [I [XI Projects inDisputedAreas (OP/BP/GP 7.60)* [I [XI Projects on International Waterways (OP/BP/GP 7.50) 11 [XI 7. Policy Exceptions and Readiness 120. The project does not require any exceptions froin Bank policies. The project does meet the Regional criteria for readiness for implementation. * By supporting theproposedproject, the Bank does not intend toprejudice thefinal determinationofthe parties' claims on the disputed areas 27 Annex 1:CountryandSector or ProgramBackground MEXICO: EnvironmentalServices Country and sector issues. 1. Since the 1994 economic crisis, Mexico has undertaken impressive reforms leading to a major political and economic transformation during the past 10 years. Today, the country enjoys a more open political and economic system, is more integrated into the world economy, belongs to the OECD, has investment grade rating in the financial markets, and has strong ownership o f its development strategy, Yet, there is still a substantial agenda that the government seeks to advance within the context of its National Development Plan, including very important goals in poverty reduction, improved competitiveness, environmental management, and institutionalchange. 2. The problems of water quality/supply and deforestation are two important environmental challenges facing Mexico. Aquifer overexploitation, water quality degradation, and high deforestation rates put at risk critical ecosystems, globally significant biodiversity, availability o f natural capital for future economic growth, and the capacity o f future generations to achieve a level o f welfare equal or better to the present generation. Indigenous peoples, rural poverty, and land tenure issues are all closely related to the maintenance and conservation o f forests inMexico. 3 . Water and Forests. Water consumption patterns in Mexico are unsustainable. According to the National Water Commission (Cornisidn Nacional de Agua: CNA), although less than 16 percent o f Mexico's 653 aquifers are considered overexploited, 66 percent o f all groundwater used comes from only 188 o f those aquifers, and 57 percent o f all groundwater used i s from the 102 aquifers that are classified as overexploited. The average extraction for human use is 190 percent the level o f natural recharge, a path towards depletion. Many other aquifers are barely maintaining equilibrium (extraction between 105 percent and 95 percent o f recharge) or suffering from salinization. This creates to a fragile situation, particularly when consumption is projected to increase and natural recharge i s further threatened by the effects o f deforestation, which can lead to faster surface runoff and increased erosion with less infiltration and groundwater recharge. 4. Deforestation. Mexico's biological wealth i s in serious danger, and is undervalued as a primary factor in socioeconomic development. Loss o f forests and biodiversity have been attributed to social capital loss and pressures deriving from the unsuitability o f former development policies. For example, conversion o f natural habitats to unsustainable agricultural schemes, deforestation in temperate and tropical forests due to land use change or illegal logging, overgrazing in arid zones, illegal trade o f threatened species, conservation conflicts in protected areas, lack o f integrated coastal zone management programs, and risks o f genetic contamination. 5. In the 1990s only four countries (Brazil, Zambia, Indonesia, and Sudan) accounted for more deforestation than Mexico, according to the FAO's 2005 Forest Resources Assessment.While the amount o f deforestation in Mexico (63 1,000 hectares per year) was only one-quarter of that in Brazil, it was more than twice as much as the next nearest country in the Americas, and its annual rate o f deforestation (1.1 percent) was nearly four times greater than in Brazil. Various assessments indicate that both the amount and rate o f deforestation in Mexico i s highest in tropical forests, including areas o f high biodiversity value. According to Velasquez and others (2002), in 1993 Mexico had about 70 million hectares of forest, but by 2000 about 3.1 million hectares had been converted to agricultural uses and 5.1 million hectares had been converted to pasture. During the same period, only 1.7 million hectares o f agricultural land, pasture, or degraded forest had experienced natural or human-assisted recovery and could once again be classified as being in a good state o f conservation. Furthermore, where forests do remain standing, poor management practices have resulted in degradation o f genetic quality and loss o f regenerative capacity. 28 6. The causes of deforestation are multiple. They include natural hazards such as pests and fires but the main driving force appears to be intentional land use changes by individual or collective land owners. Agriculture expanded at an annual rate of 2 percent between 1993 and 2000, while pastures grew at an annual rate o f 4.6 percent. Illegal logging is also a cause o f concern both because it degrades the forests and because this damage lowers yields and increases the risk that rightful forest owners take into account when deciding over the alternative uses oftheir land. 7. The high rates of deforestation have had negative implications for the regulation o f water flows, sedimentation o f reservoirs, changes in rainfall patterns, conservation o f biodiversity, and release of carbon in the atmosphere contributing to climate change. Given the country's increasing probleins of water quality and supply and its decreasing soil quality, both o f which are associated with forest loss, understandingthe sources o f deforestation is becoming a central policy issue at a national level. Scientific work highlights the role that montane cloud forests play in providing surface water flows during the dry season in Mexico's Veracruz watersheds. There i s evidence o f an environmental service provided in this case by dry tropical forests, that of reducing the risk o f floods during storms in western Jalisco. Also, there is evidence that the Sierra Gorda's forests are fundamental for water recharge in the aquifers supplyingthe cities o f Queretaro and San Juan del Rio. 8. Critical Ecosystemsand GloballySignificant Biodiversity.Mexico i s one o f the mega-biodiversity countries in the world, with second place in reptilian diversity, third in mammal diversity, and fifth in both amphibian and plant diversity (Table Al-1). Its plant diversity exceeds that o f the United States and Canada combined. Mexico also ranked eighth in fish diversity and fifteenth in bird diversity. With 1.3 percent o f the world's land area, it hosts about 12 percent o f known terrestrial biota with very high endemicity, Mexico contains the five main types o f Latin American and Caribbean terrestrial ecosystems listed by WWF, nine of the 11main types of habitats in the region and 51 o f the 191 ecoregions identified. Of these 5 1 ecoregions, 14 (covering over 40 percent o f national territory) have priority at the international level regarding their biodiversity and current conservation status. There are nine large natural vegetation types inMexico, classified according to their ecological characteristics. Table Al-1: The World's FiveMostBiodiverseCountries.2004 Rank Mammals Amphibians Reptiles Vascular plants 1 Indonesia(667) Brazil (695) Australia (880) Brazil(56,215) 2 Brazil (578) Colombia (623) Mexico (837) Colombia (5 1,220) 3 Mexico (544) Ecuador (428) Indonesia(749) China (32,200) 4 China (502) Peru(361) Brazil (651) Indonesia(29,375) 5 U.S.A.(468) Mexico (358) India (521) Mexico (26,071) Source: WorldResources Institute,2005 (from WRI website)."Earth Trends DataTables: Knownand ThreatenedSpecies." Based 011 informationfor 2004 from UNEP-WCMC andIUCN. 9. The total number o f known species in Mexico is about 65,000, but there are thought to be at least 212,000, as many areas and many taxonomic groups have not yet been studied in detail.3 There are at least 6,000 known species of fungi in Mexico (9 percent o f the world total). Mexico's vertebrate fauna are among the richest in the world, with over 5,000 species (almost 10 percent o f the world total), o f which about 1,000 (20 percent) are endemic. Invertebrate species number almost 30,000, taking into account 3 . For example, the National Biodiversity Information System (SNIB) which integratestaxonomic, ecological, geographic and bibliographical information related to Mexico's biodiversity and biological resources has data on 8,176,000 specimens - this figure has increasedby 3,676,000 since 1998. 29 Table A1-2: Species ofWild Flora and Fauna at Risk,2001 Probably Subject to extinct in the special wild Endangered Threatened protection Total ut riska Total numberh Mammals 7 43 124 121 295 491 Birds 19 72 107 173 371 1,054 Reptiles 0 15 109 342 466 704 Amphibians 0 6 42 148 196 290 Freshwaterfish 11 70 74 30 185 Arthropods 0 16 11 19 46 Fungi 0 10 25 7 42 Vascular plants 4 141 350 486 981 10,819 Total 41 373 842 1,326 2,582 a) Total at risk or extinct. Sum of previous columns. b) Total number of species known. Source: NOM-059-ECOL-2001. only marine invertebrates and arthropods, o f which nearly 7,000 (almost 25 percent) are endemic to Mexico. 10. Priority Terrestrial Regions have been identified, whose ecosystems are richer and more specific than in the rest of the country and which have significant ecological integrity. These 151regions cover over 50 million ha (over one-quarter o f the territory). The most important states interms o f species richness are Oaxaca, Chiapas, Veracruz, and Guerrero. There are about 23,000 known plant species, including algae, bryophytes, pteridophytes and phanerogams. The total number is about 36,000 (i.e. over 10 percent o f the world's known species); 10,000 (40 percent) are endemic. 11. Mexico i s regarded as one o f the world's most important centers o f genetic diversification in plants and one o f the areas where agriculture originated. Some 120 cultivated plant species belonging to 39 families originated inMexico, including cocoa, kidney beans, maize, and tomatoes. 12. Mexico's biological wealth is extraordinary but the future i s precarious. One-third o f birds and nearly 66 percent o f amphibian, reptile, and mammal species are at risk. The wild species whose state and patterns of conservation are in decline are legally protected by Mexican Official Standard NOM-059- ECOL-2001; 2,582 species and subspecies are at risk (161 more than under the previous 1994 standard), of which 41 are already extinct in the wild, 1,2 15 are endangered or threatened with extinction, and 1,326 are subject to special protection. 13. Protected Areas. Nearly 60 percent o f the surface area under protection i s in biosphere reserves. Most are managed for sustainable use o f natural ecosystems (IUCN category VI); and a few are strict nature reserves (IUCN category Ia). The second most important type o f protection (27 percent o f protected territory) consists o f protected areas o f flora and fauna (IUCN category VI). National parks (IUCN categoryI1) account for 7 percent o f the total area under protection. There are various other categories o f protected areas, including forest reserves (IUCN category VI). The National System o f Protected Natural Areas (SINAP) includes natural areas o f special national importance due to their biodiversity and ecological characteristics; 41natural areas are currently included, one o f which i s state-administered. The 40 Federally administered natural areas cover almost 10 million ha (i.e. 55 percent of the total designated area) but only about 5 percent o f this area i s government property. 14. Not all the areas with relevant biodiversity are covered by a status o f NPA. The National Commission for NPAs has produced a map o f Priority Areas for Conservation, which includes the SINAP, plus the areas that should be incorporated under some kind o f protection, including economic incentives and legal agreements with their proprietors. 30 Table A1-3: Vegetation Types, 2000 Surface area Share of national Vegetation type (`000 hectares) territory (%) Temperate forest 34,504 17.6 Conifer forest 12,854 Conifer andholm oak forest 7,829 Holm oak forest 11,997 Mesophilic montaneforest 1,824 Tropical rain forest 34,229 17.5 Evergreenand sub-evergreen rain forest 11,144 Sub-broadleafrain forest 4,649 Broadleafrain forest 17,810 Low thorny rain forest 626 Scrub 55,588 28.4 Xerophilous scrub 49,386 Mezquital 3,186 Chaparral 3,016 Grassland 16,352 8.3 Inducedgrassland(not cultivated) 6,665 Natural grassland 9,687 Other types of vegetation 9,829 5.0 Sandy desert vegetation 2,172 Halophilous vegetation 5,283 Hydrophilous vegetation 2,246 Palm forest 128 Total 150,503 76.8 Source: National Institute for Statistics, Geography and Information Technology, 2002 15. Land tenure and Forests in Mexico. Any initiative to protect forest must take into account the structure of incentives embedded in the land tenure arrangements. Mexico has a special land tenure structure, resulting from more than seven decades o f agrarian reform. Large private estates (known as Zutfundios) and land belongingto the government were redistributed among organized groups o f peasants in an iiistitutional arrangement iiivolving both individual plots and common property areas (uso comtin). This type of property are known as either ejidos, which include more individual plots, or comunidudes ugrurias, which are mainly common property. Reforms to the Agrarian Law in 1992 granted ejido members more clearly defined individual property rights for their plots, making them almost private property. Because the majority o f forests are under common property regimes, their land tenure rules have important implications for conservation programs. 16. Common property implies a potential problem o f collective action. This does not mean that all forests in Mexico face the "tragedy o f the commons", but it certainly makes it possible that costly cooperation creates departures from what would be optimal decisions. Several studies in Mexico (McCarthy et al., 2001; MuAoz et al., 2003; Alix et al., 2004) have pointed out that high cooperation costs increase the probability that a particular ejido or comunidadwill choose individual activities or tenure over collective ones, a problem for forests which tend to be associated with the latter options. 17. Rural Poverty and Forests. Mexican forests are in the unique situation o f being located almost entirely in common property lands, the owners o f which are among the poorest in the country. While the incidence o f poverty i s high in all Mexican rural areas, it i s particularly high in forested areas. Nearly 85 percent of localities in forested areas have a "high" or "very high" marginality index. This has two 31 important implications. First, poverty is one o f the driving forces in deforestation (Guevara and Muiioz, 1996;Deininger and Minten, 1999).Empirical studies in Mexico suggest that poverty i s strongly linked to increases in the deforestation rate. Deininger and Minten (1999) found that municipalities with higher levels o f poverty lost a larger proportional share of their forests during the 80s than others of similar characteristics but less poverty. The econometric pixel approach developed by INE (Muiioz et al., 2004) also confirms tlie hypothesis, providing evidence that duringthe 1990s poverty and marginalization levels in the villages closest to a particular tract of forests increased tlie probability o f it being deforested. These results do not imply that deforestation was higher in poorer areas. In fact, the influence o f other variables like distance to market, slope and potential yields, result in a higher deforestation inthe richer parts of the country. However, the effect of poverty still makes a difference when comparing forests o f similar locatioii and characteristics. 18. Second, poor households are highly dependent on forest resources, so degradation o f these resources hinders their ability to sustain their livelihoods. High levels o f marginalization and poverty are a challenge for sustainability because it favors short term projects in agricultural or livestock land uses against a longer-term planning strategy that includes forestry (Guevara and Muiioz, 1990). Third, people living in poverty and lacking land titles have stronger incentives to deforest in order to claim as their own the common property land recently cleared for cultivation. Poverty may encourage deforestation as a short-term survival strategy and excessive deforestation may accentuate poverty in tlie long run. Under certain circumstances poor farmers have stronger incentives to protect the environment than wealthier farmers, because the consequences o f failing to achieve sustainability have worse consequences to them. 19. PES schemes have the potential for simultaneously alleviating poverty and addressing some of the most important environmental problems Mexico faces. 20. Indigenous Communities and Forests. The indigenous people o f Mexico have an iinportaiit presence in forested areas. Estimates show that 20 percent o f the ejidos or comunidades that have large tracts of forests (>lo0 ha) also have a large majority o f indigenous households. In comparison, only 2 percent of the ejidos without forests have a similar indigenous presence. 2 1. Indigenous communities have a unique perspective about their forests, stemming from the long-term ties that bind them to their ecosystems. This provides them with a stock o f traditional knowledge about its goods and services, allowing them to obtain more value from tlie same plot o f forest than, for example, new immigrants to the region. Also, strong ties within the community due to a shared identity and extended family relations would imply higher costs o f opportunistic behavior and make indigenous ejidos inore efficient at achieving cooperative outcomes. These two elements would have the effect o f increasing the relative profitability o f keeping the forest, reducing the incentives to switch to agriculture or cattle operations. It i s possible that forests themselves could have cultural importance for the indigenous people, so traditions and rules about its use would reflect the local bequest and existence values and help preserve them despite generating less income than its alternatives. 22. The small property ejidos and communal owners o f forest resources in Mexico have been slowly developing capacities to manage their resources and to successfully market their products, especially as technology changes and markets become increasingly complex, global and more competitive. In many cases, communities and "ejidos" have set up community enterprises to add value to timber and are in the process of taking advantage o f Non Timber Forest Products, some o f which have significant economic value and market potential. Although they have a traditional attachment to the forests, including a rich spiritual tradition rooted in the forest, they have not, in general, been able to reach a comfortable level o f income to conserve natural areas that have both spiritual and material value. Also, most o f the rural indigenous people inhabit in a broad range o f ecological niches, many o f them catalogued as fragile and remote. There exists a strong overlapping among indigenous communities and ejidos and high biodiversity areas, includingthe ones recognized as protected areas. 32 23. Government Strategy - These challenges are being met with efforts by both the government and civil society. The federal government has relatively recent laws governing water resources (December 1992, extensively modified in April 2004), forests (February 2003), and sustainable rural development (December 2001), which by definition includes "ensuring the permanent conservation o f natural resources, biodiversity, and environmental services." 24. These laws are based on Article 27 of the Constitution, vesting the federal government with original control o f all land, water, and natural resources as well as responsibility for creating laws to govern their use, preservation, and restoration to ensure environmental balance and the public good. In addition, Article 4 o f the Constitution gives individualsthe right to a natural environment that i s "adequate for their development and well being." 25. Mexico's environmental strategy i s contained in a National Biodiversity Strategy published in 2000 as part o f its obligations under the CDB and in a set of integrated five-year programs issued in 2001 for National Development (PND), Environment and Natural Resources (PNMA), Water (PNH), and Forests (PNF). The biodiversity strategy has four main lines o f action: (a) protection and conservation, (b) valuation, (c) knowledge and information management, and (d) diversification aiid use. The strategy calls for legal, administrative, and political mechanisms to be established whereby the beneficiaries o f environmental services help finance environmental and biodiversity conservation and proposes that economic analysis be conducted to valuate environmental services related to soil fertility and regulation o f hydrological cycles. Although the integrated five-year sectoral programs are designed for 2001-06, they were not developed as and are not considered to be self-contained instruments with a defined elid date, but rather as a stage in a larger strategic plan for Mexico that looks forward to 2025 and beyond. 26. Other important legislation facilitates these programs. In 1996 the Income Tax Act was amended to make all donations to NGOs carrying out conservation projects in natural protected areas tax deductible and in2001Congress reformed the Federal Law on Rights(LFD)which sets a wide range of fees both for government services such as granting concessions and licenses as well as for use o f natural resources including recreational, commercial, and extractive activities. For example, in 2002, fees for the use, enjoyment, and exploitation o f marine national parks generated 11 million pesos, which was used to help finance conservation o f marine biological resources through investments in equipment, operation, and management o f the natural areas that generated the resources. 27. Throughout the twentieth century forest policy in Mexico suffered from lack o f continuity, unstable and changing policies, and poor coordination o f programs between federal, state, and local government. However, forest policy and planning i s one o f the areas in which Mexico made the most dramatic improvements in recent years, putting into place laws, institutions, and programs that are considered by some experts to be among the best in the developing world. In April 2001 the government created the National Forest Commission (CONAFOR) with the mandate to support sustainable production of forests aiid conservation o f forest resources. In June 2001 the 2000-2025 Strategic Forestry Program (PEF) was completed, which in turn was the basis for defining the 2001-06 National Forest Program (PNF), and in February 2003 the Sustainable Forest Development law was issued. 28. The PEF calls environmental services "the most important and transcendent ecological assets of mankind." It details the problems and obstacles to creating environmental services markets as a tool for natural resource conservation and proposes a range o f activities, grouped into five major strategies, to help develop such markets: (a) evaluation o f potential, (b) pilot projects, (c) feasibility of PES mechanisms, (d) research and training, and (e) market development and instrumentation. The PNF includes these strategies and actions, as well as a specific goal o f establishing and promoting PES markets that encompass 600,000 hectares. 29. The creation o f CONAFOR and the long-term forest strategy represents a significant effort to reverse the deterioration and depletion o f natural resources and to transform this national problem into a productive asset through the launching and implementation o f guidelines for sustainable management o f 33 forests, water, and soil. Its sectoral approach i s complemented by the Sustainable Development Program (Progvama de Desarrollo Sustentable del Gobierno Federal) which represents a formal effort to build synergies and complementarities among the different government policies and instruments that historically have responded to oftentimes conflicting sectoral interests. To halt and reverse the deforestation trend, the Mexican government has pledged to be committed to a "zero" deforestation target. The Forest Resource Assessment of December 2004 is generally consistent with CONAFOR's estimate that the deforestation rate averaged more 900,000 hectares per year between 1993 and 2000, but had dropped to about 400,000 hectares per year by 2002. 30. .The policy strategy dealing with forests has a series o f programs that support commercial forestry, build capacities among poor forest-owning communities, and invest in reforestation. Based on tlie research on tlie causes of deforestation and the existing policy array to reduce it, tlie basic policy proposal o f Payments for Hydrological Environmental Services Program (PSAH), started in October 2003, was to create a financial link between those who gain from environmental services and tlie owners o f the forest that are likely to provide those services. 3 1. PSAH Program. The PSAH was designed to complement other initiatives by providing economic incentives to avoid deforestation in areas where water problems are severe, but where in the short or medium term commercial forestry could not cover the opportunity cost o f switching to agriculture or cattle ranching. PSAH consists o f direct payments to landowners with forests in good state o f conservation. Payments are made for watershed conservation-management-restoration, aimed at preserving temperate, tropical, and particularly high mountain cloud forest lands associated with the supply of water to communities. 32. Part o f its innovative approach is that it is funded through an earmarked percentage o f tlie federal fiscal revenue derived from water fees, creating a link between those who benefit from the environmental services and those who provide them. 33. Lakes, lagoons, aquifers and rivers are considered national property in Mexico and are managed by the federal government. The government charges for the utilization o f national goods (natural resources like water and minerals) through the Federal Rights Law (Ley Federal de Derechos - LFD). Articles 222, 223, and 224 contain the water fees, charged to different users and collected by the National Water Commission (CNA). Farmers pay nothing, municipalities very little, while manufacturing companies and service providers pay the highest fees. The LFD i s presented and approved each year by Congress. The initiative i s prepared by the Ministry o f Finance (SHCP) and can be modified by tlie Congress' commissions. INE and CONAFOR prepared a modification o f Article 223 that earmarked a specific share of water revenues for payments for forest environmental services. 34. A fiscal instrument was established (the Mexico Forestry Fund, FFM) to pay for the hydrological environmental services and to be a commitment device to ensure participants that the resources that would pay them for the following 5 years were already set aside. 35. Since the program's inception in 2003, it has had rapid acceptance with over three times the amount of applications from environmental services provides than funds available. Initially MXP200 million (US$18.2 million) per year o f tlie annual water revenues were allocated. In 2004 and 2005, the amounts approved were MXP300 million. The payment scheme i s MXP300 per ha (US$27.3) to all forests except cloud forests, which receive MXP400 per ha (US$36.4). In 2003/2004 the program signed 623 contracts with service providers covering 297,000 has. In2005, the program has received 411applications for PES funding. 36. Eligibility criteria for PSAH contracts in the 2002-2005 time period were: (i)the forest area committed per beneficiary should have a forest cover equal to 80 percent or more; (ii)forested area should not be more than 4,000 ha nor less than 50, unless several beneficiaries having adjacent lands totaling this minimumsubmit ajoint application-applications were not accepted from beneficiaries who, 34 together with hectares approved in previous applications, exceed 4,000 ha; (iii)the area under forest management (timber forest) either in recovery or lying fallow, should not exceed 200 ha per beneficiary; (iv) in cases o f common land in an agrarian nucleus, the representation bodies should be in coinpliance with organization requisites laid down in the Agrarian Law and that the decision to apply for iiiclusioii into the Program should be taken by agreement of the general assembly o f said agrarian nucleus, and that the surface areas committed and proposed for entry into the Program should not be the subject o f any agrarian litigation; and in cases of privately owned plots o f land, that no litigation should exist regarding legal ownership or possession o f the land, or any other; and, (v) communities must be o f 5,000 or more inhabitants. 37. Despite its achievements, there remains room for improvement. In particular, the following areas need to be addressed: (i) the majority of the contracted area is outside the priority conservation areas- less than 14 percent o f the area enrolled in 2003 and 2004, for example, was located in areas with overexploited aquifers; (ii)most o f the enrolled area is at low risk o f deforestation-less than 20 percent o f the area enrolled in 2003 and 2004 was in areas with high or very high risk o f deforestation, while 62 percent was in areas o f low or very low risk o f deforestation; (iii)most contracts have gone to the better organized, more developed communities and ejidos, and to private owners, even though their opportunity cost tends to be higher; (iv) budgetary limitations impose a 5-year limit on payments to any one participant, puttingconservation beyond that period at risk; and (v) lack o f training and capacity building (on both the supply and demand sides) to develop local markets. 38. CABSA Program. In 2004, as a complement to the PSAH, Mexico created CABSA (Program to Develop Environmental Services Markets for Carbon Capture and Biodiversity and to Establish and Improve Agroforestry Systems). CABSA supports reforestation activities and land use changes in Mexico and links them to national and international markets/financing for carbon capture and biodiversity. Like the PSAH, contracts for environmental services under CABSA will have duration o f up to five years. In 2005 CONAFOR received 955 proposals for CABSA and approved 51 (17 in agroforestry, 11 in reforestation for carbon sequestration, and 23 in biodiversity conservation). The area covered by the 51 proposals i s 68,535 hectares, but only 20,000 will be receiving direct payments while the rest represent proposals accepted for further development. While the initial success in attracting proposals reflects a strong potential for the program, several important limitations were identified in an assessment made by COLPOS, the Colegio de Postgraduados: (i)sustainability i s limited by the 5-year on payments;, (ii) international carbon and biodiversity markets are new and lack well-established prices and rules, (iii) transaction costs may be high, and (iv) there i s not adequate information and clarity on how communities will benefit from CABSA. 39. Market-Driven Payments for Environmental Services (PES). The proposed project will address these weaknesses. Its primary objectives are to: (i)secure the long-term sustainability o f the PES program by developing new, sustainable long-term financing mechanisms based on payments from service users; (ii)increase the program's efficiency and cost-effectiveness by focusing it in areas of greatest deforestation risk and in areas with water quality and supply problems; (iii) improve its contribution to poverty reduction; (iv) increase its contribution to the conservation o f globally important biodiversity by focusing it incritical ecosystems. 40. A key aspect o f the proposed project is a market-based PES approach. The market-based PES approach creates mechanisms that substitutefor missingmarkets. It i s based on the principle that those who provide valuable environmental services should be compensated and those who benefit from such services should pay for them. PES programs promise to be more efficient than traditional command-and-control approaches because market-based instrumentsnaturally seek the highest benefits at the lowest cost. Moreover, they give service users a strong incentive to be proactive inensuring that their money is spent effectively. 41. PES programs are also more likely to be sustainable because they depend on the self-interest o f the affected parties rather than taxes, tariffs, philanthropy, or the whims o f donors. By providing payments on 35 an ongoing basis, PES programs avoid the pattern o f short-term adoption followed by rapid abandonment that has characterized past approaches. They can also help reduce poverty because the areas that provide environmental services (and receive payments) correlate highly with areas o f rural poverty. The project buildson previous experience with the use o f PES, includinga successful nationwide program inCosta Rica that is supported by the Bank and GEF, and a wide range o f small-scale initiatives throughout the region, including several inMexico itself. 42. Another key aspect of the proposed project is a focus on reducing land degradation, conserving forested areas, reverting marginal agricultural areas to forest, and encouraging more sustainable land use in agriculture. It would create PES mechanisms to provide incentives to hillside farmers and other land users in at least 8 project sites (See Annex 17).4 43. It would also create a framework for application o f market-based PES approaches that could be applied to other areas on a decentralized basis, responding to local needs and conditions in particular watersheds. Mexico already has some experience with local, self-organized, environmental services markets to solve specific problems. A recent study commissioned by the World Bank and CONAFOR conducted a rapid assessment o f 40 experiences related to payment for environmental services in Mexico, and will complete a detailed analysis o f 10 o f those cases prior to implementation. The cases involved water supply and hydrological services, biodiversity, carbon capture, risk mitigation, and landscape (ecotourism) values (Table A1-4). They included a range o f stakeholders and participants, froin local communities and civil society organization to the federal government and international agencies. All the cases affected local watershed and ecosystem management in some way and usually involved more than one kindenvironmental service. Table 1A-4. Types of Mexican PES ExperiencesReviewed I. Hydrological services (9 cases): Including payments for watershedmanagement and for specific conservation measures. Mechanisms were promoted by both users and providers of ES, usually with the participation of municipal or federal government, and sometimes the PSAH program. Funds usually came froin municipalities, direct paymentsby users, and/or payments through the PSAH.NGOs usually play akey role. II, Biodiversity and habitat conservation (12 cases). Lands both inside and outside natural protected areas, generally involving restrictions on land uses and purchase of land to create conservation areas These initiatives typically involve a strongrole for NGOs and negotiation for national and international financing. III.Climate control/carbon capture (4 cases). Seek financing from the BioCarbon Fund or voluntary emission reductions, mainly for forest plantations and/or agroforestry systems. Financing to develop the mechanisms comes from private and research funds. Some schemes include organic or biodiversity-friendly production such as shade coffee. Key actors include research institutions, state and federal government, and localNGOs. IV. Riskfrom natural disaster (I case). Reduce vulnerability to natural disasters, conserve habitat, control pests (dengue), andprotect water supply. Key participantsinclude academic institutions and local CSOs. V. Esthetic/scenic/ecotourism (I1 cases). Mainly focused on tourism as the financing mechanismto preserve scenic, recreational,and cultural values, including biodiversity. Owners of forest land had substantial participationinthe developing the mechanisms, which are mainly financed from private sources, with funds from actual users, and in some cases supportedby governmentprogramsto provide infrastructure,training, etc. 4. The criteria used for site selection were (a) institutional framework, (b) hydrology and other biophysical conditions, (c) locations that can build local biological corridors, (d) land-use practices, (e) national, regional, and global biodiversity significance; (0potential supply and demand for ecosystem services, (g) socioeconomic factors, and (h) likelihood that land use changes promotedby an ecosystemservice market would support development of local biological corridors. 36 44. Although the great majority of the PES systems reviewedare still under development or negotiation, there are a handful o f decentralized PES systems that are already under implementation. For example, the Parque de la Joya-La Barreta (Queretaro) and Municipio de Coatepec (Veracruz) PES systems channel public and private money through municipal trust funds to the owners o f land in the watersheds that provide water regulation, quality, and supply services to municipal water users (as envisioned in Component 1A o f the proposed project). The landowners are rewarded for including new areas under formal conservation commitments or for improving conservation and land use practices in areas that have been degraded. The source o f funds may include money froin municipal and local government budgets, fees to urban users o f water services, or earmarking o f a share o f money spent on urban construction projects. 45. One of the most important features o f the experiences studiedi s that they rely heavily on local NGOs, civil society organizations (CSOs), and municipal governments to promote, develop, negotiate, and implement the mechanisms as well as to fund some o f the transaction costs. In this sense the experiences studied genuinely represent local mechanisms based on local conditions and local demands, even though in some cases they are facilitated by the PSAH and usually depend on funding from national and international sources. The project proposal explicitly recognizes these diverse roles and actors in its institutionalarrangements and strategy. 46. For reasons o f practicality and feasibility financing from the local demand side o f the "market" is generally represented by the collection o f fees from water users, tourists, and businesses (as in other PES mechanisms) rather than by individual voluntary buyers interacting directly with sellers. However, these fees still reflect a willingness to pay and the case review found that political negotiation (which helps create the enabling social, political, and fiscal environment requiredto sustain such a system) is at least as important as the technical negotiation o f the financial mechanisms themselves. The negotiation stage clearly i s crucial to bringing preparation and design efforts to fruition, or having an initiative stall. The proposed project emphasizes providing technical support on both the supply and demand side and helping to facilitate negotiation o f local mechanisms. It also seeks to pilot models that are locally self-sufficient and rely on international funding only to pay for global environmental services. 47. The strong national interest in PES i s reflected inthe GOM establishment of the Mexican Forest Fund and transfer of MXP300 million a year to the program. The development o f the proposed PES project for Mexico is based on lessons from the PSAH program and other experiences in Latin America. Country GEF Eligibility andDrivenness 48. Mexico ratified the Convention on Biological Diversity on March 11, 1993. It i s also a signatory to the Convention on International Trade in Endangered Species o f Wild Flora and Fauna (CITES) and the Cartagena Protocol on Biosafety). The project's objectives are fully consistent with guidance from the Conference o f the Parties o f the Biodiversity Convention regarding conservation and sustainable use o f biological diversity. The project i s consistent with the guidelines and decisions o f a number o f CBD Conference of the Parties inparticular, with the Addis Ababa Principles and Guidelines number 12 which was adopted by CBD VI1 Decision 12 under Article 10. The project contributes to the Article by promoting economic incentives to generate additional benefits to indigenous and local communities and stakeholders who are involved in the management o f any biodiversity. Furthermore, the project also contributes to the Decision 14 (Biological Diversity and Tourism) and 16 by creating appropriate mechanisms to capture the economic benefits o f ecological services. In addition, the project i s also consistentwith the COP VI Decision 15 (Incentive measures). 49. To address the daunting challenge o f environmental issues in the country, the Government o f Mexico (GOM) has taken a number o f actions including legislative, institutional and budgetary. For example, the G O M created the National System o f Protected Natural Areas (SNAP) in 1986 to provide protection to some of its rich habitats and biological diversity. With the support from GEF and the World Bank, an 37 endowment fund was created to capitalize financial resources to provide long term financing for protecting the SINAP. Furthermore, the Mexican government has pledged to be committed to a "zero" deforestation target. In addition, the government has been piloting economic incentives mechanism for changing land holder behaviors to promote conservation measures. The introduction o f fiscal instrument (e.g., water fee) and PSAH program are examples o f GOM's serious commitment in conservation and sustainable use o f its natural resources. To advance this agenda, the GOM has requested the World Bank and GEF to help them prepare the proposedproject. Rationalefor Bank involvement 50. The World Bank has considerable experience in the design, implementation, and support of PES programs in developing countries. Several Bank projects that use PES are under implementation with GEF cofinancing, and others are under preparation (see Table A1-5). In parallel, the Bank has been undertaking research on PES and providing the results to practitioners through capacity-building efforts. No other institution has the same depth of experience in implementingPES approaches. 51. GEF support is warranted because the project would help (i)conserve globally significant biodiversity, including critically endangered endemic species, (ii)enhance the Mexico sections o f the MBC, (iii)pilot PES as a sustainable, long-term conservation instrument that could be scaled up and replicated in Mexico and serve as a model for other countries, (iv) research links between land use change and environmental services; and (v) increase carbon sequestration and knowledge about biocarbon sinks. Without the GEF increment, environmental services payments might not provide sufficient incentive to adopt land uses that would yield global benefits in additionto local and national benefits. Table A1-5: World BankProjectswith PES Components Total World GEF cost Bankloan mant Countw. aroiect (US$million) Main features Costa Rica: Ecoinarkets Project 49.2 32.6 8.0 Effective 2001. Supports PESprogram ColombiaiCosta Rica/Nicaragua: 8.45 4.5 Effective 2002. Piloting PESto promote Regional Integrated Silvopastoral adoption of silvopastoral practices Ecosystem Management Project SouthAfrica: Cape Action Planfor the 49.6 9.0 Effective 2004. Uses PES to conservethe Environment (CAPE) Cape Floristic Region El Salvador:Environmental Sewices 14.5 5.0 5.O Approved by GEF and IBRD June 2005. Project Piloting market basedPES program Panama:Rural Poverty andNatural 50.0 6.0 Under preparation. Will use PES to Resource Management I1 improve biodiversity conservation and generate water services Venezuela: CanaimaNational Park 42.5 11.O Under preparation. Will use payments Project from HEP producersto support conservationof CanaimaNP Kenya:Agricultural Productivity and Under preparation. Will pilot use of PES Sustainable Land Management for watershedconservation. Project Costa Rica: Mainstreaming Market- 90.3 30.0 10.0 Under preparation. Will ensure long-term Based Mechanismsfor sustainability of the PSA program by Environmental Sewices Project developing new fmancing sources and improve the program's efficiency. h'ote: Only includes projects with explicit PES components. Figures for projects not yet approved are preliminary. Higher levelobjectives to which the projectcontributes 38 52. The environmental objectives o f the Mexican government are to increase sustainable development as a shared responsibility; facilitate decentralization of environment management and increased public participation; promote payment for environmental services program; decrease loss o f temperate and tropical forests; conserve biodiversity; and increase sustainable water resource management (200 1-2006 Mexico Environment and Natural Resources Program). 53. The 2005-2008 Mexico CPS addresses four core issues: (a) the reduction o f poverty, (b) environment management, (c) increased competitiveness, and (d) improved governance. It builds on the positive experience o f the EnvSAL (a development policy loan, or DPL) in its review o f existing programs and incentive structures, to address the implicit short-term tradeoffs between social protection and environmental protection. 54. The CPS recognizes that Mexico faces tremendous pressure on its natural environment; to the degree that failure to reverse some o f the most damaging trends may not only act as a brake on continued economic growth, but even contribute directly to reduced social welfare and increasing poverty. The CPSaddresses the need to consolidate the regulatory and legal framework for environment issues and support implementation o f measures aimed at watershed recovery, reforestation, decontamination, clean production, management o f ecosystems, and biodiversity conservation. The CPS notes that vulnerability to natural disasters i s closely related to rural poverty and that low productivity and high population pressures have depleted natural resources in many rural areas, caused soil erosion and land degradation, led to loss o f habitat, biodiversity, and natural forests, and exacerbated problems in water management and conservation. In response, the CPS supports development o f markets for environmental services and strengthening o f protected areas management. 55. The project is consistent with the Bank's 2002 rural and environment strategies for Latin America. The rural strategy aims to reduce poverty and promote growth within the context o f sustainable natural resources management and calls for better integration o f environmental issues into rural development to build consensus around possible "win-win" opportunities. The environment strategy promotes sustainable, integrated management o f natural resources and ecosystems with a focus on highly degraded and disaster-prone areas. The project would support both strategies by developing PES markets that generate win-win opportunities for poverty alleviation, economic growth, and environmental protection. 56. The project also takes into account the Bank's 2002 Forest Strategy, which i s built on (a) harnessing the potential o f forests to reduce poverty, (b) integrating forests in sustainable economic development, and (c) protecting global forest values. The strategy notes that addressing these three aspects together i s complex and multifaceted-not merely about growing trees but rather supporting a complex interaction of policies, institutions, and incentives. It focuses on economic policies and rural strategies that embrace both sustainable use and conservation o f vital environmental services, seeking to build markets and financial instruments in support o f private investments in sustainable natural resource management. 57. The GEF operational program goal supported by the project. The proposed project supports the GEF Biodiversity Focal Area by protecting natural habitats and biological diversity through forest conservation, reversion o f marginal agricultural areas to forest, and promotion o f sustainable practices in agriculture. It supports Operational Programs 3 (Forest Ecosystems) and 4 (Mountain Ecosystems) by promoting conservation o f biodiversity in key forest and mountain ecosystems. Within the Biodiversity Focal Area, the project particularly fits with two Strategic Priorities: Catalyzing Sustainability of Protected Areas (SP1) and MainstreamingBiodiversity inProduction Landscapes and Sectors (SP2). 58. Under SP1, the project would help ensure sustainability o f the national protected areas system by providing a mechanism for long-term financing o f biodiversity conservation in the buffer zoiies of protected areas and the corridors that connect them, including the Mexican portion o f the Mesoamerican Biological Corridor. 39 59. Under SP2, the project will focus on two types o f activities: (i)facilitating the mainstreaming o f biodiversity within productive landscapes, and (ii)developing market incentive measures. Facilitating the mainstreaming of biodiversity withinproductive landscapes. Through this type o f activity the GEF seeks to support development o f the systemic and institutional capacities o f government agencies and other stakeholders that would help secure biodiversity conservation. This could be achieved through enabling legislation, removing barriers to conservation, reforming or creating policies, institutional structures, and management procedures, generating relevant knowledge, and building partnerships between agencies, local communities, and the private sector. Activities o f this type under Component 2 o f the project include strengthening the capacity o f national institutions such as CONAFOR, community associations, NGOs, and academic institutionsto support development o f PES markets in Mexico. Component 1 activities will help create an enabling environment for development o f a PES market in Mexico and generate financial resources for the PES program. 