Project Concept Note

Document of

The World Bank

Report No: 33228-MX

Project Document

ON A

PROPOSED LOAN

IN THE AMOUNT OF USD 45.00 MILLION

AND

PROPOSED GRANT FROM THE

GLOBAL ENVIRONMENT FACILITY TRUST FUND

IN THE AMOUNT OF usD 15.00 MILLION

TO THE

united mexican states

FOR AN

Environmental Services PROJECT

February 15, 2006

Environmentally and Socially Sustainable Development Sector Management Unit

Colombia and Mexico Country Management Unit

Latin America and the Caribbean Region

CURRENCY EQUIVALENTS

(Exchange Rate Effective as of January 15, 2005)

Currency Unit

=

Mexican peso (MXP)

US$1

=

10.55 pesos

FISCAL YEAR

January 1

–

December 31

ABBREVIATIONS AND ACRONYMS

APROMSA

Promising areas for promoting environmental services (pilot sites), Areas promisorias para la promoción de los servicios ambientales

CABSA

Program to Develop Environmental Services Markets for Carbon Capture and Biodiversity and to Establish and Improve Agroforestry Systems, Programa para Desarrollar el Mercado de Servicios Ambientales por Captura de Carbono y los Derivados de la Biodiversidad y para Fomentar el Establecimiento y Mejoramiento de Sistemas Agroforestales

CBD

Convention on Biological Diversity, Convenció de Biodiversidad

CDM

Clean Development Mechanism

CNA

National Water Commission, Comisión Nacional del Agua

COINBIO

Indigenous and Biodiversity Conservation Project , Proyecto de Conservación de la Biodiversidad en Comunidades Indígenas de los Estados de Guerrero, Michoacán y Oaxaca

COLPOS

Postgraduates College, Colegio de Postgraduados

CONABIO

National Commission for Biodiversity Knowledge and Use, Comisión Nacional para el Conocimiento y Uso de la Biodiversidad

CONACYT

National Committe for Science and Technology, Consejo Nacional de Ciencia y Tecnología

CONAF

National Forestry Council, Consejo Nacional Forestal

CONAFOR

National Forestry Commission, Comisión Nacional Forestal (Executor of the current Program)

CONANP

National Commission for Natural Protected Areas, Comisión Nacional de Áreas Naturales Protegidas

CPS

Country Partnership Strategy, Estrategia de Colaboración

EA

Environmental assessment, Análisis ambiental

EnvSAL I & II

Environmental Structural Adjustment Loan, Préstamo de Ajuste Estructural Ambiental

ES

Environmental services

FAO

Food and Agricultural Organization

FFM

Mexican Forestry Fund, Fondo Forestal Mexicano

GEF

Global Environment Facility

IBRD

International Bank for Reconstruction and Development

IMTA

Mexican Water Technology Institute, Instituto Mexicano de Tecnología de Agua

INE

National Ecology Institute, Instituto Nacional de Ecología

IPDP

Indigenous Peoples Development Plan, Plan de Pueblos Indígenas

GOM

Government of Mexico, Gobierno de México

LFD

Federal Rights Law, Ley Federal de Derechos (sets fees for national resources and services)

MBC

Mesoamerican Biological Corridor, Corredor Biológico Mesoamericano

MXP

Mexican pesos

NAFIN

GOM’s Development Bank, Nacional Financiera, S.N.C. (Financial Agent for the Project)

NGO

Nongovernmental organization, Organismo No Gubernamental

NPA

Natural protected area, Area natural protegida

OECD

Organisation for Economic Co-operation and Development

Organización para la Cooperación y Desarrollo Económico

PES

Payment for environmental services, Pago por servicios ambientales

PHRD

Policy and Human Resources Development Grant

POA

Annual Operational Plan, Plan Operativo Anual

PROCYMAF

I & II

Community Forestry Management and Conservation Program in Mexico, partially funded with WB resources. Loan 4137-ME, Programa de Desarrollo Forestal Comunitario I y II (Proyecto de Conservación y Manejo Sustentable de Recursos Forestales en México financiado parcialmente con recursos del Banco Mundial. Préstamo 4137-ME)

