E N V I R O N M E N T (A >3 ~~D E P A R T M E N T P A P E R S PAPER NO. OlI TOWARD ENVIRONMENTALLY AND SOCIALLY SUSTAINABLE DEVELOPMENT V 7AE BIODIVERSITY SERIES Issues and Op tions in the Design of GEF Supported,' Trust Funds for Biodiversity. Conservation Kathleen Mikitin April 199: 4 Environmentally Sustainable Development The World Bank ESD Global Environment Division Issues and Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation April 1995 Papers in this series are not formal publications of the World Bank. They are circulated to encourage thought and discussion. The use and citation of this paper should take this into account. The views expressed are those of the authors and should not be attributed to the World Bank. Copies are available from the World Bank's Environment Department, Global Environment Division, Room S-21 1 7X. This paper was prepared by Kathleen Mikitin, Operations Specialist in the World Bank Global Environment Division (ENVG(') and Diane Osgood, Consultant. Chapter 3, The Legal Framework, was prepared by the Environmental Affairs Unit of the Bank's Legal Department under the supervision of Charles Di Leva, Senior Legal Counsel. Guidance was provided by an Advisory Group which included Claudia Alderman, Charles Di Leva, Agi Kiss, Francis J. Lethem, Alexandre Marc, Rudy van Puymbroeck, Michael Rubino, Susan Shen and Frederik van Bolhuis (Bank staff and Consultants), Steven Rubin, Former Director, Conservation Economics Department, Conservation Intemational, and Barry Spergel, Legal Advisor for Conservation Finance, World Wildlife Fund, USA. F196 Contents Executive Summary 1 1 Overview 5 Summary of Main Points 5 Key questions addressed by this chapter: 5 Introduction 6 What is a Trust Fund? 6 Purpose of This Report 7 Other Financing Mechanisms 7 2 Objectives of Trust Funds 9 Summary of Main Points 9 Key questions addressed by this chapter: 9 The Primary Goal of GEF-Supported Trust Funds 10 Secondary Benefits of Conservation Trust Funds 10 Alternatives 11 Prerequisites for Discussion with Government 12 3 The Legal Framework 13 Summary of Main Points 13 Key questions addressed in this chapter 13 Brief History 14 Introduction to the Legal Aspects of Trust Devices 14 Types of Trusts 14 Formal Requisites of Trusts 15 Beneficiaries 16 Trust Purposes 16 Distinct Rules for Public or Charitable Trusts 16 The Trustee's Powers and Duties 17 Trust Instruments 18 Modification and Termination 19 Trusts and their Counterparts Outside Common Law Countries 19 Transnational Aspects 20 Contents 4 Designing the Trust 23 Summary of Main Points 23 Key questions addressed in this chapter 23 Minimum Viable Size for a Trust Fund 24 Strategies in the Event of Funding Shortfalls 26 Components - Putting the Parts Together 27 5 Important Design Considerations 35 Summary of Main Points 35 Key questions addressed by this chapter 35 Introduction 36 Important Design Considerations 36 Security of Assets 38 Ensuring Trust Objectives Will be Met 39 6 Diversity of Instruments 43 Summary of Main Points 43 Key questions addressed by this chapter 43 Introduction 44 Domestic Trusts 44 Charitable Trusts Established By a Multilateral Aid Agency 46 Charitable Trusts or Foundations Established Offshore 46 A Few Options for Trusts in OECD Countries 47 U.S. Grantor's Trust (or Substantial Owner's Trust) 48 A Few Options in Tax Havens Locations 48 Turning to the Private Sector to Establish the Trust Vehicle 49 7 Asset Management 53 Summary of the Main Points 53 Key questions addressed in this chapter 53 What is Investing? 54 What is Total Real Return? 54 Devising Risk Strategies 54 Selection Criteria for Asset Managers 55 Selection of Asset Management Services and Fee Structures 57 Other Investment Issues 59 8 The World Bank's Role in GEF Trust Fund Design and Supervision 61 Summary of Main Points 61 9 GEF Umbrella Fund (GUF) 65 Summary of Main Points 65 Key questions addressed by this chapter 65 The GEF Umbrella Fund (GUF) 66 Advantages and Considerations 66 Contents Annexes Annex 1 Profiles of GEF-Supported Trust Funds 67 Annex 2 Profiles of Other Biodiversity Conservation Funds Structured as Trusts or Foundations 79 Annex 3 References for Additional Material 93 Annex 4 Asset Management Strategies and Management Fees 95 Annex 5 Alternatives for Funds Under US$ 5 Million 99 Annex 6 Other Financial Mechanisms: Debt-for-Nature Swaps and Social Funds 101 Glossary 103 Bibliography 107 Boxes Box 4.1 Strategies for Trusts Whose Funding Levels Do Not Meet Original Expectations 26 Box 4.2 Examples of Directors Structures 29 Box 5.1 Examples of Trust Funds and their Taxation Situation 37 Box 5.2 Trust Fund Characteristics and Risk 38 Box 5.3 GEF Trust Funds and Strategies to Ensure Security of Assets 39 Box 5.4 Design Features to Ensure Trust Objectives Will Not Be Frustrated 41 Box 6.1 Example of a Domestic Trust with Offshore Asset Management Account 49 Box 6.2 Offshore Trusts 51 Box 7.1 Chart of Diversification, Risk and Return 56 Box 7.2 Examples of Asset Management Arrangements and Investment Strategies 56 Box 8.1 Examples of the Role of the GEF-World Bank in Designing and Supervising Trust Funds 63 Executive Summary THE PURPOSE OF THIS PAPER IS TO EXPLORE THE CONCEPr OF adopted or adapted the Anglo-American trust CONSERVATION TRUST FUNDS, PARTICULARLY THOSE WHICH concept for their own use, albeit with more limited MIGHT BE SUPPORTED BY THE GLOBAL ENVIRONMENT scope. Others - even though they may share certain FACILITY. This paper is neither a handbook nor a legal devices that are indeed comparable to the trust manual for generic trust fund design: each trust -have developed different instruments to serve the device will be tailored to the conservation, legal and same purposes, especially as regards the public financial settings in which it is created. Rather, this ("charitable") benefits envisaged in the context of paper is aimed at familiarizing those who are the GEF supported trusts. seeking to establish sustainable finance mecha- nisms for conservation initiatives with the wide GEF trust funds for biodiversity conservation are variety of design options and issues associated not free-standing mechanisms. All are designed in with trust funds. Trust funds are a relatively new conjunction with or as a subsequent stage of concept for conservation use, and it is anticipated investment in the creation, reform or upgrading of that client governments of the World Bank and conservation areas, systems or institutions. The GEF, as well as members of the donor community, trust fund is intended to sustain activities or will be interested in gaining familiarity with the actions already underway. Most have been de- trust fund mechanism and its special features. signed to provide long term, sustained financing to Updates to this paper are envisaged as the Bank meet recurrent costs of operating and maintaining and GEF gain experience with trust fund operation. protected areas and/or to ensure sustainable use of Eleven trust-like funds have benefitted from GEF natural resources through community support. To support during its 1991-94 Pilot Phase: of these, accomplish their goals over time, the trust fund nine have received financing for fund design, five money assets are invested to earn interest and have received GEF capital contributions and one appreciate in market value. The assets in many existing foundation will be strengthened. cases are intended to grow in perpetuity and the income earned is disbursed for activities outlined in The basic legal concept behind a trust device is that the legal agreement establishing the trust. property is managed by one person or group (usually referred to as "trustee(s)") for the identified This type of trust fund has increasing appeal goals or benefit of a second person or group because of its obvious potential to stabilize the flow (usually referred to as "beneficiary(ies)"). A trust of resources to meet the recurrent costs of conserva- is thus a fiduciary relationship in which a trustee tion initiatives over the long term. Nonetheless, (or trustees) holds legal (custodial) title to specific however seductive the option may be to the conser- property including money under a fiduciary duty to vation planner, GEF-supported trust funds are not deal with it for the benefit of the beneficiaries, who a panacea and should be chosen only after a review hold equitable title. This is based on the Anglo- of all other, often simpler means of securing American law of trusts as developed and applied in recurrent cost financing have been examined and the countries usually referred to as "common law" deemed infeasible or inappropriate. The disadvan- countries, essentially the current or former member tages of conservation trust funds must also be countries of the Commonwealth and the United considered. Trust funds which seek to meet States. Some countries outside this group have recurrent costs from net income while maintaining Biodiversity Series Issues & Options in the Design of GEF Supported Trust Funds for Biodiversitv Conservation the value of their assets in real terms in perpetuity Major trust fund design issues which should be are subject to complex financial and administrative satisfactorily resolved include tax liability of trust arrangements. Furthermore, there is an opportunity income, attachment of assets, security of the assets cost of tying up the substantial capital required to and potential frustration of trust objectives. Input generate very small amounts of net income. from competent and experienced legal counsel early in the preparation stage is critical to address these Knowing when the high "price" of a trust fund issues. needs to be paid is important; hence l ower cost, equally sustainable alternative solutions deserve Most GEF supported trust funds will employ close review. Possible alternatives include: a private sector asset managers to invest the trust political commitment by governments to long-term assets. Asset managers would be selected on the recurrent budget support, establishing user-charges basis of criteria to determine investment capability, consistent with demand and carrying capacity for experience