60. Developing market incentive measures. Through this type o f activity in SP2, the GEF seeks to support innovative market incentive structures (such as demand and supply side interventions, certification o f suppliers, purchasing agreements, and codes o fconduct) that would catalyze market forces. Indoing so GEF seeks to develop partnerships with private sector stakeholders, small- and medium-size enterprises, and others to catalyze the development o f innovative processes and activities that improve market efficiency and the ability to provide biodiversityand productive system gains. Activities o f this type under Component 1o f the project will support the development o f PES markets whereby land users will receive economic incentives for adopting and/or maintaining land use practices that generate valuable ecosystem services. The markets will be piloted in eight priority areas that provide environmental benefits at the local, national, and global levels. These mechanisms will support conservation o f natural forest and changes in land use practices such as agroforestry, forest management, reforestation, afforestation, and sustainable agricultural production systems that improve water quality, increase base flows during the dry season, help regulate groundwater and surface flows, and maintain or enhance biodiversityboth on-site and by protecting critical ecosystems. 61. The project would also complement the SINAP I1Protected Areas Project, a GEF co-financed project to strengthen protected areas management. The project's goal i s to promote the conservation and sustainable use of biodiversity in Mexico through the consolidation o f the National System o f Protected Areas (SINAP). Specific objectives are to: 1) conserve globally important biodiversity in selected areas o f SINAP; 2) Promote the economic, social and environmental sustainability o f productive activities in selected protected areas; 3) Promote social co-responsibility for conservation; and 4) Promote the iiiclusioii of biodiversity conservation and sustainable use criteria in development projects and other practices affecting selected Protected Areas. The proposed project would complement the S N A P I1 objective by improving habitats on private lands in buffer zones and corridors around and between protected areas, thereby improving the viability and biodiversity conservation value o f the protected areas themselves. Developing PES markets will also foster and strengthen partnerships between local and national government, NGOs, community organizations, and the private sector and will help promote an integrated ecosystem approach to watershed management. 40 Annex 2: M a j o r Related Projects Financed by the Bank and/or other Agencies Sector Issue Project Latest Supervision Implem. Dev. Bank Financed Progress(IP) Obj (DO) Financial incentives for commercial forest plantations, PRODEPLAN. S S particularly indegradedlands where incentives may be as much Report, 1999 as 65% ofreimbursement of investments. CONAFOWSEMARNAT, inoperationsince 1998. Community Forestry Program, financedby the World Bank, to PROCYMAF I1 S S provide technical assistanceto indigenouscommunitiesand PO07700 ejidos for sustainablemanagementof naturalforests, and to improve their livelihoodthrough diversifying production. Includesa fimd for non-traditional forest productsand non-timber products. CONAFOWSEMARNAT, inoperationsince 1997. World Bank SAL which i s currently supportingthe GOM in Environmental S S reviewing the impact on the environment and naturalresources of Structural relatedpolicies and instrumentsfrom relevant sectors (Water, Adjustment Loan Forests, Energy and Tourism), and developingadequatepolicy (EnvSAL) framework and economic instrumentsto promote sustainable PO74539 development. The World Bank Mexico Environmental - StructuralAdjustment Loan has identified and is addressing some of the most relevant barriers to mainstreamingenvironmental concerns and biodiversity conservationobjectives inproductive landscapeand relevant economic sectors. SEMARNAT, in operationsince 2002. World Bank technical assistance and investment loan supporting Water S S the modernization of the meteorological service, security at dams, Management and aquifer and watershedmanagement.National Water Invest Loan. Commission (CNAISEMARNAT), inoperationsince 1996. PO07713 GEF Grants Administered bv the World Bank The NaturalProtectedAreas projects:FANP Iand SINAP 11, GEF-WB Natural S S have focused on the financial requirementsof administering the ProtectedAreas NPA System, providingfor an endowmentwhich produces System. annual financial yields to support an initial 10 (and eventually 24) NPAs, underthe Mexican Fund for Conservation,aprivate non- profit financial institution createdin 1994with the support o f Mexico's NAFTA partners. I s an institutional mechanismdesigned to reorient rural/regional GEF-WBMexico- S S development investment in4 States inthe SouthofMexico, to Mesoamerican foster biodiversity-friendly investmentsinthe connectingareas Biological betweenNPAs inChiapas andthe YucatanPeninsula,on the Corridor (MBC), southernborder of Mexico with Guatemala andBelize. PO60908 Complementaryto the Community ForestryWorld Bank loan GEF-WB S S designedto assist poor peasant and indigenous communities in Indigenous and 41 sustainable forest management, and to improve their living Community conditions. Operates inthe States of Oaxaca, Guerrero and Conservation. Michoacan, inareas where satellite images show the best PO66674 conserved forests on communally ownedproperties. An innovative approachto conservationthat recognizesthe fact GEF-WB S S that 90% ofNatural ProtectedAreas are on privately owned lands Medium-size (individualand communal properties), where there are no project Private incentivesor legal agreementsto promoteor guarantee adequate Lands Legal and participation by, or commitment from, the owners to conserve Financial their lands. Conservation Mechanisms PO65923 Developeda systematicapproachto carbonsequestration Hillside S S methodologieson poor quality hillside lands. Management PO772I 3 Developedcertification mechanismsto take advantage of niche El Triunfo S S marketsfor biodiversity-friendly coffee from plantationsinthe Productive buffer area of abiospherereserve. Landscape PO60558 Other DevelovmentApencies Two relatedprojects supportedby the GEF through UNDP, to promoteparticipation GEF-UNDP Three Priority of localplayers inconservationefforts headedby the National Commission for Eco-regions and the Sierra Natural ProtectedAreas (CONANPISEMARNAT). Both could be candidates for a Gorda Biosphere Reserve hture decree to create new protectedareas, or to producenew instruments to promote sustainable practiceswhilst conservingbiological diversity. Another initiative i s the Indigenous and Biodiversity Consewation Project (COINBIO), also orientedtowards goodmanagement of biological diversity and basedon capacitydevelopedby, and the extensionmechanismsof, PROCYMAF and PROCYMAF 11. Permanent program operatedby CONAFOWSEMARNAT with the participation of Forest Fire Prevention and local communities, governments and the military, and financially assistedby bilateral Combat Program. NorthAmerican co-operationagreements. 42 Related Projects and H o w They Interact with and are Related to this Project Gov. responsible, manager, estimatedproject amount and termination date (to Initiative confirm), and possible synergies Environmental Structural Adjustment Loan (EnvDPL) Dr. Fernando Tudela covers 4 strategic sectors Energy, Tourism, Water and Forests Ernesto Sanchez Triana The major institutional reforms sought inthe forestry sector are US600 M 1 Long Term Planningand harmonization of public 2008 expenditureprograms Developmentof the policy framework and financial mechanismsfor the 2 Creation of a specialized agency strengthening of the forest sector, promoting actively the development of new 3 PromotionofNon Timber Products instruments for consolidating new products and services 4 EstablishmentofPES schemes 5 Establishmentof afinancial mechanismand forestry fund Community Forestry (PROCYMAF 11) focuses in creating Ing. Carlos Gonzalez Vicente capacity inthe rural producers andthe professional service James Smyle piivate providers. facilitating their participationintimber, non US 30M timber products and environmental services markets 2007 Developmentof local capacities, of coinmon lands and communities to participate innew markets, with new products and services Access to Land by Young Farmers & GEFpromotesland use Secretaria de la Reforma Agraria planningto seclude areas for conservation and improve Friederich De dinechin productivity by fostering access of young farmers to plots US IOOM presently ownedby older elido workers The GEF partially 2008 blended grant aims at reducingthe threat to conservation Implementation of conflict resolution mechanismsto handle disputes over the repiesented by the lack of security in land tenure property and usufruct of the land in order to increase the eligible areas, specifically where lose studios hydrologic or of other services signaled as priority Water Management Invest Loan (GICA) promotesa Ing. Cesar Herrera watershed approach to improve the managementof basins and Douglas Olson aquiferswhich require concertedreducedabstraction, US 120M restoration, conservation.The hydrologic studies and 2011 strengtheningof water user organization will create a great Exchange of informatlon relative to studies of availability by basins and aquifers business environment for the establishmentof local PES and relation to the agencies of basin whose strengthening is hoped to achieve arrangements. through GICA. increasingthe interest and capacity ofthe users to handle and conserver the basin, including the Inc recognition , , .. .... , ,,. ... .............. ,, ,,,..... ... . ............... .................,....... .... ... ..... ........, ., GEF-WB Natural Protected Areas System (SINAP). The Dr.Ernesto Enkerlin Natural ProtectedAreas Fundwas createdto guarantee Adriana Moreira sustainabilityThe projectsglobal objective is to promote the U S 31 M conservationand sustainable use ofbiodiversity inMexico 2005 through the consolidationofthe NationalSystemofProtected The coordination with the technical teams of the ANP have been very Areas (SINAP). Project development objectives are to: 1. advantageous inthe instrumentation of the environmental services program and Conserveglobally important biodiversity in selectedareas of could be strengthened in a concertedway to take advantage ofthe resources of SINAP, 2. Promote the economic, social, and environmental the SINAP project inorder to develop the capacities of the participating owners, of the public opinion and particularly of the potential donors to the fund of Inc sustainabilityifproductive activities inselectedprotected areas; 7 J . Promote social co-responsibilityfor conservation; andPromote the inclusion ofbiodiversity conservation and sustainableuse criteria indevelopmentprojects and other practicesaffecting selectedPas. 43 GEF-WB Mexico-Mesoamerican Biological Corridor M.C. Pedro Alvarez Icaza (MMBC). The rationale for GEF involvement derives from the James Smyle opportunity to mainstream biodiversity inthe regional U S 1 4 5 M developmentprograms in Southeastern Mexico and re-orient 2007 public iiivestment towards biodiversity friendly activities. Inthe states of Chiapas, QuintanaRoo, Yucath, and Campeche, this project promotesinterinstitutionalcoordination to improve the productivity of activities with low environmental impact andto promote conservation of vegetation cover in the corridors connectingANPs Paymentfor environmental services i s one of the activities with greatest potential to achievethis and its promotion could be carried outjointly, in the searchfor sustainable local arrangements GEF-WBIndigenous and Community Conservation NAFIN (COINBIO) The project focuses on supportingthe traditional James Smyle institutions which have allowed poor indigenouscommunitiesto US 7M conservetheir forest while most ofthe surroundingareas have 2007 suffered encroachment The project already supports the local organizations and gives training to potential suppliers of environmental services GEF-UNDPSierra Gorda Biosphere Reserve focuses on local Dr.Ernesto Enkerlin participatory planning of the sustainable use and conservationof PNUD their natural resources Sierra Gorda is supportingtechnical US 7M studies and capacity buildingto participate in environmental 2006 services payments and carbon markets The project already finds support the organization andtraining of potential providers of environmental services GEF-UNDPThree Priority Eco-regions. The project focuses Dr. Ernesto Enkerlin on local participatoryplanning ofthe sustainable use and PNUD conservationof their natural resources, supportingtechnical US 7M studies and capacity building 2006 The project already finds support the organization and training of potential providers of environmental services PHRD Shade Coffee-Carbon Sequestration. SAGARF'A is Colpos developing a series of shade coffee proposalsfor carbon ChristianPieri markets US0 750 M 2004 This project contributed with the methodologyto estimatethe capture of carbon in crops of slopes PCF/BCF Los Tuxtlas Carbon Sequestration. Conafor is Ing. Carlos Gonzalez Vicente preparing a carbon sequestration proposal for the PCF-BCF in Mark Austin the Los Tuxtlas reserve. U S 2 M 2011 .. .. ... ..................................., ..... .... ,... ...... .. .... ..... ....................... .... .. .. .................. .... ..... ... .... Opportunity to pin down a semicommercial PES scheme for carbon capture. MSPGEF-WBPrivate Land Conservation. Legal and Lic.Martin Gutierrez (Pronatura) Technical Tool Kit.The project was completed in2004 and Ricardo Hernandez producedatool kit of financial and legal instruments, including US0.750 landeasements, to support conservation inprivateproperties 2004 (individualproprietors,ejidos and indigenous communities). A The project contributed with a manual for the application of legal tools inorder to legalstatus was recognizedto private reservesinitially intwo guaranteethe fulfillment of commitments of long-term conservation when the states legislatures. - donors thus require it. MX Productve Restoration in Mixteca Region This initiative Raul Hernandez Garciadiego (Alternativas) focuses on the capturing lessons from a 30 year experience ina Juan Martinez participatory watershed managementlocal iniciative US 0 200 M 2006 The systematization of the experience in conservation of the hydrologic basin of Tehuacan can yield importanttechnical and social lessons for PES 44 Annex 3: Results Frameworkand Monitoring MEXICO: Environmental Services Results Framework PDO/GlobalEnvironment Use of Outcome 0bjective OutcomeIndicators Information Projectdevelopment objective 4t least, 600,000 additionalhaunder YR1-YR3: LOW i s to enhance the provision o f mvironmental service contracts, o f implementation levels may environmental services o f national which: indicate ineffective and global significance and secure institutional arrangements or their long-term sustainability. :a) Financed from existing sources: poor selection o f land uses This would be done by - at least, 500,000 additional promoted by the PES system. strengthening and expanding the hectares under environmental YR4: feed into strategy for national PSAHand CABSA service contracts that contribute replicating PES program. programs and supporting the to increased hydrological, establishment o f local payments for biodiversity conservation and environmental services (PES) carbon sequestration services; and mechanisms in selected pilot areas. Ib) Financedfrom new sources The objective will be achieved xtablished under the project: through the following key - 100,000 additional hectares outcomes and outputs (i) underenvironmental service strengthening the capacity o f contracts aimed at increasing CONAFOR, community hydrological services, associations, and NGOsto biodiversity conservation, and increase flexibility and improve carbon sequestration. efficiency o f existingservice provision to support long-term Stand-alone local PES mechanisms YR1-YR2:Develop and development o f the PSAH jesigned for at least two pilot sites refine additions to the program inMexico; (ii) For contracting (buyingand operational manual for PES establishing and securing Zenerating) environmental services on how to develop local sustainable long-term financing in priority areas, including fundingmechanism. mechanisms; (iii)establishing Functioning M&E systems by EOP legal, institutional, and financial YR4: feed into strategy for arrangements to pilot market- replicating PES. based mechanisms for payment for environmental services, (iv) 4t least 15 proposals for carbon YR1-YR4: Assess whether documenting links between land sequestration projects are submitted targeted milestones are being use changes and water services :opotentialbuyers. accomplished and make improvements and biodiversity adjustments. conservation, and (v) defining good practices to replicate, scale [nstitutional arrangements for YR1-YR4: Assess whether up, and sustain market-based PES FacilitatingPES mechanisms institutional arrangements are programs. nanagement and learning sufficient to establish and :stablished, properly staffed, and maintain PES program. Make "esourcedto continue beyondthe adjustments as needed. EOP to replicate and scale up narket-based PES program. 45 'DO/Global Environment Use of Outcome )bjective OutcomeIndicators Information CONAFOR and INEuse (a) state-of- r'R1-YR4:Monitoring the-art techniques and procedures to nstitutional capacity to monitor data on implementation and lesigii and implement impacts o f both the national PES nethodologies to measure the program and local pilot PES mpact o f land use changes mechanisms (such as vegetation HI environmental services. cover, land use practices, ecosystem 4djust institutional and habitat conservation, indicator itrengthening activities if species o f conservation interest, ieeded. water discharge, sediment production and transport, biochemical oxygen demand, and total suspended solids); and (b) information to evaluate and draw conclusions on (i) the links between land use changes and environmental services, (ii) buyers' responses, (iii)community acceptance of the PES mechanism, and (iv) sustainability o fthe mechanism measuredby the ratio o f payments from local buyers o f ES and CONAFOR's operational costs. rhe global environment The new area enrolled includes at YR3-YR4:Monitoringo f )bjective o fthe project is to least 200,000 hectares o f forests and land use changes impact on mhance and protect biological other natural ecosystems o f global biodiversity to assess effects. jiversity and preserve globally biodiversity significance under ;ignificant forest and mountain effective conservation (protection xosystems. and sustainable management) by landowners before EOP inthe buffer zones o f protected areas and the corridors that connect them, includingthe Mexican portion o fthe Mesoamerican Biological Corridor. 200 PES contracts to conserve forest5 YR3-YR4: Monitoring o f or other natural ecosystems by EOP. land use changes impact on biodiversity to assess effects. 46 'DO/Global Environment Use of Outcome 1bjective OutcomeIndicators Information Zffective biodiversity conservation in YR3-YR4: Monitoring o f :heproject sites measured by land use changes impact on Jegetation cover and indicator species biodiversity to assess Ifconservation interest. effects. [mproved water services in pilot YR3-YR4:Monitoring of vvatersheds measured by indicators water quality impacts from ippropriate to local uses, such as and use changes. Used to seasonal mean and peak flows, idjust types o f land use "eduction o f sediment production and :hanges and volume o f ;ransport, biochemicaloxygen demand :hanged needed to generate :BOD) and total suspended solids. ncreased water quality. mtermediateResults One per Component) ResultsIndicators Use of Results Monitoring Somponent One: ComponentOne : ComponentOne: leveloping Sustainable FinancingFinancing mechanisms based on local Develop and refine additions vfechanisms: Financial demand are in place in at least six to the operational manual for vfechanisms for Water, sites. PES on how to develop local 3iodiversity and Carbon have fundingmechanism. YR4 )een created feed into strategy for replicating PES. An endowment fund for biodiversity YR1-YR2:Develop legal conservation has been establishedto and institutional provide long term funding for arrangement for the fund. biodiversity o f global significance by project year 3; A strategy has been developed for YR2-YR3:Lessons from capitalizingthe endowment fund by other countries and project year 3; implementation o f the various PES programs inthe country. A low level o f capitalization amount may indicate ineffective strategy and/or its implementation. A biodiversity conservation funding YR1-YR2:Develop legal window has been established within and institutional FFMby project year 2; arrangement for the fund. 47 [ntermediateResults I :Oneper Component) Results Indicators Use of Results Monitoring Clomponent Two: Component Two: Eomponent Two: leveloping and Strengthening Operating rules for the PSAHand YR1: More targeted and 'ES Delivery mechanism: CABSA programs are modified to a jifferentiated payment ZxistingPES Programhave been more targeted, differentiated jcheme have been identified ;trengthened, Local Stand-alone payments, in which the definition o f md agreed on. 'ES Programs have been eligible areas and the payment levels stablished and a Matching Fund offered is undertaken on a regional xogram will be operating rather than nationalbasis by end o f year 1. Monitoring (compliance and impacts) YR1: M&E system i s systems o f PSAH and CABSA developed and adequate programs are improved and under resources are budgeted. iinplementation by end o f project year 1. Substantial increase inthe efficiency YR1-YR2: Flags possible with which PSAHEABSA funds are payoffs or other problems in used in at least 75% o f area contracted compliance, and needto inpriority areas. adjust project implementation. YR2-YR3: Evaluation o f changes introduced before. Appropriate contracting, monitoring YR1: Differentiated and payment systems have been payment scheme have been developed and under implementation identified and agreed on. inat least 2 watersheds to runthe stand-alone PES Programby EOP. YR1: M&E system i s developed and adequate resources are budgeted. Component Three: Component Three: Component Three: Supporting Environmental ServiceCommunity Promoters with site- YR1: Community promoter! Providers: Technical and specific knowledge have been selected who are familiar Organizational Assistance recruited and trained to either provide with both PES and the local TA or identify TA needs and help area. contract TA services. YR2: Training provided to promoters. 80% o f service providers are satisfied YR2-YR4: Service withthe timeliness and quality o fTA. providers contact/follow up with the promoters. 48 I 4t least 75% ofPES contracts inpilot YR2-YR4: Site specific sites are for ejidos, communities and nonitoring indicates that small individual landholders (with less 3arriers have been :han 200 ha) ninimized for all eligible Iandholders. Results Indicators Use of Results Monitoring Component Four: Component Four: Component Four: Payment to Service Providers FFMwill continue to receive at least YR1-YR4: Flags any US$30million a year. potential problems with demand o f PES, and adjust project implementation. Participation o f ejidos inpilot sites YR2-YR4: Site specific increased by 50% over the national monitoring. merage. Component Five: Component Five: Component Five: Project and Program Management CONAFOR project staff, including YR1-YR4: Annually assess regional promoters, inplace and functioning o f project functioning at all times duringthe human resources in project with sufficient capacity to implementing project carry out all project activities. activities and make ' necessary adjustments Annual performance evaluations o f YR1-YR4: Annually CONAFOR project staff to be performance evaluation conducted. indicates staff competence. A project management information YR1-YR4: Annually assess system to be installed and functioning functioning o f project during the life o f the project. management information system and make necessary adjustments Quarterly physical and financial status YR1-YR4: Reports are reports prepared and submitted to the satisfactory to the Bank Bank. Semiannual documents on lessons YR1-YR4: Reports are learned and policy implications are satisfactory to the Bank prepared. To coincide with supervision missions. 49 Planning process to be followed as YR1-YR4: AIP and PIP defined inthe Operations Manual developed and are describingwhen and how Annual satisfactory to the Bank Implementation Plans (AIP) and quarterly and monthly plans will be prepared based on Project ImplementationPlan (PIP). Project communications strategy YR1-YR4: Project developed and implemented. communication strategy reflects lessons learned and includes mechanisms to reflect on experiences; Arrangementsfor results monitoring 1. Monitoring and evaluation has been mainstreamed into almost all project components and will be conducted at three levels: (i)contract compliance, (ii)impact monitoring, and (iii)project implementation. Table A3.1 shows monitoring and evaluation costs by subcomponent. Table A3.1: Monitoringand EvaluationCosts(millionUS$) Component cost 1A.Development o ffinancing mechanisms from water users 0.3 1 1B. Development o f financing mechanisms from biodiversity users 0.23 1C. Development o f financing mechanisms from carbon users 0.20 2A. Strengthening o f existingPES programs 0.63 2B. Support development o f stand-alone local PES programs 0.06 3B. OrganizationalAssistance 0.7 1 3D. Technical Assistance 0.15 5D. Project and ProgramMonitoring and Evaluation 1.20 Total 3.49 2. The project staff in CONAFOR will be responsible for overall project monitoring, including the activities of both the new and existing PES mechanisms. CONAFOR will aggregate M&E inputs for project-level decisionmaking and reporting. The baseline, beneficiary assessments, and impact evaluation studies will be contracted out, and the CONAFOR staff will be in charge o f coordination and technical supervision o f the studies. CONAFOR will provide overall project oversight, NAFIN will provide financial and procurement oversight, and World Bank staff and consultants will conduct periodic supervision missions. 3. By project launch an M&E system and methodology will be put in place to track project implementation, compliance o f land users with services contracts, and progress in attaining results. The system will have six modules: (i)a Management Information System to track results and financial indicators and provide feedback for decisionmaking; (ii) environmental services contract compliance; (iii) 50 ainiual beneficiary assessments to report target groups' perceptions; (iv) site-specific monitoring and globally significant biodiversity and hydrology evaluation studies to quantify land use changes/impacts and environmental services produced, with baseline assessments for each site and each contract and both inidterm and final project studies; (v) data collection to better understand causal links between land use changes and environmental services; and (vi) standard auditing and supervision missions at least twice a year to review the technical, fiduciary, and safeguards aspects o f the project. 4. The project would be guided by semiannual learning reviews o f project results to coincide with Bank supervision missions on which basis CONAFOR and the Bank would identify specific measures to: (i) address any areas of implementation weaknesses; and (ii) project design to ensure objectives are adapt met. These measures for improvement would be reflected in the CONAFOR semiannual learning reports and their proposal for the forthcoming year's Annual Implementation Plan including project budget. It is expected that CONAFOR would involve third party, independent evaluators for environmental contract monitoring and to perform technical biodiversity, carbon sequestration, and water quality impact studies. 5. Institutional issues: Monitoring and evaluation o f project outcomes/results (both intermediate and end of project) will be coordinated by the project staff in CONAFOR. Trained staff from specialized agencies and NGOs will have the responsibility to collect and analyze field data, while the CONAFOR project staff will archive and distribute relevant and timely information to assist in effective decisionmaking for project management. 6. The monitoring and evaluation process will function as a mechanism for assessing project impacts and as a day-to-day management tool. An M&E system will be developed to provide accountability and to strengthen the capacity o f CONAFOR for planning and monitoring o f overall project activities. The M&E system will also support the project supervision process by ensuring that baseline and follow-up data for the key performance indicators are collected and made available on an ongoing basis and at strategic times including project start-up (underway before project effectiveness), inidterm review and project closing. A baseline study will be carried out at inception, and follow-up evaluations at both midterm and project closing. Site-specific baselines studies will be performed before work begins in the pilot areas and baseline studies will be phased in on the national PSAH and CABSA programs. Site-specific follow-up evaluations will be carried out to measure impacts o f land use changes on anticipated environmental services. Specific project implementation monitoring data will be provided on agreed upon report formats, included in the Operations Manual, and will be required for the twice- yearly supervision missions. CONAFOR will develop the project monitoring system that would record the planning, physical implementation, performance o f local technical assistance, and development objective indicators from the project's Results Framework. 7. NAFINwill monitor financial and procurement management for the project as a whole. Financial information on inputs, outputs, budgeting, treasury, accounting, and audits would be monitored. The project will send to the Bank quarterly financial management and procurement reports. Monitoring and processing o f procurement of services, goods, works, and sub-projects would be carried out by the CONAFOR's project staff in coordination with NAFIN. The annual planning processes would be monitored with specific indicators on planning performance defined in the Results Framework. The physical implementation o f the project would be monitored based on the specific outputs and monitoring indicators for the project components as defined in the Results Framework. Information from the monitoring system would be analyzed by project management and disseminated according to the project's communication strategy to appropriate stakeholders. The project would provide the Bank with progress reports every quarter and an update on legal covenants compliance every six months. 8. Data collection: The CONAFOR project staff will coordinate collection o f component results indicators. Data for monitoring and evaluation o f Component 1 will come from the geographic 51 information and statistical reports from CONAFOR regional promoters, community promoters, and NGOs acting as PES transaction intermediaries. The regional promoters and NGOs will also monitor contract compliance from farmers inthe project area watersheds and from the external annual audits. 9. Semiannual Evaluations. One o f the objectives o f the project is learning how to implement an effective market-based PES program in Mexico. Semiannual learning workshops are planned to coincide with supervision missions to identify and discuss lessons learned during project implementation with project stakeholders and beneficiaries. The project staff will submit semiannual reports on lessons learned and plans for incorporating those lessons into future activities. 10. Midterm evaluation. The Bank's supervisionteam, together with a team o f external reviewers and key stakeholders, will conduct a midterm evaluation o f project execution. It will be conducted no later than thee years after o f the first disbursement. The external review will focus on (i)progress in achieving project outcomes, (ii)institutional arrangements for project implementation, (iii)operational manual[s] for payments for environmental services mechanisms, (iv) effectiveness and suitability o f the monitoring system, and (v) review o f both the project implementation plan and general project operation manual. In preparation for the MTR the CONAFOR project staff will prepare reports on the key elements o f the PES system: (i)perceptions from key stakeholders; (ii)assessment of institutional arrangements and recommendations; (iii) scientific lessons from the links between land use and environmental services; and (iv) progress on biodiversityconservation. 11. Final Evaluation.A final evaluation will be conducted in the last semester o f project execution. The key objectives of the final evaluation will be to (i) attainment o f the expected project results, assess (ii)usethe results to designa strategy for replicationinfuture projects, and(iii)design a strategy for mainstreaming future market-based PES programs. 52 %m I % c c m m .3 I Q hl p: .-C 0 >i Y 2 8 0 10 m .3 I c d d N c 8 2 0 8 .e c 0 c. 2 e, I r- m \o 6 MIA d .-c c a 0 0 8 10 N c a I 0 0 2N 0 0 N 0 2 %I * I e : II 8Z u -2 m a N .-e, e, m i 2 Guidelinesfor monitoring theproduction of hydrologic services due to land use changes 12. Scope. These guidelines serve as a starting point for assessing, designing, and operating monitoring systems for environmental services and hydrologic changes associated with planned or unplanned land use changes. Their purpose is to support the design and implementation o f PES projects on the assumption that the sustainability of such programs rests on the ability to demonstrate a causal relationship between the land use changes proposed and the environmental services promised. The problem i s to establish a structured monitoring system to assess the environmental services delivered with and without the project interventions. 13. It is very difficult to attribute a set of interventions with causality for the system response to a particular event, especially when a series o f highly complex and time-variant / time-dependant physical and ecological processes are involved. This task is made even more complex when the interventions are carried out in only a small fraction o f the watershed; when the interventions "evolve" with time; and when a specific link is sought between the interventions and a particular hydrologic outcome. As in all exercises to design a monitoring system, special care should be given to developing good technical definitions that are amenable to analytical treatment. 14. In addition, analyzing basin responses ideally requires a long series o f high-quality measurements. In experiments by the U S Forest Service, for example, hydrological response changes are assessed by first monitoring a set of comparable basins for nine years to define baseline conditions and then monitoring one of the basins for another nine years while it is "treated" or subjected to interventions. This ideal approach underscores that a meaningful assessment o f hydrologic change requires at least a medium-term time frame and a group o f "control basins" to help factor out other variables. 15. Inthe case of the Mexico PES program there is already sufficient historical hydrological and land use data available, as well as knowledge about the processes by which environmental services are produced, to build, calibrate, and verify models characterizing a baseline for each area inwhich local PES mechanisms will be piloted and against which changes in environmental services can be measured. Such modeling can also be applied to the existing PSAH program to measure impacts in areas already under PES contracts as well as innew areas to be included inthe nationalprogram under the proposed project. 16. Approach. The suggested approach for monitoring impacts is to follow a stepwise procedure in which: a. Baseline conditions are characterized. b. Environmental services to be provided are identifiedand characterized, as well as the interventions to produce the desired outcomes. C. Monitoring strategies are defined to measure the implementationo f interventions. d. Scientific descriptions are provided o f the processes by which the environmental services are thought to be produced inresponse to the interventions. e. Key steps or points inthe productionprocess are identifiedwhere changes are measurable. f. Data acquisition systems are designed to measure key points inthe process. For data characterizing interventions emphasis should be given to those elements or variables that better relate the proposed interventionto the expected environmental services. Inreference to the watershed hydrologic response, emphasis should be placed on elements/components/variablesthat leadto the quantification or estimation o f the environmental services for which willingness to pay has been identified. g. Data analysis i s structured to assess the probability o f different response functions (scenarios). 58 17. Environmentalservices associatedwith land use changes. The hydrological services that can be enhanced or preserved as the result o f planned interventions, and for which members o f the coinmuiiity are willing to pay, will vary between watersheds and communities. Some o f the possible hydrological responses resulting from an increase in vegetation cover or implementation o f new soil practices include changes in: 0 Probability distribution o f floods (peak flows, flood levels) 0 Probability distribution o f low flows 0 Probability distribution o f mean daily flows (as expressed in the flow duration curves); 0 Sediment rate curve (sediment transport) 0 Nutrientload 18. Ecological changes are also associated with the hydrologic response changes and might be considered elements o f the watershed reaction to climate stimulus. Under the general hypothesis of nonvariant climate, land use changes and the corresponding hydrologic response affect the behavior o f aquatic and riparian ecosystems along waterways, ponds, and wetlands. In-stream water uses (such as maintenance o f aquatic biodiversity) are important in selected watersheds and deserve particular attention. 19. Steps in designing a PES monitoringsystem for hydrologic services. The following sections should be developed while designing hydrologic monitoring systems to support PES programs: 0 Baseline characterization 0 Identification and characterization o f "environmental services" sought 0 Identification and characterization o f interventions 0 Monitoringo f interventions 0 Hydrologic modeling and preliminary verification ' 0 Use o f hydrologic models to guide the design o f monitoring systems 0 Assessment o f likelihoods for selected outcomes (data analysis and information use) 20. Institutional arrangements. The PSAH monitoring program would receive guidance from an interinstitutional group o f specialists through a Scientific and Technical Advisory Group (STAG), a subgroup o f the advisory committee, with the following proposed membership: 0 Participatinginstitutions 0 Science and research groups 0 Internationaladvisor(s) 21. As part o f the advisory committee, the STAG will meet at least once a year to review the latest monitoring reports, interact with scientific and technical personnel collecting and analyzing field data, provide comments and suggestions, and schedule international workshops on subjects relevant to better understanding the production o f environmental services. 22. Once a year CONAFOR will sponsor an international workshop to review and assess the state-of- the-art scientific and technical information on issues related to monitoring PES projects, Topics might include hydrologic modeling, instrumentation, remote sensing, and modeling and measurement o f erosion processes, water quality, and land use. 59 Annex 4: Detailed Project Description MEXICO: EnvironmentalServices 1. The proposedproject would increase substantially the development o f markets for environmental services in Mexico by (i) developing new, sustainable financing mechanisms for environmental services, which could be channeled either through the existing PES programs or through new, stand-alone local PES mechanisms; (ii)strengthening and improving the efficiency o f existing PES programs (PSAH and CABSA); (iii)stimulating the development of stand-alone local PES programs; and (iv) assisting local communities in service provision. 2. Figure A4-1 illustrates the main components o f PES programs, and how the various project components support their development. Component 1 focuses on developing sustainable financing mechanisms. Component 2 activities support the development and strengthening of PES delivery mechanisms. Component 3 supports environmental service providers. The actual flow o f payments to participants and the ongoing operational costs of the program are tracked under component 4. Finally, component 5 undertakes project management. Component I. Developing Voluntary payments Water fee sustainable financing mechanisms Component 2. Developing and strengthening PES delivery Stand-alone Stand-alone mechanisms local PES I 1 CONAFOR (PSAHICABSA) I I 1 3 Component 3. Assisting Land users L service providers Environmental services - 60 Table A4-1: Project Component Costs and Financing (million US$) I. Developing Sustainable Financing Mechanisms 14.47 9 7.68 53 1.26 9 5.54 38 a. Development of financing mechanisms from water users 1.81 1 0.73 40 0.76 42 0.33 18 b. Development of financing mechanisms from biodiversity 11.78 8 660 56 0.12 1 5.05 43 users - Local PES Program for Biodiversity 1.53 1 138 90 0.11 7 0.05 3 - Development and capitalization of biodiversityendowment 10.25 7 523 51 0.02 0 5.01 49 fund c. Development of financing mechanisms from carbon users 0.88 1 035 40 0.37 42 0.16 18 II. Developing and Strengthening PES Delivery Mechanisms 3.51 2 1.30 37 1.55 44 0.66 19 a. Strengthening of existing PES programs 2.52 2 088 35 1.15 46 0.49 20 b. Support development of stand-alonelocal PES programs 0.94 1 037 40 0.39 42 0.17 18 c. Establishing Matching Funds Mechanismfor Local 0.05 0 0.05 90 7 3 Financing Mechanisms 111. Supporting Environmental Services Providers 9.56 6 3.70 39 4.04 42 1.82 19 a. Community organization and capacitydiagnostic 0.43 0 017 40 0.18 42 008 18 b. Community promoters 0.57 0 023 40 0.24 42 0.10 18 c. Organizational assistance 4.46 3 166 37 1 90 43 0.91 20 d. Technical assistanceand TA grants 4.09 3 164 40 1.72 42 074 18 IV. Payment to Services Providers 127.00 81 1.58 1 37.23 29 72.29 57 15.90 13 a, Paymnents to PSAH participants 100.00 64 34.03 34 65.96 66 b. Paymentsto CABSA participants 9.52 6 3.20 34 632 66 c. Localfin. mech.from water users (est. undercomp. IA) 10.65 7 10.65 1OC d. Localfin. mech.from tourism ind. (est. under comp. IA) 1.80 1 1.80 1OC e. Paymentsfrom carbon buyers (proj. dev. under comp. IC) 3.45 2 3.45 1oc f. GEF Grant 1.58 1 1.58 100 V. Project and Program Management 1.90 1 0.74 39 0.81 43 0.35 18 Front End Fee 0.11 0 0.11 100 ~~ .. Less than $10,000 3. Table A4-1 shows the indicative costs and source o f financing for each component. 4. Key project beneficiaries would be (a) members o f the mostly poor rural ejidos and communities that would be paid to provide environmental services and (b) users o f eiiviroiiineiital services who would receive increased or improved services and/or be protected from degradation o f those services. The global community would also benefit through the conservation o f biodiversity o f global significance and increased carbon sequestration. The project will ensure that only sites with globally significant biodiversity will receive GEF funds under the national or local programs in the project area. Furthermore, all land management systems with PES support under the project (from any funding source) will be biodiversity-friendly (see Annex 10 for details). 5. As detailed in Annex 17, all eight o f the pilot sites where PES systems would be established, strengthened, or continued under the project were chosen to overlap with at least two o f the following high-priority biodiversity conservation designations: (i)existing Natural Protected Areas; (ii) Priority Terrestrial Ecoregions established by CONABIO; (iii)Important Bird Areas that are vital to the survival of endemic species or to protecting key bird breeding, feeding, and migration areas; and (iv) Rainsar Wetlands o f International Importance. 61 Component 1: Developing SustainableFinancing Mechanisms ($14.47 million,of which $7.68 millionfrom GEF) 6. PES programs are intendedto remedy situations in which service providers have no incentive to provide services that benefit others. The incentive provided by PES programs, however, lasts only as long as the payments themselves last-when payments cease, providers might no longer have an incentive to provide services. A fundamental aspect o f PES programs, therefore, i s that' payments need to be long- term. Creating sustainable financing mechanisms that capture demand for environmental services is critical to the development o f PES programs. Current financing for the PSAH relies entirely on an allocation of resources from the current water fee revenue stream, while CABSA i s funded out o f general revenue. 7. The main objective o f this component is to develop new, sustainable financing sources based on payments from service users, which could then be channeled either through the PSAH or through stand- alone local PES mechanisms, as appropriate. To achieve this objective, this component will help develop financial mechanisms based on the main types o f environmental services: water quality and regulation, biodiversity conservation, and carbon sequestration. These financial mechanisms would be piloted in about eight promising sites identified by CONAFOR (see Annex 17). Some sites might focus on a single financing mechanism while others include multiple financing mechanisms, depending 011the services being generated and the interests o f users. 8. The lessons o f other PES efforts indicate that PES mechanisms need to be adapted to site-specific conditions to be efficient. While following guidelines set by CONAFOR, the details o f individual mechanisms will therefore differ in terms o f the specific services they seek to generate and the land uses they support. 9. PES operations will be guided by a General Operations Manual, which will specify procedures for assessing applicability o f the PES approach at potential sites and will guide development of individual PES mechanisms at the sites selected for implementation, each o f which will have its own Site Specific Field Manual. Site selection will be based on factors such as the likely national and global environmental benefits that would be generated, the presence o f service users willing to pay for the services they seek to obtain, the willingness o f land users to change their land use practices in exchange for suitable compensation, and the existence o f institutions that can help implement a PES mechanism. An initial version o f this manual will be prepared prior to the beginning o f implementation, but it i s expected that the manual will be revised frequently during implementation to incorporate lessons learned. A key element of this component i s establishing the monitoring mechanisms, learning processes, and knowledge base to replicate the approach in other areas. 10. Key outputs from this component include (a) pilot financing mechanisms with local water services in at least seven sites, including some mechanisms that channel payments through the PSAH and others that channel payments through stand-alone local PES programs; (b) pilot financing mechanisms for local biodiversity users (primarily the tourism industry) in at least four sites; (c) development and initial capitalization o f a trust fund for biodiversity conservation to ensure the availability o f long-term funding for cases where water-based payments would be insufficient to ensure conservation o f biodiversity; (d) pilot financing mechanisms for carbon buyers in at least two sites; and (e) replication strategies to expand the use o fthese mechanisms beyondthe pilot sites. 11. Based on these pilot experiences, an analysis will be carried out during project years three and four to create a replication strategy for widespread development o f local environmental services markets inthe country. 