PRODEFOR

Forest Development Program, Programa para el Desarrollo Forestal

PRODEPLAN

Forest Plantation Program, Programa de Plantaciones Forestales

PROCOREF

Program for Forest Conservation and Restoration, Programa de Conservación y Restauración Forestal

PROFAS

Reinforcement Program for Forest Self-Management, Programa de Fortalecimiento a la Autogestión de los Silvicultores

PSA

Costa Rica’s Pago por Servicios Ambientales program

PSAH

Payments for Hydrological Environmental Services Program, Programa de Pago por Servicios Ambientales Hidrológicos

PSTyP

Register of Technical and Professional Services, Padrón de Servicios Técnicos y Profesionales

SAGARPA

Ministry of Agriculture, Livestock, Rural Development, Fisheries, and Food, Secretaría de Agricultura, Ganadería, Desarrollo Rual, Pesca y Alimentación

SEMARNAT

Ministry of Environment and Natural Resources, Secretaría de Medio Ambiente y Recursos Naturales

SHCP

Ministry of Finance and Public Credit, Secretaría de Hacienda y Crédito Público

SINAP

National System of Natural Protected Areas, Sistema Nacional de Areas Naturales Protegidas

PST

Technical service provider, Proveedor de servicios técnicos

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

Contents

Page

1A.STRATEGIC CONTEXT AND RATIONALE

11.Country and sector issues

52.Rationale for Bank involvement

53.Higher level objectives to which the project contributes

7B.PROJECT DESCRIPTION

71.Lending instrument.

72.Project development objective and key indicators

83.Project components

124.Lessons learned and reflected in the project design

135.Alternatives considered and reasons for rejection

14C.IMPLEMENTATION

141.Partnership arrangements (if applicable)

142.Institutional and implementation arrangements

183.Monitoring and evaluation of outcomes/results

194.Sustainability and Replicability

215.Critical risks and possible controversial aspects

226.Loan/credit conditions and covenants

22D.APPRAISAL SUMMARY

221.Economic and financial analyses

242.Technical

243.Fiduciary

254.Social

265.Environment

276.Safeguard policies

277.Policy Exceptions and Readiness

28Annex 1: Country and Sector or Program Background

41Annex 2: Major Related Projects Financed by the Bank and/or other Agencies

45Annex 3: Results Framework and Monitoring

60Annex 4: Detailed Project Description

77Annex 6: Implementation Arrangements

89Annex 7: Financial Management and Disbursement Arrangements

98Annex 8: Procurement Arrangements

102Annex 9: Economic and Financial Analysis

111Annex 10: Safeguard Policy Issues

118Annex 11: Project Preparation and Supervision

119Annex 12: Documents in the Project File

121Annex 13: Statement of Loans and Credits

124Annex 14: Country at a Glance

126Annex 15: Incremental Cost Analysis

133Annex 16: STAP Roster Review

137Annex 17: Pilot Site Selection Criteria

142Annex 18: Detailed Lessons Learned

147Annex 19: Payment for Environmental Services-Water Program (PSAH)

156Annex 20: Payment for Environmental Services-Carbon and Biodiversity Program (CABSA)

162Annex 21: Biodiversity Endowment Fund

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 quality/supply and deforestation are two important environmental challenges facing Mexico, which is experiencing rapid environmental degradation, including some of the region’s most extensive deforestation. This degradation is aggravating already severe water quality, reliability, and contamination problems, threatening current and future economic activity and the welfare of Mexico’s people, and leading to loss of globally important biodiversity.

3. Water. Water consumption patterns in Mexico are unsustainable. According to the National Water Commission (CNA), although less than 16 percent of Mexico’s 653 aquifers are considered overexploited, 66 percent of all groundwater used comes from only 188 of 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 of mean natural water availability used. While water scarcity is not directly related to deforestation, forest conservation may help ameliorate water scarcity pressures by improving the quality of available water. There is also evidence that forests and other vegetation cover may help regulate seasonal flows (and seasonal availability) of water in certain cases and increase rates of 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 of 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 in the Americas, and its annual rate of deforestation (1.1 percent) was nearly four times greater than in Brazil. Various assessments indicate that both the amount and rate of deforestation in Mexico is highest in tropical forests, including areas of high biodiversity value. According to one analysis, between 1993 and 2000 about 3.1 million hectares of forest in Mexico were converted to agricultural uses and 5.1 million hectares were converted to pasture, with only 1.7 million hectares being reforested or regenerated.