and reputation and ability to ensure the the ecosystems under use, extracting resource rents safety and stability of the assets. for conservation, creating stable long-term pro- grams of donor assistance and using variations on The trust fund designers, or board of trustees if the conventional trust funds. trust is already constituted, will need to provide guidance to an asset manager for the preparation of For the design and structuring of a trust fund, a an investment strategy. Target returns (gross, real task manager should be supported by a team and real net), tolerable risk, the currency(ies) to including one or more biodiversity specialists; a which fund assets should be tied, income distribu- financial analyst who inter l will project income tion and disbursement plans will set the basic needs to aid in determining the size of the trust parameters of such a strategy. Financial projections fund and the minimum acceptable returns on will serve to identify net income and minimum investments; legal counsel on domestic and off- return needs. shore legal issues (most often in addition to the country lawyer), and possibly financial expertise to Trust funds established with GEF support will, [in aid the local trust design team or Board of Directors almost all cases, continue operations after the life of with selection of an asset manager. The Bank's task the "project" which normally designs, vests and team should work with a client country trust design operates the trust fund for a few years. The "project team whose members represent the key stakehold- life" is an arbitrary period of sufficient length that ers in an effectively functioning trust fund. allows the Bank and donors to determine whether the trust is operating as designed and use of funds There is a wide range of trust fund forms and is consistent with the donors' requirements. In variations, with the basic elements necessary to addition to standard supervision, a mid-term or make funds operational being the: other periodic review is a highly desirable feature of * trust instrument trust fund design. Even after the " project life", there * trustee(s) should be provision for annual consultation with the main parties concerned (government, trustee(s), board of directors b~~~~~~oard of directors). * by-laws * trust administration manual From the above, it becomes clear that trusts are * income distribution plan highly individualized devices requiring consider- able resources in terms of time and expertise for Elements which are optional, but likely to be found their design and management. An option which in GEF supported trusts are an/a: merits consideration is the creation of an "umbrella i asset manager fund" which could be used to house individual * asset management conservation trust funds supported by GE financ- ing, and possibly other donor financing. Options * trust administration unit might include establishing the umbrella fund either * trust adviser or special advisory committees as a separate trust fund under the auspices of the 2 Environment Department Papers Executive Summary Bank or GEF, or as a separate legal entity. Each time intensive design factors (customized trusts, trust fund could be a restricted sub-account with its selection of asset manager) which now absorb own purpose, beneficiary(ies) and local governing resources and lengthen the time required to estab- body - operating at the local level as a separate lish a trust might find a simpler, more expedient and independent trust. resolution. However, the "costs" of establishing and operating a GUF must be examined and careful The potential benefits of a such a Global Umbrella thought must be given to designing a GUF which Fund (GUF) warrant further examination. Many of could maintain many of the secondary benefits of the difficult issues (tax liability, attachment) and trust funds which accrue to client governments. Biodiversity Series 3 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation 4 Environment Department Papers 1 Overview This chapter introduces the concept of trust funds. Annex 3 provides references for additional information on trust funds and related topics. A glossary of technical terms related to conservation trust funds follows the annexes for ease of reference. A bibliography is provided at the end of the report. Each chapter opens with a box in the text, like this one, which outlines the contents of the chapter and highlights the major points. Summary of Main Points * The concept behind a trust is that assets (GEF grants and/or other donor funds) are managed by one person or group (trustee(s)) on behalf of a second group (beneficiaries). Trust Funds are legal entities which, through their legal instruments and governing body, ensure that the assets or income from the assets is used for the specified objectives. * Trust funds are being used more frequently to respond to conservation needs, particularly since few effective measures or mechanisms exist to ensure recurrent cost financing for conservation areas or institutions. * This paper is aimed at familiarizing GEF task managers seeking to establish sustainable finance mecha- nisms for conservation projects with the wide variety of options and issues in designing trust funds. It is not, however, an exhaustive manual for establishing trust funds. Key questions addressed by this chapter: * What is a trust fund? * What is the purpose of this report? * Where can additional information on trust funds be obtained? Biodiversity Series 5 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Introduction What is a Trust Fund? Conservation trust funds can provide "an island The concept behind a trust is that assets (in this of security" in an otherwise erratic budgetary and case, GEF grants and/or other donor funds) are financial situation. Conservation of biological managed by one person or a group (trustee(s)) on diversity has only recently been recognized as a behalf of a second group (beneficiaries). A T rust national priority among many developing Fund is thus a sum of money that is legally set countries, and has therefore not benefitted from aside and whose use is restricted to specific long-term investment support or the establish- purposes for designated beneficiaries. A board of ment of reliable revenue flows to support institu- directors (sometimes called board of trustees) has tions. Trust funds of long-term duration can the responsibility for the use of the trust fund's promote financial security to build local institu- assets and has responsibility to follow the terms tional capacity and community confidence. of the trust instrument (trust deed) which legally creates the trust and to comply with applicable While investment funding of conservation efforts laws. For the purposes of this paper, "trust fund" is increasing, few measures or mechanisms exist is a general term, and the legal structures of trust to address recurrent cost financing needs. Recur- funds will vary from country to country. Chapter rent costs refer to expenses such as park staff 3 outlines the different types of trust-like arrange- salaries, vehicle operation, small civil works such ments and their legal settings. as maintenance of firebreaks or park infrastruc- ture or other annual costs to operate or maintain a Most GEF trust funds for biodiversity conserva- national park or conservation area. The need for tion have been designed to provide long terma, a special financing mechanism to meet these sustained financing to meet recurrent costs of needs arises because: operating and maintaining protected areas which have benefitted from some investment project general government budget resources are rarely adequate to meet recurrent cost support and/or to ensure sustainable use of financing adequatedto meventin keyur ent a cnatural resources through community support. financing needs even inkdevelop To accomplish their goals over time, the morpey sectors and are generally iadequate for assets of the trust fund are invested to earn conservation needs; interest and appreciate in market value. In rnany • few donors can fund operating costs for cases, the assets are intended to grow in perpetu- other than a limited project area or a me- ity, and the income earned is disbursed for dium-term project life; activities outlined in the legal agreement estab- * revenue generating potential or activities lishing the trust. Thus far, most GEF supported from ecologically sound management of the trust funds established for natural resource natural resources to be protected have not yet conservation have been designed to disburse only beenatural develourcesptobeed orharem mal; anot ythe income earned from the assets. The principal, been developed or are minimal; and.. or corpus, of the fund remains intact and in- * income generated from established ecotour- vested. Most of these trust funds reinvest sorne of ism or other commercial, ecologically sound, the income earned to ensure that the corpus ventures may be captured for general maintains its real value against inflation. Funds budgetary use, preventing capital replace- which may disburse part or all of their capital ment and or adequate maintenance of the over time are mentioned briefly in Other Financing conservation area(s). Mechanisms, page 7. Not all countries are suitable candidates for the The two main components of a trust fund are the trust fund mechanism. Alternatives which should legal entity and its governing body (usually a be examined before recommending GEF support board of directors), and the assets which the legal for a trust fund are discussed in Chapter 2, entity owns. The legal entity constituting the trust Alternatives, page 11. can be founded domestically or off-shore; it can be 6 Environment Department l'apers Overview established within or outside the framework of a have benefitted from GEF support during its government organization. In some countries, the 1991-94 Pilot Phase: of these, nine have received board of directors owns the assets; in others, financing for fund design; five have received another body, the trustee, has legal title to the GEF capital contributions and one existing