62 12. Key inputs for the success of this component include (i)providing the necessary resources for CONAFOR to implement the activities; (ii) providing adequate resources to design and implement the operational manual; and (iii)providing resources to design and capitalize the biodiversity endowment fund. Subcomponent 1A: Development ofJinancing mechanismsfiom water users ($1.81million, of which $0.73 millionfiom GEF) 13. The aim o f this subcomponent i s to develop long-term financing mechanisms from water users at each pilot site. Water services are among the most important services that ecosystems provide, particularly in a relatively dry country like Mexico. Land use change can affect the quantity, quality, and timing o f water flows to downstream water users, potentially leading to problems such as seasonal water shortages, lower water quality, or catastrophic flooding. Water services also provide the most promising approach to developing sustainable financing mechanisms, because fees linked to water use can generate a continuous flow o f funds. But such payments are likely to be forthcoming only as long as the water users receive the services they want. 14. At each o fthe promising sites identifiedby CONAFOR, the key activities are: Initial diagnosis of uses to (i)fully understand the nature o f water use and the problems water users are facing or could face (municipal water supply, for example, has very different requirements from hydroelectric power production); and (ii)verify that upstream land use affects the desired services (in some cases problems might originate from other sources, such as overuse o f water downstream or from point source contamination, neither o f which is amenable to resolutionthrough PES).6 Targeted technical studies to (i) clearly identify the specific upstream land use changes that need to be promoted or discouraged and the critical areas in the watershed in which to do so, such as erosive areas if sedimentation i s the problem or groundwater recharge areas if insufficient recharge o f aquifers is the problem; (ii)estimate the size o f the area that needs to be conserved, and the cost o f that conservation; (iii)estimate the likely impact o f conservation in terms of additional services or averted loss o f services; (iv) estimate the value o f this impact to water users (for example, costs avoided); and (v) design a monitoring system that would allow the effectiveness o f PES-supported conservation to be assessed. Promotionalefforts to show water users the benefits and practicality o f PES approaches, including, as appropriate, broad promotional efforts targeted at end-users and more technical information targeted at intermediaries (for example, managers of water supply companies). Negotiations with water users and other stakeholders to agree on payment levels and rules for their use, including agreeing on how payments would be apportioned in cases where there are multiple water user groups, possibly with conflicting requirements. Assistance to water users in establishing appropriate financing mechanisms that could channel payments either through PSAHor through a stand-alone local PES mechanism (with the assistance o f activities under component 2B). 6. Current understandingof the linkages between land use and hydrological flows is imperfect. The role of land uses such as forests in improvingwater quality is well established, for example.Thus forested catchments can substantially reduce water treatment costs. Links to sedimentationandto local-scale flooding are also well established. Linksto dry season water flows, on the other hand, are less well established. The targeted technical studies that the project will support will allow the mechanisms at the pilot sites, at least, to be basedon the best available information (though clearly this will be less than perfect), andto subsequently be adjusted inlight ofthe results of impact monitoring. The lessons learnedhere about what is likely to work (or not) and what is needed will then feed into efforts elsewhere. 63 15. These efforts inthe pilot sites would be backed and complemented by broader efforts, and lead to the development o f a replication strategy. Activities will include: 0 Evaluating experience in other Latin American countries with different approaches to generating financing from water users (for example, charging end-users directly versus using existing financial flows)7 and coordinating payments when there are multiple groups o f users, possibly with different needs. 0 Designing monitoring systems so that they also allow (i)investigation o f specific impacts to improve overall knowledge o f the link between land use and water services, and (ii)testing and validating hydrological models so that they can more confidently be used to predict impacts o f land use change. 0 Developing streamlined diagnostic methods to more rapidly and economically assess the potential for PES at future sites. 0 Developing a range of standardized financing approaches tailored to the main types o f situations encountered (for example, single versus multiple water user groups; high-value versus low-value water uses; avoiding future problems versus addressing current problems) to allow faster implementation o f additional mechanisms. 0 Improving criteria to identify promising areas for implementation o f new local financing mechanisms based on water payments, and application nationwide. 0 Development o f a nationwide replication strategy based on lessons learned for stimulating demand and mobilizing the provision o f needed environmental services. Subcomponent 1B: Development offinancing mechanismsfiom biodiversity users ($11.78million, of which $6.60 millionfiom GEF) 16. The aim o f this subcomponent is to develop financing mechanisms based on local and global biodiversity benefits. In several of the pilot sites, efforts will be made to develop financing mechanisms based on the local, nature-based tourism industry.This effort would be complementedby development o f a biodiversity endowment fund to capture and channel payments for biodiversity conservation from the global community. The incremental resources from GEF will also be used to design local PES programs that conserve globally significance biodiversity. 17. Local PES Program for Biodiversity: Mexico has a growing nature-based tourism industrythat depends on healthy natural ecosystems to attract visitors. This activity will work with the local tourism industry at several pilot sites to develop financing mechanisms under which commercial tourism enterprises contribute on an ongoing basis to support conservation o f the ecosystems from which they benefit. This i s an innovative approach for which there are only a few working examples anywhere inthe world. In the promising sites identified by CONAFOR where there i s significant nature-based tourism, key activities would include: 0 Initial diagnosis o f uses to fully understand (i) nature, size, and structure o f the tourist industry at the the site; (ii)the ways in which it uses biodiversity; (iii) how it i s or would be affected by changes in land use. 7. Both approacheshave been used.For example, the city of Heredia, CostaRica, has added an explicit conservation fee to water bills (Cordero, 2003) while inthe city o f Quito, Ecuador, the water and electric utilities are using part of their current revenues to contribute to aPES fund (Echevarria, 2002). In some cases, new approaches may well evolve: for example, when there are multiple users, payment agreements might be negotiated with a representativeof those users, who might then assess a fee to membersto providethe necessaryfinancing. 64 Targeted technical studies to (i)clearly identify the specific land use changes that need to be promoted or avoided to generate the desired services, including identification o f critical areas within the ecosystems (for example, areas critical to avian biodiversity, when the industry focuses on bird watching); (ii)estimate the size o f the area that needs to be conserved and the cost o f that conservation; (iii)estimate the likely impact, in terms o f improved services or averted loss of services, from conserving biodiversity o f interest to the tourism industry; (iv) estimate the value o f this impact to the tourism industry(for example, changes in the number o f visitors or in the fees it can charge); and (v) design a monitoring system that would allow the effectiveness o f PES-supported conservation to be assessed. Promotional efforts to show the tourism industry the benefits and practicality o f PES approaches, including, as appropriate, broad promotional efforts targeted at tourists and more technical informationtargeted at tourist industryfirms (hotels, tour operators, etc). Negotiationswith the tourism industry and other stakeholders to agree on the level o f payments and rules for their use, including agreeing on how payments would be apportioned in cases where there are multiple user groups, possibly with conflicting requirements. Assistance to the tourism industryin establishingappropriatefinancing mechanisms that could then channel payments either through CABSA or through a stand-alone local PES mechanism (with the assistance o f activities under component 2B). 18. These efforts in the pilot sites would be backed and complemented by broader efforts and would lead to development o f a replication strategy that would include: Evaluating alternative approaches for generating financing from tourisin (for example, charging tourists directly versus assessing fees on tour operators) and coordinating payments when there are multiplegroups o f users. Designingmonitoring systems that allow investigation o f specific impacts, thus improving the overall knowledge o f the link between land use and biodiversity. Development o f streamlined diagnostic methods that more rapidly and economically assess the potential for PES at other sites. Development o f a range o f standardized financing approaches tailored to the main types o f situations encountered (for example, a concentrated versus segmented tourism industry; high-value versus low- value tourism; or avoiding future problems versus addressing current ones) to allow faster implementationo f additional mechanisms. Improving criteria to identify promising areas for implementation o f new local financing mechanisms based on tourism payments, and application nationwide. Development o f a nationwide replication strategy based on lessons learned for stimulating demand and mobilizing the provision o f needed environmental services. 19. Development and capitalization of a biodiversity endowment fund: Since biodiversity conservation in Mexico also provides benefits far beyond those received by the local tourism industry, it i s appropriate that the global community support Mexico's biodiversity conservation efforts. Most global funding sources for biodiversity conservation, however, including GEF and other donors, are not equipped to provide the long-term funding flows that PES programs require. The subcomponent to develop finanancing mechanisms for biodiversity users would also include the development and initial capitalization o f an endowment fund to ensure the availability o f long-term funding for cases where payments from water users or the local tourism industry would be insufficient to ensure conservation o f 65 biodiversity.' This effort will be closely coordinated with similar efforts underway in Costa Rica and El Salvador to establish and capitalize endowment funds for use in PES programs. Specific activities will include: 0 Development o f an endowment trust fund, using best practices learned from previous efforts, including evaluation o f whether to (i)use existing trust funds; (ii)create a new, stand-alone trust fund dedicated to this purpose; or (iii) a window within the Fondo Forestal Mexicano. create 0 Development o f operating rules for trust hiid resources to help ensure that they are used in a cost- effective way for conservation o f globally Significant biodiversity. 0 Initial capitalizationusingpart o f the GEF grant, matched with funding provided by other donors and partly from counterpart financing. 0 Development o f a strategy to attract additional contributions. Subcomponent IC: Development ofJinancing mechanisms?om carbon users ($0.88 million, of which $0.35 millionfiom GEF) 20. Some initial but limited exploratory work has been undertaken on the potential for securing financing through the nascent market for carbon sequestration based on land use. The aim o f this subcomponent i s to strengthen CONAFOR's ability to promote land use change projects that sequester or conserve carbon in forest and agroecosystems while also promoting biodiversity conservation and poverty alleviation. The existing program will be strengthened and commitments under the first five-year implementation period consolidated, while new mechanisms will be explored to complement CABSA and provide added sustainability by linkingproposed land use changes to the international market for carbon sequestration.To this end the project will support (i)strengthening PSAH-CABSA to facilitate their preparation o f projects and proposals to attract funding from carbon markets; (ii)establishing financing mechanisms to improve incentives for land use changes that seek to attract carbon market participants; and, (iii)analyzing, designing, and implementing financial instruments to facilitate carbon sequestration transactions between land users, CONAFOR, carbon market intermediaries, aiid carbon buyers. Key activities will include: 0 Establishing a unit within CONAFOR to coordinate efforts to promote, prepare, and transact carbon sequestration services based on land use incoordination with the Mexican C D M Office. 0 Establishing technical know-how and experience in the formulation, evaluation, aiid preparation o f carbon sequestration projects eligible for registration as C D M activities or for financing by other interested buyers. 0 Assessing potential for selling land-use based carbon sequestration under the rules of the First Commitment Period (only reforestation allowed). 0 Improving special targeting o f existing activities. 0 Compiling and assessing available data on rates o f carbon sequestration under different land uses and leveraging ongoing monitoring efforts under the other components to improve understanding o f carbon sequestration under different land uses and ecosystems. 0 Developing methodologies to assess carbon sequestration rates by reviewing and developing approaches for demonstrating additionality; analyzing baseline methodologies for carbon 8. It is not expected that the Trust Fundwould be sufficiently capitalized, by end of project, to finance the conservation of everything that needs to be conserved. Rather, the objective i s to capitalize a TF sufficiently large to make a significant impact, along with targeting rules to ensure it is spent as effectively as possible. As the TF grows, so can its impact, but even a small TF can make a significant contributionby providing funding to otherwise unfunded areas. 66 sequestration based on land use changes, and assessingtheir suitability for Mexico so as to build up a portfolio o f applicable methodologies; and assessing transaction costs and exploring instruments to facilitate the flow o f resources to land users. 0 Working with the BioCarboii Fund and/or other interested buyers to prepare no less than 20 C D M projects for consideration by the international carbon trading community. 0 Facilitating Mexico's active participation in defining rules for carbon sequestration based on land use under the Second Commitment Period, and preparing Mexicoto take advantage o f them. Component 2: Developing and StrengtheningPES Delivery Mechanisms ($3.51 million,of which $1.30 millionfrom GEF) 21. The objectives of this component are to strengthen the existing PSAH and CABSA delivery mechanisms and to support the development of new, stand-alone delivery mechanisms for local PES markets. Having financing is not sufficient; mechanisms are needed to act as intermediaries between service users and service providers. These mechanisms must undertake functions such as determining how best to generate the services that users are paying for, identifyingcritical areas and land use practices to be targeted, negotiating with and contracting service providers, monitoring compliance, making payments, and monitoring impacts. CONAFOR has already created the PSAH (and on a smaller scale CABSA) to undertake this role. However, both PSAH and CABSA are young mechanisms that require considerable strengthening and improvement to increase their efficiency and their capacity to handle the greater and more complex demand generated through component 1 (see Annex 6 on institutional arrangements). 22. A key outcome from this component will be to strengthenthe capacity o f CONAFOR and other iiational institutions, market intermediaries, Community associations, and NGOs to undertake the functions necessary to implement PES programs. In particular, this component would increase the efficiency and effectiveness of the PSAH and CABSA by supporting their evolution toward a more differentiated and targeted set o f programs rather than their current one-size-fits-all approach. A second subcomponent would support development o f stand-alone local PES mechanisms. 23. The incremental resources from GEF will be used for both strengthening the existing PES programs and developing new stand-alone ones that specifically generate global biodiversity benefits. Subcomponent 2A: StrengtheningexistingPESprograms ($2.52 million, of which $0.88millionfrom GEF) 24. Improvingefficiency. A critical lesson from earlier PES efforts worldwide is that to be efficient they must be tailored to local situations: that is, they must target payments to the areas where services are being generated and structure payments based on both the extent o f benefits and the cost o f providing them in each area.' The major thrust o f this subcomponent is to help CONAFOR develop revised operating rules for the PSAH and CABSA programs to convert them from their current one-size-fits-all inethodology to a targeted and differentiated approach in which the definition o f eligible areas and the payment levels offered is undertaken on a regional basis (and perhaps also on a subregional basis if appropriate) based on objective technical criteria." Specific activities would include: 9, Initial lessons from Mexico's PSAH confirm this lesson: the PSAH's current payment scheme, which only differentiates between cloud forests and other forests, has attracted a large number of applicants, but most have been outside the most important areas for water supply. Less than 14 percent of the area enrolled in 2003 and 2004, for example, was located in areas with overexploited aquifers. 10. Among other changes, this would include the capacity of supporting a much broader range of conservation activities. The current PSAH program focuses exclusively on conservation of existing forests.The technical studies to be carried out during 67 Separating the general principles that govern tlie PES program from their specific application in a given location (area-specific operational manuals). Developing and applying a system of operating rules throughout the PES program to ensure that it avoids causing environmental or social harm (see Annex 10 on Safeguards for details). Developing procedures and establishing mechanisms to (i)negotiate with local service users (such as water users and the tourism industry) ifthey wish to contract the PSAH to undertake PES on their behalf; (ii)incorporate these agreements into operational inaiiuals for the affected areas; (iii)report back to service users on land user compliance, impact on the services desired by the service users, and financial accounts; and (iv) resolve disputes that may occur. Evaluating the trade-off between greater efficiency and higher transaction costs resultiiig from improved targeting and differentiation. Evaluating and testing alternative approaches to improve targeting and cost-effectiveness, iiicluding assigning points to applications based on the degree to which they meet various criteria, bidding, or reverse-auction systems, etc. Changing promotion and other strategies so they are case-specific rather than nationwide. 25. Improving compliance monitoring. PES programs make payments conditional 011 compliance with contracts. Therefore, a robust monitoring system needs to be in place to track the impleineiitation o f service contracts. This component will strengthen CONAFOR's capacity to inonitor compliance o f contracts it i s administeringand explore cost-effective methods to undertake such monitoring, 26. Improving impact monitoring. Being able to assess tlie extent to which PES-supported land uses succeed in generating the desired environmental services is critical to tlie credibility and sustained financing o f PES programs. Without such monitoring, mechanisms based on voluntary payments by service users would soon collapse, and mechanisms based on funding from government budgets could be highly inefficient. Technical studies to be carried under components IA, IB, and I C will identify the gaps in current monitoring systems and develop proposals for improving them. This component will assist the relevant institutions (for example, CNA for water, CONABIO for biodiversity) to implement these proposals, including developing appropriate mechanisms to support long-term funding. Monitoring systems will also be leveraged to undertake targeted research to clarify links between land uses and environmental services. Specific activities would include: rn Buyingequipment and training operators. rn Establishinginstitutional arrangement to ensure that monitoring is funded over time. 27. The incremental resources from GEF will be used for both compliance and impact monitoring o f contracts that generate global environmental benefits. 28. Promotional efforts. An important part o f PES programs is raising awareness at all levels o f society o f the importance of environmental services and how PES programs work. PES programs require ample support from the general populationand inparticular those who are participants inthe program and those who are directly affected by the environmental services. Furthermore, it is important to raise the awareness o f service providers and to continue reinforcing lessons and knowledge gained by the PES program. The promotional campaign will be oriented at gaining support from the general population and developmentof individual financing mechanisms may well identify many other conservation activities that might be necessary or desirable at those sites in order to generatethe desiredenvironmental services. A broader range of conservation activities will certainly be supportedunder the new financing mechanisms establishedunder the project, and potentially also inthe broaderPSAHprogram. 68 from the public and private sector, especially the water supply utilities, electricity utilities, and other private and public sector agencies that benefit from environmental services. In addition, the campaign will be oriented at promoting incorporation o f land users into the PES program and retaining their participation. Therefore, a communication strategy will be devised to (i)disseminate information about the PES program's objectives, implementation strategy, and the eligibility criteria; (ii) establish a two- way channel to motivate stakeholders and ensure ownership by beneficiaries; and (iii) a mechanism build for dialogue and exchange o f information between stakeholders (see subcomponent 5D). 29. The main outputs of this subcomponent would include: 0 Revised rules under which new PES contracts (including renewals o f existing contracts) are issued, including definition of eligible areas, criteria for eligibility within these areas, criteria for selecting applicants when applications exceed available funding, activities to be undertaken by participants, payments offered, and other aspects. These rules would no longer be identical nationwide but rather would be differentiated across and within regions according to local conditions (types o f service being sought, nature and severity o f threat to services, cost o f alternatives, type o f ecosystem, etc.). 0 Procedures for incorporating the requirements of external funding sources (for example, funds provided by local water users, or by GEF) into site-specific operational manuals. 0 Institutional capacity to monitor impacts. 0 Institutions sufficiently strengthened to implement and improve PES programs. Subcomponent 2B: Support to the development of stand-alone local PESprograms ($0.94 million, of which $0.38 millionfrom GEF) 30. In many cases, local conditions will require arrangements that differ substantially from arrangements elsewhere, or allow much simpler and cheaper arrangements than is possible in a national program, At the promising sites where such conditions exist, the program will work with interested local service users and providers to help them develop stand-alone programs, complementing the work done on creating financing mechanisms in components 1A and 1B." 3 1. Developinglocal payment arrangements. Although the required functions o f PES mechanism are similar everywhere, the details of the arrangements are likely to vary substantially from case to case because o f the diversity o f conditions encountered. Inmany cases existing institutions, initially created for other purposes, can be used to undertake some o f the necessary functions. No single recipe will be applicable everywhere, Activities under this subcomponent will include: 0 Training workshops on the functions that need to be undertaken to establish a functioning PES program (as listed above); study trips to functioning local mechanisms in Mexico and other countries in the region; and measures to ensure cross-fertilization between groups attempting to develop these mechanisms under the project. 0 Technical assistance, as necessary, on the development o f appropriate contracting, monitoring, and payment systems to service users attempting to develop stand-alone mechanisms. 0 A systematic effort to derive lessons from pilot efforts and development o f a training and dissemination program based on these lessons. 11. The local service users have the option to create their own PES mechanisms, which will also provide incentives to CONAFORto be competitive and cost-effective. 69 0 Development o f a range o f standardized approaches and instruments (e.g. standardized contract types dealing with various situations). 32. A key outcome from this subcomponent will be establishment o f several stand-alone PES mechanisms closely attuned to local conditions inthe promising sites. Subcomponent 2C: Establishing nzatchinghnds mechanismfor localfinancing mechanisms ($0.05 million, of which $0.05 millionfrom GEF) 33. Funds from the project would also be usedto designrules and arrangements for a matching grant program which would provide initial matching funds to financing mechanisms based on local demand (whether channeled through the PSAHICABSA or through stand-alone mechanisms) to help spur their development and overcome initial resistance due to weak data and/or unfamiliarity with the approach. To ensure that this does not become an open-ended subsidy or create perverse incentives to pay for low-value environmental services, these matching funds will (i)never exceed 50 percent o f total payments to service providers; (ii)gradually be phased out over five years; (iii)never be provided until an agreement is in place for the service users to eventually take over the entire payment burden, including transaction costs if they choose to channel funds through PSAH; and (iv) never be provided until initial payments from service users have been received. Financing of matching grants would be provided from financing for Component 4. Component3: SupportingEnvironmentalService Providers($9.56 million, of which $3.70 millionfrom GEF) 34. The main potential providers of environmental services are rural communities known as ejidos and conzunidades agrarias (known collectively as nucleos agrurios). Problems within these ejidos may prevent them from participating, hinder them from delivering the contracted services, or result in equity problems if the costs and benefits o f participation are unevenly distributed between members o f the communities. This component would focus on removing obstacles that may prevent these communities from participating either in national PES programs or local PES mechanisms, with a particular focus on problems faced by poor and/or indigenous communities. Therefore, key activities o f this coinponeiit will facilitate the participationo f environmental service providers inthe PES program. Subcomponent 3A: Community Organization and Capacity Diagnostic ($0.43 million, of which $0.17 nzillionfrom GEF) 35. CONAFOR will conduct a capacity diagnostic o f participating communities to evaluate whether there i s sufficient community organization (Le. legal recognition and defined community organization) and capacity to allow the community to participate inthe PES program. The diagnostic will also identify specific technical areas in which potential participants may lack the expertise needed to participate in the PES program (for example, cost-effective ways to reduce the risk o f forest fires). Communities will be classified by their level o f organization and capacity to participate inthe program. Subcomponent 3B: Communitypromoters ($0.57 million, of which $0.23 nzillion@om GEF) 36. To support communities that need assistance to effectively participate in the PES program, the communities themselves will identify "community promoters" knowledgeable about the local area and recognized and respected by local communities. These community-based promoters, along with the regional promoters from CONAFOR, will work in conjunction with ejidos, communities, and other landowners to identify and develop a plan for creating and/or strengthening the capacity o f service providers and helpingto ensure that vulnerable and marginalized groups, including indigenous groups and 70 women, can participate in the PES program. Furthermore, the strategy will articulate mechanisms to promote transparency in decisionmaking and distribution o f benefits. The work o f the coininuiiity promoters will be supported by the payment o f stipends for the services they provide. Subcomponent 3C: Organizational assistance ($4.46 million, of which $1.66millionj?om GEF) 37. As mentioned above, the ejidos and indigenous communities that are the main potential environmental service providers might be hindered-by lack o f organization or legal status-from participating in the program, delivering contracted services, or addressing equity issues if costs and benefits are unevenly distributedamong their members. For example, some ejidos do not hold regular assemblies, which is a requirement for participating in the program. Those that do not have statutes regulating access and management o f natural resources, or whose statutes are not respected, may be find it difficult to comply with environmental service contracts. Assistance will be provided by the regional and community promoters to facilitate the level o f community organization needed to participate in the PES program. Subcomponent 3 0 : Technical assistance ($4.09 million, of which $1.64millionj?orn GEF) 38. Community promoters will be provided with training inthe areas o f community organization and the identification o f key capacities that community need in order to participate in PES programs. For example, the current PSAH program requires participating providers to conserve existing forest. Even on such an apparently simple matter, technical assistance (TA) on the best and most cost-effective ways of preventing encroachment by livestock or avoiding forest fires may be beneficial. As the PES program becomes more targeted and more differentiated it will, in many cases, require more intensive management of participating areas (for example in reforestation and reestablishment o f native species). Many potential participants, particularly in poorer communities, may require TA to be able to implement the required measures. The activities envisioned inthis subcomponent are: 0 Identifying organizations capable o f providing such assistance (extension services, NGOs, etc.) and contracting them to provide it. 0 Developing the capacity o f environmental service producers. 39. The assistance to the coinmunities may be provided directly to the communities and ejidos by consultants contracted by CONAFOR, or in the form o f grants to the ejidos or communities to contract the technical assistance themselves. The contractual arrangements made with the communities follow standard forms contemplated in the operating rules for CONAFOR's programs and in the Operational Manual. Component 4: Payment to Service Providers ($127.00 million, of which $1.58 million f r o m GEF) 40. The objective of this component i s to ensure that service providers are being compensated and are generating the desired environmental services for which the service users are paying. This component will channel payments for water, biodiversity, and carbon service contracts from the financing mechanisms developed in component 1, through the delivery mechanisms developed and strengthened under component 2, to the service providers supported through component 3. While the bulk of project financing-the actual payments to service providers-is allocated to this component, most of the activities to arrange, structure, and monitor this flow o f financing are carried out under other project components. 71 41. The PES system will only function when environmental services providers are compensated for their services. This subcomponent focuses on ensuring that contracts are signed with service providers that generate specific environmental benefits and that they are paid for the services. Modalities o f land use, site-specific conditions, and expected environmental benefits determine tlie level and source of payments. For example, financial resources generated from GEF cofinancing will fund service contracts that generate global environmental benefits in a particular site. The service contracts are funded through the following potential sources: The financial resources allocated to the PSAH from the water tariff-LFD. It is estimated that the FFMwill continue to receive about US$30 million a year that it does now. Financial resources from water users, generated by mechanisms developed under component 1A. It i s envisioned, based on analysis o f initial demand, that beneficiaries o f environmental services would provide at least US$10.65 million a year by the end o ftlie project. Fees and contributions from tourism enterprises that benefit from environmental services, generated by mechanisms developed under component 1B.It is envisioned, based on analysis o f initial demand of the tourism sector, that these beneficiaries o f environmental services would provide at least US$1.8 million to the fund duringthe project. Financial resources from GEF and the Biodiversity Conservation Endowment Fund, which is primarily capitalized through GEF contribution, counterpart financing and support from other bilateral/multilateralentities. Revenue generated from carbon sales generated from programs support under component 1C. It is estimated that carbon buyers would purchase about US$3.45 million duringthe life o f tlie project. World Bank and government financing for the PSAH and CABSA programs, including both national programs and the matchingfund for pilot areas. 42. It is importantto note that all these funding sources have different restrictions ontheir use. Funds provided by each individual mechanism financed by water users developed under component 1A, for example, will only be available for use inthe upper watersheds that contribute to the water services they seek, Component 2A will put in place measures to allow and ensure that CONAFOR uses these multiple fundingsources appropriately. 43. When local financing mechanisms choose to channel their payments through stand-alone local PES mechanisms rather than through PSAHICABSA, CONAFOR will provide, on a time-limited basis, Mexican government and World Bank matching funds under component 2C. CONAFOR will also track such payments, but will not have any other role in administering them. Component5: ProjectandProgramManagement($1.90 million,ofwhich $0.74 million from GEF) 44. This component focuses on project and program management mechanisms including monitoring and evaluation (M&E) and implementation plans. The component would support new and existing institutional entities and mechanisms at the national and regional level for overall project coordination and supervision and would help strengthen the effectiveness and quality o f project operations. Inaddition, a strong monitoring and evaluation mechanism will be in place to measure performance at various project milestones. 72 45. The component will finance costs for personnel, staff training, and equipment to carry out managerial, financial, and technical coordination through CONAFOR staff assigned to project implementation, including a program coordinator, three subcoordinators (strengthening environmental service providers, financing mechanisms and PES demand, and PES operations), 12 technical staff (social scientist, compliance monitoring, promotion and contracts, committees and payments, natural resource management specialist, agricultural economist, hydrologist, financial economist, technical instruments support, management controls, monitoring and evaluation, and data base and statistical specialist), an administrative assistant, an accountant, a procurement specialist, 8 pilot-area coordinators, 16 regional promoters for pilot areas, and 50 regional promoters for the national program. A summary o f project management activities and functions-divided between human resources, equipment, planning and monitoring, and evaluation-is provided in the subcomponents below. A more detailed description o f functions, responsibilities, and associated procedures i s found in Annex 6 and in the project implementation plan and the Operations Manual. Subcomponent 5A: Human resources ($0.63 million, of which $0.21 millionJFom GEF) 46. The qualifications and stability of project personnel are critical to the project's success. The CONAFOR staff assigned to project implementation are expected to be subject to a rigorous system o f persoiinel selection, evaluation, and performance incentives. Annual perforinaiice evaluations would be conducted based on benchmarks included in the terms o f reference for each position. Project related training will also be providedto project staff. 47. The administrative staff in CONAFOR will carry out overall financial administration and control of financial flows. The operations manual defines detailed procedures and processes for budgeting, accounting, treasury, internal control, and auditing. Prior to project launch the existing program management information system will be modified and operational in CONAFOR. The project's Plan o f Accounts would be broad and flexible enough to accommodate the needs o f both the Bank and the government's budget and audit agencies. 48. Standard World Bank Financial Management Reports (FMRs) would be generated from this system and sent to the Bank quarterly. CONAFOR staff would coordinate annual budgeting with the Ministry of Finance to assure timely release of counterpart funds. The national development bank Nacional Financiera S.A. (NAFIN), would operate the project's IBRD and GEF Special Account, if established, or receive disbursements based on FMRs.Annual project financial reports would be audited by a private accounting firm and under terms o f reference, both acceptable to the Bank, and presented within four months after the accounting period. 49. Procurement-CONAFOR staff would process all procurement to be carried out during the project. NAFIN will solicit all prior review no objections from the Bank. Detailed procurement procedures are included in the operations manual. These procedures include how each type o f procurement will be evaluated and selected with associated evaluation tables and methodology. Contract management arrangements for each type o f contract are also defined. A procurement information system, as part of the project management information system, will be functional in CONAFOR to allow for coordination and timely exchange o f procurement related information and generation o f the Procurement Management Reports on a quarterly basis. Subcomponent 5B: Equipment ($0.03 million, of which $0.02 millionJFom GEF) 50. The objective of this subcomponent is to provide CONAFOR with the required physical resources to manage the project. It includes the acquisition o f basic office equipment, vehicles, hydrologic 73 and biodiversity monitoring equipment, and other goods required to carry out project activities. The incrementalresources from GEF will be usedto acquire both goods and equipment. Subcomponent 5C: Planning ($0.04 million, of which $ 0.02m i l l i o n ~ o mGEF) 51. Annual implementation plans (AIPs) prepared by the project staff and approved by the CONAFOR Governing Board and by the Bank will be the principle tool for coordination between these three entities. The plans must be presented prior to the start o f each budget year and will reflect the activities, goals, objectives, and planned outputs o f each component, including the financial and human resources needed to complete all activities. The plans will also analyze execution o f the previous year's plan and recommend changes to remedy shortfalls in implementation, ifjustified. Subcomponent 5D: Project andprogram monitoring and evaluation ($1.20 niillion, of which $0.51 niillion>om GEF) 52. In view o f the project's innovative approach, exceptional attention will be paid to the establishment o f a rigorous monitoring and evaluation system. The system will have six modules: (i)a Management Information System to track results and financial indicators and provide feedback for decisionmaking; (ii)environmental services contract compliance; (iii)annual beneficiary assessments to report target groups' perceptions; (iv) site-specific monitoring and global significant biodiversity and hydrology evaluation studies to quantify land use changeshmpacts and environmental services produced, with baseline assessments for each site and each contract and both midterm and final project studies; (v) data collection to better understand causal links between types o f land use changes and environmental services; and (vi) standard auditing and supervision missions at least three times a year to review the technical, fiduciary, and safeguards aspects of the project. Given the pilot nature o f the project, an intensive monitoring effort will be conducted to ensure that there is abundant (and internalized) learning on the physical land uses being undertaken, their success in generating the desired services, and the effectiveness o f institutional arrangements. Specific mechanisms for monitoring the quality and quantity of water, sedimentation, biodiversity, and carbon sequestration will be developed to track and clarify links between land uses and environmental services (subcomponents 1A-1 C). 53. Program Management Information System (PMIS). Before project launch, the existing PMIS would be modified to meet new program needs and operational in CONAFOR. The system would consist o f planning, financial, procurement, human resources, evaluation, monitoring, risk management, and communications modules. Some o f the modules would be designed specifically for the project and others would utilize off-the-shelf software and standard databases, word processing, and spreadsheet packages. 54. Risk Management-the CONAFOR staff would be responsible for defining and implementing the risk management mechanism for the project. This would include the processes and tools for (i) identifying and describing internal and external potential risk events; (ii)quantifying potential project risks-what probability and what impact each potential risk event would have; (iii)risk response preparation that defines potential risk mitigation measures; and (iv) risk response control that focus on monitoring potential risk and regularly updating the risk management plan-archiving outdated risks and adding new ones and continuing the cycle from risk identification through risk mitigation. The project coordinator would carry out risk management functions by working with technical specialist and other team members to update and present the risk management plan at the project staffs regular coordination meetings. 55. Communications. Given the project's approach, a specific communication strategy and program will be developed. A communications audit will be carried out as part o f project preparation and a communication strategy acceptable to the Bank will be prepared. The strategy would support a 74 communication program to (i)disseminate information about the project's objectives, implementation strategy, and eligibility criteria; (ii)establish a two-way channel to motivate stakeholders and ensure ownership by beneficiaries; and (iii)build a mechanism for dialogue and exchange o f information between stakeholders. The cominunications strategy will provide inputs for execution o f subcoinponent 4C (Promotional Campaign). 75 Annex 5: ProjectCosts MEXICO: EnvironmentalServices I.DevelopingSustainableFinancingMechanisms A. Development o f financing mechanisms from water users 1,813 1,813 B. Development of financing mechanisms from biodiversity users 11,778 11,778 1. Local PES program for biodiversity 1,528 1,528 2. Development and capitalization o f a biodiversity endowment fund 10,250 10,250 C. Development of financing mechanisms from carbon users 882 882 Subtotal ComponentI 14,473 14,473 11. Developing And Strengthening PES Delivery Mechanisms A. Strengthening of existing PES programs 2,522 2,522 B. Support development of stand-alone localPESprograms 940 940 C. Establishing MatchingFunds Mechanism for Local Financing 50 50 Mechanisms Subtotul Component11 3,512 3,512 111. Supporting Environmental Services Providers A. Community organization and capacity diagnostic 434 434 B. Community promoters 572 572 C. Organizational assistance 4,462 4,462 D. Technical assistance 4,092 4,092 Subtotal Component111 9,560 9,560 IV. Payment To ServicesProviders 127,000 27,000 V. Project And Program Management 1,901 1,901 76 Annex 6: ImplementationArrangements MEXICO: EnvironmentalServices 1. Inaddition to the three main institutional actors with a direct responsibility to the Bank-the loan and grant recipient, financial agent, and executing agency-the Mexico Environmental Services Project will involve a wide range of other institutions and actors that are critical to effective implementation and achievement o f project objectives. These actors and their roles will be described at the end o fthis section (A matrix at the end of the annex provides an overview o f the planned roles and responsibilities of the institutions and actors involved inthe project). MainResponsible Institutions 2. The Ministry o f Finance and Public Credit (SHCP) is the official recipient o f the loan and grant. SHCP i s the only entity o f the Federal Government that has the capacity to obtain external loans and receive donations from international financing agencies and it also assignsthe financial agent for the project. 3. The National Forestry Commission (CONAFOR) will execute the project and be responsible for all technical and fiduciary matters, monitoring and evaluation o f the project, and overall management and supervision o f the grant and loan. Direct implementation will be undertaken by staff in CONAFOR's Department o f Production and Productivity, Office o f Forestry and Management (GSM), which operates the existing PES programs in Mexico (PSAH and CABSA), with financial management and procurement support from CONAFOR's administration department. In addition to the central project staff at CONAFOR's headquarters in Guadalajara, the Commission's regional/state offices will include 8 pilot- area liaisons, 13 regional liaisons, 16 regional promoters for pilot areas, and 50 regional promoters for the national program. Inaddition, community-based promoters, selected by the communities themselves, will help the regional promoters to maintain close links with local communities and leaders, address community-level problems and concerns, and tailor the PES strategy to local conditions. The institutional structure of CONAFOR is shown inFigure A6-1. 4. Nacional Financiera (NAFIN), a federal development agency responsible for managing the administration o f many different projects receiving both national and external financing, will provide overall financial management of the project and any accounts or Special Accounts created for the loan and grant. NAFINwould also be responsible for all formal correspondence with the Bank, including prior review for procurement and consultant contracting. 5. The institutional framework for the project will be legally defined by a subsidiary agreement between the SHCP, CONAFOR, and NAFIN.Annual implementation plans (AIPs), described below, will be the principle tool for coordination between these entities. Structure of CONAFOR and ResponsibilitiesofProjectStaff 6. The highest decisionmaking body for the project will be CONAFOR's Governing Board, which will approve the AIPs and quarterly project reports. It is made up of representatives from the National Water Commission and the ministries o f National Defense, Finance and Public Credit, Social Development, Environment and Natural Resources, Economy, Agriculture, Agrarian Reform, and Tourism. 77 I 00 b - I I I I I I I * I I I I I - I I 7. CONAFOR's implementation of the project will also benefit from the guidance o f an Advisory Committee that was formed at the outset of the PSAH program. The committee's function i s to act as a consultative and advisory body for project design and implementation of the PES project. The committee usually meets every six to eight weeks to review advances in achievement o f project objectives, timetable for project activities, and relevant experiences or developments in PES both in Mexico and other countries. The committee consists o f 17 individuals from government and private institutions, NGOs and academic bodies. This committee includes institutions with technical oversight for biodiversity aspects of the PES programs. The NGOs PRONATURA, the Nature Conservancy, and the Mexican Civil Council for Sustainable Forestry (which operated the first Smart Wood/FSC Certification Service in Mexico), bring with them their broad-based knowledge accumulated through practical experience o f developing projects on environmental issues in Mexico. Academic institutions are represented by two researchers from the National University (UNAM) and the National Council of Science (CONACYT-Ceiitro GEO). The Ford Foundation i s also a member o f the Advisory Committee. The government i s represented on the committee by delegates from CONAFOR, SHCP, and the National Institute o f Ecology (INE). Other relevant players, namely representatives of local PES schemes, will also be invited to join the Advisory Committee. 