5. Rapid deforestation has adversely affected water quality and resulted in sedimentation of reservoirs. 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 is also evidence that dry tropical forests provide the environmental service of reducing the risk of floods during storms in western Jalisco and that the Sierra Gorda’s forests are fundamental for water recharge in the aquifers that supply the cities of Queretaro and San Juan del Rio.

6. Critical Ecosystems and Globally Significant Biodiversity. Mexico is one of 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 of the United States and Canada combined. Mexico is regarded as one of the world’s most important centers of genetic diversification in plants and one of the areas where agriculture originated. Some 120 cultivated plant species (belonging to 39 families) originated in Mexico, including cocoa, kidney beans, maize and tomatoes.

7. Land use change is eroding Mexico’s extraordinary biological wealth. One-third of 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), of 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 of localities in forested areas have a “high” or “very high” marginality index. This has two important implications. First, poverty is one of the driving forces in deforestation. Second, poor households are highly dependent on forest resources, so degradation of 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 in the 20 percent of ejidos or communities that have more than 100 hectares of forest, but are the majority in only 2 percent of the ejidos without forests.

9. Government Strategy. The Government of Mexico (GOM) has taken a number of legislative, institutional, and budgetary actions to address daunting environmental challenges. For example, in 1986 the government created the National System of Protected Natural Areas (SINAP) to safeguard some of 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 is also committed to a “zero deforestation” target and in April 2001 it created the National Forest Commission (CONAFOR) to support sustainable production and conservation of 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 is part of an overarching approach to national development that also includes formal sector strategies for water, rural development, and biodiversity. To help support and implement these strategies, the government recently passed or extensively modified laws on water resources, forests, and sustainable rural development. These sectoral initiatives are complemented by the Sustainable Development Program, which seeks to build synergies and complementarities among different government policies and instruments. The introduction of a fiscal instrument (the water fee) and the PSAH and CABSA environmental services programs are further examples of the government’s serious commitment to conservation and sustainable use of 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 of switching to agriculture or cattle ranching. PSAH consists of direct payments to landowners with forests in a good state of conservation. Payments are made for watershed conservation, management, and restoration aimed at preserving temperate and tropical forest lands (and in particular, high montane cloud forests) associated with the supply of water to communities. Part of its innovative approach is that it is funded through a portion of the water fees collected under the Federal Rights Law (LFD).

11. The PSAH gained rapid acceptance from the outset, despite the very short time between its creation and the implementation of its first year of environmental service contracts. In 2003, 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 of almost 600,000 hectares for inclusion in the program. From these applications, 271 were selected, covering 127,000 hectares. In 2004 the PSAH received 960 applications of which 352 were chosen, covering about 184,000 hectares. In 2005 there were 688 applications, 256 applications accepted, and 169,031 additional hectares included in the program. In total, 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 of 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 is a lack of 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 of 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 is 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 is 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 is to recognize the value of those services and create markets through which the users of 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 of land degradation, reduction of erosion and sedimentation, prevention or attenuation of 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) in the case of 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 of donors. By providing payments on an ongoing basis, such PES programs avoid the pattern of 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 of rural poverty. The project builds on previous experience with the use of PES approaches or schemes, including a successful nationwide program in Costa Rica that is supported by the Bank and GEF, and a wide range of small-scale initiatives throughout the region, including El Salvador and several in Mexico itself.

16. Market-driven approaches are harder to implement in the case of biodiversity conservation services because, with some exceptions, it is hard if not 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 of 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 established to 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. Funding from this Fund will be targeted at areas of globally significant biodiversity in the buffer zones of protected areas and the corridors that connect them, thus helping to ensure the sustainability of the national protected area system and the Mexican portion of 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 of 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 of 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 of land in the watersheds that provide water regulation, quality, and supply services to municipal water users (as envisioned in Component 1A of 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 of water services, or earmarking of a share of money spent on urban construction projects.