assets but is governed by the board of directors. foundation will be strengthened. Annex 1 There are two common modalities to manage the provides a brief profile of each of these. assets. One is for the board of directors to hire an asset manager, either locally or off-shore, to It is worth noting that GEF trust funds are not directly invest the trust assets. The other is to intended to be free-standing mechanisms. Most establish a two-tier system with a locally based are designed in conjunction with or as a subse- trust fund that is the sole beneficiary of a foreign- quent stage of investment in the creation, reform based (off-shore) trust which is created for the sole or upgrading of conservation areas, systems or purpose of holding the assets. institutions. The trust fund is intended to sustain activities or actions already underway. Trust funds can be managed by a small board of directors which relies on the advice of a technical As in any specialized field, jargon has infused committee and local community groups or by a much of the writing concerning conservation broad board which has substantive in-house trust funds. Although every effort has been expertise and therefore has lesser need for re- made to avoid the use of technical jargon in this course to outside advice. The board may include report, it is recognized that some terms may be representatives from local and international new to readers. Therefore, a glossary has been NGOs, local communities, international donors, provided for easy reference at the end of the local and national governments, and the scientific annexes to this paper. community. Chapters 4,5 and 6 provide guid- ance on structuring and locating the trust fund Other Financing Mechanisms and its assets. Through contacts with legal, financial and Purpose of This Report conservation specialists, task managers will be exposed to terms for financing mechanisms The purpose of this paper is to explore the related to or serving the same function as trusts. concept of conservation trust funds, particularly Among these are: those which might be supported by the GEF. * Foundations This paper is neither a handbook nor a manual * Endowments for generic trust fund design: each trust device s Sinking funds will be tailored to the conservation, legal and * Revolving funds financial settings in which it is created. Rather, * Debt-for-nature swaps this paper is aimed at familiarizing those who * Social Funds are seeking to establish sustainable finance * Local Currency Funds mechanisms for conservation initiatives with the wide variety of design options and issues Foundations are very similar vehicles to trust associated with trust funds. Trust funds are a funds and can also meet the long term financing relatively new concept for conservation use, and needs of conservation areas (see Chapter 3, The it is anticipated that the World Bank and GEF's Civil Law "Foundation" as Functional Alterna- client governments, as well as members of the tive, page 20). In civil law countries, there is no donor community, will be interested in gaining legal basis for trusts, so that establishing a familiarity with the trust fund mechanism and its charitable foundation may be a suitable alterna- special features. Updates to this paper are tive. Foundations can be designed by applying envisaged as the Bank gains experience with many of the principles for trust funds set out in trust fund operation. Eleven trust-like funds this paper. Biodiversity Series 7 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation An endowment can be a grant or gift which may Social Funds are generally sinking funds which or may not have conditions attached. Endow- make small distributions of funds to mitigate the ments may be bestowed upon trust funds or social costs of economic adjustment and to foundations. This paper does not cover the support economic and social rehabilitation. Some creation of endowments. GEF projects have incorporated a social fund component in support of alternative economic Unlike trusts created in perpetuity, Sinking Funds development activities aimed at relieving pressure are designed to disburse their entire principal over on conservation areas. Some trust funds also a fixed period of time. Sinking funds can also be dedicate a portion of their annual revenue flow to setup using the trust-like arrangements described fund these activities. An overview of social funds in this paper. is provided in Annex 6 and additional references are given in Annex 3. A Revolving Fund provides for new resources through the regular addition of resources to the Local Currency Funds can operate like a trust trust assets or trust-like vehicle as existing funds fund, endowment, or social fund. The major are spent. The newly added funds can replenish distinction is that the assets are held in the local or augment the original principal. Revolving currency in an on-shore account. While the focus funds are not covered in this paper. of GEF supported trust funds has been to meet conservation area recurrent costs, local currency Debt-for-Nature Swaps involve the purchase of funds often have different and broader primary developing country debt at a discounted value in objectives. The financial aspects of local currency the secondary debt market, and cancelling the debt trusts are discussed briefly in Chapter 5, Securihy in return for environment-related action on the ofAssets, page 38, and Chapter 7, Other Investment part of the debtor nation. A brief overview of debt- Issues, page 59. SeeAnnex 3 for additional refer- for-nature swaps is provided in Annex 6. ences. 8 Environment Department Papers 2 Objectives of Trust Funds This chapter examines the objectives and benefits of trust funds, some of the alternatives to trust funds, and the prerequisites for establishing a trust fund. Summary of Main Points * The primary objective of GEF supported conservation trust funds is to provide a stable source of income to meet recurrent costs of conservation areas and institutions. * Secondary benefits of conservation trust funds may be realized as a result of careful design and structuring of the trust fund. Some of the secondary benefits are: - More diverse types of activities can be funded than is possible with conventional investment lending - Financial flows can be matched to absorptive capacity - Capacity building is fostered - Broad participation is promoted - Co-financing possibilities are expanded * A GEF supported trust fund should be proposed only after a review of all other, and often simpler means of securing recurrent cost financing have been examined and deemed infeasible or inappropri- ate. Alternative solutions which deserve close review include: - A government's political commitment to long-term recurrent budget support - User-charges consistent with demand and carrying capacity for the ecosystems under use and certainty that revenues will benefit conservation - Extracting resource rents for conservation - Stable long-term programs of donor assistance - Variations on conventional trust funds * Once the trust option has been justified as the most appropriate solution, discussions with the client country government should be initiated to ascertain acceptance and support for the special conditions of trust arrangements. Key questions addressed by this chapter: * What is the primary goal of GEF supported trust funds? * What are possible secondary benefits of the trust fund mechanisms? * Are there alternative means for financing recurrent costs? * What special features of trust arrangements should be signalled to governments pior to proceeding with preparation of a trust-like altemative? Biodiversity Series 9 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation The Primary Goal of GEF-Supported Trust funds can adapt to the absorptive Trust Funds capacity of the recipient nation and imple- menting organizations. Absorptive capacity The primary goal for GEF supported trust funds is refers to the extent to which government to provide a stable source of finance to meet the agencies, NGOs and local groups can recurrent costs of conservation areas and institu- manage additional projects and programs. tions. Most conservation activities require This depends to a large degree on how sustained funding of recurrent costs to secure a effectively agencies, institutions and local lasting impact. communities can organize for action. Trust funds give rise to more manageable dis- Some projects will generate income, but rarely bursements which can be tailored to the will they secure sufficient funds to cover all capabilities of the recipients. For example a recurrent costs. In this instance, trust funds can slow start up period with smaller disburse- be used to supplement the income generated and ments for the first years of a project may be smooth out any fluctuations in income flow. preferable until other components of the project are ready to receive more funding. The nature of most GEF support (and most Small flows carry no stigma of "slow donor funding) is medium-term, usually cover- disbursement" and unused revenue may be ing a period of three to five years. Even in cases plowed back into the assets to earn addi- where donors do provide follow-up financing for tional income until needed. projects, interruptions in funding flows between Critical to absorption are expansion of separate project cycles can be detrimental to partica tion a re buildin of progress achieved. Trust funds can ensure a participation and capacity building. Local smooth and regular financial flow to eliminate government, private sector, NGO and lapses. community level participants can be in- volved together at various levels of trust A reliable source of income in the longer term fund design and operation. It is common, should help develop stronger conservation and desirable, to have representation on the related institutions which can benefit from board of directors from among relevant program stability, undertake long range plan- government agencies, private enterprise, ning and attract, develop and retain quality local communihes and local and interna- personnel. Trust funds