8. The Advisory Committee will also include a subgroup called the Scientific and Technical Advisory Group (STAG) which will provide guidance for the PES monitoring program. This would be an interinstitutional group o f specialists with members from participating institutions, science and research groups, and an international advisor. As part of the advisory committee, the STAG will meet at least once a year to review the latest monitoring reports, interact with scientific and technical personnel collecting and analyzing field data, provide comments and suggestions, and schedule international workshops on subjects relevant to better understanding the production o f environmental services. 9. Central CONAFOR staff dedicated directly to project implementation will include a program coordinator, three subcoordinators (strengthening environmental service providers, financing mechanisms and PES demand, and PES operations), 12 technical specialists (social strategies and organization, performance and monitoring, promotion and contracts, payments and committees, water markets, biodiversity markets, carbon markets, environmental services evaluation, technical support, management control, impact monitoring and control, statistics and data bases), an adiniiiistrative assistant, a financial management specialist, a procurement specialist, 8 pilot-area liaisons, 13 regional liaisons, 16 regional promoters for pilot areas, and 50 regional promoters for the national program. A summary of project management activities and functions-divided between human resources, equipment, planning and monitoring and evaluation-is provided inthe subcoinponents below. 10. Regionalpromoters will be responsible for proinoting the PES programs, providing support to environmental service providers submitting proposals, monitoring contract compliance, and evaluating results. Specifically,they will (a) arrange meetings with ejido members, communities, small property owners, and associations to plan and coordinate the PES program, (b) promote the program among these groups through meetings and assemblies, respond to public inquiries to the regionalhtate offices, enter proposals from ES providers into CONAFOR's records, keep files with the required documentation for each request, and notify PES applicants o f missing documentation, (c) georeference the plots to be included in the program, (d) conduct field surveys o f the plots that are accepted to verify existing vegetation cover and compliance with conditions o f the PES contracts, (e) notify applicants o f the final decisions of the Technical Committee or other authority reviewing the proposals, (f) sign contracts on behalf of CONAFOR, if authorized, and make contract payments, and (g) write follow-up reports on implementation, compliance, and closing o f all contracts and on other matters related to the program, including compiling data for program monitoring and evaluation. 79 11. Community promoters. A central part of the leadership, technical, and organizational capacity building strategy for ejidos and communities is the training o f community promoters, choseii by the communities themselves, to serve as program facilitators and liaisons with the regional promoters, technical assistance providers, social and indigenous specialists, and CONAFOR in general. The cmmunity promoters are not employed by CONAFOR, but will receive a modest stipend to cover personal expenses, program promotion, and costs for training and travel. The promoters must have strong roots in the community, good rapport with local groups and stakeholders, and be committed to public service. Where appropriate, a promoter may be responsible for two or even three communities. They will follow up on implementation o f community agreements, serve as translators, support the work of technical advisors and regional promoters, keep the community informed o f program developments, and help organize community participation in meetings or other events. They will be deeply involved in community and regional capacity building and participation strategies, will receive trainiiig in management o f public programs, and will share knowledge and and best practices with other community and regional promoters. The community promoters will be instrumental in helpingCONAFOR's regional program promoters maintain close interaction and consultation with local communities and leaders, address community problems and concerns, and tailor the PES strategy to local conditions. 12. The CONAFOR staff and consultants assigned to the project will be responsible for processing environmental service contracts with private landowners, signing environmental services purchase agreements with the private and public sector, monitoring contract compliance, and preparing project reports. Some o f these functions will be carried out or facilitated by the staff or coiisultants in the regional offices (with assistance from the community promoters), as well as by federally recognized Technical Service Providers, NGOs, and other actors contracted by CONAFOR. 13. CONAFOR will maintain satisfactory financial management and procurement procedures during project implementation. The financial management and procurement assessments described in Section D3 have identified areas that need to be addressed. Since project management and implementation is completely integrated into the institutional structure o f CONAFOR, these actions will not only strengthen project implementation, but also yield sustainable improvements inCONAFOR's institutional capacity. ProjectDocumentation, Planning, and Reporting 14. All components will be carried out following the procedures of the Operational Manual for the project. A draft o f the manual will be available before negotiations and will require no objection by the Bank. The Operational Manual will detail the rules and regulations for implementingeach component and the responsibilities o f the project staff in CONAFOR (planning, monitoring, evaluation, institutional arrangements, environmental review, reporting, communication, human resources, risk, coordination, procurement, and financial management). An annex to the Manual will set out rules governing operation ofthe PES mechanisms. The Manual and any changes to it will require no objection from the Bank. 15. The Operational Manual will also contain (a) the financial management, disbursement, and procurement requirements o f the project and the details o f capacity building action plans developed during appraisal; (b) criteria for determining the eligibility o f communities, beneficiaries, and technical assistance to communities as provided for in CONAFOR's operating rules, and any revisions to those rules that are needed to comply with Bank environmental and/or social requirements; (c) model forms of agreement with the beneficiaries o f the technical assistance to be provided to ejidos/communities; (d) the organizational structure o f the staff within CONAFOR that will execute the project; and (e) applicable safeguard documents, including the indigenous peoples plan and the environmental management plan (EMP) that includes sections for natural habitat protection and forests. 80 16. A project implementation plan (PIP) will be prepared by CONAFOR and submitted to the Bank for no objection prior to project launch. The PIP will be broken into annual implementation plans (AIPs), which will be submitted for no objection prior to the start o f each budget year and will include four principal sections: (i)description o f project activities to be executed each year; (ii) Gantt Chart o f the project schedule showing the timing o f activities, relationship with other activities, and responsible entity; (iii) plan; and(iv)procurementplan.TheAIPswillbetheprincipaltoolforprojectexecutionand budget supervision o f the Bank. 17. Annual and quarterly implementation progress reports to the Bank will analyze execution and lessons learned during the preceding year or quarter, within the context o f the AIP, and will recommend adjustments to remedy shortfalls in implementation, ifjustified. FinancialManagement and Procurement 18. Disbursements will be transaction-based against statements o f expenditure (SOEs), full documentation, direct payments, or special commitments, but they may later become based on Financial Monitoring Reports (FMRs) if the Borrower so chooses. Special accounts for the loan and grant, denominated in U.S. dollars, may be maintained and operated byNAFIN.Deposits into the special account and replenishmentsupto the authorizedallocation set out inthe legal agreement would be made on the basis of applications for withdrawals prepared by the project and accompanied by the supporting documentation in accordance with Bank disbursement procedures. Accounting and financial reportingwill be done by the project staff in CONAFOR and NAFIN under Bank rules spelled out in the Operational Manual. Separate accounts will be opened to handle multiple sources o f financing (IBRD, GEF, private sector payments). Auditsofproject andNAFINaccounts will be carried out underTORSby firms acceptable to the Bank. The project includes financing for audits. 19. The main capacity constraints related to procurement and financial management have been detailed in the procurement and financial management assessments. To help the Government o f Mexico address administrative capacity limitations, the Bank will provide sufficient training to CONAFOR's procurement and financial management staff as well as to NAFIN if needed. Annex 7 contains a more detailed description o f the project's financial management and disbursement arrangements. Review and Selection of PESProposalsandPaymentof Contracts 20. In the case of local, demand-based mechanisms to be explored and developed under the project, their final structure, delegation of responsibilities, contract selection process, and flow o f funds cannot be determined in advance. For the PSAH and CABSA programs, the regional prograin promoters contracted by CONAFOR (see paragraph 9) will review the contract proposals from ES providers for eligibility, completeness, and conformity with the programs' operating rules, and will prioritize the list o f eligible proposals for final review. Two National Technical Committees composed o f representatives from CONAFOR, SEMARNAT, and other federal agencies will conduct the final review and selection of subprojects and PES contracts to be financed. The regional promoters will then notify applicants o f the committees' final decisions. The actual commitment letters or contracts with the service providers selected as beneficiaries of the programs will be signed by CONAFOR staff or by regional promoters authorized to sign on CONAFOR's behalf. 21. The composition and responsibilities of the Technical Committees for the PSAH and CABSA vary, but are more similar than they are different. The General Director o f CONAFOR or his designee acts as president and a representative o f the Office o f Forestry and Management serves as technical secretary (to record and supervise contracts) for both committees. The rest o f the committee i s made up o f 81 Table A6-1. Compositionof PSAHand CABSA TechnicalCommittees Role PSAH CABSA President CONAFOR CONAFOR Voting members INE SEMARNAT CONANP CNA CONAF Sector Privado CONAF Sector Social (organizacionesde productores) Technical secretary Gerenciade Silvicultura y Manejo Gerenciade Silvicultura y Manejo Nonvotingmembers CONAFOR internal controller's office CONAFOR internal controller's office permanent, voting members from relevant ministries and CONAFOR's iiiteriial accounting office as an invited, nonvoting member (Table A6-1). 22. Contract payments are made by the regional liaisons from local commercial bank accounts, which are replenished by CONAFOR with funds transferred from the Mexican Forest Fund(FFM) as described in Annex 7 and Figure A7-1. Environmental services payments using project resources and the GEF Biodiversity Trust Fund are also likely to become part o f the FFM, which also manages the financial accounts o f several other forest programs. Other FederalGovernmentActors 23. Currently there i s insufficient coordination and cooperation between the various government ministries and technical support agencies that are relevant to environmental services and PES mechanisms. The project has identified the current roles o f key government institutions and technical support agencies in PES systems as well as the role they could play to make these mechanisms more effective and sustainable. Participating goveriiinent agencies will receive training to facilitate coordination, increase understanding of the PES system, and help them assume a greater role in the system. 24. The Ministry o f Environment and Natural Resources (SEMARNAT) will take the lead in bringingthese institutions together to better cooperate inthe promotion o f PES programs and provision of important services and functions that either directly benefit or indirectly complement the program. In some cases this cooperation will mean merely adjusting their activities to better complement the PES program, while in other it will iiivolve carrying out program-specific activities, possibly under a specific agreement with CONAFOR. SEMARNAT will also work with Congress and the Finance Ministry to help ensure adequate resources and flow o f funds to the PES programs. 25. The Ministry o f Agriculture, Livestock, Rural Development, Fisheries, and Food (SAGARPA) also plays little if any role in PES programs presently, but could make a valuable contribution to achieving project goals by providing information on uses o f environmental services (mainly water and water quality), coordinate programs, raise awareness, and mainstream environmental concerns, and help negotiate local PES mechanisms with private actors such as farmers, ranchers, and coffee growers. 26. The Ministry o f Tourism (SECTUR) has an important stake in conservation but currently has little active coordination with CONAFOR or other agencies in promoting strategies for PES. Under the project SECTUR could provide information on the use and demand for environmental service in the tourism sector, incorporate environmental issues more proactively in sectoral strategies (Ecotourismo, 82 Agenda XXI), help negotiate local PES mechanisms and payments froin commercial actors such as hotels, tour providers, cruise ships and others, provide resources from the Tourism Sector Fund, promote awareness and favorable attitude toward environmental services such as biodiversity, water quality, and scenic beauty. TechnicalSupportAgencies 27. The National Water Commission (CNA) currently collects water fees and provides data to help define eligibility zones for PES mechanisms, but the project will seek to involve C N A more fully as allies in promoting PES and particularly in generating data, disseminating information, raising awareness among water users o f the importance of conservation, increasing demand for environmental services, and negotiating environmental services payments with water users. 28. The National Ecolow Institute (INE) provides scientific and technical support for decisionmaking and develops studies to help define policies and strategies related to environmental services. Under the project INE would more specifically help other agencies develop and coordinate monitoring and evaluation strategies, analyze the results, and make recommendations, particularly related to biodiversity, carbon capture, and agroforestry. It would help draft terms o f reference for projects in these three areas and would also coordinate and formulate studies related directly to PES, such as baselines, value o f environmental services, and determination o f eligibility zones. 29. The National Commission for Biodiversity Knowledge and Use (CONABIO) currently i s responsible for developing the national biodiversity strategy and helping formulate the operating rules for CABSA. Under the project CONABIO would provide many o fthe same inputs as INE, but specific to the area o f biodiversity and to some extent agroforestry (support in monitoring, evaluation, recommendations, terms of reference for project development and evaluation, coordinating scientific and technical studies), 30. The National Commission for Natural Protected Areas (CONANP) currently helps coordinate the PES programs and provides technical assistance to producers in some natural protected areas (ANPs), but the project will seek to increase CONANP's role both geographically by providing services in more areas, and substantively by increasing its assistance to producers in putting together requests and ensuring compliance with their PES commitments and contracts. MunicipalGovernments Municipal governments currently have limited participation inPES programs by developing some local strategies (such as in Coatepec, Veracruz) and by operating some drinkingwater and sewerage systems that collect fees that are used inpart to provide payments for environmental services. The project will seek to increase the role o fmunicipal governments by having them participate actively inthe development and implementation o f local PES mechanisms, provide funds from municipal sources to match federal and multilateral financing, help innegotiatingPES with local stakeholders, improve payments mechanisms based on water fees and other services, and participate in monitoring o f contract compliance and program impacts. Privateand NongovernmentalActors 3 1. Private and nongovernmental actors are expected to play a critical role in implementing the PES programs, in large part by providing services and information through consultancies and contracts, and by representing stakeholder interests and liaison inthe case o f producers' organizations. 83 32. CONAFOR maintains of register (padr6n) o f nearly 160 officially recognized Technical Service Providers (TSPs) for contracting and consultancy purposes. These consultants will help federal government agencies, municipal governments, and other actors by promoting PES programs, providing technical assistance services to producers in writing PES proposals and complying with commitments, helping develop projects, and participating in monitoring and evaluation o f contract compliance, project results, and impacts. While the directory certifies certain consultants as capable o f providing such services, other actors such as NGOs, academic and research institutions, and individuals are also expected to compete for consultancies and provide services under the project, as well as provide training and capacity building to the service providers on CONAFOR's registry. 33. Nongovernmental organizations currently play an important role in the PES programs and are expected to increase their participation under the project, usually financed by their own resources or other financing, but in close coordination with the project. NGOs are uniquely positioned and qualified to give technical assistance to environmental service providers in natural protected areas, help monitor contract compliance, evaluate project performance, help develop and promote local PES mechanisms, develop demand for environmental services, support negotiations, lobby on behalf o f stakeholders or the program itself, gather and disseminate local information, and act as intermediaries between government agencies and local stakeholders. 34. Education and research institutions will help monitor and evaluate project performance, impacts, and contract compliance, and do research that supports the project such as valuation o f environinental services and environmental impact studies. The wider national and scientific community will help promote exchange of experience and ideas, evaluate project performance and outcomes, and design monitoring strategies. 35. Producer organizations are expected to play a key role in program, particularly promoting and monitoring the supply of environmental services. These organizations will provide technical assistance to producers, help monitor contract compliance and program evaluation, develop local PES mechanism by supporting negotiations and providing local information, raise awareness o f environmental services and increase demand, and help identify and eliminate barriers to program participation on the supply side, particularly by poor and marginalized populations. Component Execution 36. Component 1 will be implemented by CONAFOR in coordination primarily with the relevant agencies, states, and municipalities. The major federal agencies involved would be (a) for water services CNA, IMTA, and NE, (b) for biodiversity services CONABIO, SECTUR, CONANP, and INE, and (c) for carbon sequestration SEMARNAT, INE, and SAGARPA. N o later than six months from the date of the loan agreement CONAFOR will enter into cooperation agreements with all such agencies as required for implementation o f the activities. Drafts o f such cooperation agreements will be available by the date o fnegotiations. 37. Capitalization o f the endowment fund will occur only upon coinpletion o f all the preparatory work for the establishment of such fund as an independent subaccount o f the existing Mexican Forest Fund(FFM) under the direction o f a financial and asset manager, with its own operating rules, board of directors, and secretariat. The operational implementation o f programs and payments financed by the fund would be managed by CONAFOR. Disbursement o f the GEF allocation will be subject to the Bank's approval o f the establishment of such funding mechanism and o f its operating rules and operational manual. The fund i s described in more detail inAnnex 21. 84 38. Component 2 will be implemented by CONAFOR in cooperation with CNA, CONANP, and INE.CONAFOR will furnishto the Bank for its review and comment, prior to final approval, all changes to the operating rules o f the CABSA and PSAH programs, in particular those revised as per this component. The matching grants will be financed out o f loan and grant proceeds subject to the Bank's approval of the operating rules for such matching grants, including the contractual arrangements to be made with the beneficiaries. 39. Component 3. CONAFOR, in cooperation with CONANP, INE, and NGOs, will carry out activities to strengthen eligible ejidos and/or indigenous communities (prospective providers o f environmental services). This assistance may be provided directly to the communities and ejidos by consultants contracted by CONAFOR, or in the form o f grants to the ejidos or communities to finance technical assistance that they contract themselves. The contractual arrangements made with the communities follow standard forms contemplated in the operating rules o f CONAFOR's programs and in the project Operational Manual. The subcomponent to support community promoters (local residents chosen by the community to act as program facilitators and liaisons with the regional promoters and CONAFOR) will provide stipends to cover the costs o f program promotion, training, travel, and other incidental expenses. 40. Component 4. Environmental services for water, biodiversity and carbon sequestration will be financed by the government and also out o f the proceeds of the loan and grant subject to the Bank's approval o f the operating rules to such payment mechanisms, including those prepared under Component 1 for local financing mechanisms. 41. Component 5: The organizational structure o f the staff responsible for project execution is detailed in Figure A6-1. Loan and grant proceeds would be available to finance the staff o f the implementation team. The financial management and procurement staff will be in place within three months of the date o f the loan agreement and all other staffed will be in place within six months after signingo fthe agreement. 85 i I I I I I a, a, ca, .-v) 0 d C E cui 2 u - a0, 0) 0 .... - x ca, .-3 e c b . C m 0 -xu v) m 0 .-c K - 0 w w 8 .-c 3 -Kc v) z . 3 L 0 m m c I Annex 7: Financial Management and Disbursement Arrangements MEXICO: Environmental Services FinancialManagementAssessment (FMA) 1. The Mexico Country Financial Accountability Assessment (CFAA) was completed in October 2003. This assessment focused on the federal public sector, which was considered to have generally sound financial management (FM) systems and institutions. Country FM risk was rated moderate, and all iiidividual risk factors were rated low or moderate. The results o f the CFAA have an indirect impact on this project, as funds will flow into Mexico's public FM systems and then through CONAFOR. The Bank has recently supported government efforts to strengthen some o f the areas considered by the CFAA to be opportunities for improvement, such as the accounting processes and information systems. Specifically for the Environmental Services Project, the Bank has carried out a Financial Management Assessment (FMA), which involved ensuring that project design allows for an appropriate level o f transparency, facilitating oversight and control while also supporting smooth implementation. Based on this analysis, the regional financial management team (LCOAA) has concluded that project risk i s high, based on the following: (i)Fund flow must be accompanied by sound controls such as the new integrated system, which will include accounting, and which must be operational before project launch. These sound controls are needed because (a) project funds corresponding to component 4 will flow through a trust fund; (b) flow o f funds involves both CONAFOR's central offices and its regional and state agencies. (ii) Certain actions will need to be taken to strengthen program financial management prior to the launching o f the proposed project. Based on the results o f the appraisal mission, LCOAA will agree with CONAFOR, Nacional Financiera (NAFIN), and SHCP on the timetable to implement all agreements before project launch. The procedures must be described in the corresponding section o f the project Operational Manual (OM) and will reflect the simplifications proposed in the FWDisbursements section of the Bank's Review o f Country Systems document, which was delivered to the federal government in July 2005. (iii) accounting records o f the project will be prepared at the state level and at the central The level. CONAFOR is implementing a new automated accounting system named "GRF"', which i s expected to be fully operational in January 2006. Before project launch, additional visits will be carried out at the central and state level to assess the adequate functioning o f this system. (iv) For disbursement purposes, the recognition of expenditures will be for components 1, 2, 3 and 5 upon payment to suppliers and to beneficiaries, and for component 4, once CONAFOR's state offices make payments to the Environmental Service Providers. (v) CONAFOR i s in the process o f creating a specialized group in its administration unit to support all externally financed CONAFOR projects. This group will be responsible for the financial management aspects o f the project. DuringJanuary 2006 CONAFOR will inform the Bank of the organizational structure, staff, and duties o f this group; however, it i s expected that this group will be staffed with personnel already responsible for all FM matters o f the Bank-financed PROCYMAF I1 project currently under implementation. ImplementingAgency 2. The project will be executed by the Conzisidn Nacional Forestal (CONAFOR), whose central office i s in Guadalajara, Mexico. CONAFOR also has 13 regional offices throughout Mexico, each of which is responsible for two or more state offices. The manager o f each regional office reports to a General Coordinator inthe central office. 3. CONAFOR has implemented other Bank projects and is currently responsible for the PROCYMAF I1project, which became effective in July 2004 and i s supported by a Bank loan of US$21 million. CONAFOR's record in project financial management has been generally good. Due to slow 89 disbursements, there was no project audit report due for PROCYMAF 11's 2004 fiscal year, however the institutional audit report for CONAFOR was submitted to the Bank and did not suggest any significant reporting or control issues. Before project launch, LCOAA will discuss and agree on the arrangements for the audit review (which will cover the entire periodnot yet audited). Flow of Funds and Information 4. As in most Bank-financed projects in Mexico, all project expenditures will first be funded through the country's budgetary system. For disbursement purposes, the recognition o f expenditures will be: (i) For Components 1, 2, 3, and 5 upon payment by CONAFOR to suppliers of goods and services. The Bank agrees that the recognition o f expenditures will not be untilthe payments are made. (ii) For Component 4, the funds process is the following: (a) the CONAFOR central office receives funds from the National Treasury (TESOFE), and then transfers the resources to the Mexican Forestry Fund(FFM)managed by NAFIN;I2(b) once the funds are assigned to the Environmental Services Providers (ESPs) and the contracts are signed, the FFM transfers the resources back to the CONAFOR central office; and (c) the CONAFOR central office transfers the resources to its regional and state offices, which are responsible for making the payments to the ESPs. The Bank agrees that the recognition o f expenditures will be once CONAFOR's state offices make payments to the ESPs. 5. Once payments are made, CONAFOR, with NAFIN's assistance as required, will request disbursements from the Bank (see reporting and disbursements sections below). The Bank will make its disbursement as a reimbursement to the TESOFE, or if requested by the government, through a Special Account held by NAFIN and established in U S dollars at the Mexican central bank, Banco de Mkxico. More precise details o f the funds flow processes will be agreed before project launch and the project OM will be updated to incorporate these agreements. 6. Ifineligibleexpendituresareidentifiedin(i)anyexternalorinternalauditreview;(ii)anyBank supervision mission; (iii)NAFIN's review; or (iv) if any contract between CONAFOR and an EPS i s cancelled due to any noncompliance with its conditions, CONAFOR would be authorized to substitute the ineligible expenditures (contracts) with a new eligible contract, otherwise, the Government o f Mexico will have to reimburse the entire amount o f funds corresponding to cancelled contracts to the Bank. l2 CONAFORaccountingpolicies recognizethe expendituresat this point ofthe process. 90 . "... --.- I WORLD BANK 9A (US$) I i I I NationalTreasury TESOFE eports SOElSOT ** 1 (Nix$) BUDGET I--. CONAFOR ~- 7 I Central Office 1 suppliers of good CONAFOR Regional Offices Mexican , 5 (MX$) Forestry Fund endowment fund (Managedby (( Nafin) CONAFOR State Offices r I Funds flow (steps 1to 11) 6 (MX$) 1 _______---_--___- Information flow (steps A and B) 7" * Optional Paymentto ** While it is contemplated that disbursements Environmental will be based on SOEs, component 4 will be Service Providers disbursed by an SOE/SOT type disbursement report. Accounting Policies and Procedures 7. Overall. CONAFOR will maintain accounts for preparation o f project financial reports. Duringits most recent preparation mission LCOAA reviewed the accounting policies and procedures currently in place and considers them acceptable to the Bank. An attempt will be made before project launch to bring project accounting procedures, as much as possible, in line with existing procedures within CONAFOR. 91 8. Component 4. The internal control environment around Component 4 is considered adequate mainly because: (i)to assure fulfillment o f the conditions established in the contracts to provide environmental services, CONAFOR conducts field reviews and satellite supervision, covering approximately 90 percent of the program; (ii)CONAFOR keeps individual files at their central office for each one o f the ESPs; (iii)the environmental services programs' main guidelines are included in their operating rules; (iv) the accounting system will permit the control o f the funds transferred to the states and regional offices by creating "accounts payable" registers for each one o f the ESPs, which are cancelled once the funds are delivered to the ESPs. InformationSystems 9. The accounting records o f the project will be prepared at the state and at the central level using CONAFOR's existing systems. CONAFOR is implementinga new automated accounting system named "GRP", which will be usedfor project accounting and reporting. According to CONAFOR's FMstaff, the new system is capable o f aligning the accounting records o f the institution with the components and subcoinponents o f the project and will also generate financial monitoring reports (FMRs),semiannual and annual financial statements, and disbursement reports. 10. A Bank FM specialist began evaluating this system, but since it is iiot expected to be fully operational until the end o f January 2006 the review will be not be concluded until February 2006. A database o f program monitoring indicators will be used to prepare technical monitoring reports, which can be combined periodically with the financial reports to provide a comprehensive picture o f project activities (however, these reports will not be considered integral part o f the FMRs). See Financial Reporting section below. Staffing(key financialmanagementstaff) 11. CONAFOR has experience with Bank projects and with the types o f activities to be carried out in this operation, and its record to date on FM matters has been acceptable to the Bank. It is important to mention that CONAFOR i s in the process o f creating a specialized group in its administration unit to support all externally financed CONAFOR projects. This group will be responsible for the financial management aspects o f this and other projects. At the end o f January 2006 CONAFOR will inform the Bank of the organizational structure, staff, and duties o f this group. However, it i s expected that the staff currently responsible for the Bank-financed PROCYMAF I1project already under implemeiitatioii will join this group. FinancialReporting 12. Financial Monitoring Reports (FMRs) will include financial and disbursement information in a format agreed with the Bank. The FMRs will be submitted on a quarterly basis by CONAFOR, through NAFIN. Duringthe FM assessment of the PHRD and PDF-B grants, and during initial work carried out for this project, CONAFOR submitted to the Bank examples o f financial/budget reports that it normally submits to SHCP. Before project launch, attempts will be made to align project reporting with these existingreportingrequirements. 13. The physical progress information, traditionally included with the other reports in the FMR, will be provided inthe semiannual progress report preparedby CONAFOR and submittedto the Bank through NAFIN inApril and October of every year. The procurement informationnormally included inthe FMRs will take the form of procurement plans that are updated at least annually, and will be submitted to the Bank separately from the financial and disbursement reports o f the FMR.The precise formats of the FMR 92 will be agreed before loan negotiations. The agreed format will be includedas an annex o f the Minutes of Negotiations. 14. Annual project financial statements will be prepared by CONAFOR to be used for the financial auditing o f the project (see audit section below). The project financial statements should resemble those prepared on a quarterly basis for the FMR and should be consistent with the formats presented in the standard Terms o f Reference for audit, agreed annually between the Bank and the Secretaria de la Funcion Publica (SFP). The Financial Management section o f the project's Operational Manual (OM) will include detailed information on reporting and monitoring. Internal and ExternalAudit 15. Annual financial audits covering the management o f project funds until they reach the final beneficiaries (see PAD section on project description) will be carried out according to Bank policy and in combination with the country systems approach currently being implemented in Mexico. The framework for all project audits in Mexico is the Memorandum o f Understanding (MOU) agreed between the Government o f Mexico and the Bank. The project audit will be carried out by the same audit firm that audits CONAFOR as an institution. CONAFOR, through NAFIN, will submit the audit report to the Bank. CONAFOR's institutional audit report i s already being submitted to the Bank as per the audit requirements o f PROCYMAF 11, as summarized in the paragraph below on project audits. The Financial Management section o f the project OM will include more detailed information on project audits. 16. A project audit covering all project activities is due six months after the end o f any fiscal year in which project expenditures were incurred (as determined by the government's SFP-which coordinates audit supervision-and by the Bank). Unless substantial retroactive expenditures are incurred in2005, the first report will likely be for 2006 and will be submitted by June 30, 2007. The final audit report will be due six months after the final year of project implementation. The standard period covered i s the calendar year (January 1to December 31). 17. CONAFOR also has an Office of Internal Control (OIC), which reports to the SFP. The OIC is in charge o f conducting a review of CONAFOR operations, and in particular the physical audit of subprojects. Results o f the OIC's their work will be integrated with Bank supervision reports (i.e. FMRs) for greater effectiveness. Disbursement Arrangementsand RetroactiveFinancing 18. Method. The National Treasury will prefinance all project operations through CONAFOR's standard budget. The Bank will reimburse upon request and against agreed financial reports. For component 4, CONAFOR will send to the Bank each year through out the life o f the project 70% of the contracts supporting the payments to the ESPs o f contracts signed during or after 2003. . The Bank will finance the 100% o f these contracts which should be included in the disbursement report (in terms of years). Regarding the components 1, 2,3 and 5, the financing percentages are the reflected in Table A7-2. 19. Table A7-1 summarizes, by component and subcomponent, the agreement on the amount o f the loan and grant, the use o f funds, and when the Bank will recognize expenditures for the activities to be financed with loan funds. This table will be updated as a result of the work which will be carried out before negotiations. 93 TableA7-1. DisbursementArrangementsandRecognitionof Expenditures Component/ Responsible Description subcomponent entity (use) Recognition of expenditures 1. Developing CONAFOR Consultants, Payment to consultantsand suppliers of Sustainable training and goods and services. Financing operating costs. Mechanisms Establishmentof Transfer to the endowment fund financed by an endowment GEF. (Subcomponent 1.B.2 has the fund. following disbursement conditions: Disbursements of the endowment fund seed contribution under Component 1 will be subject to the fund being established and operational in form and substance satisfactory to the Bank.) 2. Developing and CONAFOR Consultants, Paymentto consultantsand suppliers of StrengtheningPES goods training goods and services Delivery and operating Mechanisms costs 3. Supporting CONAFOR Consultants, Paymentto consultantsand suppliers of Environmental goods, training, goods and services ServiceProviders stipends, and operating costs 4. Paymentto CONAFOR Payment to Payments from CONAFOR's state offices to ServiceProviders Environmental the ESPs. Services Providers(ESPs), The following subcomponents have as defined in disbursementconditions: project documents 4.1.3 LFDcontributions to matching fund and Operating 4.2.3 CABSA contribution to matching Rules and operating costs fund 4.3.3 Payments to providers through local water PES mechanisms 4.4.3 Payments to providers through local tourism PES mechanisms 4.6.3 GEF contribution to matching fund Disbursementconditions: Disbursementsof each ofthe three types of environmental services (water, biodiversity, and carbon) under . Component4 will be subject to the Bank's approval of the respective operatingrules developedunder the project. Disbursements of matching grants under 94 component 4 will be subject to the Bank's approvalof the operatingrules for such financing mechanismto be developed under the project. 5. Project CONAFOR Consultants, Payment to consultantsand suppliers of Management goods, training, goods and services and operating costs for the CONAFOR project staff and for monitoring & evaluation Front-end Fee SHCP 1%of loan Automatic (World Bank pays to World amount (less Bank) any Bank's waiver applicableto this loan) 20. Statements of Expenditures (SOEs). Disbursements will be based on SOEs with component 4 disbursed by an SOE type disbursement report (already agreed between CONAFOR, NAFIN, and the Bank). The agreed format o f the SOEs and o f the "Disbursement Report" will be included in the project Operational Manual. 21. Designated Account (DA) /Special Account (SA). As part o f a streamlining o f Bank disbursement processes under the Country Systems initiative, the Bank i s working with the government to reduce the number o f funds flow processes. One aspect o f this is to utilize Special Accounts only when the nature o f the project deems the SAs to be necessary. If deemed necessary for this project, NAFIN (as financial agent) will establish in the Mexican Central Bank a Special Account in U S dollars, one for the loan and one for the grant. The Special Account will likely maintain a "zero balance" status, but might receive Bank funds to reimburse the National Treasury (TESOFE). It would therefore have occasional balances for a brief time until the transfer i s made to TESOFE. Otherwise, a Designated Account will be utilized to reimburse funds to TESOFE. 22. Retroactive Financing. The project will be eligible to submit applications for retroactive reimbursement, based on reports of expenditures eligible for loan financing, o f up to 10 percent o f the loan amount, incurred on or after project appraisal. 95 TableA7-2. AllocationofLoanProceeds(US$ million) Amount ofthe GEF Trust Amount o fthe FundGrant % of Expenditures Loan Allocated Allocated % of Expenditures to be Financed (Expressed in (Expressed in to be Financed by the GEF Categorv USDollars) U S Dollars) by the Loan Trust FundGrant (1) Goods, 10,674,000 8,450,000 100% 100% Training, Operating Costs and consultants' services for all Parts o f the Project and Technical Strengthening Activities and Stipends (2) Endowment 0 5,000,000 0% 100% Fund contribution (3) (a>PES 25,938,500 750,000 100% 100% Contract Payments (b) Local 8,275,000 800,000 100% 100% Financing Grants (4) Front-end fee 112,500 0 Amount due 0 under Section 2.04 o f the Loan Agreement (5) Premia for 0 0 Amount due 0 Interest Rate Caps under Section and Interest Rate 2.09 (c) o f Collars the LoanAgreement ~~ TOTAL 45.000.000 15.000.000 OperationalManual (OM) and Written Procedures 23. The project's Operational Manual will include a chapter to cover all aspects o f project financial management (including a fully detailed description of the different areas covered in this annex). The manual must be satisfactory to the Bank prior to negotiations. SupervisionPlan 96 24. Because of the project's high risk, complexity (involving a Bank loan and a GEF trust fund), and unique nature and size: (i)at least two financial management supervision inissions will be conducted each year, (ii) a Bank financial management specialist will review the annual audit reports and the semi annual FMRs; and (iii)inore intensive supervision will be needed prior to effectiveness and in the first year of implementation. 97 Annex 8: Procurement Arrangements MEXICO: Environmental Services Procurement in Mexico: Recent Developments 1. Procurement for the proposed project would be carried out in accordance with the World Bank's "Guidelines: Procurement under IBRD Loans and IDA Credits" dated M a y 2004; and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" dated M a y 2004, and the provisions stipulated in the Legal Agreement. The various items under different expenditure categories are described in general below. For each contract to be financed by the Loan, the different procurement methods or consultant selection methods, the need for prequalificatioii, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank in the Procurement Plan. The Procurement Plan will be updated at least annually or as required to reflect the actual project implementationneeds and improvements in institutionalcapacity. 2. The Bank has agreed with the Government o f Mexico to accept the full-fledged use of the COMPRANET as a vehicle for Bank-financed procurement for N C B and I C B pursuant to paragraphs 2.11, 2.18, 2.44, 2.45 and other parts o f the Procurement Guidelines o f M a y 2004. In order to remove some perceived obstacles for international participation in Bank-financed procurement, COMPRANET has agreed that it will (a) provide the bidding documents free o f charge, (b) adopt The Hague Convention on national certification o f the back-up, paper signedcopy o f the signature o f the prospective bidders and will enter into relevant agreements with countries that have not signed that Convention as needed, and (c) add a facility inthe system to post the ads in dgmarket and UNDB possibly through the use o f the Bank's Client Connection. Harmonized Standard Documents for ICB Procurement o f Goods have been agreed in November 2005 and negotiations for ICB procurement o f civil works are planned for January 2006. 3. The Secretaria de la Funcidn Publica (SFP) and the Bank have agreed on a new generation o f standard bidding documents for goods and works under NCB. These documents are to be used by all federal purchasing entities for international procurement under the national law and for all N C B procurement financed by the Bank and include several modifications due to recent changes to the Law. The Bank, IDB, and the Government reached agreement on a harmonized Request for Proposals package in October 2005. The Bank has completed two sector studies: one at the federal level and another one at the state level to determine the acceptability o f the country systems in procurement and other fiduciary areas, and to monitor and evaluate government procurement performance at the state level. The findings of the studies continue to demonstrate that Mexico has robust procurement procedures. 4. The methods to be used for the procurement o f goods and services under the loan are described below with the estimated amounts, and summarized in Table A. Table B suggests thresholds to be usedin the Procurement Plan and the Operational Manual for the various procurement methods. Procurement Summary 5. Giventhe nature of this Program, which consists mostly o f financial transactions to private sector beneficiaries, there are no substantial procurement actions identified under the Project. Under component B "Payment for EnvironmentalServices" there are no procurement transactions as the beneficiaries of the private sector are not required to use the proceeds o f the payments for the procurement o f any specific goods or services. For the nonfinancial components o f the project under components 1 and 3, there would be technical assistance, training, and dissemination campaigns. Procurement of Works 98 6. There are no civil works expected under the project; any small rehabilitation works required in the regional dependencies to improve space and meeting facilities, will be disbursed through the Operating Costs category of investment; the procurement o f such small works will be made through quotations from qualified local contractors. Procurementof Goodsand NonconsultingServices 7. Vehicles, monitoring equipment, printing services, sundry goods, and small-value items, including didactic materials and furniture will be procured under this category. The procurement method to be used is NCB and price quotations from local suppliers. Employmentof Consultants 8. Consultant services would be procured in accordance with "Guidelines: Selection and Employment o f Consultants by World Bank Borrowers" published in May 2004 and the agreements inthe procurement plan. Consultant services to be contracted under this Program include audits; advisory services in financial, institutional, legal and information technology support and development; and technical consultant services for policy studies and program monitoring and evaluation. The short list o f consultants for contracts estimated to cost less than US$500,000 equivalent, may comprise entirely national consultants, inaccordance with the provisions o f paragraph 2.7 o f the Consultant Guidelines. 9. Firms: All contracts for firms would be procured using QCBS procedures except for small contracts for assignments of standard or routine nature and estimated to cost less than US$lOO,OOO equivalent that would be procured using Least-Cost Selection or using other procurement methods as defined in the annual procurement plan review 10. Individuals: Specialized advisory services would be provided by individual consultants selected through comparison o f qualifications o f at least three qualified candidates. They would be contracted in accordance with the provisions o f paragraphs 5.1-5.3 o f the Consultant Guidelines as defined in the annual procurement plan review. 11. Commercial Practices: In the case o f technical strengthening activities hired directly by the beneficiaries these may be procured through comparison o f at least two proposals from qualified providers for contracts estimated to cost less than US$25,000.00, larger contracts shall follow formal competitive procedures as outlined inthe Operational Manual. 12. Prior Review Thresholds: The prior review o f procurement actions will be defined inthe annual procurement review and will not exceed the thresholds determined by the procurement capacity assessment of CONAFOR as summarized in Table B and will be further defined inthe Procurement Plan. Payments to beneficiaries will not exceed US$150,000 equivalent per beneficiary per year at a rate of US$40 per hectare per year up to a maximum o f 4,000 hectares; these transactions are o f a financial nature and do not involve procurement actions. OperationalCosts 13, Operational costs will include reasonable expenditures to carry out the project such as travel and per diem cost for supervision activities and training, communications services, maintenance o f project facilities, equipment, vehicles, and consumable material and supplies. These activities will be procured using administrative procedures available in CONAFOR that were reviewed by the Bank and found acceptable. 