19. Country GEF Eligibility and Drivenness. Mexico ratified the Convention on Biological Diversity (CBD) on March 11, 1993. It is also a signatory to the Convention on International Trade in Endangered Species of Wild Flora and Fauna (CITES) and the Cartagena Protocol on Biosafety. The project’s objectives are fully consistent with guidance from the Conference of the Parties (COP) of the CBD regarding conservation and sustainable use of biological diversity. The project is consistent with the guidelines and decisions of a number of CBD Conference of the Parties in particular. For example, the project contributes to Practical Principle 12 (on the equitable distribution of the benefits for indigenous and local communities) of the Addis Ababa Principles and Guidelines adopted by COP VII Decision 12, by promoting economic incentives to generate additional benefits to indigenous and local communities and stakeholders involved in the management of biodiversity. Furthermore, the project contributes to COP VII Decision 14 (Biological Diversity and Tourism) and Decision 16 (Article 8j and related provisions) by creating appropriate mechanisms to capture the economic benefits of ecological services, and is 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-term sustainability of 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 on the areas at greatest risk of 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 of globally important biodiversity by focusing it on critical ecosystems.

2. Rationale for Bank involvement

21. Mexico has requested World Bank assistance to strengthen the PSAH and CABSA Programs because of the Bank’s knowledge and experience in the design, implementation, and support of 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 institution has 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 of 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 addition to local and national benefits.

3. Higher level objectives to which the project contributes

23. The environmental objectives of 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 programs; decrease loss of temperate and tropical forests; conserve biodiversity; and increase sustainable water resource management (2001–2006 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 of the EnvSAL—a development policy loan (DPL) for the environment sector—in its review of existing programs and incentive structures to address the implicit short-term tradeoffs between social protection and environmental protection.

25. The CPS recognizes that Mexico’s natural environment is under tremendous pressure and that failure to reverse some of the most damaging trends may not only 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 of ecosystems, and biodiversity conservation. The CPS notes that vulnerability to natural disasters is 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 of habitat, biodiversity, and natural forests, and exacerbated problems in water management and conservation. In response, the CPS supports development of markets for environmental services and strengthening of protected areas management.

26. 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 of sustainable natural resources management and calls for better integration of environmental issues into rural development to build consensus around possible “win-win” opportunities. The environment strategy promotes sustainable, integrated management of 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.

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 economic development, and (iii) protecting global forest values. The strategy notes that addressing these three aspects together is 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 of 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 of marginal agricultural areas to forest, and promotion of sustainable practices in agriculture. It supports Operational Programs 3 (Forest Ecosystems) and 4 (Mountain Ecosystems) by promoting conservation of 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 Mainstreaming Biodiversity in Production Landscapes and Sectors (SP2).

29. Under SP1, the project would help ensure sustainability of the national protected areas system by providing a mechanism for long-term financing of biodiversity conservation in the buffer zones of protected areas and the corridors that connect them, including the Mexican portion of the Mesoamerican Biological Corridor.

30. The project would complement the SINAP II Protected Areas Project, a GEF cofinanced project to strengthen protected areas management. The goal of SINAP II is to promote conservation and sustainable use of biodiversity in Mexico through consolidation of the National System of 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 of 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 II 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 of 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.

31. Under SP2, the project will focus on two types of activities: (i) facilitating the mainstreaming of biodiversity within productive landscapes, and (ii) developing market incentive measures, as described below.

32. Facilitating the mainstreaming of biodiversity within productive landscapes. Through this type of activity the GEF seeks to support development of the institutional capacities of 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 of this type under Component 2 of the project include strengthening the capacity of national institutions such as CONAFOR, community associations, NGOs, and academic institutions to support development of PES markets in Mexico. Component 1 activities will help create an enabling environment for development of a PES market in Mexico and generate financial resources for the PES program.