can therefore strengthen tional NGOs. By involving local NGOs, institutional capacity and bolster institutional community groups and local government in stability.1 management, the use of trust funds can encourage ownership and train and em- Secondary Benefits of Conservation power a wide group of local stakeholders. Trust Funds * Last, trust funds offer a new alternative for donors to co-finance projects. Trusts can be The following points outline some of the second- structured to accept, manage, and disburse ary benefits and advantages which may flow additional grants from a variety of sources from conservation trust funds: (public, private, domestic or international). The cofinancing can support recurrent costs, Trust funds, like other funding mechanisms, start-up costs, or entire sub-programs. can support many different ty]pes of Establishment of a trust may also be contin- activities, provided they are permitted gent on contributions from bilateral under the terms of the legal document cofinancing sources, requiring the recipient establishing the trust and approved by the government and partners to solicit dona- trust fund's board of directors. As noted tions. In Bhutan, disbursement of initial above, some GEF trust funds have a portion funds to the trust was conditional on the of their annual revenue assigned to support trust receiving contributions from other community activities. sources. In these cases, it must be clear 10 Environment Department Papers Objectives of Trust Funds whose responsibility it is to seek out and consumption of the amenity preserved for this secure additional funds. Donors may also and future generations. The Governments of contribute technical assistance to initiate the Mexico and Congo have made this judgement trust formation process. by agreeing to progressively finance an increas- ing proportion of recurrent costs of conservation Alternatives activities as GEF financial support for these costs decreases over the project life. Conservation trust funds have increasing appeal because of their obvious potential to stabilize the Establishing user-charges consistent with flow of resources to meet the recurrent costs of demand and carrying capacityfor the ecosys- conservation initiatives over the long term. tems under use: Some protected areas or However seductive the option may be to the conservation sites have such high amenity value conservation planner, GEF-supported trust funds that most consumers are prepared to pay a user are not a panacea and should be chosen only fee which could generate income in excess of after a review of all other, often simpler means of recurrent financing requirements. In fact, user- securing recurrent cost financing have been charges and fees can be used to manage demand examined and deemed infeasible or inappropri- at the level of carrying capacity for various types ate. The disadvantages of conservation trust of consumption, such as in the GEF Ecuador funds must also be considered. Trust funds Galapagos NP and the GEF Czech Republic which seek to meet recurrent costs from net project (Krkonose Park) which have been income while maintaining the value of their designed to demonstrate this approach to park assets in real terms in perpetuity are subject to management. Nepal has recently initiated a fee complex financial and administrative arrange- in its world famous Chitwan National park ments and the opportunity cost of tying up the which has this potential. Occasionally, revenue substantial capital required to generate very potential, particularly for a charismatic ecosys- small amounts of net income. As this paper tem, may so exceed the needs of that ecosystem, demonstrates, net income may be very small, that surpluses can be contributed to parts of the and even this net income may display annual national protected area systems which are not so fluctuations requiring considerable management well endowed with ecotourism potential. skill for its stabilization. Where grant resources for biodiversity conservation are scarce - invari- Extracting resource rents for conservation: Loss ably the case - and biodiversity losses rapid, of biodiversity in production zones for forestry, locking up large amounts of capital which could mineral extraction or other uses may be taxed to be otherwise applied to urgent conservation provide a conservation levy for meeting recur- needs may not be the most efficient way to rent costs of conservation in associated protected achieve biodiversity conservation. areas. Examples include proposed log export levies in Laos and PNG associated with Bank, Knowing when the high "price" of a trust fund UNDP and related GEF assistance to these needs to be paid is important, hence lower cost, countries. Levy revenues in these cases will be equally sustainable alternative solutions deserve contributed to conservation funds to meet, inter close review. Possible alternatives include, ahi, recurrent costs of conservation programs. among others: Stable long-term programs of donor assistance: Political commitment to long-term recurrent Where Governments are stable and absorptive budget support: Especially in middle income capacity is adequate, a sequence of projects countries with healthy economies and political every 2 or 3 years in line with long term pro- stability, commitments to underwrite recurrent grams of conservation agreed with Governments costs of conservation action as counterpart may be more effective and less costly than single funding for donor supported capital costs of major investments in trust funds. For example, projects or programs may be consistent not only full expenditure of one million per year over ten with social policy but may also be economically years through a series of $2-3 million grants justified by returns to the economy from the carefully tailored to implement a dynamically updated biodiversity action plan should have Biodiversity Series 11 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation more impact than the net income of a ten million ness to proceed and acceptance of special dollar trust fund over the same period which features of trust funds which may be particular may be only $3 million. to the trust device or to good practice which will ensure timely and effective trust establishment Variations on conventional trustfunds: A and operation. These are: sinking fund which seeks to exhaust its assets (both capital and interest) over a period of 10-20 * that funds will be legally set aside (possibly years may be more appropriate than those even offshore), and decisions regarding operating only off net income if the biodiversity their use will not be taken solely by the targeted for conservation is globally recognized. government. If major investment were attracted to trust funds now, the same biodiversity would be even more * that management of the trust should precious and attractive to investors in 20 years as include a broad representation of stakehold- loss of biodiversity globally inexorably proceeds ers (NGOs, local communities, private elsewhere in the world. Sinking funds could sector). provide the same funds as a series of small projects, but with the added security that funds * the need to support the legal actions to are in place from the beginning and protected create a trust or, if this is not a feature of the from economic and political volatility which may country's legal system, a trust-like arrange- disrupt the sequence of lending in long term ment. programs. * that a trust design committee, preferably Prerequisites for Discussion with with a broad representation of stakeholders, Government should be created in a timely manner to work with the Bank team. Once the alternatives described above have been reviewed and the trust option justified as the o that exchanges of views with the Bank and most appropriate arrangement, discussions with or/donors may need to continue even after the client government should determine willing- the designated project life. 1 At the same time, however, entitlement should not be created; a system of monitoring and evaluation must be integrated and control mechanisms designed so that funding can be terminated if the objectives of the trust are not being met. 12 Environment Department Papers 3 The Legal Framework This chapter covers the legal aspects of trust devices. Summary of Main Points • A trust is a fiduciary relationship in which a trustee (or trustees) holds legal (custodial) title to specific property including money under a fiduciary duty to deal with it for the benefit of the beneficiaries, who hold equitable title. * The law of trusts has evolved in countries following common law tradition, but counterparts exist in other legal systems. Generally, an appropriate substitute for a trust in a civil law system is the founda- tion. * Most GEF supported trusts will be public or "charitable", designating indefinite beneficiaries such as a social community or segment of a community. * If a GEF supported trust is to benefit an insolvent recipient, it will be necessary to determine the lawful means to set up a trust to protect the assets from attachment before the GEF funds are disbursed by the Bank. * It may be best to set up trusts as irrevocable to prevent the trustee from being pressured to dissolve the trust. In case the goals of the trust are not being met, power to redirect the funds can be addressed in the trust's by-laws. * Before setting up a trust, there should be investigation of the relevant tax laws where the trust is estab- lished and where it will operate. * In general, the legal instruments necessary to establish a trust fund include the trust deed and/or articles of incorporation, by-laws and, in some cases, a grant agreement Key questions addressed in this chapter: * What is the legal concept behind a trust? * What are the main categories of trusts? * What are the requisites of a trust? * What are the rules for establishing public or charitable trusts? * What are the powers and duties of the trustee? * What are the trust instruments? * How can a trust be modified or terminated? * What are the counterparts of trusts outside of common law