99 ProcurementCapacityAssessment 14. The Bank carried out a procurement capacity assessment o f CONAFOR. CONAFOR appears to apply national procurement practices adequately in a consistent manner. As a result o f the capacity assessment, the Bank defined the procurement implementation risk as average. The weakest aspect identified inthe assessmentwas the planning capacity and this may affect the opportunity and accuracy o f the project's procurement plan. If during the ex-post reviews delays in processing o f the project's procurement actions are noticed, the risk would be reassessed. The Bank shall carry out two procurement reviews annually: one at the head office inGuadalajara and a field visit. ProcurementPlan 15. Procurement Plan covering the four years o f project implementation was prepared by CONAFOR. NAFIN and CONAFOR will present a procurement plan (PAC) for the first 18 months o f project implementation, this Plan will be updated at least once a year. TableA: ProjectCostsby Procurement Arrangements (US$ millionequivalent) ProcurementMethod' Expenditure Category ICB NCB Other' Total Cost 1. Goods 0.32 0.47 0.79 (0.26) (0.28) (0.55) 2. Nonconsultant services, including training 1.65 1.65 (1.38) (1.38) 3. Consultant services and technical assistance 13.52 13.52 (11.26) (11.26) 4. Incremental operationalcosts 3.48 3.48 (2.89) (2.89) 5. Payments for environmentalservices 127.00 127.00 (3 8.82) (38.82) 6. Capitalization 10.00 10.00 (5.00) (5.00) 7. Front-end fee 0.11 (0.11) Total 0.32 156.12 156.55 (0.26) (59.63) (60.00) 'Figures in parentheses are the amounts to be financed by the IBRD loanandthe GEF donation. All costs include contingencies. 'Includes procurementof goods, training, services, and consultantsservices required by CONAFOR. 100 Table B: Thresholds for ProcurementMethodsand Prior Review' ContractValue Threshold Procurement Contracts Subjectto Prior Review Type of Expenditures (US$> Method (US$millions) 1. Goods, and non- >500,000 ICB All consultant services >100,000 NCB TBD ineachreview of <100,000 Shopping procurementplan 2. Consultant services a. Firms >100,000 QCBS All contractsover $250,000; <100,000 LCS TBD in each review ofprocurement plan for contractsunder $250,000 b. Individuals IC TBD ineachreview of procurement plan 'To be reviewed and confirmedin the review o fthe procurementplan annually ICB = InternationalCompetitiveBidding NCB =National CompetitiveBidding. QCBS = Quality- and cost-BasedSelection LCS = Least-CostSelection IC = Individual Consultant Action Planto Improvethe ImplementingCapacity 16. The following is the summary of the agreed action plan to improve CONAFOR implemeiitatioii capacity on procurement to be confirmed duringNegotiations: website to announce project bidding processes. procurement 2. Improve filing and archiving facilities Improve the quality of files During the first year of and document digitalization, including and archives the project furniture, space, and equipment 3. Include a flow diagramon Facilitate transactionsand Before negotiations procurementtransactionsinthe define responsibilities OperationalManual 4. Modify OperationalManualto Strengthenlegal security Before negotiations strengthen legal security in procurement 5. Provide technicalresourcesto the Increase quality, economy, Before negotiations ProcurementDepartmentto improve efficiency market competitiveness 6. Speedup the programof electronic Increase quality, economy, During the first year of purchases efficiency the project 7. Submit to the Bank arevisedversion Increasequality, economy Before negotiations ofthe ProcuerementPlan for the initial and efficiency period of 18 month. 101 Annex 9: Economic and Financial Analysis MEXICO: Environmental Services 1. The project aims to strengthen and expand the use o f market-based PES mechanisms whose purpose i s to induce land use changes that provide increased levels o f environmental services that briiig both national benefits (primarily water services, and in some cases landscape benefits) and global benefits (increased biodiversity conservation and carbon sequestration). 2. Eight promising sites for implementation of pilot PES mechanisms have been selected (Annex 17) from within the areas eligible for PSAH payments, based on the presence o f substantial potential demand for water services (urban centers of more than 50,000 people; hydraulic infrastructure serving hydroelectric power producers, industry, irrigated agriculture, domestic use, or tourism) or biodiversity services (priority areas for biodiversity conservation identified by CONABIO, Ramsar sites, ecotourism areas). Several already have local proposals or initiatives for the development o f PES mechanisms. Provision of services 3. Improved water services. Currently, the PSAH's only contract modality i s for the conservation of existing forests. Expectations that this modality would improve water services are based on the view that forests are always beneficial to water services. This view i s well entrenched in Mexico, as in most of the region. In fact, the evidence on the links between landuse and forest is far from clear, and there has been no monitoring o f the impact o f PSAH-supported forest conservation on water services. Notwithstanding this lack of precise data, the PSAH Program's forest conservation activities are likely to generate benefits in terms of avoiding the degradation o f water quality and the higher treatment costs that would imply; reduced sedimentation o f reservoirs and water intakes, thus avoiding the need for costly desilting operations; and reduced flood risk at the local level. It may also help improve dry season water flow (an important issue in several areas), though data on this point are particularly uncertain. It i s unlikely, however, to increase total water availability, which i s an issue in the drier parts o f the country. On the contrary, forests may reduce total water availability inthese areas, except inthe case o f cloud forests (for this reason, the PSAH program pays more for conservation o f cloud forests). However, since water services are highly site-specific these benefits will only be received if forests are conserved in the right place. This means targeting payments to areas at high risk o f deforestation and in areas where water services are threatened. However, the current PSAHprogram scores poorly in this regard: less than 14 percent o f the area enrolled in2003 and 2004, for example, was located in areas with overexploited aquifers; and most o f the enrolled area was at low risk of deforestation-less than 20 percent o f the area enrolled in 2003 and 2004 was in areas with high or very highriskof deforestation, while 62 percent was inareas o f low or very low risko f deforestation, 4. The project will improve impact on water services in several ways: (1) it will introduce a greater range of modalities tailored to the specific conservation needs o f particular watersheds in the pilot areas (for example, modalities focusing on erosion reduction, where sedimentation i s an issue, or on reduced use of agrichemicals, where contamination o f drinkingwater supplies i s an issue); (2) it will better target eligible areas, including targeting notjust particular watersheds but also specific areas within a watershed (for example, sloping lands, when erosion i s an issue). Both o f these changes will be made on a site- specific basis, based on an assessment o f the needs o f water users in that watershed, and governed by contracts with the water users providing the financing (thus reducing the problem o f having payments mis-directed because o f political pressure). The project will also include careful monitoring and targeted research to improve understanding o f the links between land use and water services. 5. Improved biodiversity conservation and scenic beauty. Although biodiversity is primarily a global benefit, it can also bring direct benefits to Mexico, in particular through its contribution to the tourism sector. There can also be local benefits to agriculture, for example through improved pollination. 102 Neither o f these impacts can be easily quantified. CONAFOR will work to develop financing mechanisms with the local nature-based tourism industry at several of the project's sites. Payments froin outside donors such as GEF, to be channeled through an endowment fund, will provide additional financing to conserve globally significant biodiversity in the buffer zones of protected areas and the corridors that connect them, in cases where no other funding sources are available. 6. Carbon sales. Sales of carbon emissions reductions could provide considerable financing for reforestation in degraded areas. Mexico has had prior experience with the sale o f carbon emissions reductions: the Scolel Te project in Chiapas has received payments from international carbon buyers for carbon sequestration in agroforestry. The project will explore the potential for and build the capacity to undertake sale o f emissions reductions under the rules o f Clean Development Mechanism (CDM). Experience in other countries suggests that such carbon sales may not by themselves fully pay for reforestation. Even so, they would substantially reduce the cost to the country o f undertaking reforestation; thus, reforestatioii would bejustified with only small amounts o f national benefits, Demandfor services 7. Domestic water users are likely to be the most important single potential financing source at most o f the pilot sites. Domestic water supply systems have been a primary financing source for PES programs throughout the region. Urban centers that contribute to PES programs range in size from several million people in Quito, Ecuador, to 3,800 people in Yamabal, El Salvador. Domestic water supply systems are typically eager to ensure they receive a constant flow o f high-quality water. Watershed degradation could increase their cost o f supplyingwater ~ubstantially.'~Table A9-1 shows the main urban centers that derive their water supplies from the pilot sites, and their population. Water use ranges from about 0.18m3/person/dayin Saltillo to about 0.4m3/person/day in Colima. Even relatively small fees could generate substantial amounts, particularly at the Monterrey and Saltillo sites. In Saltillo, for example, given total use o f about 38 million m3/year, a fee o f M$0.5/m3 would generate M$19.2 inillion (US$1.8 million) ann~ally.'~Smaller urban centers, not shown in Table A9-1, would generate smaller streams of funding, but their protection needs would be correspondingly smaller. 8. Existing local PES initiatives in Mexico have demonstrated that there is a willingness to pay for water services. Since 2001, for example, the town o f Coatepec, in the state o f Vera Cruz, has been soliciting voluntary donations o f M $ l (about US$0.09) froin municipal water users, to be dedicated to watershed conservation. Despite the purelyvoluntary nature o fthis contribution, it generated US$9,100 in its first year. Other experiences are summarized in Table A9-2. Experience elsewhere in the region also shows a willingness to pay for water services from a variety o f water users. 111Costa Rica, a number o f hydropower producers, bottlers, hotels, irrigation systems, and municipal water supply systems are paying for watershed protection, generating over US$0.5 million a year for that country's PSA program. 9. Irrigated agriculture, as a major water user, has been another common contributor to PES programs. Indeed, some o f the earliest PES programs involved irrigation water user associations in Colombia's Cauca Valley assessing themselves an additional fee to pay for watershed conservation, In 13. In a well-documented case, New York City was able to save the estimated US$S.S billion cost of building and operating a water treatment plant by spending US$1.5 billion on watershed conservation. In Costa Rica, the town of Heredia faced a very similar situation. Like New York City, it does not filter its water as it emerges from the well-conserved upper watershed with very high quality. To ensure that this continuesto be the case, Herediais paying FONAFIFO to conserve its watershed through the PSA program.*inconjunction with Florida Ice & Farm, a large bottler located in the same watershed. 14. Current water charges are M$6.86/mJ(about M$450/person/year), so a M$0.SO/m3fee would representa 7 percent increase. It is interesting to note that municipal water supply system do not usually pass on the cost of the PES payments to their consumers. Heredia, in Costa Rica, has done so, adding an explicit conservation fee to water bills. However, most water supply systems have financed the payments from their regular revenue streams, citing the savings resulting from preserving their water supplies. Quito's water company, for example, finances its contribution to a PES mechanism froin current revenues. 103 Costa Rica, four agribusinesses with substantial irrigated areas pay US$45/ha to FONAFIFO to coilserve watersheds. Irrigated areas typically wish to avoid sedimentation, which can clog their pumps and distribution channels, and secure a reliable flow o f water. They may also be vulnerable to flooding. As Table A9- 1 shows, irrigation is only significant at the Monterrey site. 10. Reducing the risk of floods and landslides can be a locally-important benefit of forest conservation. As Table A9-1 shows, significant areas are at risk from floods or landslides at many of the pilot sites. 11. Biodiversityservices.The localtourism industryoften relies heavily on natural ecosystems-for scenic beauty and/or for direct use in recreational a~tivities.'~Damage to these ecosystems may result in lower visitation rates or in lower prices. There would thus appear to be considerable potential to develop financing agreements with the tourism industry.Table A9-1 shows that nature-based tourism i s found at several of the pilot sites. Although there has been a long experience with the use o f market-based instruments to protect biodiversity in the country", none to date have involved direct payments from the tourism industry. Table A9-1 shows visitor numbers at some o f the protected areas that are wholly or partially located inthe promising sites." If a mechanim could be devised to capturejust US$1 per visitor, it would generate at least US$1.4 million annually. Supply of services 12. Land users often find that land uses that provide environmental services are less profitable to them than other land uses. Unsurprisingly,they usually adopt those land uses that are most profitable from their own perspective, irrespective o f whether they generate environmental services for others or not. Inducing them to adopt land uses that bring benefits to others thus requires compensating them, at a minimum, for the difference in net returns they will receive with the new land uses compared to those they would have received under their most privately-profitable alternative. A comparison o f net returns under current land uses to those o f land uses that are more desirable from an environmental service perspective provides an estimate o f the cost required to induce the desired land use changes. 13. Studies by INE (Jaramillo, 2002, 2004) examined the distribution o f returns to agricultural production in Mexico. These can be interpreted as the minimumpayments necessary to induce land users not to convert forest to agriculture, as they would be forgoing these potential earnings. This study found average net returns to maize productiono f US$29.50/ha and average net returns to livestock production o f US$84.80/ha. About 43 percent o f maize producers had net returns o f US$4l/ha or less, while 20 percent of livestock producers had net returns o f that same level. That is to say, an annual payment o f US$4l/ha or more would likely attract 43 percent o f maize producers and 20 percent o f livestock producers. The PSAH program subsequently offered payments o f US$36.4/ha in cloud forest areas and US$27.3/ha in other areas. It attracted almost 2,000 applications, from which a total o f over 300,000 ha were accepted, confirming the widespread willingness to accept the offered payment levels. 14. Table A9-3 shows the estimated net returns to agricultural productioninthe eight pilot sites selected by CONAFOR. These can be interpreted as the minimum payments necessary to induce land users not to convert forest to agriculture, as they would be forgoing these potential earnings. As can be seen, these costs are in every case higher than the payments the PSAH Program i s currently offering; land users in these areas, therefore, have no incentive to participate. This demonstrates the need for a differentiated payment 15. The tourism industry is also often amajor water consumer. It may, therefore, also be involved in PES inthis guise as well. 16. For example, WWF has provided funding for the Monarch Butterfly Conservation Fund, which uses direct paymentsto land users to protect the wintering home of the monarch butterfly in central Mexico. 17. These figures are underestimates, because data were only available for protected areas that are part of the national protected areas systems, SINANP. Visitors to protected areas not registeredwith SINANP are not included. In addition, nature-based tourism activities also use many areas outsideprotected areas. 104 program: ifthe overall payment level was raised to the levels necessaryto secure participationinthe highest opportunity-cost areas, the cost o f the program would soar. Table A9-3 also shows that there i s substantial variation in opportunity cost within each site. At Cerro Grande, for example, the mean Opportunity cost i s about US$l5O/ha but 20 percent o f producers have opportunity costs o fUS$SO/haor less. 15. The areas that would need to be conserved at each site have not yet been determined, either in terms of their size or their location. This i s a process that will be undertaken under implementation, based 011 detailed diagnostics o f the precise problems facing local service users and technical studies to identify the sources o f these problems, and negotiations with service users on what they wish to pay for. Table A9-3 shows some very crude, order-of-magnitude estimates o f possible costs, based on various proportions of forest areas that might need to be conserved. These show that if about 5 percent o f the current forest area needs to be conserved, the annual cost would be about US$10 million. Ifgreater areas need to be conserved, the cost would rise correspondingly. If reforestation were needed to reverse previous damage to services, the costs would be higher still. The transaction costs o f contracting land users and monitoring compliance would also needto be added.'' 16. For a number o f reasons, the estimates presented in Table A9-3 are likely to be over-estimates: The cost estimates in Table A9-3 depend on the opportunity cost at the site and on the size of forest cover assumed to need conservation. The proportion o f total forest area needing to be conserved i s likely to be lower at sites with substantial remainingforest cover. These across-the-board estimates do not reflect this. . The opportunity cost estimates are based on returns to agriculture in already-cleared land, and land that i s still under forest i s likely to be less productive, and so have a lower opportunity cost. The actual payments necessary to induce conservation will depend on which specific areas within the promising sites need to be conserved. These payments may either be higher or lower than assumed in Table A9-3, depending on actual opportunity costs inthese areas. 17. Note that these estimates assume that the dominant form o f PES-supported land use will be conservation o f existing forest, as in the current PSAH. In some cases, however, generating the desired environmental services may require additional actions, such as the implementation o f improved management in forest, or in some cases reforestation. The costs o f these actions would have to be added to the opportunity cost o f land. Conversely, in many cases environmental services can be generated by land uses that allow some continued use o f the land; for example, many agroforestry and silvopastoral practices can produce a variety of services while continuing to provide direct income to land users. The cost of implementing such measures would then be limited to the difference in net revenue between the PSAH-supportedpractice and the most profitable practice (for land users). Net benejk to the country 18. Determining whether implementation o f the PSAH program i s beneficial for Mexico requires assessing whether total benefits exceed total costs. The lack o f quantitative data on benefits precludes a iiumerical analysis, however. Nevertheless, it can be concluded that (1) in areas with significant numbers of water users, water benefits are likely to be sufficient by themselves to justify the PSAH program's conservation activities; (2) in areas eligible for sales o f CDM-compliant carbon emission reduction credits, carbon income will bear the bulk o f costs, meaning that only small amounts o f additional benefits would be necessary for these activities to be economicallyjustified; and (3) contributions by the GEF and other donors, through the Trust Fund that will be established, will compensate the country for the 18. Experience in Costa Rica suggeststhat the transaction costs borne by the PES implementing agency are about 5-7 percent of payments, and that those borne by participants are of a similar magnitude. Contracts in Mexico cover much larger areas, however, so the transactioncosts are likely to be substantially lower. 105 incremental costs of extending conservation efforts to areas o f high biodiversity significance where funding from local services users and from carbon buyers is unavailable or insufficient. Thus it is likely that PSAH program activities will be economically justified for the country. To help ensure that this i s the case, the project will also support efforts to identify and prioritize areas most likely to generate valuable biodiversity benefits (thus increasing average service generation per dollar spent) and to differentiate and target payments so that they are inore likely to result in land use change (thus reducing the cost per unit o f service generation). These conclusions are predicated on payments being closely targeted to areas where valuable services are at risk. The project is dedicating substantial resources to ensuring that this i s the case: by basing payment programs on detailed diagnostics o f service user needs and the specific threats to those needs; and by tying payments to providers to financing from service users.I9 Alternative approaches 19. It is important to consider the alternatives to the PES approach. Mexico has very serious environmental problems. Degradation o f its water supplies, in particular, pose grave threats to ecoiiomic activity (hydropower generation, irrigation, industry, tourism, fishing) and to social welfare (lack of water and low quality o f water for domestic use). The PES approach will allow some of these important problems to be addressed using funding from service users. Lacking such a mechaniin, the cost o f addressing these problems would fall entirely onto the government budget. It i s for this reason, among others, that so many countries are moving to develop and implement PES programs. Costa Rica has developed a nationwide PES programs, while El Salvador, Ecuador, and Colombia have decentralized programs. 20. In the absence of the PSAH program, the main alternative for Mexico to obtain the services the program generates would be to place additionalareas under formal protection. This approach would likely be more expensive, as it would tend to preclude all econoinic uses o f the land concerned. A PES approach, in contrast, allows economic uses to continue as long as they are compatible with the specific restrictions o fthe contract, and thus has lower opportunity costs. This factor will be particularly important as the PSAH program moves from its current approach o f focusing exclusively on conservation o f existing forest and adds new modalities such as reforestation and agroforestry. 21, Financial cost-effectiveness. Whatever its economic merits, the protected areas approach would be prohibitively costly in financial terms, as it would require compensating land users for the full value o f their land (rather than just for the difference between its value under an alternative land use compared to its value under a conservation use) and it would require the entire value o f this compensation to be paid up front (rather than being paid annually, as under a PES contract). Creating additional protected areas, and thus displacing their owners, would also be socially unacceptable. Sustainability 22. The PES approach is predicated on a quid pro quo between service users and service providers. Service users wish to secure or improve the services they are receiving, and are willing to pay for the benefits this would bringthem. Experience inother countries has shown that there i s substantial demand for such services. In Costa Rica, for example, a wide range o f water users (private and public hydropower producers, bottlers, municipal water supply systems, irrigation) are paying for conservation o f the watersheds from which they obtain their water, as well as for the administrative costs of FONAFIFO, the organization that operates the Costa Rican PSA program. In Mexico itself, there already are examples o f service users paying for services, for example in Coatepec, as mentioned above. Similarly, service providers are willing to provide such services, as long as they are compensated for the cost of doing so. Again, there i s ~~ ~ 19. This latter measures means that payments will be tied to agreements with a constituency that has a very strong interest in ensuringthat payments are made efficiently, as their money is on the line. The current financingmechanism; which is based entirely on budget transfers through the Ley Federal de Derechos has no such constituency, and has indeed proven very vulnerableto politically-motivatedtargeting. 106 substantial evidence of this willingnessto provide services, most notably inthe high application rates to the PSAH program in its first two years. Thus PES does not rely on the whims of government decisionmakers and external donors. As long as service users are satisfied that they are receiving the services they are paying for, they have no reason to stop paying for them. And as long as land users continue to be compensated for the cost of providing them, they likewise have no reason to stop providing them. A properly-implemented PES program, therefore, is likely to be structurally sustainable. The project's activities are designed to ensure this as much as possible. The PSAH will only make payments to service providers for activities agreed by the service users who are paying. There will be a strong monitoring system to document the extent to which service providers are complyingwith their contracts and the extent to which services are being generated. With these elements in place, experience has shown that payments can be sustainable. In Costa Rica, for example, water users who first signed contracts with FONAFIFO in 1997 and 1999 have since renewed their contracts. The sustainability o f the mechanism also depends on the service users trusting the institutions involved to serve their interests and to do so efficiently. The project builds on the experience o f other countries by establishingan independent institution with clear, transparent rules. 23. Financial sustainability. CONAFOR currently receives about US$30 million annually to implement the PSAHprogram. It i s anticipated that this level o f funding would continue, and would allow a corresponding level of conservation (though improvements inprogram efficiency should allow a larger area to be conserved).*' The additional funding provided by the new financing mechanisms to be developed under component 1 of the project will allow an expansion o f the area under conservation. It i s iinportant to notice that this expansion o f conservation will only occur to the extent that additional funding allows. Thus additional obligations to pay service providers will be matched by additional income streams from service users. Indeed, service users who elect to channel their funding through the PSAH program will also pay a fee to CONAFOR to cover the administrative costs o f runningthe PSAHprogram. 24, There is a specific sustainability problem in those areas where local services are insufficient to generate sufficient fundingto pay for the needed landuse change, but where this change would be desirable to conserve globally significant biodiversity. When services are mainly local, they can generate a continuous flow of resources to support the needed payments. Payments made by water users, or by the ecotourism industry, would be continuous. However, it is not possible to arrange a similar continuous flow of funds when the benefits being sought are primarily global. The project recognizes this explicitly and is establishing an endowment fund, which would convert short-term funding into a continuous funding stream. There have been very successful experiences with such endowment funds in Mexico, Peru, and Bolivia, for example, and Colombia i s creating such a fund. In particular, Costa Rica i s establishing a Biodiversity Conservation Trust Fund precisely to address this need to provide long-term financing for conservation payments in areas o f globally significant biodiversity where other funding sources are not available or insufficient. El Salvador is also exploring this option under its Environmental Services Project. 25. The design of the project has taken full advantage o f lessons learned from the experience of other countries, especially as regards sustainability. Costa Rica's PSA program, for example, has been justly celebrated, but faces significant sustainability concerns and continues to depend primarily on fuiidiiig from an earmarked tax. A new project i s addressing these weaknesses, using approaches very similar to those proposed in this project: development o f new financing mechanisms based explicitly on service user demand, and capitalization o f an endowment fund to address the specific long-term financing needs of biodiversityconservation. 20. Each year's budget allocation is placed in a sinking fund that covers the full five years of payments due under contracts signed in that year. Thus future cutbacks in allocations to the PSAH program would not affect its ability to make payments under contracts already entered into. 107 2 .I 4- E a2 28 W a .I L .I F2 a L Q Ccl 0 .rl $ Ra c, m v1 Q 2 c1 6a 4LEa m c, Q) .I m c, 0 e .I a c, e .I E28 c, w0 c, VI z?i 0 0 c, .I w" c, 24.. z Q) c1 E N . Annex 10: SafeguardPolicy Issues MEXICO: EnvironmentalServices EnvironmentalAnalysis: 1. Overview. This project is intended to be entirely positive from an environmental standpoint. It seeks to improve existing, and develop new, systems o f payments for environmental services (PES), thereby encouraging rural landowners to maintain or enhance the vegetative cover on their lands, in terms of hydrological functions, biodiversity, and/or carbon sequestration. The only possible adverse environmental impacts would be strictly unintended; the project design includes inechanisins to prevent any such negative impacts during implementation. 2. Project Summary. The project would expand and improve PES systems in Mexico through (i) developing new, sustainable financing mechanisms for environmental services, which would be channeled either through the existing PES programs or through new, stand-alone local PES mechanisms; (ii)strengthening and improving the efficiency of existing PES programs (PSAH and CABSA); (iii) stimulating the development o f stand-alone local PES programs; and (iv) assisting local communities in service provision. See Annex 4 for a more detailed description o f each project component. 3. Project Expenditures. A substantial proportion o f project funds (including IBRD loan, GEF grant, and Mexican counterpart) would go to landowners as PES, either during project implementation or (in the case of project-supported trust funds) later in the future. The remaining project funds would go mostly to technical assistance, consulting services, training, promotional campaigns, and institutional strengthening neededto establish and strengthen PES programs and their long-term funding mechanisms. The project would purchase office and field equipment, vehicles, and other equipment and supplies, as needed, for the institutional strengthening o f implementingagencies and some participating landowners' associations. No civil works are expected to be procured under the project. The main on-the-ground environmental impacts associated with project expenditures would thus be the maintenance o f desired vegetative cover on the rural landholdings o f PES recipients. 4. Positive EnvironmentalImpacts. The project is expected to be overwhelmingly positive from an environmental standpoint, by using PES to induce rural landowners to inaiiitaiii the forests or other natural vegetation on their lands, thereby (i) conserving globally significant biodiversity, (ii) maintaining or improving hydrological functions, and (iii)reducing greenhouse gases by storing carbon. The currently proposed eight pilot sites all contain substantial areas o f forests and other natural vegetation that i s important for all three types o f environmental services (biodiversity, water, and carbon). See Aiinex 17 for a description o f these pilot sites, along with an explanation o f how they were selected. In addition to these pilot sites at the national level, the project would promote the establishment o f local level PES systems at other sites o f conservation interest, either for water users interested in improved upstream watershed management, or for tourism operators and others interested in maintaining biodiversity and scenic beauty. 5. Potential Adverse EnvironmentalImpacts. Any environmentally adverse consequences from this project would be strictly unintended. Nonetheless, it is importantto assess what these adverse impacts might possibly be, in order to design mechanisms to prevent or minimize them. Based on this project's Environmental Assessment (EA) report and other project preparation work, potential adverse environmental impacts might arise under the following types o f scenarios: a. Tradeoffs Between Different EnvironmentalObjectives. In the overwhelming majority o f cases, the conservation o f forests or other mature or regenerating natural vegetation poses no significant 111 tradeoffs in terms of preserving biodiversity, maintaining desired water flows, and sequestering carbon. No such tradeoffs have been noted to date in the implementation o f the ongoing PSAH and CABSA programs in Mexico, nor in Costa Rica's Ecomarkets Project. However, as new PES schemes are established under this project (particularly at the local level), it is conceivable that the ideal vegetation management systems for one type o f environmental service might reduce another type (for example, optimal water supply vs. flood mitigation vs. the habitat for threatened species); b. Misallocation of PES Funds. Since environmental service payments are popular with the PES recipients as well as politicians, there might exist pressures to provide these payments even for land uses that are not optimal (nor even desirable) from an environmental standpoint. Such risks might include (i) continuing PES payments to landowners who have not complied with their contracts (and cleared or degraded the natural vegetation) or (ii)authorizing PES payments for maintaining suboptimal land uses from an environmental services standpoint (such as agricultural systems rather than forests, even in watersheds where enough forested land exists to absorb all the available PES money); or c. Perverse Incentives. The potential for receiving PES money might induce strategic behavior among rural people that could be environmentally damaging. For example, some people might want to settle within a watershed targeted for PES, thereby clearing forested land to establish their claim. 6. Environmental Management Plan. The Environmental Management Plan (EMP) for this project i s intended to prevent the abovementioned types of unintended negative environmental impacts, The EMP is mainstreamed within the overall project, rather than being a separate component. The environmental safeguards recommended by the EMP (to prevent unintended adverse impacts) will be incorporated as criteria and procedures within the operational rules. The details o f the operational rules will reflect the EMP recommendations and subsequent agreement between the Bank and Borrower; they will be finalized prior to PES disbursements under Component 4. These operational rules will include (i) clear eligibility and prioritization criteria for the types o f lands and landowners that could receive PES contracts and (ii)review procedures and specific responsibilities within CONAFOR to ensure that all contracts are awarded, administered, and supervised in accordance with these criteria. 7. To minimize the risk o f any unintended, adverse environmental consequences o f the types mentioned above, the PES eligibility criteria are expected to require, inter alia, (i)no clearing o f forests or other natural habitats to establish new agricultural systems; (ii)any reforestation must be with species native to the site; and (iii) all eligible landowners (whether communities, ejidos, or individuals) will need to present a title or other evidence o f legally secure land tenure (to prevent the risk o f settlement by outsiders seeking PES benefits). Within any watershed selected for PES support, the prioritization criteria will tend to favor the conservation o f native forests (or other natural habitats) over the maintenance o f agro-ecosystems (such as shade coffee), although the latter could receive PES contracts where an insufficient area exists o f the original natural ecosystem (such as at Coatepec, Veracruz). For specific sites with particular hydrological or biodiversity characteristics, differentiated criteria might be established (such as the maintenance o f particular animal or plant species o f special conservation interest), along with the appropriate PES performance monitoring systems. However, even for locally based PES schemes focused on hydrological benefits from specific watershed management interventions (and not receiving GEF grant funds), the operating rules will require that the land management criteria be biodiversity-friendly, and will specifically prohibit practices which would harm vulnerable or threatened species. One possible example o f such a practice to be avoided i s the removal o f most snags (standing dead trees) from a forest, because o f their importance to many species o f cavity-nesting birds. In technically complex cases (such as whether to thin native pine-oak forest to reduce catastrophic fire risks), CONAFOR would require that any PES contracts that would allow such interventions be reviewed and approved by a biodiversity specialist. 112 Compliancewith SafeguardPolicies: 8. This project is designed to comply fully with the letter and spirit o f applicable World Bank Safeguard Policies, as indicated below. 9. Environmental Assessment. This project is classified as Category B, the appropriate classification for projects which involve natural habitats, but would not lead to their loss or degradation (as is explained in BP 4.04, Paragraph 2). This category is consistent with most other conservation and natural resource management projects in Latin America and the Caribbean (including the PES projects in Costa Rica and El Salvador). In accordance with this classification, a relatively brief, free-standing Environmental Assessment (EA) report has been drafted and reviewed by the Bank; it will be publicly disclosed prior to appraisal, but thoroughly revised and improved during appraisal. The EA assesses the abovementioned risks o f adverse environmental impacts, most o f which are rather minor. The EA report will be revised during appraisal to include an appropriate EMP, which will specify the criteria and procedures-including operating rules-that will be used during project implementation to avoid any adverse environmental impacts (or to minimize them, so that they are not significant). Preparation o f the EA (including EMP) has included a number o f public consultation meetings about the project design (including the environmental aspects) with a broad range o f stakeholders, including representatives o f ejidos, indigenous communities, and individual landowners; conservation NGOs; tourism and water user interests; and relevant national, state, and local government entities. 10. Natural Habitats and Forests. This project is fully compatible with both the Natural Habitats OP/BP 4.04 and the Forests OP/BP 4.36. It would not support any clearing or degradation o f forests or other natural habitats. On the contrary, it i s intended to promote the conservation and restoration o f forests and other mature natural vegetation, through the mechanism o f providing PES to participating landowners under eligibility criteria consistent with Bank safeguards policies(see paragraph 7 o fthis annex). 11. Pest Management.This project does not trigger the Bank's Pest Management Policy (OP 4.09), because it would not (i)procure any pesticides (or pesticide application equipment), (ii)lead to increased pesticide use, nor (iii)support pest management practices that are risky or unsustainable froin an environmental or health standpoint. The eligibility criteria and operating rules will specifically prohibit any pest management practices that violate OP 4.09. 12. Cultural Property. This project would not trigger the mitigation requirements o f the Bank's Cultural Property Policy (OPN 11.03). The project is not expected to finance civil works, so there will not be the earth movement that is sometimes associated with archaeological or paleontological chance finds. Moreover, the maintenance o f natural vegetation on lands covered by PES contracts i s not likely to affect archaeological or other sites o f cultural importance. The conditions o f PES contracts would not preclude low-impact archaeological or paleontological research or salvage activities. 13. Involuntary Resettlement. This project does not trigger the Involuntary Resettlement OP/BP 4.12, because (i)no taking o f land or other assets would take place; (ii) no physical relocation o f anyone would be required; and (iii)all PES contracts, and the land use restrictions associated with them, are strictly voluntary with each landowner. In many or most cases, the landowners will be coininunities or ejidos, rather than individuals. In these cases o f collective decision making (where the community or ejido decides to restrict the consumptive use o f its own natural resources to obtain a greater overall benefit), the Involuntary Resettlement Policy does not apply (as explained in OP 4.12, Footnote 6). To ensure the legitimacy, transparency, and fairness o f the decisionmaking process carried out prior to agreeing to a PES contract (and the associated land use restrictions), the cominunity or ejido must present to CONAFOR its General Assembly Resolution (Acta de Asamblea General), a document registered with the National Agrarian Registry (Registro Agrario Nacional). This i s existing practice for the current 113 PSAH and CABSA programs and will be continued and supervised for all types o f PES contracts under the new project. 26. 14. Indigenous Peoples. A substantial proportion(though by no means all) o f PES recipients will be indigenous peoples. To ensure consistency with Bank policy regarding indigenous people, an Iiidigenous Peoples Development Plan (IPDP) was completed and disclosed during project preparation. The IPDP has included a number o f public consultation meetings at the community level about the project design (during preparation o f the social assessment) with a broad range o f stakeholders, including representatives of ejidos, indigenous communities, and individual landowners, conservation NGOs, tourism and water user interests, and relevant national, state, and local government entities. The IPDP includes the following sections: (a) financial allocation for all activities related to indigenous peoples, (b) a legal instrument(convenio de adhesi6n) to define and confirm the obligations between CONAFOR and participating communities, and (c) proposed changes to the applicable program operating rules. The IPDP specifies activities to be carried out with Indigenous communities participating in the national PSAH and CABSA programs. An Area Specific Indigenous Action Plan (IAP) will be prepared for each ofthe eight pilot areas in accordance with the IPDP before ES contracts, with local private financing, are signed ineach pilot area . Summary Social Assessment: 15. Consultations with stakeholders and analysis o f issues and risks were carried out to help select potential sites for establishing local PES programs. A participatory social assessment of five o f the sites considered promising for project implementation was completed. 16. Participants and Beneficiaries. The populations and communities that will be affected by the project fall into two main categories: (i)environmental services users that will help finance the PES programs, and (ii)environmental services providers, including both indigenous and nonindigenous people, who will be compensated for maintaining or adopting desirable land uses and practices. Service users and service providers are both beneficiaries of PES programs. 17. The financing or service user side o f the relationship includes users o f water services (municipalities, utilities, irrigators, individual consumers), biodiversity (tourism companies, national and international conservation organizations), and carbon sequestration (CDM and the international community). 18. Recipients o f the PES payments and capacity building assistance-the environmental service providers-include owners o f forested land in the targeted watersheds, most o f which is commonly owned land held in the form o f ejidos and comunidades agrarias, both indigenous and nonindigenous. These areas also tend to correspond to some o f the poorest communities in the country, with some of the highest marginalization indexes. Ejidos or comunidades with large tracts o f forest are also much more likely than nonforested landholdings to have significant majorities o f indigenous people. 19. PES payments could be decisive in allowing poor and indigenous communities to resist pressure to generate income in the short term through unsustainable activities and instead engage in more sustainable land uses that improve incomes and well-being in the long run while providing benefits to other groups inthe form o f environmental services. 20. Socioeconomic Risk Mitigation. The risk o f negative socioeconomic impacts on both groups is strongly mitigated by the inherent theoretical foundation o f the PES concept-that these systems, and particularly their long-term sustainability, rely on voluntary participation based on the perceived self- 114 interest and well-being o f the participants. That is, users will pay no more for the services than the perceived benefits they provide, while providers of services will only accept payments for activities if they exceed the opportunity cost o f their available alternatives. 21. Areas o f concern identifiedby the project include insufficient awareness o f environmental service benefits and costs to support the program, barriers to participation by providers o f service due local political and community organizational obstacles or lack o f technical capacity, and issues of equitable distribution o f costs and benefits. 22. To address these concerns, the project will include considerable promotional, educational, analytical, and consultative activities to ensure that both users and providers o f services understand the benefits and costs o f the PES system, have input into the design o f local PES arrangements, and have the capacity to take advantage o f the opportunities offered and meet their obligations as participants. Components 1 and 2 (to develop PES financing and delivery mechanisms) include activities to educate service users, identify their needs, ensure that service payments are targeting the right land uses, monitor both compliance and impacts, and avoid creating perverse incentives. Component 3 of the project (to support environmental service providers) and Component 4 (to pay the providers and monitor delivery o f services) help ensure that service providers, and particularly marginalized groups, are capable o f participating in, delivering on, and benefiting from the payment systems created. Consultative mechanisms are included throughout the project components to ensure relevancy, feedback, and compliance, not only to protect the interests o f stakeholders and mitigate socioeconomic risk, but because the efficacy o f the PES mechanisms is almost wholly dependant on their success inproviding benefits to stakeholders. 23. Partial Assessment o f Promising Sites. The project will promote and provide technical assistance to interested parties to establish local arrangements for payment o f environmental services in about eight promising sites. These sites are areas targeted for special assistance to improve the quality o f their environmental services-"areas promisorias para la promocionde 10s servicios ambientales" or "apromsas." 24. About 80 percent of forested land in Mexico i s held under common property, either as ejido or indigenous community land (indigenous common property is more often categorized as an ejido than named explicitly as indigenous community property). Another 15 percent o f forested land i s private property, and 5 percent is public property. 