33. Developing market incentive measures. Through this type of activity the GEF seeks to support innovative market incentive structures (such as demand and supply side interventions, certification of suppliers, purchasing agreements, and codes of conduct) that would catalyze market forces. In doing so the GEF seeks to develop partnerships with private sector stakeholders, small- and medium-size enterprises, and others to catalyze the development of innovative processes and activities that improve market efficiency and the ability to provide biodiversity and productive system gains. Activities of this type under Component 1 of the project will support the development of 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 environmental 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 protecting critical ecosystems.

B. PROJECT DESCRIPTION

1. Lending instrument.

34. Fixed-Spread Loan (FSL). The proposed project would be financed through an IBRD loan of US$45.00 million, a GEF grant of US$15.00 million, government counterpart funds of US$80.66 million, project beneficiary contributions of US$15.00 million, and other funding of US$0.90 million for a total project of US$156.55 million.

2. Project development objective and key indicators

35. The project development objective is to enhance the provision of environmental services of 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 of CONAFOR, community associations, and NGOs to increase flexibility and improve efficiency of existing service provision to support long-term development of 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 of the project is to enhance and protect biological diversity and preserve globally significant forest and mountain ecosystems.

38. This objective will be achieved through the following key outcomes and outputs: (i) improving the targeting of 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 in the project area. In addition, these sites (see Annex 17) are recognized as part of 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 of 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 survival of 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:

· At least 600,000 additional hectares under environmental service contracts of which, (a) financed 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;

· 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);

· At least 15 proposals for carbon sequestration projects submitted to potential buyers;

· Institutional arrangements for facilitating management and learning of PES mechanisms established, properly staffed, and resourced to continue beyond the EOP to replicate and scale up market-based PES programs;

· CONAFOR and INE use (a) state-of-the-art techniques and procedures to monitor data on implementation and impacts of both the 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 of the PES mechanism, and (iv) sustainability of the mechanism, as measured by the ratio of payments from local buyers of environmental services (ES) and CONAFOR’s operational costs;

· The new areas enrolled include 200,000 additional hectares of forests and other natural ecosystems of global biodiversity significance placed under effective conservation (protection and sustainable management) by landowners before EOP in the buffer zones of protected areas and the corridors that connect them, including the Mexican portion of the MBC.

3. Project components

41. The proposed project would substantially enhance the provision of 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 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. 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. Component 4 manages the actual flow of payments to environmental serrvice providers and for the ongoing operational costs of the program. Finally, Component 5 focuses on project and program management mechanisms, including monitoring and evaluation. (See Annex 4 for detailed component description.)

Table 3: Project Component Costs and Financing (million US$)

Component / Subcomponent

Total

GEF

IBRD

Govt.

Private

$

%

$

%

$

%

$

%

$

%

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 users

11.78

8

6.60

56

0.12

1

5.05

43

 

-Local PES Program for Biodiversity

1.53

1

1.38

90

0.11

7

0.05

3

 

-Development and capitalization of biodiversity endowment fund

10.25

7

5.23

51

0.02

0

5.01

49

 

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

19

 

b.Support development of stand-alone local PES programs

0.94

1

0.37

39

0.39

41

0.17

18

 

c.Establishing Matching Funds Mechanism for Local Financing Mechanisms

0.05

0

0.05

100

0.00

0

0.00

0

 

III. 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

19

 

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

1.66

41

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

 

34.04

34

65.96

66

 

b.Payments to CABSA participants

9.52

5

 

3.20

34

6.32

66

 

c.Local fin. mech. from water users (est. under comp. 1A)

10.65

7

 

 

 

10.65

100

d.Local fin. mech. from tourism ind. (est. under comp. 1A)

0.90

1

 

 

 

0.90

100

e.Payments from carbon buyers (proj. dev. under comp. 1C)

3.45

2

 

 

 

3.45

100

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

0.11

100

Total:

156.55

100

15.00

10

45.00

29

80.66

51

15.90

10

Component 1: Developing Sustainable Financing Mechanisms ($14.47 million, of which $7.68 million from GEF)

42. The main objective of 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 of 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 of 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 of protected areas and the corridors that connect them in cases where other sources of 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: for water services CNA, IMTA, and INE; for biodiversity services CONABIO, SECTUR, CONANP, and INE; and for carbon sequestration SEMARNAT, INE, and SAGARPA. CONAFOR will enter into cooperation agreements will all such agencies as required for implementation of the activities but not later than six months from the date of the loan agreement. Drafts of such cooperation agreements will be available by negotiations.