countries? Biodiversity Series 13 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Brief History terms of the trust). This idea is often expressed as the "splitting of title" between legal obligations of The search for a means to create sustainable the trustee and the beneficiary. Despite the finance for conservation has lead to the recent apparent simplicity of this concept, however, use of an old financial instrument: trust funds complicated laws have developed over time to and foundations. Private trust funds and ensure that the rights and responsibilities con- foundations have been favored mechanisms of cerned are properly implemented and protected, families (and communities) to create secure and especially as they pertain to the obligations of the lasting sources of income for future generations. trustee. The lawyers drafting trust devices must In some cultures, private trust funds and founda- be sure that the device complies with the letter of tions date back centuries. When men left En- the law, otherwise a trust may fail if challenged in gland for the religious crusades, they 'gave' their court. land to a 'trustee' to ensure its safe keeping until they returned (or to pass to the next generation While the law of trusts has evolved over centu- should the crusader not return). ries mainly in countries following the Anglo- American legal tradition, trust devices and their Recently, innovative groups have been applying equivalents have also been developed or adapted the trust fund concept to benefit conservation. in other countries. The present discussion, after Most of the early trust funds were born out of summarizing the main legal features of the trust, debt-for-nature swaps in Latin America and will therefore conclude with a brief synopsis of were local currency funds. (See Annex 6 for an its counterparts in other legal systems. overview of debt-for-nature swaps) The use of trust funds has now spread worldwide, and their Types of Trusts applications have broadened to include off-shore hard currency trust funds and foundations. (See A trust arises from the expressed intention of the Annex 2 for information on non-GEF Trust owner of property to create a trust with respect Funds and Annex 3 for references to the USAID to the property. Trusts fall into two categories: initiative.) express trusts for private beneficiaries and public or charitable trusts. GEF trusts in common law Introduction to the Legal Aspects of countries should be designed as charitable trusts. Trust Devices Private Trusts This chapter is meant to provide a non-lawyer A private trust has one or more ascertainable with a basic understanding of the legal aspects of persons as beneficiaries: for example, a trust to trust devices. pay the trust income to the settlor's wife for life and at her death to distribute the remaining trust In its simplest form, the basic legal concept cru otestlrsdsedns behind a trust device is as follows: property is corpus to the settlor's descendants. managed by one person or group (usually referred to as "trustee(s)") for the identified Public or 'Charitable" Trusts goals or benefit of a second person or group A public or charitable trust is for a purpose (usually referred to as "beneficiary(ies)"). A which is classified as public or charitable (e.g., trust thus is a fiduciary relationship in which a educational, or for the protection of the environ- trustee (or trustees) holds legal (custodial) title to ment), and it must designate "indefinite" benefi- specific property including money under a ciaries; i.e., a social community or a category or fiduciary duty to deal with it for the benefit of segment of such a community rather than the beneficiaries, who hold equitable title (in- individual persons. A charitable trust can be cluding the right to sue the trustee to carry out the perpetual. 14 Environment Department Papers The Legal Framework Formal Requisites of Trusts Nature of Trustee's Estate: To have a trust, there must be a settlor (normally * Holds Legal Title, Not Beneficial Interest. In the GEF grant recipient) who delivers the trust other words, the Trustee's creditors ordi- property (e.g., GEF grant fund) to a trustee(s) narily cannot satisfy their claims from trust with the intention to create a trust, whereupon assets (see "creditors' rights", page 16). the trustee(s) holds, manages, and administers the property for the benefit of designated benefi- * Tutle Terminates on Executlon or Termiation of ciaries. The trust must be for a lawful purpose. Trust. The common law typically holds that an express trust vests in the trustee the legal estate, subject only to the execution of the The Trustee(s): trust, and the beneficiary does not take any There must be a trustee, or several cotrustees. legal estate in the property but may enforce the trust. Further, when the purpose for Individual as trustee: An individual named as a which an express trust is created ceases, the trustee must be of legal age and in most jurisdic- estate of the trustee also ceases. On execu- tions must have no disqualifying matters of tion or termination of the trust the legal and record such as a criminal record. beneficial estate vest in the person entitled thereto without the necessity of a reconvey- A trustee is charged with the duty of effectively ance as the trustee's estate ceases by opera- managing and administering the trust estate. tion of the law. Moreover, the trustee's There are three basic categories of trust adminis- authority to administer the trust terminates tration problems: (1) the powers and duties of on termination or execution of the trust, and the trustee in handling trust affairs; (2)the duty any further acts with respect to assets (other of fairness to the beneficiary in investment than conveying them to the persons en- decisions, and in apportioning receipts and titled) are improper. expenses among the income and principal accounts; and (3) the rules prohibiting commin- The Trust Property gling or self-dealing by the trustee. There must be property subject to the trust. Settlor can be trustee. The settlor can be a cotrustee. He can even be the sole trustee Basis of the requirement: Because a trust involves a provided that he is not the sole beneficiary of the transfer of legal title in specific property to the trust. trustee, and raises fiduciary duties in relation to specific property, there must be specific assets or If sole trustee is also sole beneficiary, there is no trust. property (also referred to as "corpus" or "princi- The reason for this rule is that the trust relation- pal") to which the trust duties relate. ship presupposes enforceable fiduciary duties; there must be someone who can hold the trustee The trustee'sfiduciary obligation to manage assets for accountable (suing, if necessary) to carry out the the benefit of a beneficiary must exist with terms of the trust, and the same person cannot respect to specific assets, so that the beneficiary owe duties to himself as trustee. who is not satisfied with the trustee's perfor- mance can pursue relief against a trustee failing No trustfails for want of a trustee. This is a basic to fulfill its fiduciary duties. rule of trust law. If the named trustee dies, Any property which settlor has power to convey can resigns, or is removed for misfeasance, and the be subject of trust. The trust property must be settler has not provided for designation of a existing propert which the settlor (the GEF successor trustee, the court will appoint someone grantg pipety wha the setr (the GEF to serve as trustee. grant recipient) has the power to convey. It need not be tangible property, but the settlor must have Biodiversity Series 15 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation an assignable interest. Thus the subject matter of Distinct Rules for Public or Charitable a trust can be a debt, whether or not represented Trusts by a note or writing, a contract, a patent or royalty interest, or a future interest. For the most part, when devising GEF-funded trust instruments in common law countries, it Beneficiaries will be best if the trusts are legally recognized (sometimes by Charitable Trust Commissions) as While a private express trust must be for "public" or "charitable trusts".' These trusts ascertainable beneficiaries, for charitable trusts ordinarily have advantages for tax and control the rule is exactly the opposite: A central re- purposes. quirement for a charitable trust is that it be for a segment of society and an indefinite class of The rules governing charitable trusts differ from beneficiaries. those applicable to private express trusts in several important particulars. The settlor can be a beneficiary of the trust. He can even be the only beneficiary - so long as he is Indefinite Beneficiaries not also the only trustee. The trust must be in favor of a reasonably large Trust Purposes class of indefinite beneficiaries. Since environ- mental benefits by definition accrue to the An express trust must state its purpose, which community as a whole, GEF objectives will must be a lawful purpose. A trust will fail if its normally meet this requirement. implementation will involve commission of a crime or tort. Since the purpose of a charitable trust is to benefit the community, the courts consider the Creditors' Rights community at large the beneficiary of a chari- table trust rather than the particular individuals Ordinarily, trust funds are exempt from being who happen to receive direct benefits. The rule used to satisfy any money judgment for a debt requiring a private trust to have definite benefi- owed by the settlor (i.e., the GEF grant recipient). ciaries does not apply to charitable trusts. However, some countries have recognized that the establishment of a trust should not be used to Cy Pres Doctrine enable a settlor/ debtor to shield assets from his creditors and have enacted legislation to provide If the charitable purpose is accomplished or the the creditors with rights to "pierce" the trust designated charity goes out of existence, the "shield" and attach the trust assets. Thus, if the court or other lawfully designated entity may GEF- funded trust is to benefit an insolvent redirect the trust to a purpose "as near as recipient, it will be necessary to determine the possible" to the charitable endeavor initially lawful means to set up a trust to protect the designated by the creator. assets from attachment. Where the specified charitable use is no longer Of course, these steps should be taken before the possible or practical, the court must decide GEF funds are transferred from the Bank (i.e., whether the settlor intended the trust to fail or while they are still protected by the Bank's would have wished the property to be devoted immunity) to the trustee. In such cases, the task to a similar use. Of course, where the settlor has manager should work closely with the opera- provided for such a contingency, his direction tional lawyer as it may be necessary to investi- controls (see Revocabilihy, page 17.). In formulat- gate alternative sites for locating the trust assets ing an alternative use for the trust property, the or managing the means for distribution. In some court must determine the settlor's primary cases, this may require enactment of legislation purpose although his other purposes should be establishing or designating another entity as taken into account. recipient. 