25. A participatory social consultation, focused on common property owners who live in the area, was held infive o f the six sites in Table A 10.1. Most private forested lands are under absentee ownership, and even many o f the collective owners work (and live either temporarily or permanently) away from the area due to lack o f economic opportunities there. 115 26. Some o f these sites have been declared as natural protected areas, with varying organizational approaches and degrees o f success. In those sites there is clear data on the geographic area, population, and number o f agrarian communities. Other areas, particularly those not included in previous specific institutional environmental sustainability efforts (the last three mentioned below), still are not precisely defined. 27. A total of 20 participatory workshops were held inthe first five o f the abovementioned sites, with a total attendance o f 278 local inhabitants. Three o f those workshops were held specifically for women (66 indigenous, 10 nonindigenous). In addition to the workshops, interviews were conducted with 74 people, including ejido and indigenous community leaders, NGO workers, communityiejido technical field workers, and local managers and staff o f protected areas and CONAFOR. 28. Community proJile. The inhabitants of these areas largely live in poverty and extreme poverty. Local production, be it agriculture, livestock, or handcrafts, lacks viable market access and therefore i s destined for local consumption only. Sustainable and legal forestry i s not usually viable economically under present technologies and rules. Local communities typically survive on cash incoine froin working in nearby cities or commercial agricultural enterprises, or from remittances sent by family members working inthe United States. 29. Decline of ejido/community cohesion. The freedom to treat individual holdings within ejidos as private property, combined with extensive migration by property owners, has fundamentally changed the dynamic o f community life and resulted in a wide variation in the capacity o f ejidos and communities to manage their common lands (as described in the typology o f communities in the SA). Lack of a communal economic interest has made many rightful owners indifferent toward actively managing their forested property, and opened the way in some places for opportunistic individuals, sometimes allied with economically or politically powerful outsiders, to engage in a predatory use o f common property with little concern for the long-term health or productivity o f the land. 30. However, most forest in areas that are promising sites for PES programs demand active care in order to thrive (extracting excess flammable material; preventing the spread o f fires and pests; land conservation activities in degraded forests; reforestation activities, etc.). An indifferent community, even without predatory activities, usually leads to deterioration o fthe forest. 31. Action strategy. In this context local consultations have helped craft a design that emphasizes Table A1O.l: BasicData on Six PromisingAreas for PESPrograms Area Stakeholder Agrarian Indigenous Potential site (hectares) population pop. centers population Cerro Grande, Colima 40,000 4,000 11 2,000 Zapaliname, Coahuila 45,000 5,000 11 Cumbres de Monterrey, Nuevo Leon 177,000 3,000 27 Ida-Popo (spans several states) a 50,000 24,000 15 12,000 Zona Maya, Quintana Roo 200,000 22,000 30 22,000 Cuenca Copalita, Oaxaca 80,000 26,000 18 26,000 Total 592,000 84,000. 112 52,000 a. The calculation of indigenous population in Izta-Pop0 depends on conceptual definitions. Inhabitants o f the higher altitude towns are of indigenous ancestry, have a strong community attachment to the land and keep many elements of an indigenous culture. Most however do not longer speak an indigenous language, or self identify as indigenous. 116 strong indigenous community and ejido participation in a strategy that integrates the following pillars o f action, as reflected inthe Project Operational Manual: 0 Making environmental services a source o f income for the ejido/community. This would be done by paying the ejido/community for conservation activities. This is clearly preferred by local inhabitants to payment for mere ownership of.the forest. 0 Promoting the re-appropriation o f collective administration and control o f common property. Reactivating ejido/community assemblies and the means to assert collective rights under specific cultural and sociopolitical conditions would help displace the activities of predatory minorities. 0 Providing technical assistance in sustainable management o f ejido/community lands, forested common property, agricultural individual holdings, and other property. 0 Strengthening social capital and local capacity for ejido/community integrated planning, integrated land and forest management plans, and design o f development subprojects. 0 Building local capacity to attract public programs and funding for specific environmentally friendly subprojects. This amounts to a much needed bottom-to-top mainstreaming o f environmental sustainability concerns into public programs. 0 Establishinga new local entity in potential PES areas to represent social and community concerns inthe negotiation of environmental service payment arrangements and commitments. This could take the form, as a first step, o f a local participatory committee comprising ejido members, indigenous communities, grassroots organizations, NGOs, and other stakeholders. 32. Ongoing regional and community promoters. Regional promoters hired by the project would maintain close interaction and consultation with local communities and leaders and would play a key role in addressing community problems and concerns and in defining how to tailor the strategy to local conditions. In addition, indigenous ejidos and communities would select community-based promoters from among their members to serve as liaisons with the regional promoters and with the project. The community promoters, who would receive stipends to cover part o f their expenses, would facilitate follow-up on activities agreed with the regional promoters, serve as translators at community meetings, and help facilitate local absorption o f technical knowledge. Community promoters would also participate inregional seminars several times a year for training and knowledge sharing. CONAFORwould provide training and facilitate peer-to-peer learning and knowledge sharing for both the regional and community- based promoters. 33. Participants.inthe consultations made clear that they demand regular face-to-face communication and outreach, with clear rules, on a long-term basis, with stable technical personnel who are directly accountable to them. Another strong message is the very high value they place in knowledge and capacity building. 117 Annex 11:Project Preparationand Supervision MEXICO: EnvironmentalServices Planned Actual ~~~ PCN review 812004 812004 InitialPID to PIC 912004 912004 InitialISDS to PIC 912004 912004 Appraisal 1212005 1212005 Negotiations 212006 212006 BoardlRVP approval 312006 Planned date of effectiveness 612006 Planned date of mid-termreview 712008 Planned closing date 6/2011 Key institutions responsible for preparation of the Project: National Forestry Commission (Comisi6n Nacional Forestal - CONAFOR) Bank staff and consultantswho worked onthe Project, included: Name Title Unit Stefan0 Pagiola Sr. Environmental Economist ENV Ricardo Hernandez Sr. Environmental Specialist LCSEN DineshAryal Operations Analyst LCSEN Alejandro Deeb Sr. Hydrologist LCSEN George Ledec Lead Ecologist LCSEN Peter Brandriss Sr. Program Assistant LCSEN John Kellenberg Sector Leader LCSEN Gunars Platais Sr. Environmental Economist LCSEN Monique Pelloux Patron Team Assistant LCSES BlancaAlonso Team Assistant LCSES Mark Austin Sr. Operations Officer LCSER Juan Martinez Sr. Social Specialist LCSEO MarthaMolares-Halberg Lead Counsel LEGLA Daniel Boyce FinancialManagement Sp. LCOAA Victor Ordonez FinancialManagement Sp. LCOAA Efraiin Jimenez Procurement LCOPR Carmen Machicado Operations Officer LCSPS Edgar Ortiz Sr. Forestry Specialist Consultant Maria Clara Mejia Social Specialist Consultant Julio Cordoba Sr. Institucional Specialist Consultant Marco A. Zambrano Eiivironmental Specialist Consultant Bernard0 Madriz Institutional Dev. Specialist ConsuItant Bank funds expendedto date on project preparation: 1, Bank resources:USD340,000 2. Trust funds: USD 400,000 3 .Total: USD 740,000 Estimated Approval and Supervision costs: 1. Remaining costs to approval: USD 50,000 2. Estimated annual supervision cost: USD 100,000 118 Annex 12: Documentsinthe ProjectFile MEXICO: EnvironmentalServices Project Documents 1Prniect Annraisal Document 102/09/2006 1 PAD Project Reports and Studies Technical assistance for the coordination o f the design o f the Project, Jose Armando Ala& de la Rosa Technical assistance for the coordination o fthe design o f the Project, Jaime Baray Terrazas Technical Assistance for the Determinationo f Areas o f Eligibility o f Environmental Services, Shatya Quintero Gradilla Technical Assistance for the Determinationo f Areas o f Eligibility o f Environmental Services, Jesus Gutierrez Cacique Technical Assistance for the Determinationo f Areas o f Eligibility o f Environmental Services, Rodolfo Valdez Garcia Technical Assistance for the Determinationo f Areas o f Eligibility o f Environmental Services, Erika del Rocio Martinez Guevara Technical Assistance for the Determinationof Areas o f Eligibility o f Environmental Services, David L6pez Ramirez Technical Assistance for the Determination o f Areas o f Eligibility o f Environmental Services, Victor Tejada Vazquez Preparation o f the Conceptual Project Note (PCN) o f Environmental Services from the Forest to the Fundof BioCarbono of World Bank for the project inMexico, Edgar Ortiz Malavasi Environmental and Social Assessment of Conceptual Project Note (PIN) for the Fundo f BioCarbono o f World Bank for the project in Mexico, Hilda ElizabethHesselbachMoreno Social Study, Jorge Franco L6pez Social Study -Fase 2, Jorge Franco L6pez -work inprogress Identification o f experiences relative to the development o f environmental service markets o f the forest inMexico (case study), Sergio MadridZubiran Eiivironmental Assessment of the Impact o f the Environmental Service Project o fthe Forest, Marco A. Zainbrano Chhvez Formulation o f the Procurement Plan and Operative Manual o f Procurements, Bernard0 Madriz Specialist in Procurements and Procedures, Alma Gonzalez Technical Assistance for the Financial Control duringthe design o f the Project for the Market Development o f Environmental Services in Mexico, Ana Ma. Rosales Monroy Study for the Formulation o f the Logical Framework, Julio C6rdoba Case Study on the Market Development o fEnvironmental Services inMexico, Scolel-Te, Chiapas - in progress 119 0Case Study on the Market Development o f Environmental Services inMexico, San Pedro Cliichila- Taxco, Guerrero - inprogress 0Case Study on the Market Development of Environmental Services inMexico, Copalita-Huatulco, Oaxaca- in progress 0Case Study on the Market Development o f Environmental Services in Mexico, Cofre de Perote- Coatepec, Veracruz - in progress 0Case Study on the Market Development o f Environmental Services inMexico, Cerro Grande-Colima, Colima y Jalisco inprogress - 0Case Study on the Market Development o f Environmental Services inMexico, Cafe de Sombra, Oaxaca - in progress 0Case Study on the Market Development o f Environmental Services inMexico, Amanalco-Valle de Bravo, Mexico inprogress - 0Case Study on the Market Development of Environmental Services inMexico, San Pedro Atlapulco- Ocoyoacac, Mexico - in progress 0Operational Manual on the Environmental Services Project 0Project ImplementationPlan 120 Annex 13: Statementof Loans and Credits MEXICO: EnvironmentalServices Differencebetween expectedand actual Original Amount inUS$Millions disbursements ProjectID FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. Rev'd M X (APLI) Tertiary Educ PO85593 2006 Student Ass 180.00 0.00 0.00 0.00 180.00 11.87 0.00 180.00 M X (APLI)School-Based PO88728 2006 ManagementProg 240.00 0.00 0.00 0.00 240.00 15.00 0.00 240.00 M X Accessto Landfor Young PO88732 2006 Farmers 100.00 0.00 0.00 0.75 99.00 15.75 0.00 100.00 M X ModernizationWater & PO91695 2006 Sanit Sector TA 25.00 0.00 0.00 0.19 24.81 0.00 0.00 25.00 M X BasicEducationDev PO85851 2005 PhaseI11 300.00 0.00 0.00 1.61 146.94 -76.46 0.00 300.00 M X Housing& Urban PO88080 2005 Technical Assistance 7.77 0.00 0.00 0.00 7.64 3.23 0.00 7.77 M X StateJudicial PO74755 2005 ModernizationProject 30.00 0.00 0.00 0.00 30.00 2.00 0.00 30.00 MX-(APL1) Innov.for PO89865 2005 Competitiveness 250.00 0.00 0.00 0.00 248.75 5.42 0.00 250.00 M X (CRL1)Savings& Rurl 0.38 37.30 -23.29 0.00 75.50 PO87152 2004 Finance(BANSEF1) 75.50 0.00 0.00 M X CommunityForestry I1 PO35751 2004 (PROCYMAF 11) 21.30 0.00 0.00 0.00 16.12 4.46 0.00 21.30 M X Decentralized 0.00 0.00 79.73 6.40 0.00 108.00 PO80149 2004 InfrastructureDevelopm 108.00 0.00 M X Irrigation & Drainage 0.00 0.00 183.82 -3.21 0.00 303.03 PO35752 2004 Modernization 303.03 0.00 GEF MX-Climate Measures in 5.80 0.00 2.15 1.89 0.00 0.00 PO59161 2003 Transport 0.00 0.00 M X Savings& Credit Sector 0.00 18.01 8.65 0.00 64.60 PO70108 2003 Strengthening 64.60 0.00 0.00 GEF M X Consolidat.ProtAreas 18.31 0.00 4.06 1.27 0.00 0.00 PO65988 2002 (SINAP 11) 0.00 0.00 M X Tax Admin Institutional 0.00 13.07 9.56 0.00 52.00 P077602 2002 Development 52.00 0.00 0.00 GEF MX- Indigenous&Community 0.00 0.00 7.50 0.00 3.19 2.13 0.00 0.00 P066674 2001 Biodiversity GEFMX-MESO AMERICAN 14.84 0.00 12.02 7.94 1.88 0.00 PO60908 2001 CORRIDOR 0.00 0.00 METHANE CAPTURE& USE 6.27 0.00 0.08 0.08 -0.08 0.00 PO63463 2001 AT A LANDFILL 0.00 0.00 M X FEDERAL HIGHWAY 0.00 5.73 5.73 0.00 218.00 PO65779 2001 MAINTENANCE PROJ. 218.00 0.00 0.00 MX: I11BASIC HEALTH 0.00 0.00 266.67 167.87 16.89 350.00 PO66321 2001 CAREPROJECT 350.00 0.00 GEF MX ALTERNATIVE 0.00 0.37 0.37 -0.37 0.00 PO60718 2000 ENERGY 0.00 0.00 8.90 M X HIGHERED. 0.00 0.00 23.20 23.20 0.00 180.20 PO49895 1998 FINANCING 180.20 0.00 Total: 2,505.40 0.00 61.62 0.00 1,619.47 166.66 18.31 2,505.40 121 MEXICO STATEMENT OF IFC's HeldandDisbursedPortfolio InMillionsofU S Dollars Committed Disbursed IFC IFC FY Company Loan Equity Quasi Partic. Loan Equity Quasi Partic. Approval 1998 Ayvi 3.57 0.00 0.00 0.00 3.57 0.00 0.00 0.00 BBVA-Bancomer 11.33 0.00 0.00 0.00 11.33 0.00 0.00 0.00 1995 BaringMexFnd 0.00 1.14 0.00 0.00 0.00 1.14 0.00 0.00 1999 BaringMexFnd 0.00 1.41 0.00 0.00 0.00 1.41 0.00 0.00 1998 CIMA Puebla 3.25 0.00 0.00 0.00 3.25 0.00 0.00 0.00 2005 CMPDH 14.50 0.00 0.00 0.00 14.50 0.00 0.00 0.00 2006 Carlyle Mexico 0.00 20.00 0.00 0.00 0.00 8.08 0.00 0.00 Chiapas-Propalma 0.00 0.97 0.00 0.00 0.00 0.97 0.00 0.00 2001 Compartamos 1.oo 0.66 0.00 0.00 1.oo 0.66 0.00 0.00 2004 Compartamos 15.83 0.00 0.00 0.00 15.83 0.00 0.00 0.00 2002 Coppel 27.86 0.00 0.00 0.00 27.86 0.00 0.00 0.00 2005 Coppel 35.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1999 Corsa 4.64 3.00 0.00 0.00 4.64 3.00 0.00 0.00 2005 Credit0 y Casa 21.58 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2004 DTM 19.17 0.00 0.00 0.00 19.17 0.00 0.00 0.00 2001 Ecomex 4.00 0.00 0.24 0.00 2.00 0.00 0.24 0.00 2000 Educacion 3.81 0.00 0.00 0.00 3.81 0.00 0.00 0.00 2005 FINEM 15.36 0.70 0.00 0.00 0.00 0.00 0.00 0.00 1997 Fondo Chiapas 0.00 3.14 0.00 0.00 0.00 0.00 0.00 0.00 1998 Forja Monterrey 4.64 3.00 0.00 4.64 4.64 3.00 0.00 4.64 2001 GFNorte 97.81 0.00 0.00 0.00 47.81 0.00 0.00 0.00 1996 GIBSA 8.11 0.00 0.00 27.29 8.11 0.00 0.00 27.29 1996 GIRSA 0.00 0.00 0.71 0.00 0.00 0.00 0.71 0.00 2000 GIRSA 25.71 0.00 0.00 34.29 25.71 0.00 0.00 34.29 2005 GMAC Financiera 122.60 0.00 0.00 0.00 10.01 0.00 0.00 0.00 1998 Grupo Calidra 5.33 6.00 0.00 1.67 5.33 6.00 0.00 1.67 2004 Grupo Calidra 23.46 0.00 0.00 0.00 22.72 0.00 0.00 0.00 1989 Grupo FEMSA 0.00 0.02 0.00 0.00 0.00 0.02 0.00 0.00 1997 Grupo Minsa 0.46 0.00 0.00 0.00 0.46 0.00 0.00 0.00 1996 Grupo Posadas 1.60 4.77 0.00 0.00 0.00 4.77 0.00 0.00 1999 Grupo Posadas 0.00 0.00 10.00 0.00 0.00 0.00 10.00 0.00 1998 Grupo Sanfandila 4.56 0.00 0.00 1.49 4.56 0.00 0.00 1.49 Grupo Su Casita 0.00 8.85 0.00 0.00 0.00 8.85 0.00 0.00 2000 Innopack 0.00 15.00 0.00 0.00 0.00 15.00 0.00 0.00 Interoyal 0.00 0.01 0.00 0.00 0.00 0.01 0.00 0.00 2003 Lomas de Real 50.05 0.00 20.00 101.25 48.76 0.00 20.00 101.25 1998 Merida I11 25.44 0.00 0.00 54.76 25.44 0.00 0.00 54.76 2003 Mexmal 0.00 0.00 1.30 0.00 0.00 0.00 1.30 0.00 1995 MexplusPuertos 0.00 0.55 0.00 0.00 0.00 0.55 0.00 0.00 1999 MexplusPuertos 0.00 0.25 0.00 0.00 0.00 0.25 0.00 0.00 1999 NEMAK 0.00 0.00 0.01 0.00 0.00 0.00 0.00 0.00 2003 Occidental Mex 26.40 0.00 0.00 35.20 26.40 0.00 0.00 35.20 Occihol 0.00 9.99 0.00 0.00 0.00 9.99 0.00 0.00 2003 POLOMEX S.A. 5.29 0.00 0.00 0.00 5.29 0.00 0.00 0.00 2000 PanAmerican 0.00 2.15 0.00 0.00 0.00 2.15 0.00 0.00 2002 Puertas Finas 9.75 0.00 0.00 0.00 9.75 0.00 0.00 0.00 2002 Qualita 0.00 0.00 3.50 0.00 0.00 0.00 3.50 0.00 2000 Rio Bravo 44.88 0.00 0.00 49.83 44.88 0.00 0.00 49.83 2004 SSA Mexico 45.00 0.00 0.00 0.00 45.00 0.00 0.00 0.00 122 2000 Saltillo S.A. 31.69 0.00 0.00 36.02 31.69 0.00 0.00 36.02 2000 Servicios 6.37 1.52 0.00 5.54 6.37 1.52 0.00 5.54 2004 Su Casita 16.76 0.00 0.00 0.00 16.76 0.00 0.00 0.00 2005 SuCasita 51.49 0.00 0.00 0.00 51.49 0.00 0.00 0.00 1997 TMA 1.18 0.00 3.16 4.08 1.18 0.00 2.44 4.08 2003 TMWC 3.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2005 UNITEC 30.72 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2003 Valle Hermoso 5 1.75 0.00 20.00 106.35 51.16 0.00 20.00 106.35 ZN Mexico I1 0.00 7.62 0.00 0.00 0.00 6.05 0.00 0.00 1998 ZN Mxc Eqty Fund 0.00 1.69 0.00 0.00 0.00 1.69 0.00 0.00 portfolio: 874.95 92.44 58.92 462.41 600.48 75.11 58.19 462.41 Approvals Pending Commitment FY Company Loan Equity Quasi Partic. Approval 2001 Ecomex 3.50 0.00 0.00 0.00 2003 Mexmal 0.00 0.00 5.00 0.00 2003 Polomex 2.00 0.00 0.00 0.00 2005 Coppel I1 5.00 0.00 10.00 0.00 2000 Educacion 3.20 0.00 0.00 0.00 2001 GFNorte-CL 0.00 0.00 0.00 100.00 2006 Protego Sofol 0.00 2.49 0.00 0.00 2005 Centro Espanol 5.00 0.00 0.00 0.00 2006 Mexico MBS CEF 30.00 0.00 0.00 0.00 2005 PanAmerican 2 0.00 4.50 0.00 0.00 2005 Sanfandila(R) 0.00 0.00 0.00 6.49 1998 Cima Hermosillo 0.00 0.00 7.00 0.00 Total pending commitment: 48.70 6.99 22.00 106.49 123 Annex 14: Country at a Glance MEXICO: Environmental Services Latin Upper- POVERTY and SOCIAL America middle- Mexico &Carib. Income Developmentdiamond` 2004 Population, mid-year (millions) 103.8 541 576 I GNI per capita (Atlas method, US$) 6,790 3,600 4,770 ` Life expectancy GNI (Atlas method, US$ billions) 704.9 1,948 2,748 Average annual growth, 1998-04 Population(%) 1.4 1.4 0.8 Laborforce (77) 2.5 0.9 -0.9 1 GNI Gross Per + primary Most recent estimate (latest year available, 1998-04) enrollment Poverty(% ofpopulation belownationalpovertyline) 18 I Urban population (% of totalpopulation) 76 77 72 Life expectancyat birth (years) 74 71 69 Infant mortality(per 1,000live births) 23 28 24 Child malnutrition (% ofchildren under5) 8 1 Access to improvedwater source - Access to an improvedwater source (% ofpopulation) 91 89 93 Literacy("7ofpopulation age 15+) 90 89 91 Gross primaryenrollment (% of school-agepopulation) 110 123 106 -I-* Mexico Male 111 126 108 1 - Upper-middle-incomegroup Female 110 122 106 KEY ECONOMIC RATIOS and LONG-TERMTRENDS 1984 1994 2003 2004 1 Economicratios. GDP (US$ billions) 175.6 421.7 639.1 676.5 Gross capital formation/GDP 19.9 21.9 20.6 21.3 Exportsof goods and services/GDP 17.4 16.8 27.8 30.1 Trade Gross domestic savings/GDP 27.7 17.1 19.0 19.9 Gross national savingsiGDP 22.7 14.9 19.3 20.8 Currentaccount balancelGDP 2.4 -7.0 -1.3 -1.1 Interestpayments/GDP 6.4 2.1 1.8 1.6 Total debffGDP 54.0 32.9 22.0 20.8 Total debt service/exports 45.1 25.7 17.6 15.0 Presentvalue of debffGDP 24.6 Presentvalue of debtlexports 80.7 I indebtedness 1984-94 1994-04 2003 2004 2004.08 (average annual growth) GDP 2.7 3.3 1.4 4.4 3.0 1 *-*-Mexico GDP par capita 0.8 1.8 -0.1 2.9 1.6 Upper-middle-incomegroup Exportsof goods and services 6.0 9.6 2.7 11.5 4.1 I STRUCTURE of the ECONOMY 1984 1994 2003 2004 `Growthof capital and GDP(Oh) (% of GDP) Agriculture 9.4 6.0 3.9 4.1 115 - I Industry 34.9 26.8 25.8 26.4 Manufacturing 22.7 18.7 18.0 18.1 Services 55.7 67.2 70.3 69.5 Householdfinal consumptionexpenditure 63.1 71.4 68.6 68.5 Generalgov'tfinal consumptionexpenditure 9.2 11.5 12.4 11.7 imports of goods and sewices 9.6 21.6 29.5 31.9 I 1984-94 1994.04 2003 2004 (average annual growth) `Growth of exports and imports (%) Agriculture 0.8 1.9 3.5 4.0 ,30 ~ Industry 3.3 3.3 -0.2 3.8 Manufacturing 3.5 3.6 -1.3 3.8 Services 2.7 3.3 1.9 4.6 Householdfinal consumptionexpenditure 3.6 3.7 2.3 5.5 Generalgov'tfinal consumptionexpenditure 2.2 1.2 0.8 -1.2 Gross capitalformation 5.6 4.8 -4.2 1.5 Importsof goods and services 14.8 10.6 0.7 10.2 ~ Note: 2004 data are preliminaryestimates. *The diamonds show four key indicatorsinthe country (in bold) comparedwith its income-groupaverage.if data are missing,the diamond will be incomplete. 124 Mexico PRICES and GOVERNMENT FINANCE 1984 1994 2003 2004 Domesticprices Inflation(Oh) (77change) I20 I T Consumer prices 65.4 7.0 4.5 4.7 `15 implicit GDP deflator 59.1 8.5 8.5 6.1 10 Government finance (77 of GDP, includes curentgrants) 1 5 Current revenue 31.2 22.7 23.2 23.2 ~ -0 01 02 03 041 Current budget balance -1.2 3.3 2.2 3.1 Overall surpius/deficit -6.4 -0.3 -0.1 -0.3 "*'w-*A`GDP deflator +CPI TRADE I 1964 1994 2003 2004 (US$ millions) Export and import levels (US$ mill.) Total exports (fob) 29,100 60,882 164,923 189,159 1250 ooo - Oil 16,601 7,445 18,654 23,706 Agriculture 1,461 2,678 4,664 5,421 200 000 - Manufactures 10,499 50,402 141.087 159,093 Total imports (cif) 15,916 79,346 170,546 197,247 Food Fuel and energy Capital goods 2,573 13,322 20,205 22,599 1 Export price index (2000=100) 114 90 105 117 98 99 00 01 02 03 O4 I Import price index (2000=100) 77 93 103 108 Terms of trade (2000=100) 148 97 102 108 BALANCE of PAYMENTS 1984 1994 2003 2004 (US$ millions) ICurrentaccount balance to GDP (%) Exports of goods and services 33,926 71,184 177,299 201,911 Imports of goods and services 21,028 91,616 187,680 215,372 Resource balance 12,898 -20,432 -10,380 -13,460 Net income -10,076 -13,012 -12,082 -10.938 Net currenttransfers 1,361 3,782 13,858 17,044 Current account balance 4,183 -29,662 -8,604 -7,355 Financing items (net) -2,034 12,463 18,437 11,416 Changes in net reserves -2,149 17,199 -9,833 -4,061 Memo: ReSeNeSincluding gold (US$ miliions) 7,355 6,300 59,027 64,204 Conversion rate (DEC, iocal/US$) 0.2 3.4 10.8 11.3 EXTERNAL DEBT and RESOURCE FLOWS 1984 1994 2003 2004 (US$ millions) Compositionof 2004 debt (US$ mill.) Total debt outstandingand disbursed 94,830 138,545 140,391 140,778 IBRD 2,852 13,038 10,717 9,567 I G 9900 9,900 A: 9,567 IDA 0 0 0 0 D. 6,743 D 6 7 4 3 ~ A 9 5 6 7 Total debt service 16,960 20,076 34,219 33,566 I iBRD 485 1,989 1,972 2,499 IDA 0 0 0 0 Composition of net resourceflows Official grants 27 47 Official creditors 832 -583 -372 -182 I Private creditors 791 5,296 -418 1,578 Foreigndirect investment (net inflows) 390 10,973 12,625 17,377 _- Portfolio equity (net inflows) 0 4,084 I F 112 001 World Bank program Commitments 576 2,380 888 621 A IBRD E Bilateral - Disbursements 682 942 1,258 767 B IDA -- D Other multilateral - F .Private Principal repayments 253 1,065 1,359 1,976 IC-IMF G - Short-term Netflows 430 -123 -101 -1,209 Interest payments 233 924 613 524 Net transfers 197 -1,046 -714 -1,733 Development Economics 9/8/05 125 Annex 15: IncrementalCost Analysis MEXICO: EnvironmentalServices Introduction 1. Two o f the most important environmental challenges facing Mexico are water quality/supply and deforestation. Aquifer overexploitation, water quality degradation and high deforestation rates are seriously threatening critical ecosystems and globally significant biodiversity. One-third o f all Mexico's bird species and nearly two-thirds o f all Mexico's amphibian, reptile, and mammal species are at risk. Although many wild species are legally protected, 2,582 species and subspecies are at risk, o f which 41 are already extinct in the wild, 1,215 are endangered or threatened with extinction, and 1,326 are subject to special protection. The causes o f deforestation are multiple, however, the main driving force appears to be intentional land use changes by individual or collective land owners mainly to agriculture. 2. A significant portion o f Mexico's surface area is under some sort o f protection, but not all the areas with relevant biodiversity are covered. The National Commission on Natural Protected Areas lists 154 federally administered natural protected areas that cover almost 19 million hectares, but only a small percentage o f this area i s government property. The Commission has produced a map o f Priority Areas for Conservation, which includes the National System o f Natural Protected Areas (SINAP), plus the areas that should be incorporated under some kind o f protection, including economic incentives and legal agreements with their proprietors. 3. Any initiative to protect forests must take into account the structure o f incentives embedded in the land tenure arrangements. Mexico has a special land tenure structure with ownership granted to ejidos, which include more individual plots, and to comunidades agrarias, which are mainly common property, Because the majority o f forests are under common property regimes, their land tenure rules have important implications for conservation programs. Furthermore, the owners o f these forest areas are among the poorest in the country. They are faced with short-term survival decisions even through their long-term livelihood depends on the protection and sustainable use o f these resources. 4. To help address the environmental issues, one o f the tools that the Mexican government adopted was to provide economic incentives by creating the program o f Payments for Hydrological Environmental Services (PSAH) in 2003. The PSAH program has expanded rapidly, enrolling over 300,000 hectares o f forest into conservation by the end o f 2004, and has built experience on PES implementation. Initial evaluations, however, show substantial room for improvement. Moreover, the funding and objectives o f the current program are very limited. 5. The objective o f proposed project i s to improve the provision o f environmental services that bring both national benefits (primarily water services) and global benefits (primarily increased biodiversity conservation) by strengthening and expanding the PSAH and CABSA (Program to Develop Environmental Services Markets for Carbon Capture and Biodiversity and to Establish and Improve Agroforestry Systems) programs and establishing market-based payments for environmental services (PES) approaches. The objective will be achieved through (i)developing new, sustainable financing mechanisms for environmental services, which could be channeled either through the existing PES programs or through new, stand-alone local PES mechanisms; (ii)strengthening and improving the efficiency of existing PES programs (PSAH and CABSA); (iii)stimulating the development of stand- alone local PES programs; and (iv) assisting local communities in service provision. Baseline Scenario 126 6. Mexico i s a mega-biodiversity country, ranking second in the world in reptilian diversity, third in mammal diversity, and fifth in both amphibian and plant diversity. Its plant diversity exceeds that of the United States and Canada combined. Mexico also ranks eighth in fish diversity and fifteenth in bird diversity. With 1.3 percent o f the world's land area, it hosts about 12 percent o f known terrestrial biota with very a high incidence of endemism. Mexico contains the five main types o f Latin American and Caribbean terrestrial ecosystems listed by WWF, nine o f the 11 main types of habitats in the region and 5 1 o f the 191 identified ecoregions. Fourteen o f these 51 ecoregions (covering over 40 percent o f national territory) have priority at the international level regarding their biodiversity and current conservation status. There are nine large natural vegetation types in Mexico, classified according to their ecological characteristics. 7. Under the baseline scenario there are very few activities that would lead to sustainable payment for environmental services. Currently efforts are limited to disparate activities aimed at maximizing the returns in terms of water services. These activities would certainly generate important conservation benefits to the biodiversity o f local and global significance, but they will be specifically targeted to generate water and carbon sequestration benefits. The global biodiversity conservation benefits under the baseline scenario would be uneven and would be difficult to quantify, at least in the preparation phase o f the project. Therefore, a distinction between global and local benefits i s considered too difficult to discern to accurately quantify, and have been reported under the Baseline Scenario. Inthe absence o f this project, there would be little incentive for these efforts to orient their objectives towards conservation o f biodiversity o f global significance and even less prospect o f widespread replication o f schemes to encourage payment for environmental services. 8. The consequence o f this i s that in the absence o f this project, the baseline scenario would see very little increase in payment for environmental services and the global benefits in terms o f the potential to reduce current threats to globally significant biodiversity would not be realized. 9. Total expenditures under the baseline scenario during the lifetime o f the project are therefore US$190.82 million. 10. The following sections give further detail on the baseline scenario for each component and what global environmental benefits they will provide. Following each explanation is a detailed breakdown o f economic costs o f current initiatives. Component 1:DevelopingSustainable Financing Mechanisms 11. The main objective o f this component i s to develop new, sustainable financing sources based on payments from service users, which could then be channeled either through the PSAH or through stand- alone local PES mechanisms, as appropriate. Under the baseline scenario, several disparate activities to create markets for water services do exist. However, these are mostly within the specific watersheds that have been targeted for their water and hydrological benefits and are not oriented towards optimizing protection of biological diversity. Indeed, in the baseline scenario, some o f the most important areas of biodiversity will not be targeted, those areas that are targeted may not have any biodiversity o f global significance, and even where targeted areas do contain globally significant biodiversity it may not be appropriately recognized. 12. Currently the government i s spendingUS$3.27 million a year to pay for environmental activities to promote water services through the PSAH. Of this amount US$0.29 million is being spent on activities relevant to this component. This equates to US$1.18 million for the duration of the project. There is, however, currently no spending to pay for environmental activities that would specifically promote 127 biodiversity services. Inparticular, there i s no trust fund along the lines o fthat proposed by the alternative scenario. 13. Currently the government i s spending approximately US$0.55 million a year to pay for environmental activities to promote carbon sequestration services through the CABSA. Of this amount US$0.12 million i s being spent on activities relevant to this component. This equates to US$0.49 million for the duration o fthe project. 14. The total baseline amount for this component is therefore approximately US$1.67 million. Component 2: Developing and StrengtheningPESDelivery Mechanisms 15. The objectives o f this component are to strengthen the existing PSAH and CABSA delivery mechanisms and support development of new, stand-alone delivery mechanisms for local PES markets. Under the baseline scenario, the PSAH (and on a smaller scale CABSA) will perform this role to a certain extent. However, both the PSAH and CABSA are young mechanisms that are directed towards providing hydrological and carbon sequestration services in limited areas. These will require considerable strengthening and improvement to increase their efficiency and their capacity to handle the increased and more complex demands that would be necessary to achieve the global environmental benefits offered by the alternative scenario. 16. The baseline scenario would therefore only achieve limited biodiversity benefits. Rather, it would concentrate on delivering water and, in the future some carbon sequestration services in a few disparate areas. 17. Subcomponent 2A will build on some baseline activities that are currently being undertaken by the PSAH and CABSA. The current cost per year for these activities is US$0.32 million for the PSAH and US$0.05 million for the CABSA. This equates to US$1.48 million for the duration o fthe project. 18. Subcomponent 2B may use existing institutions and local service providers initially created for other purposes. It is estimated that the baseline cost o f activities on which the project will build is around US$0.14 million per year. 19. The total baseline amount for this component i s therefore approximately US$1.62 million. Component 3: Supporting Environmental ServiceProviders 20. The only baseline funds going towards providing technical or organizational assistance come from the PSAH and the CABSA. Projected funding for this i s US$4.88 million from the PSAH and US$O.81 million from the CABSA. 21. The total baseline amount for this component is therefore approximately US$5.69 million for the lifetime o f the project. *Component 4: Payment to Service Providers 22. Inthe absenceofthe GEFAlternative, it is estimated that the PSAHwill continueto receive around US$27.27 million a year from water tariffs, or US$109.08 over the life of the project. The baseline revenue from carbon sales i s estimated to be around US$1.5 million per year, or US$6.0 million over the life o f the project. 128 23. Furthermore, the baseline includes the US$45.OO million loan from the World Bank and US$15.90 million contribution from the beneficiaries. Although some global environmental benefits will also be achieved by these contributions, they cannot be differentiated to provide the exact amount, and therefore has been included as the baseline. 24. In addition to this, under the baseline US$1.09 millioii per year would be paid to .perforin compliance monitoring for the PSAH and US$O.lS million per year for CABSA. This would total US$5.09 million duringthe lifetime o f the project. 25. The total baseline amount for this component i s therefore US$181.07 million over the lifetime of the project. Component 5: Monitoring and Evaluation 26. The costs for the project staff and the functions they perform would be entirely incremental. N o baseline costs for this exist. 27. Monitoring and evaluation will partly build on structures provided by the PSAH and CABSA. These would be US$0.66 million from the PSAH and US$O. 11 million from the CABSA over the lifetime o f the project. 28. The total baseline amount for this component is therefore approximately US0.77 million for the lifetime o f the project. GEFAlternative 29. The alternative scenario proposed here would leverage the current baseline activities and build on them to ensure that they contribute as much as possible to conserving Mexico's globally significant biodiversity and increasing carbon sequestration. The project would do this by (i)developing new, sustainable financing mechanisms for environmental services, which could be channeled either through the existing PES programs or through new, stand-alone local PES delivery mechanisms; (ii)strengthening and improving the efficiency o f existing PES programs (PSAH and CABSA); (iii)stimulating the development o f stand-alone local PES programs; and (iv) assisting local communities in service provision. 30. Sustainability would particularly be ensured through creation o f an endowment fund to finance payments for activities that promote conservation o f globally significant biodiversity. The project would also catalyze further replication throughout Mexico by reducing barriers to creation of new schemes. It would offer the potential for future investment both directly through the endowment fund and through new PES schemes and would serve as a benchmark for promoting such projects in other highly biodiverse countries. Both the immediate and the future global biodiversity benefits o f this project would be significant in terms o f reducing species loss. In addition, the project would contribute to future carbon sequestration activities. 31. Total incremental costs of this proposed project-the difference between the baseline scenario and the GEF alternative-are therefore calculated to be USS32.62 million, of which $15.00 million is being requestedfrom the GEF. 32. Details on the activities and global benefits that would be achieved by each component of the project and the costs associated with them are presentedbelow. 129 Component 1: Developing Sustainable Financing Mechanisms 33. Component 1 of this project would produce pilot financing mechanisms for local water service users, local biodiversity users, and carbon buyers. It will also set up an endowment fund to cover continued payment for environmental activities that contribute to biodiversity conservation and will produce replication strategies to ensure that these financing mechanisms proliferate throughout Mexico. 34. The incremental costs o f this component under the alternative scenario would be: 0 US$0.73 million from the GEF, US$0.76 million froin the IBRD loan, and US$0.33 million from the Mexican government for developing financing mechanisms for water services. 0 US$1.38 million from the GEF, US$O.11 million from the IBRD loan and US$0.05 millioii from the Mexican government for developing financing mechanisms for promoting biodiversity conservation. 0 US$5.225 million from the GEF for developing and capitalizing the biodiversity endowment fund; US$0.02 million from the IBRDloan; and US$5.01 million from the Mexican government to capitalize the biodiversity endowment fund. 0 US$0.35 million froin the GEF, US$0.37 million from the IBRD loan, and US$0.16 million from the Mexican government for developing financing mechanisms to promote carbon sequestration. 35. The total incremental cost o f this component i s therefore US14.47 million. Component 2: Developing and Strengthening PES Delivery Mechanisms 36. Component 2 of this project would strengthen the delivery mechanisms already being provided under the PSAH and the CBSA and also Strengthen the capacity o f CONAFOR, other national institutions, market intermediaries, community associations, and NGOs to implement stand-alone PES programs. 37. The incremental costs o fthis component under the alternative scenario would be: 0 US$O.SS million from the GEF, US$1.15 million from the IBRD loan, and US$0.49 million from the Mexican government for strengthening existingPES programs. 0 US$0.37 million from the GEF, US$0.39 million from the IBRD loan, and US$0.17 million from the Mexican government for supporting stand-alone local PES programs. 0 US$0.05 million from the GEF, US$0.004 million from IBRD loan, and US$0.002 million from the Mexican government to provide matching funds to promote local financing mechanisms. 38. The total incremental cost o f this component is therefore US$3.51 million. Component 3: Supporting Environmental Service Providers 39. The incrementalcosts ofthis component underthe alternative scenario would be: 0 US$0.17 million from the GEF, US$O.lS million from the IBRD loan, and US$O.OS million from the Mexican government for providing support to community organization and capacity diagnostic. 0 US$0.23 million from the GEF, US$0.24 million from the IBRD loan, and US$O.lO million from the Mexican government for providing support to community promoters. 0 US$1.66 million from the GEF, US$1.90 million from the IBRD loan, and US$0.91 million from the Mexican government for providing organizational assistance. 130 0 US$1.66 million from the GEF, US$1.72 million from the IBRD loan, and US$0.74 million from the Mexican government for providing technical assistance and TA grants. 40. The total incremental cost o fthis component is therefore US$9.56 million. Component 4: Payment to ServiceProviders 4 1. The incremental costs o f providing payments to service providers under the alternative scenario would be: 0 US$1.578 million from the GEF and US$1.53 million from the government funds for payments to service providers. Although some global environmental benefits will also be achieved by the World Bank, GOM, and beneficiary contributions, they cannot be differentiated to provide the exact amount, and therefore have been included inthe baseline. 42. The total incremental cost o fthis component is therefore US%3.108million Component 5: Monitoring and Evaluation 43. The incremental costs of project and program management under the alternative scenario would be: 0 US$0.74 million from the GEF, US$O.Sl million from the IBRD loan, and US$0.35 million from the Mexican government. 44. The total incremental cost o f this component is therefore US$1.90 million. 45. The matrix below summarizes the baseline and incremental expenditures duringthe project period. cost Category US$ Million Domestic Benefit GlobalBenefit I h 1Component I Provision o f water services Some services of carbon sequestration.Very Baseline US$1.67 million minor accidental conservation o f globally significant biodiversity Enhancedprovision of water The global environmental consequences of this L services would be to enhance andprotect biological diversity andpreserve globally significant forest and mountain ecosystems within Mexico andto encourage and assist further conservation globally. Inaddition to this, the project would assist global carbon sequestration Incremental I~ ~ 1 4 .million 4 7 Provision o f water services Some services of carbon sequestration. Very Baseline US$l.62 million minor accidental conservation of globally significant biodiversity Enhancedprovision of water The global environmental consequences o f this Alternative With GEF US$5.13 million services would be to enhance and protect biological diversity and preserve globally significant forest 131 andmountain ecosystemswithin Mexico andto encourage and assist further conservation globally. Inadditionto this, the project would assist global carbonsequestration Incremental US$3.51million Component3 Some servicesof carbon sequestration.Very Baseline US$5.69 million minor accidentalconservation of globally significant biodiversity The global environmental consequences o f this services would be to enhance andprotect biological diversity and preserveglobally significant forest With GEF andmountain ecosystemswithin Mexico andto Alternative US$15.25 million encourage and assist further conservation globally. Inaddition to this, the project would assist Incremental USS9.56 million I nent 4 Provision of water services Some services of carbon sequestration. Very Baseline US$l81.07million minor accidental conservation of globally significant biodiversity Enhancedprovision of water The global environmental consequences of this services would be to enhance andprotect biological diversity and preserve globally significant forest With GEF and mountain ecosystems within Mexico andto Alternative US$184.25 million encourage and assist hrther conservation globally. 1 Inaddition to this,the project would assist ~~ ~ I Incremental USS3.18million 1 - Corn] lent 5: ProjectCoordination Provision o f water services Some serviceso f carbon sequestration.Very ~~ Baseline US$0.77million minor accidental conservation of globally significant biodiversity Enhancedprovisionof water The global environmental consequences of this services would be to enhance and protect biological diversity andpreserveglobally significant forest With GEF US$2.67 million and mountain ecosystems within Mexico and to encourage and assist further conservation globally. Inaddition to this, the project would assist global carbon sequestration Incremental I US$I.PO million TotalBaseline: US$l90.82 million Total GEFAlternative: USS223.44million Total Incremental Costs: USS32.62 million 132 Annex 16: STAPRosterReview MEXICO: EnvironmentalServices STAP REVIEWFOR: MEXICO: ENVIRONMENTAL SERVICES (WorldBank-GEF) Dr.Eduardo R. Fuentes Santiago. Chile PhoiIe: (56-2) 220.3 I25 e-mail: eduarclo-fuentes0,osorno-inc.com eduarclo-fuentes0,terra.cl Overall Appraisal This is a well designed project aimed at Payments for Ecosystem Services (PES) in Mexico. The project will strengthen existing PES (water-related) and create new ones (biodiversity, carbon). The design builds upon lessons learned from similar initiatives in Mexico and in the rest o f the continent. By having ecosystem users pay for benefits obtained from ecosystem maintenance, the project incorporates privates and especially local indigenous land owners into the conservation effort, a welcome initiative from the overall perspective o fthe CBD and the GEF. The project will help protect globally significant biodiversity in Mexico and thus also help contribute to the maintenance o f the Mesoamerican Biological corridor. Emphasis will be on forested areas with biodiversity o f global significance. The proposed payment for conservation services by the tourist sector is very innovative. Biodiversity concerns will be mainstreamed into tourism, forestry, agriculture environment, and water sectors. There are a few queries that if solved during the remaining preparation time, will improve the project and make it a replicable model in other areas on highbiodiversity. World BankResponse: Thank you. The project design includes a replication strategy and the lessons will be disseminated widely. 1. Scientific and Technical Soundness The project i s basically sound and well constructed. Perhaps the most important issue i s the existence or lion-existence o f site-specific reliable evidence that ecosystem services (water supply and biodiversity) are in fact closely connected with the degree o f conservation o f their flora and fauna. It i s known that water services are not always closely connected with the biodiversity in the ecosystems, and users of biodiversity (for example birdwatchers) may be interested only on in some taxa. If true that linkages between services used and ecosystem attributes are weak, it may lead to reluctance to pay for ecosystem maintenance. Good models, surveys and other empirical evidence relevant to each one o f the sites would be needed. The problem is that obtaining this evidence may take several years and without it, users may not be willing to pay and thus the whole sustainability may be jeopardized. The text is not sufficiently clear regarding how much o f this evidence i s available at this point. Unfortunately, the problem may be augmented because so far there have been no specific consultations with ecosystem users at the various sites about their willingness to pay, and the reader is left with the 133 impression o f a weak link in the whole argument. Willingness to pay by the tourism sector i s particularly intriguing. (Proponents make plausible arguments, however, for why providers would be willing to participate inthe scheme). Both o f the issues just raised are included in the list o f good practices listed in the project, but so far have not been included inthe design. World BankResponse: We agree that there i s much yet to be learned about the hydrological impacts o f land use changes at different sites. For this reason, the project will support additional applied, site-specific technical studies to fillgaps inavailable knowledge oflinksbetweenlanduseandwater services andbiodiversity(through Component 1A and 1B). However, enough is known about the hydrological impacts o f land use changes at different sites to serve as a basis for action, as evidenced by the existing Mexican PES programs (PSAH and CABSA), which the project would strengthen and improve upon. The pro-iect also suppoits the establishment and operation o f a robust impact monitoring system to verify that the desired services are infact being generated, or allow mid-course correctioiis to be made. There are already incipient PES proposals at several o f the pilot sites, indicating a strong interest among at least some service users to pursue this approach. That there are service users actually making payments for conservation - in Mexico and elsewhere in the region - demonstrates that establishing such financing mechanisms is possible. There have been few efforts to extend the approach to the tourism industry to date, so there i s much that will have to be learned in doing so, but many o f the lessons learned in developingfinancing from water users i s likely to be applicable. 