44. The capitalization of the endowment fund will occur only upon completion of all the preparatory work for the establishment of such fund. Disbursement of the GEF allocation will be subject to Bank’s approval of the establishment of such funding mechanism, i.e. a separate fund or a sub account of the existing forestry fund managed by CONAFOR, the appointment of the financial agent to manage the fund, and the operating rules of the fund. The GEF contribution to the Fund would 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 of an endowment trust fund for biodiversity conservation to ensure the availability of long-term funding for cases where water-based payments would be insufficient to ensure conservation of biodiversity; (d) pilot financing mechanisms for carbon buyers in at least two sites; and (e) develop replication strategies to expand the use of 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 million from GEF)

47. 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, 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 revised as per this component, CONAFOR will furnish the 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 of the PES programs of PSAH and CABSA, including the introduction of revised rules and location-specific operational manuals using a more targeted and differentiated system of payments in which the eligible areas and payment levels offered are defined by region rather than nationwide (and perhaps also by subregion if appropriate) on the basis of objective technical criteria, (iii) improved compliance and impact monitoring to increase the credibility and sustainability of PES programs, (iv) better promotion to foster broader support and participation in the programs, (v) development of 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 of 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 of matching funds.

Component 3: Supporting Environmental Service Providers ($9.56 million, of which $3.70 million from GEF)

51. This component would focus on removing obstacles that may prevent communities 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, INE and NGOs will carry out the strengthening of the eligible ejidos and/or indigenous communities (prospective providers of 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 of 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 in the operating rules of CONAFOR’s programs and in the project Operational Manual. The subcomponent of support for community promoters (chosen by the community to act as liaisons in the preparation and implementation of 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 and resolution of technical issues that constrain potential environmental service producers from participating in PES programs, (ii) greater capacity of service providers to fulfill contract commitments, (iii) more equitable distribution of the costs and benefits of participation in the program, and (iv) greater transparency in decisionmaking and greater participation of vulnerable and marginalized groups.

54. Key inputs include (i) consultancies to identify key technical issues and constraints to participation and to identify the organizations most capable of providing appropriate technical assistance, (ii) resources to contract the appropriate technical assistance, and (iii) funding 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 $1.58 million from GEF)

55. The objective of this 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 of project financing is allocated to this component, most of the activities to actually arrange, structure, and monitor this flow of 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 of the proceeds of the loan and grant subject to the Bank’s approval of the operating rules for such payment mechanisms, prepared under Component 1. The matching grants will be financed out of 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.

57. The key output of this component is delivery of 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 of PES financing mechanisms and funding sources already in existence or developed under Component 1, including:

· Share of water tariffs from the Ley Federal de Derechos (LFD) that are directed to PES.

· New financial resources from water users generated by mechanisms developed under Component 1A.

· Tourism industry fees and contributions developed under Component 1B.

· GEF and Biodiversity Conservation Endowment Fund resources.

· Carbon sales from programs supported under Component 1C.

· 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 million, of which $0.74 million from 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 of a group of staff within CONAFOR to manage the project, (ii) overall financial management and control of 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 of the staff of 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 of the project. A draft of 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 of the Bank.

4. Lessons learned and reflected in the project design

63. Design of 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 in Annex 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 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 of the Protected Areas System Project (SINAP II) in Mexico.

· Need for sustainable, long-term financing mechanisms. To ensure the sustainable provision of environmental services there must also be a sustained flow of program 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 of 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 ecotourism 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 fund that will allow time-limited biodiversity conservation funding to be converted into a sustainable long-term funding stream. Preparation of the SINAP II project 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 of the fund, matching such funds to the type of need (short- versus long-term), and having a clearly defined mission and goals that are relevant to donor interests.