16 Environment Department Papers The Legal Framework Perpetual Goals investment income is tax exempt, it would be necessary to obtain a tax exemption ruling under Provided the trust complies with the cy pres Section 892 of the Internal Revenue Code. doctrine, it can be designed to exist in perpetuity, unlike a private trust. However, a charitable The Trustee's Powers and Duties trust must be strictly limited to those goals considered charitable, usually defined by statute Powers of the Trustee to include religious, charitable, educational, or benevolent purposes, the promotion of health, Depending upon the law in the jurisdiction and the accomplishment of governmental where the trust is established, a trustee's power purposes, e.g., parks. includes: Revocability * To accept additions to any estate or trust. * To take out and maintain fire, title, liability, In order to create a revocable trust the creatorcaulyorthrisaneopoet must, in clear terms, reserve the power (can be casualty, or other insurance to protect reserved to the trustee) to revoke, alter, or amend property of estate or trust. the trust, and also to direct the income from the * With respect to any property in estate or trust for life. (See Termination According to the Trust trust except that specifically disposed of: Terms, page 19). However, in the case of GEF, it - To take possession of, collect rents may be best to set up trusts as irrevocable to from, and manage same. prevent the trustee from being pressured to - To sell at public or private sale on dissolve the trust. In case the goals of the trust terms deemed appropriate to the are not being met, power to redirect the funds trustee. can be addressed in the trust's by-laws. - To lease property. - To mortgage. Enforcement by Attorney General * To make ordinary repairs. In most common law countries, the Attorney * With respect to any mortgage held by the General is commonly empowered to represent estate or trust, to continue same after the beneficiaries of charitable trusts and has the maturity, with or without renewal or duty to enforce the rights of such beneficiaries by extension, on terms deemed appropriate to appropriate proceedings in the courts. The the trustee. Attorney General is an indispensable party to any suit concerning construction or,enforcement To employ any bank as custodian of stocks Or other securities held by the trustee. of a charitable trust. * To enable the trustee's successor to succeed Tax Exemption to all powers, duties, and discretions as were given to the original trustee (unless Before setting up a trust, there should be investi- this result is expressly prohibited by a will gation of the relevant tax laws where the trust is or trust instrument). established and where it will operate. In some instances, especially if a non-governmental entity * To contest, compromise, or otherwise settle is to be the trustee, there may be domestic laws claims. that might be interpreted by over-zealous tax * In some jurisdictions, to vote securities in collectors to justify the imposition of a tax on person or by proxy (a departure from the trust income or the receipt of grant funds. In "no delegation" rule of the common law.) most instances, contact with the relevant taxation or finance agency or ministry should enable the * To execute and deliver agreements, assign- Bank to obtain the necessary assurances that a ments, bills of sale, contracts, deeds, notes, tax exemption will apply. For example, if the receipts, and any other instrument neces- funds are invested in the U.S., to insure that the sary or appropriate for the administration of the estate or trust. Biodiversity Series 1 7 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation * To delegate authority to conduct ordinary Trust Instruments business. * To continue a business. Trust Deed * To pay debts. Assuming the settlor (i.e., the GEF grant recipi- * To allocate expenses, income, and carrying ent) has identified the goals for which it wishes charges and to apportion stock distributions the funds to be managed by a trustee (or del- as the trustee deems appropriate. egated agent of the trustees) for the beneficiaries' benefit - it will most likely wish that its goals be * To create reserves for depreciation, obsoles- recorded in a binding trust instrument. In cence, wasting assets. common law countries, this is most often re- * To rely on information deemed reliable ferred to as the trust deed2 and it may not be without proper investigation, possible to operate a trust until the trust deed has been duly registered with the appropriate Duties of the Trustee governent office. A trustee has the following duties and responsi- The trust deed is in essence a contract, which bilities, some expressly imposed by statute and spells out the goals of the trust and the obliga- others imposed by well-established case law tions to carry out those goals. Most often these principles: obligations are owed by the trustees for the benefit of the beneficiaries - and these obligations • To take possession of trust property. may be enforceable in a court of law. * Not to delegate his fiduciary responsibilities. By-Laws * To make periodic accountings. While the trust deed spells out the trust's guid- ing principles and is meant to govern for the life * Toeecierasnbecaeadklof the trust, in certain instances it will be desir- • To preserve trust property. able to have "by-laws" govern the day-to- * To keep trust property separate. A trustee operations of the trust. In this manner, changes cannot invest or deposit such property in necessary to handle day-to-day operations do his own name individually; this must be not require amending the trust deed. While the done in his name as trustee. However, a trust deed is drafted in order to bring the trust to corporate trustee can register stocks and life, the by-laws can be drafted after the trust is other securities in the name of the nominee. in operation and the trustees have an idea of how they wish to operate - either on their owIn or * To prevent breach of duty to co-trustee. If through a management board. the trustee knows or should know of a breach of duty by a co-trustee, he is fully Grant Agreement liable for any loss resulting from the breach. A grant agreement may routinely be required as * To make prudent investments. A trustee a means to transfer funds from a donor (such as holding funds for investment may invest the GEF) to the government or directly to the them in such securities as would be ac- trust. If special rights are given to the grantor, quired by prudent men of discretion and for example to recall the funding if the objectives intelligence seeking a reasonable income of the trust are frustrated, it must be spelled out and preservation of their capital. The in a Rights of the Grantor statement. This may prudent investor investment standard is not be possible in all legal jurisdictions. Where it applicable to all trusts. is possible, the rights and conditions to revoke the funds are also spelled out in the trust deed. 18 Environment Department Papers The Legal Framework Modification and Termination Trusts and their Counterparts Outside Common Law Countries Invasion of Principal The foregoing discussion has been based on the Most trusts give either the trustee or the benefi- Anglo-American law of trusts as developed and ciary (or perhaps both of them) a discretionary applied in the countries usually referred to as power to "invade" the principal of the trust "common law" countries; i.e., essentially the under certain circumstances. This gives a current or former member countries of the desirable flexibility to the trust arrangement and Commonwealth and the United States. Some permits the trust to meet the beneficiary's needs countries outside this group have adopted or should trust income be insufficient or should adapted the Anglo-American trust concept for some emergency arise. their own use, albeit with more limited scope. Others - even though they may share certain If an invasion power is given to the trustee to be legal devices that are indeed comparable to the exercised on behalf of the beneficiary, quite trust - have developed different instruments to commonly a standard is inserted to give the serve the same purposes, especially as regards trustee guidance as to when to exercise the the public ("charitable") benefits envisaged in power. (E.g., "so much of the principal as the the context of the GEF. trustee in its discretion deems appropriate to achieve the sustainable practices in the Bwindi Adaptations of the Common Law Trust Forest.") A number of countries outside the "common Deviationfrom Trust's Terms: Emergency or law" group have found it convenient to intro- Unforeseen Circumstances duce the (suitably modified) trust concept by way of national legislation more or less pat- A court may permit deviation from trust terms if terned on Anglo-American