2. Global Benefits Mexico i s a Megadiversity country, rich in ecosystem types, species and within-species diversity. The eight demonstration areas correspond to earlier identified sites o f globally significant biodiversity. The project would help stop forest conversion and thus contribute to biodiversity conservation. It will also restore damaged ecosystems in otherwise highbiodiversity areas. The connection made between global/domestic benefits and incremental costs deserves special mention. The project aims at water services (local benefits), biodiversity and carbon services (global benefits). It is unclear from the project to what extent improving conditions for water services (domestic benefit) at any one site will actually serve protectingbiodiversity. Effects may be marginal, particularly as water services are more related to plant cover and are not closely relatedto plant or faunal composition. The incremental costs analysis, however, does not seem to reflect this situation. The GEF seems to be asked to support some activities with mostly local benefits as well as those with clear global benefits. Clarifications may be needed. World BankResponse: This project would promote, through PES contracts, the conservation o f existing natural forests, their restoration through reforestation with native species, or the improvement o f agro-forestry systems so that they more closely resemble the original native forest in structure, species composition, and ecological function. Based on the scientific evidence available to date, these land use interventions are highly positive for both the conservation o f Mexican biodiversity (since so many endemic Mexican animal and plant species depend upon natural forests for their survival) and for improving water flows--in terms of seasonal peak flows, groundwater recharge, water quality, reduced sedimentation and flood intensity, and (at least in the case of cloud forests) added flows through water harvesting from clouds. Under the project, some locally-based new PES systems might possibly focus on improving hydrological services iii areas o f lesser biodiversity priority (but not with GEF funds). Conversely, PES contracts in some areas (including natural grasslands and wetlands) might be driven by the desire to conserve biodiversity (such 134 as for eco-tourism) rather than water supply concerns. The Cancun pilot site. for example, was selected almost entirely for its biodiversity conservation benefits. However, the project would not support any PES systems that would encourage land use changes harmful to biodiversity (or to environmental protection in general), as is explained in Annex 10. The project recognizes that the overlap between preserving hydrological services and preserving biodiversity, although considerable, is not 100%. This i s illustratedby the impact indicators, for example, in which only a part of the total area to be enrolled under the project is expected to be "of global biodiversity significance." This is also recognized through the creation and capitalization o f the Biodiversity Endowment Trust Fund, which will provide sustainable long-term payments in areas where financing from water users or the local tourism industry i s either absent or insufficient to preserve biodiversity o f global significance. 3. Innovativeness There are several innovative aspects inthe proposal. 0 The most innovative aspect is the inclusion of the tourist sector as a biodiversity user, eventually payingto maintainthem. 0 The flexible approach allowing for small independent, larger arrangements covering several watersheds and one or more ecosystem services is also innovative. 0 The trust fund to complement PES in biodiversity is also an innovative instrument. 0 Connections between a GEF-supported project and support from the Clean Development Mechanism are also an innovative aspect. 4. GEF and ConventionFit The project is consistent with CBD guidance and with GEF policies under SP2, OP3 and OP 4. The proposal i s consistent with COP guidance referring to incentive measures, ecosystem services, tourism, and sustainable uses, particularly by indigenous communities. The proposal is also consistent with GEF policies regarding conservation and sustainable uses o f forested (OP3) and mountain ecosystems (OP4) and, by helping mainstream conservation into production sectors o f the economy, with SP2. 5. Consultations and Participation There have been social surveys and consultations but participation o f the key actors may still be a weak point in this proposal. Proponents have consulted with government agencies, NGOs, academics, private institutions. But so far a key link in the whole argument, namely willingness to participate o f users o f services at the specific demonstrations sites has not been secured. This may be a critical area for the coming months of project preparation. WorldBankResponse: Additional consultation with stakeholders, including determination of the "willingness to pay" of environmental service users, will take place during pro-ject preparation and as part o f Component 1. As noted, several o f the pilot sites have incipient PES proposals (this was one o f the selection criteria), indicating a strong interest among at least some service users to pursue this approach. 6. Capacity-Building The project will strengthen capacities at CONAFOR, market intermediaries, community associations, and NGOs. It will create the enabling environment allowing for a very flexible PES system in the country. The project will help generate new legislation, remove barriers to conservation, change policies, and build partnerships. All these capacities will allow for replication within Mexico. Inturn the approach chosen to buildcapacities could be later replicated inother countries. 135 7. Sustainabilitv and Reulicabilitv It is a big question at his point to what degree the whole effort will be sustainable. Proponents suggest that sustainability will be largely secured by the self interest o f suppliers and users o f ecosystem services, and the project will trigger the process by providing capacities and substantive resources (nearly $ 150M) to start paying providers. However, the system o f PES will be sustainable ifthis fund i s replenishedwith contributions from beneficiaries of the services. At present we do not know to what extent private beneficiaries will want to pay for the services claimed. As mentioned, unless there i s solid evidence for the linkages between ecosystems attributes and services, users may not be interested in PES. Unfortunately, so far there have been no specific consultations on this issue and scientific evidence for close linkages between ecosystem services and biodiversity i s unclear from readingthe document. It would also help to see more on how CONAFOR will strengthen and later maintain its capacities to secure long-term sustainability o f these efforts. The project should be replicable both in approaches, types o f services as well as.specific mechanisms (such as the trust fund) within Mexico and elsewhere. The proposal has several important activities addressing replicability o f its components. World BankResponse: The existing PSAHwater fee i s evidence o f considerable willingness to pay for environmental services by water users, Project sustainability will be enhanced through the project's promotion o f additional schemes where environmental service users in specific areas provide funding for PES in their upstream watersheds. The planned biodiversity trust fund and linkages to carbon finance mechanisms will also enhance the project's long-term sustainability. 8. Miscellaneous 0 The reviewer suggests that in drawing baselines for indicators, testing areas as well as nearby areas without projectbe used. These would serve as "controls". World BankResponse: Agreed, since measuring significant changes in environmental services through improved land use at a given site will ofteii take longer than the time available for project implementation. 136 Annex 17: Pilot Site Selection Criteria MEXICO: EnvironmentalServices 1. Biodiversity in Mexico. Mexico is one o f the mega-biodiversity countries inthe world, with second place in reptilian diversity, third inmammal diversity, and fifth inboth amphibian and plant diversity (Annex A, Table Al-1). Its plant diversity exceeds that o f the United States and Canada combined. Mexico also ranked eighth infish diversity and fifteenth in bird diversity. With 1.3% o fthe world's land area, it hosts about 12% o f known terrestrial biota, with very high endemism. Mexico's rich biodiversity includes the wild relatives o f some 120 cultivated plant species, including maize, cocoa, kidney beans, and tomatoes. 2. Mexico's biological wealth is extraordinary, but the future i s precarious. About one-third o f birds and nearly two-thirds of amphibian, reptile, and mammal species are at risk (see Annex 1, Table A1-2). Historically, much of the species loss and endangerment was due to the introduction o f aggressive, non- native species to fragile Pacific island ecosystems, such as the Revillagigedos and Guadalupe islands. Many terrestrial and aquatic species are also threatened by direct exploitation, including over-fishing, uncontrolledhunting,wildlife capture for pets, and collection o f rare ornamental plants (such as cacti and orchids). However, by far the greatest threat to Mexican biodiversity today is the destruction and degradation o f natural habitats, includingmany types o f forests, shrublands, and natural grasslands. Inthe 1990s only four countries (Brazil, Zambia, Indonesia, and Sudan) accounted for more deforestation than Mexico, according to the FAO's 2005 Forest Resources Assessment. Both the amount and rate o f deforestation in Mexico is highest intropical forests, including areas o f highbiodiversity value. A World Bank-World Wildlife Fund study (Dinersteinet al., 1995) identified 33 unique ecoregions (including forests and other ecosystem types) that occur exclusively within Mexico, o f which nine are classified as Critical, nine as Endangered, and four as Vulnerable. Many o f these unique ecosystems, along with their endemic species, still lack adequate on-the-ground protection; others occur completely outside o f formally protected areas. 3. Watershed Management in Mexico. The availability o f fresh water is a major constraint on Mexico's development options, interms o f urban and industrialexpansion as well as irrigated agriculture. According to the National Water Commission(Conzisidn Nacional de Agua: CNA), 66% o f the 188 most important aquifers inthe country suffer from overexploitation, a fragile situation when consumption i s projected to grow and natural recharge is often reduced by deforestation. For example, forests in the Sierra Gorda are believedto be fundamental for water recharge inthe aquifers supplyingthe cities of Queretaro and San Juan del Rio. Mexico's rapid deforestation also has negative implications for the regulationo f water flows, water quality, and the sedimentation o f reservoirs and canals. Scientific work to date highlightsthe role that montane cloud forests play inproviding surface water flows duringthe dry season (as in Veracruz), and that tropical dry forests reduce the flooding risks duringstorms (as in western Jalisco). Given Mexico's growing dependence on scarce fresh water resources, combined with vulnerability to seasonal floods in some cities, improving watershed management by retaining and restoring forests and other natural vegetation has become a Government priority. PES mechanisms are Seen as a promising mechanism to persuade land users in upper watersheds to adopt conservation practices, using funds made available largely by the downstream water users and urban dwellers who stand to benefit directly from improved water flows, better water quality, increased groundwater recharge, and reduced vulnerability to flooding. 4. Existing PES Programs. Mexico presently has two PES programs-Payments for Hydrological Environmental Services (PSAH) and Carbon and Biodiversity inAgro-Forestry (CABSA). PSAH provides direct payments to landowners who maintain their natural forests ingood condition from a conservation standpoint. The PSAH sites were intendedto be chosen on the basis o f their hydrological 137 importance, including (i) proximity to downstream areas of water scarcity and (ii)where deforestation risks (due mainly to agricultural or cattle pasture expansion) are significant (so that the PSAHpayments would make a real on-the-ground difference in land use and forest cover). CABSA was designed to use PES to (i) conserve biodiversity; (ii)promote carbon storage; (iii) improve existing agro-forestry systems, includingthrough increased use of native forest species; and (iv) convert areas of field crops or pasture to agro-forestry systems. 5. Project Site Selection. Under this project, the areas where PES systems would be established, strengthened, or continued include eight pilot sites. In addition to these pilot sites, other PES areas are expected to be established under this project as a result o f local-level initiatives, inwhich eiivironmental service users seek to use PES to improve hydrological services (water supply, flood protection, or erosion control) or biodiversity linked to eco-tourism. The eight pilot sites are all within reasonable proximity of urban centers, with at least 50,000 inhabitants and a presumeddemand for environmental services, such as iinproved water flows and water quality, flood mitigation, and biodiversity and scenic beauty (for eco- tourism). In addition, all eight sites have (i) importantwatersheds upstream o f areas where the supply and quality o f fresh water is a significant concern, (ii)globally significant biodiversity inneed o f improved conservation, (iii)natural vegetation important for carbon storage, (iv) significant risks o f deforestation and other loss and degradation o f natural habitats, and (v) extensive community and ejido landholdings potentially suitable for PES contracts. All the pilot sites have been classified as Priority Hydrological Regions (RHP) by the Mexican Government. Interms o f biodiversity significance, all pilot sites were chosen to overlap with at least two o fthe four following categories o f high conservation priority: (i) existing Natural Protected Areas (ANP, Areas Naturales Protegidas); (ii)Priority Terrestrial Eco-regions (RTP, Regiones Terrestres Prioritarias), which are areas o f highbiodiversity conservation priority (with or without existing legal or on-the-ground protection) established by CONABIO; (iii) Important Bird Areas (AICA, Areas Importantes para la Conservacion de Aves), which are important for the survival o f endemic bird species or as key bird breeding, feeding, or migration staging areas; and (iv) Ramsar Wetlands of InternationalImportance, which are wetland sites previously designated by the Mexican Government for international recognitionas highly important for migratory birds or other biodiversity. 6. Under this project, only sites with globally significant biodiversity will receive GEF funds under the national or local programs inthe project area. Furthermore, all land management systems with PES support under the project (from any funding source) will be biodiversity-friendly (see Annex 10 for details). Within the project sites, private landowners (ejidos, communites, and possibly individuals) with secure tenure will be eligible for PES contracts, ifthey choose to participate. Some o f these landholdings will be within the buffer zones of protected areas (where human occupation is legally permitted). Within the eight pilot sites, the lands of sufficient importance for biodiversity conservation to merit GEF-funded or other targeted biodiversity conservation payments have already been identified, as have the (often overlapping) lands that would be eligible for PES payments based on hydrological and carbon storage significance (see Table A17-1). Table A17-1: PromisingAreas and Eligible Hydrological, Biodiversity, and Carbon Services Size of area (hectares) Environmental services eligiblefor PES Promising area Total Forested Hydrological Biodiversity Carbon Subtotal Cancim 603,232 559,638 130,712 415,730 9,848 556,290 Cerro Grande (Colima- 254,503 142,520 27,229 96,919 53,319 177,467 Villa de Alvarez) Copalita (Crucecita- 239,291 187,273 67,825 234,195 101,841 403,861 Huatulco) 138 Oaxaca de Juarez 1,601,001 254,980 50,104 1,O 16,493 778,414 1,845,010 Valle de Bravo 278,993 140,777 24,837 53,496 63,110 141,444 Xalapa-Coatepec 160,497 51,453 18,141 160,497 42,177 220,816 Zapaliname (Saltillo) 1,071,720 888,35 1 45,691 85,925 84,619 216,236 Zona Metropolitana 1,932,558 1,150,312 222,926 912,019 181,830 1,3 16,775 Monterrey Total 6,141,795 3,375,305 587,466 2,975,274 1,315,158 4,877,899 Note: Because areas with eligible services in different categories frequently overlap, the subtotal may count the same hectares more than once. Source: CONAFOWCGPPIGSM. Based on National Water Commissiondata and the Municipal Geostatistical Framework of the National Institute of Statistical and Geographic Information (INEGI). 7. PilotProjectSites. As shown inTable A17-1,the eight pilot project sites total some 6.1 million hectares, o f which about 600,000 ha (10 percent) are likely to be placed under PES contracts duringthe life o f this project (based on the expected availability o f funds and demand from potential PES recipients). All these sites have legal protection at the national level, since deforestation i s prohibited. They are briefly described below (not inany priority order): a. Coatepec-Xalapa-Pico de Orizaba. Located inthe states o f Veracruz and Puebla, this site comprises an important area o f remaining cloud forest (much o f which has been replaced by shade coffee and other agricultural systems), with humidpine forest at the higher elevations and dry forest inthe lower foothills. The cloud forests and adjacent well-shaded coffee plantations harbor many endemic plant and animal species o f conservation concern, includingthe globally threatened Bearded Wood-Partridge Dendrortyx barbatus, for which the Coatepec area is an important stronghold. The project would continue and expand the area o f PES payments under a successful ongoing program, which i s motivated by water supply concerns for the urbanareas o f Coatepec and Xalapa. PES payments would maintainthe cloud forests and possibly also the shade coffee areas o f highwatershed and biodiversity conservation value, and reduce the expansion o f field crops and pastures to hillside areas. b. Colima-Manantlan-CerroGrande-Villade Alvarez. Located inthe states o f Colima and Jalisco, this site comprises a biologically highly diverse mix o f moist and dry pine-oak forests, cloud forests, and tropical dry forests. It encompasses a portion o fthe Sierra de Manantlan Biosphere Reserve, which is renowned for its biodiversity that includes many endemic bird species (including the globally threatenedMexican Woodnymph Thaluraniaridgwayi and Black-capped Vireo Vireo atricapillus) and the wild-growing Perennial Maize Zea diploperennis. It also forms a corridor betweenthe Sierra de Manantlan and the Nevado de Colima National Park, with its high-altitude pine and fir forests and substantial eco-tourism potential. Maintaining adequate forest cover i s needed for ensuring adequate water supply to Colima city, as well as to reduce the significant soil erosion and landslide problems in the area. PES contracts with the ejidos and communities at this site would serve to prevent further deforestation within areas o f high importance for biodiversity conservation, improved watershed management, and carbon sequestration. c. Huatulco-Crucecita-Copalitdzimatan. Located on the Pacific slope of the State o f Oaxaca, this site encompasses a diverse mix o f cloud and humidpine-oak forests inthe Sierra de Miahuatlan, lowland tropical (humid and dry) forests inthe coastal foothills, and mangroves. The moist forests o fthe Sierra de Miahuatlanharbor numerous plant and animal species o f conservation concern, including the endangered Blue-capped HummingbirdEupherusacyanophrys (found nowhere else) and globally threatened White-throated Jay Cyanolycamirabilis. Huatulco is an important beach resort with growing 139 dependence upon fresh water, and the montane forest cover that helps to ensure its reliability. There i s also the potential for expanded eco-tourism, including on community-owned forest lands. PES contracts would reduce deforestation for agricultural expansion, while helpingto maintaining water supplies, reduce catastrophic flooding risks, and enhancingthe survival prospects o f many threatened species. d. Saltillo-Zapaliname. Located inthe states of CoahuilaandNuevo Leon, this site includes the Area Natural Sierra Zapaliname, an official protected area with substantial ejido landholdings suitable for PES contracts. The Sierra Zapaliname contains a diverse mix o f native pine and oak forests, along with semi-arid scrub at lower elevations. This mountainrange i s also an AICA because its pine forests are an important feeding area for the threatened endemic Maroon-fronted Parrot Rhynchopsitta terrisi. The pilot site also includes a highlythreatened (by agricultural expansion) natural grassland area known as the Pradera de Tokio, which is the main global stronghold for the endangered Mexican Prairie Dog (Cynomys mexicanus) and Worthen's Sparrow (Spizella worthenil, as well as an important wintering area for many North American grassland birds. The city o f Saltillo is ina semi-arid zone with over-exploited aquifers and depends upon water originating inthe Sierra Zapaliname. e. Valle de Bravo-Amanalco. Located in the states o f Mexico, Michoacan, and Guerrero, this site comprises two endangered ecosystems classified as "Highest Priority" inthe World Bank-WWF ConservationAssessment of the Terrestrial Eco-regions of Latin America and the Caribbean (Dinerstein et al., 1995): Mexican Trans-Volcanic Pine-Oak Forest in the higher mountains (along with patches of cloud forest) and Balsas Dry Forest inthe foothills. The site includes the buffer zone o f the Nevado de Toluca National Park. The city o f Valle de Bravo and surrounding irrigation districts suffer from over- exploited aquifers and relyupon these forests to improve seasonal water flows. PES contracts with ejidos and communities with key forested lands would serve to enhance water flows, protect hydraulic infrastructure from sedimentation, and conserve the habitat o f numerous endemic plant and animal species. f. Cancun-SianKa'an. Located inthe StateofQuintana Roo, this site includesthe SianKa'an Biosphere Reserve and the El Eden Private Reserve. It comprises humidand dry tropical forests, mangroves, and semi-arid scrub inthe extreme north. The site contains most o fthe diverse endemic fauna and flora o f the Yucatan Peninsula and is a concentration area for many species o f migratory land and water birds. This pilot area is inthe general vicinity o f Cancun and the booming tourist resorts o f the Mayan Riviera, where there is considerable potential to promote eco-tourism as a complement to the well- developed tourism around beach resorts and Mayan ruins. This i s an area where PES arrangements based on maintaining natural habitats for biodiversity-based eco-tourism shows genuine promise. PES contracts would help to ensure that participatingcommunities maintain the natural forest and other biodiversity- friendly vegetation. g. Oaxaca de Juarez-SierraSan Felipe. Locatedinthe State o f Oaxaca, this site comprises the unique dry oak forest andthorn scrub inaportion of Oaxaca's central valley and adjacent slopes, along with the moist pine-oak and cloud forests inthe mountainranges both north and south o f Oaxaca city. The cloud forests inthe Sierra de Norte are presently the most extensive ones remaining in Mexico, with iiumerous plant and animal species o f conservation interest. The moist pine-oak forests north of Oaxaca city are the main stronghold o f the globally threatened Dwarf Jay Cyanolyca nana. The remaining thorn scrub and dry oak forests inthe foothills harbor many range-restricted species, including near-threatened birds such as Pileated FlycatcherXenotriccus mexicanus and Oaxaca Sparrow Aimophila notosticta. The hydrological services from the mountain forests (both north and south o f Oaxaca city) are especially significant because the aquifers that provi,dewater to the city and nearby irrigated lands are classified as over-exploited by the National Water Commission(CNA). Although Qaxaca city i s a popular tourist attraction because o f its history and nearby archaeological sites, the adjacent mountains (with their pleasant climate, beautiful forests, and exceptional biodiversity) have significant, underutilized eco- 140 tourism potential. PES contracts with communities holding important lands for biodiversity, hydrological functions, and carbon sequestration would serve to limit the clearing o f forests for various types of subsistence and commercial agriculture. h. Monterrey-Cumbres. Located inthe states ofNuevo Leon and Coahuila, this site comprises the Sierra de Arteaga, an extensive area o f native pine forest, with semi-arid scrub inthe lower foothills and moist forest along water courses. It includes the Cumbres de MonterreyNational Park and the El Taray Reserve. This site contains a highproportion o f the world's nestingcliffs and feeding area for the threatened endemic Maroon-frontedParrot. The city o f Monterrey has over-exploited aquifers and relies significantly on surface water originatinginthe pine forests. Conservation o f these forests i s also considered important for reducing the intensity and damage from periodic floods and gully erosion. PES contracts with ejido landowners inthe Sierra de Arteaga would reduce deforestation, as well as the pine forest degradation that results from excessive burning. 141 Annex 18: Detailed Lessons Learned MEXICO: EnvironmentalServices 1. The design o f proposed project has been enriched by lessons and recommendations from several initiatives. The key lessons learned from other relevant projects including those co-financed by GEF and/or other donors (listed in Annex 2), has enriched the design o f the proposed project. This Annex reviews the lessons learned in: (a) Mexico's current Payments for the Hydrological Environmental Services (PSAH Program); (b) other Payment for Environmental Services initiatives; and (c) other GEF- supported biodiversity and sustainable use projects, including the Biodiversity Conservation and Sustainable Use in Productive Landscapes Project in Chiapas and the Consolidation o f the Protected Areas System Project (SNAP 11) inMexico. Lessonsj?om Mexico's Paymentsfor the Hydrological Environmental Services Program (PSAH) 2. The proposed project builds on Mexico's current program o f Payments for the Hydrological Environmental Services (PSAH). This program has already been quite successful. In 2003 more than 900 applications were received offering close to 600,000 ha, o f which 271 were selected, incorporating 127,000 ha into the program. In 2004, Congress increased the PSAH's budget by 50%. 960 applications were received, o f which 352 were chosen, covering about 180,000 ha. Despite the program's achievements, there remains room for improvement. In particular, the following areas need to be addressed; (i) the majority o f the contracted area i s outside the priority conservation areas-less than 14% of the area enrolled in 2003 and 2004, for example, was located in areas with over-exploited aquifers; (ii) most of the enrolled area i s at low risk o f deforestation-less than 20% o f the area enrolled in 2003 and 2004 was inareas with high or very highrisk o f deforestation, while 62% was in areas o f low or very low risk of deforestation; (iii) contracts have gone to the better organized, more developed communities most and ejidos, and to private owners, even though their opportunity cost tends to be higher; (iv) budgetary limitations impose a 5-year limit on payments to any one participant, putting conservation beyond that period at risk; and (v) there is a lack o f training and capacity building (on both the supply and demand sides) to develop local markets. 3. Lessons from evaluations o f the PSAH program to date have been instrumental in the design o f the proposed project. These include: 9 High-level government buy-in: High-level government commitment was crucial for PSAH program to obtain funding. In designing the program, a thorough analysis was conducted by experts from universities and the World Bank. After securing the commitment from SEMARNAT and CONAFOR, the PSAH program proposal received support from National Water Commission (CNA) and the Ministryof Finance (SHCP) with a very strong lobby from within the government. The support from the reputable members o f academia and professionals and the empirical studies provided the credibility of the program that helped secure CNA's and SHCP's buy-in as well as from the large . majority of the entire chamber o f the legislative branch. Likewise, the proposed project i s strongly supported by SHCP and SEMARNAT. Design eligibility criteria carefully: One o fthe eligibility criteria for PSAH program participationwas that the forest areas should have at least 80 percent forest cover. This criterion excluded some o f the most deforested and high deforestation risk areas from the program. The project will support a thorough re-appraisal and modification o f eligibility criteria. 9 Differentiatepayments: The payment scale o f US$27.30 per ha per year (non-cloud forest areas) and US$36.40 per ha per year (cloud forest areas) attracted widespread participation in some areas, but very little in others. In some respect, it was set too high, attracting forest areas that did not have any conversion risk due to low or no opportunity cost. Many o f these areas could probably have been enrolled at much lower payments, thus freeing resources for additional areas elsewhere. Attracting 142 participants in areas of highdeforestation risk, however, may be difficult at current payment levels, as these areas tend to have high opportunity costs. Raising payment levels across the board to attract these higher-risk areas, however, would result in much higher program costs. A differentiated payment program i s needed to escape this trap. A differentiated, targeted scheme will be much inore cost effective and less expensive than an undifferentiated payment system that pays everyone the same. Base payment levels and targeting on both expected benejits and opportunity costs: The overall payment levels of the current PSAH were set based on an analysis o f average opportunity costs. Basing payments purely on opportunity cost, however, creates the risk o f making payments in areas where very few benefits are being produced. Indeed, the PSAH program has attracted substantial participations in areas with limited or no likely water benefits. The PSAH did partially reflect expected benefits by offering a higher payment for conservation o f cloud forests, which are thought to be particularly valuable for water services. In any given area, efficiency o f the program requires both (i)targeting paymentsto highpriority areas (of highconservation value as well as relatively high deforestation risk) and (ii)ensuring that PES in these high priority sites are reasonably close to the landowners' actual opportunity costs. Through Components 1, 2 and 4, the project will refine the existing Mexican PES program to promote increased cost-effectiveness, which will, in turn, ensure both (i) greater positive conservation impact for the GEF and other funds invested and (ii)increased likelihood o f long-term financial sustainability. Define (and enforce) clear eligibility criteria: Defining the operational procedure and eligibility criteria should be based on detailed analysis and be adaptive to reflect the lessons learned during implementation o f the program. For example, the PSAH program's operating rules state that eligible areas needed to be located either inthe recharge area o f an overexploited aquifer, in a watershed with high water scarcity, or where hydrological natural disasters are more frequent. Some o f these were difficult to assess to conclude a "yes" or "no" result, and therefore the eligibility criteria was modified from a binary (i.e., "yes" and "no") to a grading system. Eligibility criteria will only contribute to effectiveness ifthey are enforced, however. Ensure that the rural poor can participate: PES programs are not designed to be poverty reduction programs, and targeting them on the basis o f poverty objective risks undermining their primary objective o f providing valuable environmental services. However, they can often contribute to this aim, as many potential service providers are poor. This i s certainly true in Mexico, where more than 85% of communities with more than lOOha o f forest are classified as having high and very high marginalization. To date, however, the most organized communities or ejidos, who were already receiving other government aid and were better off, have received the most benefits from the PSAH program. Emerging lessons indicate that PES programs need to be carefully designed to ensure that the rural poor are able to participate. Lack o f training and capacity building activities in the PES program for both the supply and demand sides have created a barrier for less organized and marginalized families to participate in the program.Expand the Scope to include Globally SigniJicant Areas: The PSAH program focused only on local and regional environmental and natural resource management benefits. Though there was some overlap between local and global benefits, some o f the most vulnerable areas with globally significant habitats and biological diversity were not part o f the program. In the design o f the proposed project, global environmental objectives have been considered. Build trust between communities and the regional PES program promoters: Creating a long-term relationship between communities and the PES program i s important. A hasty approach and/or limited transparency can create false expectations and misunderstandings that could alienate communities and lead to reduced participation, particularly by the marginalized stakeholders the project seeks to target through the organizational and technical assistance in comuonent 3. The incorporation o f communitv- 143 based, community selected promoters to facilitate interactions with CONAFOR staff and the project is an important element o fthe project design intendedto addressthis issue. LessonsPom Other Paymentfor EnvironmentalServices Initiatives 4. The design o f proposed project has been enriched by lessons and recommendations from several PES projects, including the Costa Rica Ecomarkets project, the regional Silvopastoral project in Central and South America, the El Salvador Shade-grown Coffee, and the El Salvador Payment for Environmental Services project, all supported by GEF and the World Bank. In addition, the proposed project has gleaned lessons and recommendations from publications o f the World Bank, Forest Trends, the International Institute for Environment and Development (IIED), and other sources. Some o f these lessons include: Country ownership: Political "buy-in" is an important aspect and must be attained at the highest levels o f executive and legislative branches of the government. Coatepec (Mexico) example highlights the importance o f political "buy-in" at the municipal level and at the federal level. It highlightsthe importance of having discussions and agreements with finance ministry in furthering the environmental agenda, and therefore, should also be a part o f the strategy o f the program, Furthermore, early identification o f supporting local partners (e.g., NGOs) including their capacity i s important for promoting participation and strengthen ownership at the local level. It will strengthen the institutional sustainability. Flexibility in project approach: As evidenced in Coatepec and in other regions and countries, that environmental services are very site specific and consequently the administrative mechanism should be sufficiently flexible to adapt to the different needs that transpire in the country. Payment scheme, for example, should be site specific as demonstrated by the fixed payment o f US$90 per ha per year in Coatepec was not sufficient to cover the opportunity cost of some o f the most marginalized areas. A balance, however, needs to be found between the efficiency advantages and the higher costs o f more accurate targeting. A central aim o f the project is to assist CONAFOR in converting the current `one-size-fits-all' approach to a much more targeted and differentiated approach. Identify the services being provided clearly: Potential buyers are not interested in generic "forest services," nor even in "water services" or "biodiversity services." Rather, they are interested in clean water, or in a reliable dry-season water supply, or in access to genetic information. Without a clear understanding o f which specific services a given forest is providing, and to whom, developing sustainable financing mechanisms will be difficult. The design o f sustainable financing mechanisms depends on identifying service users and understanding the specific services they use and how these services affect their wellbeing. Start with the demand side: Without demand, there can be no market. Beginning from the supply side risks developing mechanisms that supply the wrong services, in the wrong places, or at prices that service users are unwilling to pay. Quantify environmental services:It is essential to estimate the magnitude o f the costs and benefits to be achieved through conservation, including the willingness o f downstream users to pay for services is, and the minimum payment level requiredto induce landholders to adopt conservation land uses. Make payments continuous and open-ended Land users should receive payments as long as they comply with the stipulated land use and management activities in their contract. The benefits being sought will generally be enjoyed year after year, as long as appropriate land uses are maintained. Previous approaches have tended to provide only front-loaded payments, coinciding with the project's implementation cycle. The typical result is that once the project ends, land users revert to previous practices and the project's benefits are lost. Pilot the scheme before scaling up: It is important to initiate work at reasonable scale such as tens of thousands o f hectors before scaling it up to hundreds o f thousands o f hectares. The knowledge from 144 the pilot experiences should be shared with all the stakeholder groups and applied in the design of scale up program. Developing institutional arrangements that work Having the right institutional arrangement without creating a cumbersome mechanism is important. How are payments to be made and collected? Who should manage the funds? How can the process be made transparent and avoid corruption? Are indefinite, sustained payments necessary? In addition, current research on scale o f intervention mentioned above, speaks to a strong role for community organizatioiis and local governments in the negotiation o f management strategies (including payment for environmental services). Mexico, with its ejidos in the rural setting, i s well placed to explore this dimension. Monitoring and Evaluation: The pilot environmental service payment sites are for testing the design and institutional arrangements for a more widespread system. As such, it would be important to monitor (both in-project sites, and nearby out-of-project sites) land use, socioeconoinic changes, biodiversity, and other key indicators to properly evaluate the pilots. Monitoring and evaluation i s an integral part o f project design. It must include the establishment o f a baseline, as well as the socio- econoinic and environmental impacts o f the project. Remove regulatory and information barriers: Reducing excessive regulatory barriers would provide opportunity for landowners to participate in the market. Furthermore, to "level the playing fields", access to information, that discriminate small landholders to participate in the market need to be removed. Amenable and effective extension system is necessary: An extension system i s not only vital to help farmers and other stakeholders (e.g., fishermen) adapt their agriculture and harvest practices but also to raise awareness about the importance o f sustainable management o f natural resource base. Inclusion of nonforest areas in PES schemes: Although the main emphasis in Mexico should still be conservatioii o f existing forests, PES schemes can sometimes usefully support reforestation, improved agroforestry systems, and conservation o f nonforest natural habitats important for biodiversity. LessonsJi.om Biodiversity Conservation and Sustainable Use in Productive Landscape Projects 5. One o f the most important lessons learned from projects supported by GEF includes the importance of stakeholder participation and ownership involving local populations and institutions (e.g., local government, community and sectoral organizations, NGOs) in project design and implementation in order to ensure long-term conservation o f biodiversity inprotected areas, as well as inthe production landscape. As such, the design o fthe Mexico project includes technical assistance for ejidos, comunidades, and local NGOs to support forest conservation activities carried out by individual members o f ejidos and comunidades, small landowners, and other rural organizations. Consultations have taken place in priority areas to strengthen local participationinthe project. 6. The experience of projects throughout the M B C and other natural protected areas with buffer zone communities includingMexico M B C and Mexico Consolidationo f the Protected Areas Program (SNAP) indicates the importance of: . Limit Project Focus: Limiting the project focus so that the activities are targeted and limited to those appropriate to the social context and current institutional capacity. It should have measurable results . in its own right as well as making a contributionto the longer term plan in conservingthe country's biodiversity; Strengthen Institutional Sustainability: Strengthening the institutional sustainability include building capacity o f the executing entity, strengthening public-private partnerships and building capacity within partner organizations to implement co-management arrangements. Provide a strong administrative and coordinative capacity supported by adequate technical assistance and, initially, close implementation supervision. The strengthened institutional capacity should be both at the 145 national level as well as at the local level. At the site level greater involvement o f civil society in park management i s expected to contribute to long-term viability and social and institutional sustainability o f the protected areas. This project will strengthen public-private partnerships and further build capacity within partner organizations; Define Rules of the Game and Responsibilities: High quality public participation is key. Project experiences suggest that providing for a strong role for NGOs and the private sector can be very effective during implementation. For example, one o f the most important lessons learned from activities associated with the projects within the Mesoamerican Biological Corridor i s the importance of involving local populations and institutions in the design, implementation and benefits o f the project. This approach helps assure sustained impacts after project completion. Therefore, clearly defining the roles o f the project and the communities i s critical including in project administration, decision making, and implementation in order to avoid creating false expectations or leaving ambiguities which cause implementation delays; Monitoring is Important: Ensuringthat adequate monitoring and evaluatioii system is in place. Project activities include developing mechanisms to monitor biodiversity impact and protected area management effectiveness. Econonzic Cost-Benefit analysis needs to be clearlypresented and made available to decision makers: Inthe case o f El Salvador coffee, though yields per hectare were lower for shade coffee than for sun coffee or monoculture plantations, production costs were also lower because shade coffee required less fertilizer, pesticides, and fungicides. Lower production cost and multiple use o f land (e.g., coffee, timber/firewood and none-timber products) may generate more profit per hectare. 27. Preparation o f the Consolidation o f the Protected Areas System in Mexico (SINAP 11) was particularly valuable in analyzing lessons relatedto conservation trust funds. These lessons-based on the independent analysis o f the Mexico Protected Areas Fund ( FANP) established under SINAP I,the project's midterm review, the 1999 Impelemenation Completion Report (ICR) for the Mexcio Environmental Project, and the GEF Secretariat's Evaluation Report No. 1-99 on Experience with Conservation TrustFunds-include the importanceo f 0 The endowment fund, government commitments, and incentives for capitalization must be structured to avoid having government fundingo f conservation decrease because o f the fund itself. 0 While endowment funds are appropriate where sustained, relatively low-level inputs are required, other funding mechanisms are important to address specific short- and medium-term needs. 0 A focused capitalization strategy is required, including clear program goals and mission for the fund, relevance to the interests o f donors, unconditional commitment by core groups involved in the initiative, information dissemination, and fundingto conduct a capital campaign. 0 Public-private partnerships are key for capitalization and sustainability, and bring in outside expertise. 0 A trust fund's best fund-raising tool is arecord of success in its initial project cycles. 146 Annex 19: Paymentfor EnvironmentalServices-WaterProgram(PSAH) MEXICO: EnvironmentalServices 1. Designing the PSAH Program. Analysis and design for the Payment for Hydrological Environmental Services Program (PSAH) began in mid-2001 and was completed in M a y 2003 by a joint team from the National Forestry Commission (CONAFOR) and the National Statistics Institute (INE). This team was support by a group o f researchers from the Universidad Iberoamericana, the Centro de Estudios y Docencia Econbmica (CIDE), and the University o f California at Berkeley, which was led by Professors Alain D e Janvry and Elizabeth Sadoulet. Additional support was provided by the World Bank's Environment Department staff, which channeled a donation from the government of Japan to finance data collection and analysis, and provided advice and feedback throughout the different stages of program development. 2. The initial proposal was presented to the Secretary o f the Environment and Natural Resources Secretariat (SEMARNAT) and the Director General o f CONAFOR. They both agreed that it should be one of the key policies put forward by the administration and that they would negotiate persistently with the Ministry o f Finance and Public Credit (SHCP), Congress, and the agricultural lobbies to pass the necessary legislation. 3. The first step o f the strategy was to create a fiscal instrument to provide resources for the program and a trust fund to administer those resources. This fund was called the Fondo Forestal Mexican0 (FFM), which was to serve as a commitment device to assure participants that resources were being set aside to provide payments over the five-year span o fthe environmental services contracts. 4. The strategy to sell the program involved winning over government officials from agencies linked to SEMARNAT, most notably the National Water Commission (CNA). Their reluctance to support the program was due to their view that water scarcity i s primarily an infrastructure investment problem. Simultaneously, a strong internal lobbying effort was required to convince SHCP officials that the fiscal instrument was well designed and could be approved by Congress. However, it was too great a departure from existing fee designs to win immediate approval. Staff from C N A and SHCP strongly opposed the PSAH because in prior negotiations they had promised municipalities that 100 percent o f the water fee paid to the federal government would effectively go back to municipalities as investments in local water supply infrastructure. SEMARNAT's main rebuttal to this argument was that to ensure water supply it was equally important to invest in natural capital and that this could only be done at the watershed level. 5. The support of respected academics was essential for conveying the program's strengths and overcoming early reservations about its innovative nature and associated risks. In addition, empirical studies and consultations with professionals working with forest communities facilitated an initial review of the PSAH program's capacity for monitoring and incentives, which in turn developed a more realistic and pragmatic field program. 6. During the process of lobbying the Mexican Congress, several key members o f the Environment, Natural Resources, and Revenue committees where very supportive o f the draft initiative and even told SHCP officials that they would present it as their own proposal if SHCP effectively blocked its presentation by the executive branch. In the end, a compromise version was presented that effectively earmarked the expected PSAHbudget amount from the water fees paid by users other than municipalities, thereby resolving the issue o f municipal fees paying for conservation rather than infrastructure. Interest from different political parties stemming from their diverse agendas (environment, poverty reduction, 147 water supply, and forest conservation) helped build the consensus needed for the initiative to be passed by the Review Committees and approved by a large majority o f the entire chamber. 7. Once the fiscal instrument was approved, a set of operating rules (Reglas de Operacih) for the program were drafted. Duringthis phase there was very active lobbying by agricultural groups from the Acuerdo Nacional por el Campo (ANC), an umbrella organization for campesino and producer associations. Since most of the groups associated with the ANC represent producers, their lobbying efforts were aimed at steering payments to communities that already had timber operations or shade- grown coffee plantations. INE and CONAFOR resisted this on the grounds that payments should go to communities that derived little income from their forests and were therefore more prone to deforestation rather than to communities that were already obtaining significant income from forests and therefore had an interest in preserving them. 8. Noncommercial forest owners are not as well organized as timber producers and lack the lobbying power to compete with producer groups. At first the Mexican government took a firm position on behalf of tbe noncommercial owners, but ultimately had to negotiate certain clauses to allow restricted PSAH payments intimber producing areas as well. 9. Federal Rights Law and the PSAH. Lakes, lagoons, aquifers, and rivers are considered national property in Mexico and are managed by the federal government. This allowed for establishment o f a fiscal instrument to pay for hydrological environmental services, because the government can charge for the use o f national goods through the Federal Rights Law (Ley Federal de Derechos, or LFD), which sets fees for the use o f for natural resources like water and minerals (Cortina 2002). Articles 222, 223, and 224 of the LFD set out the water fees charged to different users. Farmers pay nothing and municipalities very little, while manufacturingcompanies and service providers pay the highest fees. 10. The LFD is prepared each year by the SHCP and presented to Congress for review, modification, and approval. The INE-CONAFOR team prepared a modified version o f LFD Article 223 to earmark part o f the revenues from water fees in order to finance payments for environmental services. The initial proposal earmarked 2.5 percent o f annual water revenues to pay for the program, but after negotiations with SHCP this was changed to nominal terms: 200 million Mexican pesos (US$18.2 million) per year. 11. Mexican fiscal policy generally discourages the earmarking o f taxes. However, thanks to the successful negotiations o f Francisco Giner de 10s Rios, the then Director General in SHCP's Undersecretariat of Revenue, several environmental fees were earmarked on the grounds that fees, not taxes, were paid in exchange for the goods and services provided by the government. This i s the case, for example, for fees collected from visitors to Natural Protected Areas or for wildlife utilization in federal lands. 