· Need for robust monitoring and evaluation. The credibility of environmental service programs relies not only on fiduciary monitoring but also on quantification of the impacts of 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 of project design and implementation. It must include the establishment of a baseline, and the socioeconomic and environmental impacts of the proposed project.

· Need for differentiated payments. Both the value of environmental services and the cost of providing them vary tremendously from case to case. Current targeting efforts have not succeeded in concentrating conservation payments in priority areas. There is considerable scope for improvement in targeting. Linking “buyers” and “sellers” of 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 of 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 of the benefits to be achieved through conservation and the costs of 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 of poverty reduction objectives risks undermining their primary objective of generating valuable environmental services. However, they can often contribute to poverty reduction, because many potential service providers are poor and marginalized groups. Lack of training and capacity-building activities in PSAH Programs for both the supply and demand sides have created a barrier for less-organized and marginalized ejidos to participate in the program.

5. Alternatives considered and reasons for 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 in question are more interested in selling their land for a reasonable price than in managing it for long-term conservation and (ii) the entity managing the land after acquisition would protect and manage the land better than the original landowners. However, most of the lands eligible for PES under this project (80 percent of Mexico’s forest land) are owned collectively by communities and ejidos. With a modicum of 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 of community and ejido land is 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 of improved land used practices and recognition of good forest practices or management among buyers of forest products, this alone would not be enough to increase public awareness of environmental services or effectively target priority areas. Most of the time the direct beneficiaries of environmental services are not themselves the direct buyers of goods from certified forests, which limits the potential of eco-labeling to help develop local markets for environmental services. An advantage of this approach is the possibility of obtaining funds from people interested in good forest management.

C. IMPLEMENTATION

1. Partnership arrangements (if applicable)

66. There are a number of related donor activities that are currently under execution or preparation. A detailed list of these initiatives as they relate to this project are included in Annex 2.

2. Institutional and implementation arrangements

67. In addition 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 important to effective implementation and achievement of project objectives. These actors and their roles are described in detail 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 Ministry of Finance and Public Credit (SHCP) is the official recipient of the loan and grant. SHCP is the only entity of 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 Forestry Commission (CONAFOR) will execute the project and have responsibility for all technical and fiduciary matters, monitoring, and evaluation of the project as well as overall management and supervision of the grant and loan. Direct implementation will be undertaken by staff in CONAFOR’s Department of Production and Productivity, Office of 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. In addition to the project staff at CONAFOR’s headquarters in Guadalajara, key functions will be carried out by program coordinators and regional promoters in CONAFOR’s regional/state 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 of many different projects receiving both national and external financing, will provide overall financial management of the project and the Special Accounts, if utilized, for the loan and grant. NAFIN would 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 and Responsibilities of Project Staff

71. The highest decisionmaking body for the project will be CONAFOR’s Governing Board, which will approve the Annual Implementation Plans 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, and Tourism.

72. Implementation of the project will also benefit from the guidance of an Advisory Committee that was formed informally at the outset of 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 of the PES programs. Before project implementation begins, representatives of local PES schemes will be invited to join the Committee. 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 of specialists with members from participating institutions, science and research groups, and 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 of environmental services.

73. The CONAFOR staff responsible for 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 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 of 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 of CONAFOR. More detailed descriptions of these functions, responsibilities, and associated procedures are contained in Annex 6, the Project Implementation Plan (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 of 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 contracted by CONAFOR. CONAFOR will maintain satisfactory financial management and procurement procedures during project implementation.

Project Documentation, Planning, and Reporting

75. All components will be carried out following the procedures of an Operational Manual of the project. A draft of 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 of the manual will set out rules governing operation of 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 of 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 of 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 of the technical assistance; (d) description of the organizational structure of the staff within CONAFOR that will be responsible for implementing the project; and (e) applicable safeguard documents, including the indigenous peoples plan and the environmental management plan that includes sections for natural habitat protection and forests.

77. A Project Implementation Plan will be prepared by CONAFOR and submitted to the Bank for no objection prior to project launch. Annual Implementation Plans (AIPs) will be submitted for no objection prior to the start of each year and will include (i) description of project activities; (ii) Gantt Chart showing the timing of 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 if necessary.