experience. Ex- due to circumstances not known to or antici- amples are Japan, Liechtenstein and Mexico, all pated by the settlor, compliance with the trust with highly advanced trust statutes dating back will impair or frustrate the purpose of the trust. to the 1920s. Several other countries, especially However, it takes a strong case to justify devia- in Latin America, permit and facilitate the tion from a trust's terms. The mere fact that an establishment of trusts, though primarily for investment would be beneficial to the trust is not, private beneficiaries and often expressly exclud- in itself, a basis for permitting a deviation. It is ing charitable trusts (e.g., Panama and Venezu- only when the objectives of the trust would be ela); others have adopted trust features for defeated or substantially impaired that deviation limited sectors of the economy, such as mort- is permitted. gage-secured bonds (Brazil, Chile, Colombia) or certain banking operations (Ecuador, Peru, Termnination According to the Trust's Terms Nicaragua). Even though trust devices are thus, in principle at least, available in these jurisdic- A trust will terminate automatically at the tions, these may not be suitable for GEF purposes expiration of the time specified in the trust and/or require careful study of the applicable instrument. If there is no direction that the legislation and regulatory practice. corpus be paid out to designated persons, the trustee holds control over the future distribution Limited Historical Parallels of the funds. If the settlor and all beneficiaries consent, a trust can be revoked or amended. The It is frequently pointed out that the trust concept revocation or amendment must usually be has historical antecedents in different legal acknowledged before a notary public. systems, and hence should also be adaptable for Biodiversity Series 19 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation contemporary use in the different countries common law cy pres doctrine, the competent concerned. For example, the above-mentioned government agency may change the charitable Latin American trust legislation uses the terms purpose of the foundation if the purpose origi- fiducia andfideicomiso which can be referenced nally specified by the settlor can no longer be back to ancient Roman law, and hence to a achieved (e.g., in Switzerland: articles 83 and 86 common tradition shared by all countries of the Civil Code). deriving their legal system from European civil law. Closer scrutiny of these concepts, however, One major difference, as compared to common and their modern-day European equivalents3 law trusts, is that foundations acquire a separate reveals that their scope is far more limited than legal personality of their own, including the the common law trust, especially as regards the capacity to own property etc., which is exercised rights of the beneficiaries. by a corporate Board. This legal independence also serves to shield the foundation's property Similar parallels have been drawn to ancient against claims by the founding donor's cred:itors institutions of Islamic law, such as the waqf, except in the case where (as for donations) the which historically served as a legal device for the donor can be shown to have used the very establishment of (perpetual and irrevocable) establishment of the foundation as a means t:o public charities.4 While environmental benefits defraud prior creditors (Swiss Civil Code article would qualify for the legitimate purposes of a 82). Once established, the foundation can only waqf, several contemporary Islamic countries be revoked by a formal public act (at the request have severely restricted or regulated the eco- of the competent government agency or of any nomic use of this traditional instrument, which interested person, if the purpose of the founda- may thus be virtually superseded by modern tion has become unattainable; or by judicial (secular) legislation. decision if the purpose has become illegal, see Swiss Civil Code articles 88-89). The Civil Law "Foundation" as Functional Alternative Transnational Aspects The most appropriate substitute for charitable Normally, a trust is intended to be effective in trusts in" civil law" systems generally is the the jurisdiction where it is established. Whenever "foundation" (fondation,fundaci6n, Stiftung, a trust (or foundation) established in one juris- stichting), which exists in most modern legal diction is expected to have legal effects also in systems based on continental European law and other countries (as in the case of the GEF Eastern is widely used by major environmental institu- othecnt (asom thecias oftec Gf tions in these countries; for example, the World private international law (conflict of laws) need Wide~~~~~~~~~~~ ~rvt intrntina law (conflic ofrmrl laws nored Wide Fund for Nature (formerly the World to be taken into account, including the recog-ni- Wildlife Fund, WWF) was established in 1961 as tion abroad of the trust and of legal acts related a foundation under article 80 of the Swiss Civil to it. In order to avoid disputes it is advisable to Code. specify in the trust deed which national law shall The establishment of a civil law foundation determine the validity, administration and construction of the trust (choice-of-law clause). normally requires approval by the competent The 1985 Hague Convent*on on the Law Applicable government agency, and charitable foundations to Trusts and Their Recognition facilitates mutual are under strict government supervision (e.g., in recognition between countries which have Switzerland: annual audits, and periodic official become parties to it. attendance at Board meetings). Not unlike the An Example of Legal Requirements in Poland Polish law requires that any foundation in which a Polish concem is involved must have a representative office in Poland. To accommodate this, the Foundation for Eastem Carpathian Biodiversity Conservation framework states that the Foundation may establish branches and representative offices in any of the three participating nations, as decided by the board of directors or as required by law. 20 Environment Department Papers The Legal Framework This recognition may require a decree through a Charitable Trust Commission or Ministry of Finance, Taxation or Attorney General. 2 Copies of trust instruments may be obtained through the Bank's Legal Department Environmental Affairs Unit (LEGEN) or Operations (LEGOP). 3 E.g., the prete-nom in France, the Treuhand in Germany, the bewind in the Netherlands, or other possible combinations of agency, contract and bailment law, which cannot be considered here in detail. 4According to the Ghayat el-Bayan collection (1369 A.D.), the Prophet is reported to have defined a waqf as follows: "Tie up the property and devote the usufruct to human beings and it is not to be sold or made the subject of gift or inheritance; devote its produce to your children, your kindred, and the poor in the way of Allah." Biodiversity Series 2 1 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation 22 Environment Department Papers 4 Designing the Trust This chapter focuses on designing and structuring trust funds. It addresses the question of minimum size and the components which most trust funds will require to be operational. Summary of Main Points * The minimum size of a trust fund should be determined taking into account (1) reasonable returns (interest, dividends and capital appreciation) on invested assets, (2) expenditures (income for conservation activities, plus fees, administrative and tax charges and any plowback to the corpus necessary to maintain the real value of the trust assets). * The components needed to operate a GEF supported trust fund will vary, but in general will include a trust instrument, trustee, board of directors, by-laws, a trust administration manual and a plan for income distribution. In most cases, the trust will also require an asset manager, an asset manage- ment agreement, and a trust administration unit. Depending on in-country expertise available, a trust adviser or other special advisory committees reporting to the board may be desirable. * The income distribution plan should include strategies for periods of lower than targeted or negative return on assets. Key questions addressed in this chapter: * What are the determinants of minimum size for a trust fund or asset management account? * What strategies can be followed for trusts whose return on assets does not meet expectations? * What are the roles of the trustees, board of directors, asset manager, trust administration unit and trust adviser(s)? * What are the considerations for an income distribution plan? Biodiversity Series 23 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Minimum Viable Size for a trust fund, at least one firm source of funding is Trust Fund generally known and can be used as the point of departure for initial iterations to project the The net income available for conservation viable trust fund size. Estimated net income activities is derived after (1) either capital required and expenditures and assumptions on appreciation or a portion of the income earned expected annual return can be used to determine on investments is added to the corpus to main- what the minimum viable size of the trust fund tain its real value and (2) fees, administrative must be in order to meet conservation needs. The costs and taxes are deducted from the total following formulae can be used to estimate trust income earned on the invested assets. When fund size and identify acceptable target returns determining the minimum start-up size for a to invested assets. Criterion One: Minimum Fund Size Required annual income (net income + plowback + expenses) Minimum start-up size for trust Expected return on assets 1 Criterion Two: Satisfactory Net Income Requirement Plowback + expenses (fees + < Net income required for administrative charges + taxes) conservation activities Some trust funds will be established initially with a small capital base and expectations to grow the capital base by either additional donor contributions or a return to the corpus of a larger portion of income earned on investments, and thus will not meet the above test. In this case, the medium term objective of trust management should be that the corpus maintain its real value while net income becomes progressively greater than charges against the trust assets. The longer-term objective would be to secure additional contributions from donors. Criterion Three: Efficient Asset Management Criterion The size of the trust fund capital (corpus) must also take into account the incentive structure for asset managers to take on the trust account as a client. Considerations are somewhat different for off-shore asset management, a trust company establishing an off-shore trust fund or founda- tion and asset management by a multilateral aid agency. 