12. The justification for excluding fees paid by municipalities from directly financing the PSAH was based on the Programa de Devoluci6n de Derechos (PDD), which created strong incentives for municipalities by linking the water fees they collected to the amount o f the federal budget dedicated to projects in each municipality. This political decision was difficult to assess from a public policy perspective. On the one hand, the PDD was delivering fee collection results unseen before in Mexico (Sainz and others 2004) thereby generating resources to address Mexico's serious shortfalls in water supply infrastructure. Onthe other hand, a 2.5 percent allocationto support conservation o f natural capital (forests) i s a very good investment that complements and can even reduce the need for investments in physical capital (infrastructure). Excluding fees collected by municipalities from financing the PSAH definitely softened the message that all users, and particularly urban centers, should contribute to protecting the ecosystems that supply them with environmental services. 148 13. Rules of Operation. One criterion for the PSAH program was that it should give taxpayers the highest possible returns in environmental services. This meant that initial payments should target forests that are at risk o f deforestation, are important for water quality and regulation, and have low but positive opportunity costs so that smaller payments would be required to prevent landowners from converting themto other uses. 14. The coffee growers wanted to participate inthe program, arguing that shade-grown coffee provides an environmental service similar to those provided by natural forests. The reply was that since the program was at an early stage, with limited funding, resources needed to be channeled to non-income generating forests where PSAH payments could make a greater difference. During final negotiations, this pressure from coffee growers was undermined by the revelation that they were already receiving inore than 3 billion pesos (US$273 million) a year in subsidies to ensure coinpetitiveness in the crowded international coffee market. 15. Another goal o f the program was to preserve natural forests, even though other ecosystems and agricultural lands could also provide hydrological services. With limited funds and a large amount of forest to potentially protect, pass/fail criteria were incorporated into the rules for site selection so that forests included in the program would not only provide hydrological services, but also be in a good state of initial conservation, and be likely to be sustainable and/or provide other environmental services or address other priorities in addition to water services. These criteria are shown on Figure A19-1 and explained in greater detail below. Figure A19-1. Basic Eligibility Criteria for the PSAH (2003-2004) I Rules of Operation for PSAH (2003-2004) Good quality With potential & future clients acquifers cover Cities > 5K zones ,----*---, Priority Providing o t h e 7 Mountains environmental H related natural services 1 disasters Natural xx^-^xxI_III-x^- 1_ I protected areas 16. Water benefits The 2003 operating rules o f the PSAH stated that eligible areas had to be located either in the recharge area o f an overexploited aquifer, in a watershed with high water scarcity, or where there i s heightened risk from hydrological natural disasters. It was relatively simple to provide an indicator about overexploited aquifers. The National Water Commission had published in the Official Federal Gazette (Diario Oficial de la Federacibn, or DOF) the geographical coordinates for 188 aquifers and their degree o f exploitation. This information was used in the 2004 eligibility map that CONAFOR usedas a guide to approve or reject proposals, and was perceived as objective and fair. 149 17. Incorporating indicators of water scarcity and vulnerability to natural disasters posed a greater challenge. In 2003, the first year of the program, CONAFOR was concerned that there might not be sufficient participation and did not want to define very restrictive eligibility requirements. The agency was also worried that the zones o f highest water scarcity (as defined in the LFD) were concentrated in only a few states and that using this as a prerequisite would limit the scope o f the PSAH, reduce its political support, and sendthe message that it was not a truly national program. Additionally, the National Disaster Prevention Center (CENAPRED) had not yet produced a map o f natural disaster risk that could be used to clearly define priorities. 18. Since water scarcity and natural disaster risk did not have clear indicators, many applications submitted in 2003 were supported by local documents o f little scientific value claiming eligibility on these criteria, and in 2004 the criteria were not used. To address this problem, INE suggested incorporating scarcity and disaster risk into the 2005 Rules o f Operation as factors in grading the applications rather than as prerequisites to accepting them. 19. The program also assembled a committee o f national and international scientists to help evaluate the importance o f different types of forests in providing hydrological services. They recoininended placing higher priority on cloud forests because o f their role in capturing water from mist and fog duringthe dry season, Although the committee also discussed giving special priority for dry tropical forests because of their role in reducing flood impacts, particularly in lower watersheds, there was not consensus on this point, so all forests except cloud forest were placed in a single group. Because all types o f forests could provide hydrological services, the program decided to distinguishbetween cloud forests and other forests inthe price paidto landowners rather than inthe eligibility rules. 20. Forests in good state of conservation. To maximize results and actual environmental services provided by the program, the main target group for conservation i s noncommercial primary forests. As a practical indicator the Rules o f Operation required 80 percent forest cover in participating plots of land, butthis criterion was not properly understood in2003 and faced implementationproblems in2004. 21. In 2003 the rule was interpreted as requiringthat 80 percent o f the plot be covered by forests rather than requiring 80 percent density of forest cover per hectare. That mistake created a bias towards the largest ejidos and communities, where agricultural plots were relatively small relative to forested areas. In 2004, the personnel responsible for the program concluded that their satellite imaging system could not correctly interpret density of forest cover and that it therefore should not be considered in evaluating the proposals. Furthermore, forester organizations in northern Mexico argued that their forests have naturally low densities. For 2005 CONAF i s working on a practicaland inexpensive system to estimate density, but inthe review o f the Rules of Operations some members of the Technical Committee suggested dropping the indicator altogether untilthe system can be tested. 22. Potential Future Clients. The third eligibility criterion sought to (i) increase the likelihood that local governments would join in efforts to protect their own watersheds by selecting areas with population centers larger than 5,000 people, and (ii) conserve areas that provide environmental services in addition to water quality and control by focusing on areas located either inside a Natural ProtectedArea System or in a mountain area belongingto the priority mountains program. 23. The population center criterion was included to increase the likelihood o f local governments having sufficient capacity to develop their own PSAH programs and being able to generate enough revenue to make collection o f an environmental fee worthwhile. If smaller cities and towns demonstrate a viable interest in the 2005/2006 program to develop local PSAH, then the criteria might be changed to allow participation by smaller municipalities. 150 24. The criteria for priority mountains and Natural ProtectedAreas were included as the result o f internal lobbying by the officials responsible for those programs. After the United Nations declared 2002 the InternationalYear of Mountains, Mexico created a list of 60 "priority mountains," carried out a series of activities related to mountains, and announced a long-term National Program for Sustainable Development o f Mountains. However, there was insufficient funding to further develop and carry forward the strategic agenda for the 60 mountains initiative, so including it as a criterion in the PSAH program was seen as a way of implementingthe concept. 25. The Natural Protected Areas were not included in the PSAH untilthe 2004 Rules o f Operation. The success of the PSAH in 2003 attracted the attention of the National Commission for Natural Protected Areas (CONANP), which saw the PES payments as a way to ease the impact on poor campesinos o f regulations prohibiting changes in land use. Poor communities and landowners were understandably reluctant to provide global and regional environmental services for free, particularly now that CONANP was more strongly enforcing compliance with land use regulations. The inclusion o f Natural Protected Areas inthe PSAH was justified on the basis o f watershed protection despite the fact that not all the areas included had serious water problems and even fewer offered strong potential for local government participation inthe program. 26. Determining PES amounts. To estimate the opportunity costs o f forest conservation versus other uses, a team from INE studied the profits earned in agriculture and livestock operations near forested areas (Jaramillo 2002). The data was provided by the main commercial agricultural credit organization of the government, the Fideicomisos Instituidos en Relaci6n a la Agricultura (FIRA). Although FIRA's clients tend to represent the most profitable agricultural producers, and therefore the opportunity cost estimate would be on the high side, this was the only readily available source o f information. 27. The results in Table A19-1 show average annual profits of US$37 per hectare from corn production and US$66 for livestock production. However, it was estimated that a payment a 200 pesos per hectare (US$18.2) would have been enough to prevent 21 percent o f deforestation for agricultural use and 12 percent o f deforestation to create pastures. 28. The initial proposal was to pay 200 pesos (US$18.2) per hectare per year to owners o f all types of forests except cloud forests, which would be paid 300 pesos per hectare (US$27.3) because o f their higher value in terms o f hydrological services. The payments would be made yearly, after verifying that no land use change occurred, and would continue for five years. During the approval process for the Rules of Operation, rural organizations lobbied for higher payments, even though this would mean that fewer people would receive payments (leaders of the organizations hoped that the higher payments would go to their constituents). CONAFOR was strongly opposed to raising the payments, and after lengthy negotiations a compromise was reached to pay 400 pesos per hectare (US$36.40) for cloud forest and 300 pesos per hectare (US$27.30) for all other forest. Table A19-1: Profits in Agriculture and Livestocknear Forest Areas versusPESPayments Percent of landowners withproJits below Average net theoretical PESpaymentper hectare profits per 200pesos 400pesos Activity hectare (US$) (US$18.20) (US$36.40) Agriculture 37 21 % 43 % Pasture 66 12 Yo 20 % 151 29. It was decided not to differentiate payments between regions, despite differences in opportunity costs, because it would be too controversial and regional interest groups would likely argue that opportunity costs for their land are higher than calculated by the program or that they were being discriminated against, possibly derailing implementation o f the program. The academic advisors suggested using a reverse auction approach in which land owners would bid down the amount they were willing to be paid. That would have created better payment differentiation based on actual opportunity costs and could yield greater benefits at less cost for water users. However, the potentially higher administrative costs and difficulty o f selling such an unusual allocation mechanism in Mexico, convinced CONAFOR officials that the two-tiered payment option was the most practicalto use at the beginningo f the program. 30. Issues related to opportunity costs. Though easier to implement, a two-tiered system that does not attempt to fine-tune payments to match opportunity costs introduces the problem that (i)in areas where opportunity costs are low the program could pay more than is necessary to conserve forest (or pay to conserve forest that i s at little risk o f conversion), and (ii) where opportunity costs are high the program may fail to protect forest that is critical for providing hydrological services. 31. Since the problem o f low opportunity cost i s closely related to the issue o f deforestation risk, a deforestation risk map was developed to help evaluate proposals as described in the section of this annex on the selection process. Where the opportunity cost i s too high for landowners to be interested in the program it was concluded that in most cases the cost o f buying their participation would be higher than the environmental services provided, particularly relative to other areas, and that with the current five- year limit on program participation some landowners might participate temporarily but then convert their forest to other uses once the contract expired anyway. Initially many local authorities interviewed during the design phase the PSAHprogram to provide a solutionto the pressure o f urban expansion pressure into natural areas, but the PSAH payments alone would not be sufficient to protect such lands in the absence of other forms o f compensation or regulations restrictingcertain types o f land use. 32. Limiting benefits. The PSAH had two main considerations in terms o f setting limits on the amount of benefits a service provider could receive under the program. On the one hand, protecting large contiguous areas would strengthen protection o f local environmental services in a specific region and allow benefits to be more easily monitored. On the other hand, contracting smaller individual plots with participation by more forest owners over a larger region would broaden the program's profile and learning experience. Ultimately, and inpart due to pressure from the timber producers lobby, two separate restrictions were chosen on the size o f individual applications: a limit o f 4,000 hectares where there were no commercial timber operations, and a limit o f 200 hectares for conservation areas associated with timber operations. 33. Selection process. Applicants for PSAH payments fill out an application form and attach the necessary documentation to validate their eligibility according to the Rules o f Operation. An initial review determines whether the applications are eligible and include all the required documentation. All complete and eligible applications are then evaluated by CONAFOR's regional offices. By law, the cost of implementation and evaluation can be no more than 4 percent o f total costs o f the federal allocation for the PSAHprogram. CONAFOR bears much o f the expenses by absorbing the cost o f its own staff and the hiring external suppliers, but probably the highest costs are the satellite images and the processing requiredfor monitoring and evaluation. 34. When the contract is breached. To fulfill its purpose, the program must have clear negative consequences for noncompliance. If there was an intentional change in land use not allowed by the contract, no matter how small a change, then there i s no payment at the end o f the year for any of the forest covered by the contract. If forest loss occurred unintentionally, for example because of a forest fire or timber theft, the participating community i s not paid for the forest lost, but is still paid for the 152 unaffected forest. Inthe case of unintentional loss, the community must inform CONAFOR o f the natural disaster or theft. This helps the agency monitor threats to its priority forests and it can also offer the community support from other programs such as reforestation or training to combat forest fires. 35. Deforestation risk. It makes little sense to use a limited budget to pay for areas that would not otherwise be deforested in the near future because either (i)other forest uses are already generating more profit than agriculture or cattle ranching would, or (ii)conversion to agriculture or cattle ranching would not be profitable regardless o f alternative forest uses. Formal forest uses that currently are profitable could be measured and used as part o f selection and eligibility criteria. Determiningwhich forests are at low risk because they are not worth converting to other uses is more difficult to measure, but has been attempted for use inthe PSAH selection process. 36. Knowing that it would be an important targeting problem, INE collected data to estimate an econometric model o f deforestation. The hypothesis was that the incentives to deforest would be negatively related to the distance from roads and towns, the potential agricultural yields o f the land, and the slope of the plot. It would also be influenced by the degree o f poverty in surrounding areas and whether it was within a declaredNatural Protected Area. 37. Based on observed historical data from 1993194 and current forest cover, an econometric analysis o f deforestation risk was developed that assigned a value to each pixel in an assessment map. However, since it i s based on previous deforestation patterns the prediction o f future deforestation risk could be biased. Economic growth and increasing trade liberalization have produced changes in important variables influencing forest opportunity costs. For example, real prices for corn have declined while agricultural wages have increased. Based on INE's recommendation to the PSAH Technical Committee, deforestation risk, dividing in five tiers, was incorporated into the process for evaluating proposals under the program. 38. Implementation.The PSAH program was not announced in the Official Federal Gazette until early October 2003 after long negotiations to get the operating rules approved, leaving little time for promotional activities, applications, evaluation, and selection before the December deadline. It was very important not to postpone the program because failing to show results during the same year that the earmarking o f fees was debated couldjeopardize congressional support. 39. The program was welcomed by collective and private forest owners, who expressed their satisfaction that, for once, all the restrictions they had on land use were being compensated. However, the short timeframe was a challenge and as a result o f this and other factors, targeting was not optimal, as explained below. Also, communicating in detail the nature and objectives o f the operating rules to CONAFOR field operatives, communities, and ejido members was not an easy task. In addition, contracting obligations are not always clearly explained and understood by participants. A common situation was that elected representatives o f nzicleos agvarios negotiated directly with CONAFOR and asked the community assembly for approval to participate in a federal program that would transfer financial resources in exchange for conserving the forest, but they only partially informed their members o f the restrictions and duties o f the program. 40. 2003-2005 beneficiaries. The launching o f the PSAH program attracted the attention o f ejidos, communities, and private land owners. In 2003, applications from 271 forest owners representing 127,000 hectares were selected for inclusion in the program out o f 900 applications proposing almost 600,000 hectares. In 2004, 960 applications were received and 352 new participants with more than 170,000 hectares were incorporated into the program. For 2005 the PSAH received 688 applications and accepted 256 o f them, covering 169,03 1hectares. 153 Table A19-2: Applications Receivedand Approvedfor PSAHProgram,2003-05 2003 2004 2005 (Jan-Jun) Total Received Applications 953 960 688 2,601 Hectares 600,000 793,476 Approx. 700,000 2,093,476 Approved Applications 271 352 256 879 Hectares 127,000 184,000 169,03 1 480,03 1 41. During the selection processes a large number o f applications are typically discarded because they were incomplete. For ejidos and comunidades the main omission in documentation was the Assembly Record that verifies the members' discussion, vote, and decision to participate in the program, while for private land owners the missing documentation was most often the proof o f up-to-date tax compliance. Another important omission was the map o f participating plots, which is required for reliable use o f satellite imaging to measure forest cover. For this reason a common attribute o f successful applications was that ejidos and comunidades had participated in the PROCEDE program, which included mapping communal properties, and private land owners had their land inthe Public Property Registry. 42. Independent o f the selection criteria used, a critical lesson from the first two years o f the program is that the payments (US$36.40 and US$27.30 per hectare) were too high and deforestation risk was not given sufficient weight. The large number o f applications received was probably due in part to the promised payments being substantially higher than the expected opportunity costs for most participants. 111 addition, it was assumed that plots with high risk o f deforestation and located in important aquifer recharge areas were going to be selected, but in practice CONAFOR's eligibility criteria were not narrow enough to achieve these goals (Tables A19-3 and A19-4). The lesson is that deforestation risk and importance o f hydrological services must be given greater weight in the future. Though not one of the official criteria for selection, the program failed to reach the most marginalized and at-risk owner o f communal forest lands, as shown in TableA19-5. This could reflect a lack o f capacity or opportunity among the poorest communities and suggests that efforts should be made to provide technical assistance and education to identify and overcome barriers to participate inthe program. Table A19-3. PSAHTargeting: Aquifer Exploitation Percent of National Land in PSAH Land in PSAH Degree of aquifer use territory Population 2003 2004 Extremely overexploited 0.1 9.2 <0.1 0.0 (+loo% to +800%) Highly overexploited <0.1 19.5 0.0 (+50% to +loo) 0.0 Moderately overexploited 18.6 14.5 13.3 9.6 (+5% to +50%) Inequilibrium 2.9 11.3 <0.1 0.0 (-5% to +5%) Capacity for expanded use 65.1 45.4 78.7 85.0 (-5% or less Unknown 13.4 0.1 8.0 5.3 Total 100.0 100.0 100.0 100.0 154 Table A19-4. PSAHTargeting: DeforestationRisk Deforestation Share of all for PSAH PSAH 2003 PSAH 2004 risk forests PA) Hectares Percent Hectares Percent Hectares Percent Very high 20 404,549 12 5,922 4 18,550 11 High 20 198,762 6 11,034 7 28,529 17 Moderate 20 613,763 18 28,446 17 34,953 20 Low 20 856,519 25 50,046 30 50,940 30 Very low 20 1,350,704 39 68,815 42 37,133 22 Total 100 3,424,297 100 164,263 100 170,105 100 Table A19-5. Targeting of the PSAH: Socioeconomic Marginalization Marginalization index Communalproperties w/ 100 ha. offorest PSAH 2003 PSAH 2004 Very high 25.0 21.5 69.1 High 46.9 61.4 17.2 Moderate 18.1 7.9 8.6 Low 7.9 5.7 3.3 Very low 2.1 3.4 1.8 Total 100.0 100.0 100.0 155 Annex 20: Paymentfor EnvironmentalServices-Carbonand BiodiversityProgram (CABSA) MEXICO: EnvironmentalServices 1. The Programto Develop EnvironmentalServices Markets for Carbon Capture and Biodiversity and to Establish and Improve Agroforestry Systems (CABSA) was created in 2004 in response to some o f the critical issues identified duringthe preparation o f Mexico's National Forest Program. It complements the Payment for Hydrological Environmental Services Program (PSAH), which was created in 2003. Both programs are operated by the National Forestry Commission (CONAFOR), and their financing i s collected and payments to providers o f environmental services are made through the Mexican Forest Fund (FFM). 2. The FFM was created by the March 2003 General Law for Sustainable Forest Development as an instrument (managed by CONAFOR) for promoting the conservation, restoration, expansion, and sustainable exploitation o f forests and associated agroforestry resources. It seeks to facilitate access to financial services markets, promote projects that improve the competitiveness and integration o f the production chain in the forest sector, and develop mechanisms for payment for environmental goods and services (PES). Main Outlinesof the Program 3. CABSA's main goals are to facilitate access to national and international markets related to carbon sequestration and biodiversity conservation in forest ecosystems, promote the conversion o f land used primarily for agriculture into agroforestry systems, and strengthen and improve existing agroforestry plantations that already grow crops integrated with forest trees. 4. CONAFOR manages CABSA following operating rules that are published in the Official Federal Gazette. These rules define the eligibility requirements for participation in the program, criteria for evaluating proposals and awarding contracts, and the procedures for payment o f benefits under the program. The budget for CABSA in 2004 was 100 million pesos, o f which 96 percent was directed toward direct payments to beneficiaries for developing and implementing projects, and only 4 percent for CONAFOR's operational, evaluation, and monitoring costs relatedto the program. 5. The payments are supposed to be divided evenly between the four categories (carbon, biodiversity, conversion of agriculture to agroforestry, and strengthening o f existing agroforestry), but if there are not enough eligible proposals in one category the unused funds can be shifted to another category. The payments can be directed to three types of activities-project development, project execution, and project support-each o f which has specific guidelines and funding limits. Project support can include monitoring and evaluation o f environmental services, training o f community promoters, and project technical assistance and support. 2004 and 2005 Programand Budget Allocations 6. The initial allocation for 2004 between the different categories o f projects and types of activities is presented in Table A20-1. Since there were not enough qualified proposals to use the entire budget earmarked for conversion to agroforestry, the remainder was transferred to other categories. The table also indicates that while resources were allocated evenly between preparation and implementation, there was wide variation within categories. For example, while nearly 80 percent o f payments for agroforestry conversion were for project preparation, more than 90 percent o f those for agroforestry strengthening went to implementation. In total, projects under implementation encompassed 31,448 hectares, while projects were inpreparation for more than a half million hectares. 156 7. In 2005 there was no direct budget allocation for CABSA from the federal budget. However, 52.4 inillion pesos from the PSAH budget were designated for payments under CABSA rules. Table A20-2 shows the aggregate projects approvals and allocations for the 2005 CABSA program, along with the updated program data for 2004 including modifications to the area affected and contract amounts that were cancelled. Table A20-1: Initial CABSA Budget Allocation by Category, 2004 Area Budgeted amount Project category Requests (hectares) @esos) Biodiversity Preparation 88 264,399 19,235,011 Implementation 8 11,270 17,376,580 Total 96 275,670 36,611,591 Carbon Preparation 69 247,448 21,930,114 Implementation 2 3,781 7,103,905 Total 71 251,228 29,034,019 Agroforesty improvements Preparation 22 16,894 2,550,000 Implementation 6 16,262 26,449,29 1 Total 28 33,156 28,999,291 Conversion to agroforestry Preparation 30 10,041 4,250,000 Implementation 1 136 1,104,650 Total 31 10,177 5,354,650 All projects Preparation 209 538,782 47,965,125 Implementation 17 3 1,448 52,034,425 Total 226 570,230 99,999,550 Note: This table reflects initial allocations, prior to field verification and not including contractsthat were withdrawn or cancelled. Table A20-2: Aggregate CABSA Program Data for 2005 and 2004 (updated) Year 2004 2005 Proposals Received 830 955 Approved (total) 216 51 Biodiversity 91 23 Carbon 71 11 Conversionto agroforestry 30 5 Improvement of agroforestry 27 12 Area inprep. or impl. (hectares) 557,360 68,535 Budget allocation (million pesos) 96.7 52.5 157 Lessons Learned from the Strategic Forest Program 8. The Mexico Strategic Forest Program 2025, a recently completed study for the forest sector, analyzed in detail the PES mechanism for forestry activities. It identifies strengths and weaknesses in relation to the market for environmental services. Some strengths identified are: 0 There i s great potential for utilizingthe environmental services market. 0 The vast area of forest ecosystems inthe country allows for important carbon sequestration. 0 Pilot projects may be used for developing the environmental services market. 0 MCxico has great genetic diversity; it is in one of the most biologically diverse countries in the world. But this comparative advantage has not been exploited. Development o f this potential would serve as a source o f additional income for the forest sector. 9. The weaknesses identifiedare: 0 A major problem in payment for environmental services, and its long-term sustainability, is that the market is young and does not function well; there is not a price that reflects the cost of providing the services or the value o f benefits generated (Figure A20-1). 0 Limited knowledge is another reason for concern. It i s still difficult to quantify the production o f environmental services, and therefore to price them accordingly. Also, the lack scientific information on the relationship between land use changes and the supply o f eiivironmental services poses a serious difficulty to PES implementation. In addition, the likes and preferences o f consumers (willingnessto pay) generate uncertainties o f the financial side. 0 Supplying environmental services is linked with problems in organizing forest management and akcheiving economies of scale. The transaction costs o f providing many potential environmental services may be prohibitive unless done on a large scale. Fragmentation o f forests into small parcels may accentuate the problems o f economies o f scale and uniform management. 0 Another problem is related to private property and the production o f environmental services. Since environmental services are considered an externality rather than a product generated by owners o f forests, it i s difficult to charge directly for their use. To establish a market for environmental services there must be a legal framework and mechanisms for collection of fees for and for payments to landholders. 0 Carbon sequestration markets basically do not exist in Mexico. International negotiations are protracted and currently there i s only very limited availability o f funding for forests as carbon sinks. However, if financing were available the carbon sequestration potential linked to the formation o f forest biomass inMexico could be as highas 24 million tons. 0 In relation to bioprospecting and markets for biodiversity there are still many unresolved issues, such as the rightsto ownership and use o f flora and fauna for such purposes. 0 Ecotourism also has potential for generating income from forests, but does not ensure environmental or economic sustainability. Problems include low profit margins and lack o f strong interest by landholders. 158 Figure A20-1. Problem Tree of Environmental Services in Mexico Difficulties to assess Lack of adequate the price of Imperfect market production functions Forest The externality environmental information for environmental fragmentation character of the sewices services environmental I services , - of the economic value of environmental costs elIIuILeI11e1I --icsd to --z t 2 services mechani--- 31IIJ I I... .-I" Undeveloped marketfor environmentalUcveloped' services 1 Reduce investment for the production of environmental services I Source: Mexico Strategic Forest Program 2025 Review of CABSA's FirstYear of Implementation 10. In 2005, the Institute o f Natural Resources of the College o f Postgraduates (COLPOS-Colegio de Postgraduados) conducted a review of the CABSA program through a multidisciplinary team. The principal results o f the evaluation were: 0 CABSA i s a useful mechanism for strengthening Mexico's position in the global market for environmental services. 0 CABSA provides a positive image o f Mexico's commitment to global environmental quality. 0 There i s a lack o f research specific to Mexican ecosystems. 0 The short time allowed for the call for proposal was the most serious limitation faced by the CABSA program in 2004. 0 Lack o f personnel also posed a severe limitation for CABSA Proposed Activities for Strengthening CABSA 11. To strengthen CONAFOR's ability to implement forest-based PES mechanisms, complementary activities and criteria will be added to CABSA's mandate and operating rules. Inparticular, new measures will address issues o f sustainability, adaptation to climate change, building stakeholder capacity, attracting international resources to pay for global environmental services, and disclosure and dissemination of lessons learned: (g Sustainability 0 Fiiiaiicial: Complement CABSA incentives-which are limited to five years-with longer-term revenues for carbon sequestration and the production and commercialization of other environmental services. 0 Economic: Monitor market behavior and applying corrective measures as needed. 159 0 Environmental: Encourage planting of native species, build forest corridors, protect biodiversity, reduce fragmentation, monitor interventions, produce good practice guidelines, and enforce environmental and forest regulations. (ig Adaptation to change climate 0 Incorporate climate change scenarios into forest management plans. 0 Select species resilient to climate change. 0 Monitor climate change information and assessment o f expected impacts in forest productivity and health. 0 Monitor insects and diseases affecting forest productivity. (iii) Building stakeholder capacity 0 Strengthen links with the office o f Clean Development Mechanism (CDM) in Mexico (COMEGEI-Comite' Mexican0 para Proyectos de Reduccidn de Emisiones y de Captura de Gases de Efecto Invernadero) to develop methodologies to assess and monitor carbon sequestration inprojects relatedto forestry. 0 Promote research and transfer o f technical know-how (baseline methods and procedures to estimate carbon sequestration rates, etc.). 0 Strengthen Mexican participation in international forums about the theme. 0 Create, through qualified professionals, the technical capabilities to provide assistance in the formulation, implementation, and monitoring of forest projects that increase carbon sequestration. 0 Develop procedures to monitor compliance o f commitments agreed as the basis for participation incarbon sequestration projects. 0 Provide adequate technical assistance to producers, in order to guarantee achievement o f set goals. (iv) Attracting internationalJinancia1 resources 0 Develop strategic alliances with other Latin American countries to search for special funds for forest-related projects and/or to promote the sale o f environmental bonds. Voluntary schemes for the promotion o f forestry activities should be encouraged. 0 Define a national strategy for bundled commercializationo f carbon sequestration initiatives. (v) Dissemination of results 0 Design a dissemination campaign emphasizing project achievements and forest contribution to global commons. 0 Dissemination o f results from Mexican participation in international forums, and the country as compliance with UNconventions. 0 Disseminate results o f successful projects, in terms o f environmental (preservation o f biodiversity, reduction o f erosion, as examples), social (social capital formation, training, solidarity) and economic (creation o fjobs, income, betterment o f life conditions o f the residents, etc.) achievements. 0 Design cross-fertilization strategies to facilitate technological know-how. Description of the proposed activities 160 12. The aim o f the proposed actions is to strengthen CONAFOR's ability to promote land use change projects that sequester or conserve carbon in forest and agroforestry systems while also promoting biodiversity conservation and poverty alleviation. The existing program will be strengthened, following existing rules, to provide incentives duringthe first period o f land use change, when consolidation o f new practices occurs (five years), while new mechanisms will be explored to complement CABSA and provide added sustainability to the proposed land use changes through the sale o f sequestered carbon in the international carbon market. To this end the project will support (i)strengthening PSAH-CABSA to facilitate their preparation of projects and proposals to attract funding from carbon markets; (ii) establishing financing mechanisms to improve incentives for land use changes that seek to attract carbon market participants; and, (iii)analyzing, designing, and implementing financial instruments to facilitate carbon sequestration transactions between land users, CONAFOR, carbon market intermediaries, and carbon buyers. K e y activities will include: 0 Establishing a unit within CONAFOR to coordinate efforts to promote, prepare, and transact carbon sequestration services based on land use incoordination with the Mexican C D M Office. 0 Establishing technical know-how and experience in the formulation, evaluation, and preparation of carbon sequestration projects eligible for registration as C D M activities or for financing by other interested buyers. 0 Assessing potential for selling land-use based carbon sequestration under the rules o f the Second Commitment Period (only reforestation allowed). 0 Improving special targetingo f existing activities. 0 Compiling and assessing available data on rates o f carbon sequestration under different land uses and leveraging ongoing monitoring efforts under the other components to improve understanding of carbon sequestration under different land uses and ecosystems. 0 Developing methodologies to assess carbon sequestration rates by reviewing and developing approaches for demonstrating additionality, for analyzing baseline methodologies for carbon sequestration based on land use changes and assessing their suitability for Mexico so as to build up a portfolio o f applicable methodologies; and assessing transaction costs and exploring instruments to facilitate the flow o f resources to land users. 0 Working with the BioCarbon Fund and/or other interested buyers to prepare at least 15 CDM projects for consideration by the international carbon trading community. 0 FacilitatingMexico's active participation in defining rules for carbon sequestration based on land use under the Third Commitment Period, and preparing Mexico to take advantage o f them. 161 Annex 21: Biodiversity Endowment Fund MEXICO: EnvironmentalServices 1. The Biodiversity Fund will be an independent, long-term financial inechaiiism specialized in providing payments to eligible private landholders to generate biodiversity conservation benefits. It will be capable o f leveraging resources from a broad spectrum o f donors and institutions. Payments to landowners funded by the Biodiversity Fundwill contribute to expand the conservation o f biodiversity. 2. The Biodiversity Fund will operate under a private legal regime, and will have clear, transparent and democratic mechanisms for participation and decisionmaking. The operation o f the Fund will ensure an active participation of private organizations specialized in biodiversity, conservation, and sustainable use management. 3. The Biodiversity Fund's Board of Directors will have both public and private sector representation, with a majority from the private sector. Most Board members will have specialized experience or background in environmental services management, sustainable use o f biodiversity, and finance. The Board will be chaired by a CONAFOR representative. The Biodiversity Fund will have an administrative and technical structure defined according to the needs of different donors. Its administrative processes will be efficient and transparent and its structure will be small and professional, 4. The Biodiversity Fund's proposed structure finds adequate support in Mexico's legal framework. The proposed mechanism will allow the fund to invest outside itsjurisdiction, leverage public and private donations, and undertake debt swap investments. A small and agile Board would contain majority representation from the private sector but would be able to execute public-sector policies, 5. The National Forestry Commission (CONAFOR) has been selected to manage the Fund. CONAFOR i s a public decentralized agency established in March 2001 to develop, advocate, and promote forest conservation and restoration activities. With nearly four years o f implemeiitation experience and a track record of inanaging five existing sinking accounts, CONAFOR i s expected to be able to manage the Biodiversity Fund efficiently and effectively. 6. To implement the Biodiversity Fund, CONAFOR will maintain the existing institutional design under which it administers the Mexican Forest Fund (FFM). The basic structure includes a corporate public Board and a Technical Committee that oversees the FFM. 7. The Biodiversity Fundwould contain an endowment account to respond to the interests o f various donors. The Biodiversity Fund will be designed with enough flexibility to accommodate new donors and will create specific subaccounts, if requested, to provide payments for environmental services in specific areas. At the donor's request, the Biodiversity Fund's subaccounts may contain independent steering committees and will maintain independent financial statements and monitoring mechanisms so that the various donors can keep track o f their contributions and evaluate their impact. 8. CONAFOR will enter into a contract with NAFIN as asset manager to be responsible for the investment management o f the fund's financial capital under the guidance o f Board o f Directors of the Fund. NAFIN is suitable to carry out the Fund's asset management role because o f its track record and experience in managing a number o f funds including the FFM. Furthermore, this arrangement will provide economies o f scale because NAFIN is already managing several funds for CONAFOR. To complement its experience, an internationally selected advisor will provide fund management advice to 162 NAFINfor at least the first year of the Fund's operation. The investment management guidelines will be defined inaccordance with Bank guidelines and supervisionrequirements. 9. According to the financial return and capitalization needs o f the Biodiversity Endowment Fund, the Board o f Directors is responsible for hiring a small secretariat with proper staff to carry out the operational, administrative, and financial assignments, including financial reporting and auditing tasks required for project management. The staffing needs o f the Board's secretariat will be defined by CONAFOR in consultation with the Board, and approved by the World Bank when the design of the Fundis finalized. Endowment Fund Capitalizationand Management 10. For the purpose o f initial capitalization of the Biodiversity Fund, GEF resources will be disbursed on a one-to-one basis ( U S 1 from the GEF for each US$1 from other donors), following verification of deposits by other donors. Once the donor's deposits are confirmed, the GEF will disburse its funds. The disbursement procedures and requirements will be included inthe operational manual. 11. Detailed financial projections, from the basis for estimated annual costs to be covered by the Biodiversity Fund's investment income, as well as the required capitalization and capital asset allocation are presented below. 7.1 Financial Proiections for Endowment Capital. 12. The following financial projection pertains both to the GEF endowment contribution and to the matching contributions from other donors. The current proposal assumes that the GEF capital aiid matching contributions will occur from 2006 to 2009 in the amount o f 10 million dollars, which will generate income to cover the endowment's investment and administrative costs and will be able to support the payments for environmental services of at least 17,000 hectares from the year 2010 on. 13. To meet these objectives, a specific asset allocation strategy, consistent with investment guidelines agreed with the Bank, will be defined by the Fund's Technical Committee/Board aiid reflected inthe Biodiversity Fund's operational directives. 14. Given current market conditions, a 6 percent annual return can be derived froin an assumed investment o f 75 percent o f the endowment in fixed income securities. This strategy avoids market fluctuations that can affect the availability o f the required annual cash flow. It i s expected that the remaining 25 percent o f the endowment will be invested in equities.21 15. The total operating costs o f the endowment will be financed by the interest generated from the capital invested. The endowment will be able to cover 100 percent o f its operating costs beginning with the first year o f operation. 16. Total annual requirements of the project will consider an income derived from $5 million GEF grant, and an estimated $5 million contribution by the Government o f Mexico. 21. The asset composition and portfolio will be decidedby Biodiversity Fund's Technical CommitteeiBoard, from advice received from a financial advisor and asset manager. 163 Source Year 1 Year 2 Year 3 Year 4 GEF contributions $1,000,000 $1,500,000 $1,500,000 $1,000,000 Matchingcontributions $1,000,000 $1,500,000 $1,500,000 $1,000,000 Total $2,000,000 $3,000,000 $3,000,000 $2,000,000 Balance $2,000,000 $5,000,000 $8,000,000 $10,000,000 Inv. inFixedIncome (75%) $1,500,000 $3,750,000 $6,000,000 $7,500,000 Inv. inEquities(25%) $500,000 $1,250,000 $2,000,000 $2,500,000 Year 1 Year 2 Year 3 Year 4 InvestmentCosts $10,000 Administrative Costs $90,000 $90,000 $90,000 $90,000 Total Project Costs $100,000 $90,000 $90,000 $90,000 Source Year 1 Year 2 Year 3 Year 4 GEF $60,000 $150,000 $240,000 $300,000 Government ofMexico $60,000 $150,000 $240,000 $300,000 TOTAL $120,000 $300,000 $480,000 $600,000 FundCosts $100,000 $90,000 $90,000 $90,000 Tot. available to support PES $20,000 $210,000 $390,000 $510,000 164 To Los Angeles 115°W 110°W 105°W 100°W 95°W 90°W 85°W To Albuquerque To To Gila Bend Alamogordo Tijuana Mexicali UNITED STATES OF AMERICA Ensanada Sonoita San Ciudad Juárez To Felipe Midland Nogales BAJA G Agua Prieta MEXICO CALIFORNIA Rio Brav o RioGrande To 30°N 30°N ulf San Antonio of SONORA Yaqui C H I H U A H U A To Ojinaga San Antonio C Hermosillo To Guaymas Santa M Rosalia Conch os Sierra ado Sal BAJA a l i f o r n i a Sierra Houston Chihuahua Laredo Navojoa adre A CALIFORNIA Fuert C O A HMU I LFrontera SUR O e Loreto NUEVO Los Mochis adre LEON Gulf of Mexico 25°N 25°N ccidenta Matamoros Torreón Torreón Monterrey Saltíllo Saltíllo Culiacán Culiacán PACIFIC S I Nl O La Paz D U R A N G O TAMAULIPAS Durango OCEAN A L O A ZACATECAS riental Ciudad Victória Victória Mazatlán Mazatlán Cabo San Lucas Zacatecas SAN LUIS AGUASCALIENTES POTOSI Tampico QUERÉTARO QUERÉTARO San Luis This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information NAYARITLeAguascalientes Potosí Potosí YUCATAN Cancun shown on this map do not imply, on the part of The World Bank Tepic rma VERACRUZ Merida Group, any judgment on the legal status of any territory, or any GUANAJUATO Guanajuato HIDALGO endorsement or acceptance of such boundaries. 110°W Cozumel PuertoVallerta Guadalajara Querétaro Querétaro DISTRITO FEDERAL JALISCO Pachuca TLAXCALA Campeche MEXICO 20°N QUINTANA MEXICO MEXICO Morelia Jalapa CITY Bay of Campeche ROO Tlaxcala Veracruz Colima Toluca Chetumal Citlaltépetl (5,747 m) Citlaltépetl COLIMA Cuernavaca MICHOACAN Puebla CAMPECHE SELECTED CITIES AND TOWNS PUEBLA TABASCO Ba lsa s Villahermosa Gulf of STATE CAPITALS GUERRERO Chilpancingo BELIZE Honduras NATIONAL CAPITAL Oaxaca CHIAPAS Usumacinta RIVERS Acapulco S i e r r aM a d r e OAXACA Tuxtla Gutierrez MAIN ROADS d e l S u r Tehuantepec MORELOS Puerto NOVEMBER RAILROADS 0 100 200 300 Kilometers Escondido Gulf of GUATEMALA 15°N Tehuantepec HONDURAS IBRD STATE BOUNDARIES 15°N Tapachula To 0 50 100 150 200 Miles San Salvador EL 33447 2004 INTERNATIONAL BOUNDARIES 105°W 100°W 95°W SALVADOR