Financial Management and Procurement

78. Disbursements will be transaction-based against statements of 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 of 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 of 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 of representatives from CONAFOR, SEMARNAT, and other federal agencies make the final selection of 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 Fund will also be channeled through the FFM (see Annex 21 for more details). The administrative structure and flow of 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 in the regional/state CONAFOR offices will give technical support to local environmental services providers and help them 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 of 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 of 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, not later than six months from the date of the loan agreement. The main federal agencies involved would include:

Federal Government Institutions:

· Ministry of Environment and Natural Resources (SEMARNAT)—foster cooperate and coordination between other agencies and actors.

· Ministry of Agriculture, Livestock, Rural Development, Fisheries, and Food (SAGARPA)—provide information on use of ES, coordinate programs, raise awareness, mainstream environmental concerns, and negotiate local mechanisms with private actors.

· Ministry of Tourism (SECTUR)—information on demand for environmental services in tourism sector, mainstream environment in sectoral strategies, negotiate PES mechanisms and payments from commercial actors, promote awareness of 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 (INE)—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 (CONABIO)—scientific and technical support and studies, specifically related to biodiversity and agroforestry.

· National Commission for Natural Protected Areas (CONANP)—provide technical assistance to producers in protected areas, monitor compliance with contracts.

82. Municipal governments currently have limited participation in PES 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 in part to provide payments for environmental services. The project will seek to increase the role of 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 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 information through consultancies and contracts, and by representing stakeholder interests and liaison in the case of producers organizations. CONAFOR maintains a register (padrón) of 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 of 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 building to 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 of the objectives of the project is 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.

Table 4: Monitoring and Evaluation Costs (million US$)

Component

Cost

1A. Development of financing mechanisms from water users

0.31

1B. Development of financing mechanisms from biodiversity users

0.23

1C. Development of financing mechanisms from carbon users

0.20

2A. Strengthening of existing PES programs

0.63

2B. Support development of stand-alone local PES programs

0.06

3B. Organizational Assistance

0.71

3D. Technical Assistance

0.15

5D. Project and Program Monitoring and Evaluation

1.20

Total

3.49

86. 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 of coordination and technical supervision of 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. During project implementation special semiannual reports will be prepared on the lessons learned during the 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 is critical to understand for each project site the causal links between specific land uses or land use changes and environmental services, and the amount of change needed to produce specific quantities of those services. A critical weakness of many PES programs is that these links are poorly documented. In addition, site-specific indicators will be defined in each area as part of 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 of 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) annual 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 midterm and final project studies; (v) data collection to better understand causal links between types of 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 of the project.

4. Sustainability and Replicability

89. Ensuring long-term sustainability of the PES program is a major objective of the project. Current funding is only guaranteed for five years at a time, and the future of the existing program is entirely dependent on continued government support. The project will pilot the development of 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 of service users and service providers. For this to occur, it is 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 is 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 of financing mechanisms based on demand from the local nature-based tourism industry. It also supports the creation and capitalization of an endowment trust fund that will provide sustainable long-term financing to PES targeted at biodiversity conservation in the buffer zones of protected areas and the corridors that connect them, thus helping to ensure the sustainability of the national protected areas system and of the Mexican portion of 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 inputs to prepare a replication strategy being developed for the development of additional such mechanisms throughout the country. The 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 of an array of standardized instruments that could easily be used in new settings with appropriate adaptations to local conditions.

92. The Mexican PSAH is only the second effort in any emerging economy to develop a nationwide PES program (the other being Costa Rica’s PSA program). The lessons learned here, in a context much more complex than Costa Rica, will also provide valuable lessons for the many other countries contemplating this approach. At the same time, the parallel effort to stimulate the development of stand-alone local PES mechanisms will also provide valuable lessons to countries opting for a more decentralized approach. Although a wide variety of such stand-alone local PES mechanisms has emerged spontaneously throughout the region, this is one of the first efforts to attempt to systematically encourage and support their development (the other being the recently approved El Salvador Environmental Services Project). The proposed project includes a strong replication element. A replication strategy will be developed along with evaluation of the project and analysis of lessons 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