24 Environment Department Papers Designing the Trust Minimum for simple asset management Minimum for establishing an off-shore trust account Fees involved in establishing an off-shore trust Virtually any international asset manager can are usually a percentage of the assets, plus any manage the assets of an off-shore trust or of a separate legal fees. The legal fees and minimum domestic trust fund which has its assets man- size of a trust depend directly on the complexity aged off-shore. There are two types of asset of the instrument required. For example, a management: private client and institutional. simple family trust which uses standardized forms will be charged very low fees and there- Private client asset management offers fore may operate viably for as little as $500,000. services for individuals and usually man- Management fees and start-up expenses will be ages smaller accounts. Fees are higher than increased if a customized trust deed is required for larger institutional accounts. The con- and/or the bank feels frequent contact with the sensus is that for private client manage- board of directors is necessary to fulfill their ment, an account under US$1 million obligations as trustees. Conservation trust funds should not be invested in individual stocks will require customized legal work which may and bonds because ample diversification be complex. In general, a revocable trust dictates can not be obtained for such small amounts. more involvement by the trustee and therefore (see Chapter 7, Diversification, page 54). A potentially a slightly higher fee. Furthermore, more realistic minimum, based on a general banks use a sliding scale of fees which favors consensus of private client asset managers, larger trust funds. Each case will vary, however is US$ 5 million. With thisamount the a rough census of trust managers in the private investments can be well diversified and the sector shows that any trust which cannot use account could produce a satisfactory net standardized forms should not be under $ 5 annual income. Private client services million. usually include an annual visit from the The factors which a trust company will consider asset manager to the board of directors, when negotiating fees for a given trust size are: semi-annual or quarterly letters concerning . Who will manage the assets (if the bank the market conditions, and direct personal does, better terms can be reached); response to any inquiries. Commingled * how often interaction will be required with funds or mutual funds may be effective the board of directors; options for accounts with less than US$ 5 * what are the terms of revocability of the million, trust. * Institutional asset management accounts See Chapter 6, Turning to the Private Sector to serve small businesses and major corpora- Establish the Trust Vehicle, page 49, on the role of tions. The service is less personal and fees commercial banks for establishing trust funds. are lower. The bank relies on returns to scale to make its profits on institutional accounts; the client can usually expect a Minimum for an account with a slightly higher return due to reduced fees multilateral agency and better diversification of a larger ac- Some of multilateral agencies, such as UNDP, count. The minimum for institutional can man ateral age nservation ast clients is US$ 10 to US$ 20 million. How- can manage the assets of conservation trust ever, some banks may be interested in funds. These agencies administer very large establishing a relationship with GEF funded sums of money which are usually invested in prjcsand may offer institutional manage- blocks of US$ 3-5 million per type of investment projects and maller acconal (e.g. US$ 5 million of one bond). This practice ment services for smaller accounts. Biodiversity Series 25 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation may not be optimal for conservation trusts: an account with US$ 10 million could only be invested in two or three financial instruments, and would not benefit from wide diversification of investments. Furthermore, some of these agencies are limited to investing in short-term fixed income securities. General conclusions on minimum account size for asset management can be made as follows: A simple asset management account, US$ 5 Million managed as a private client A simple asset management account, US$ 10 Million managed as an institutional account Off-shore trust fund, managed by US$ 10 Million a commercial bank Trust and assets managed by Large trust funds, generally exceeding multilateral agency US$ 10 Million Strategies in the Event of Funding Shortfalls In the event a donor or donors withdraw their commitment(s) to fund a trust, the minimum trust size criterion will no longer be met. Experience has shown that the time to obtain commitments from other donors can be between two months and two years. The following options should be reviewed should this situation arise: * can donor funds be found for an "investment" project to cover costs while the fund assets grow and other donors identified? * can an asset management option be found which could allow a smaller fund to be cost-effective and viable, i.e. can start-up occur with reduced expenses and income during the period when additional funds can be sought and secured? Strategies adapted by existing Trust Funds are given in Box 4.1. Whatever interim strategy is pursued, it is important that the responsibility (government, trust entity, donor agencies or joint) for seeking out and securing donor funds be determined early in the dialogue on trust design. Box 4.1 Strategies for Trusts Whose Funding Levels Do Not Meet Original Expectations Trust Fund Expected Funds Starting Funds Strategy BTF (Bhutan) US$ 12 US $ 9.5 Established trust with US $9.5; seeking additional funds from bi-laterals MBIFCT (Uganda) US$ 4 million US$ 4 million Would like to increase size of trust in year 3; USAID covers administrative expenses for first two years to allow asset growth. 26 Environment Department Papers Designing the Trust Components - Putting the Parts the trustee(s) is(are) entirely separate from the Together board of directors. For example, in Bolivia the government entity, FONAMA and the commer- Despite the wide range of trust fund forms and cial bank which will house the offshore trust variations, the basic elements necessary to make account are co-trustees of the fund known as funds operational are: CF/SNAP. * trust instrument Board of Directors. Experience has shown that * trustee(s) designing the board of directors is often the most * board of directors time consuming part of establishing a trust fund. * by-laws Extreme care must be taken so that the Board * trust administration manual remains: * income distribution plan * functional (not too large, not too political, with reasonable meeting periodicity) etc); Elements which are optional, but likely to be found in GEF supported trusts are: * has an internal check and balance system to prevent domination by one constituency * asset manager (voting system, rotating membership). * asset management agreement * represents the critical stakeholders for the * trust administration unit project (local government, local communi- * a trust adviser or special ties and NGOs, national government, advisory committees conservation agencies, private sector). While Chapter 3 sets out the legal principles * embodies or has access to special expertise governing the roles and responsibilities of the (conservation, financial, and legal). trustee and board of directors, the following Two key considerations in structuring the board paragraphs highlight practical aspects and are memberanong stemg the board examples to guide the trust design team. are membership and voting systems. The issues below can be addressed by the way membership The Trust Instrument. In most cases, this docu- and/or voting systems are structured: ment (be it a trust deed, articles of incorporation, * perception that the trust fund is "too close decree law, etc.) will establish the trust or trust- to the government", (or an NGO or any like alternative, outlining its objective(s) and other organization); scope of activities, beneficiary(ies), governance * assertion of influence by one or more structure and initial capital. Input from compe- parties for their special interests; tent and experienced legal counsel early in the * representation of international donors, preparation of this document is critical2. possibly in a passive manner or in a rotating The Trustee(s). The Trustee(s) will receive legal seat; title to the GEF grant either directly or through a * inclusion of local communities and regional settlor (often a government recipient of the GEF representatives; grant).3 The trustee's powers and duties will be * flexibility to change priority activities determined by the law in the jurisdiction in supported by the trust fund as circum- which the trust is established (see Chapter 3, The stances and needs change; Trustee's Powers & Duties, page 17, for a list of Trustee's powers and duties). Trustees17for can hThe board must represent at all times a broad operate on their own or through a board of spectrum of legitimate interests, requiring that its directors. In the latter case, local law will dictate structuree formulated with this in mind. Ways the exact roles and relations between the trustees to achieve this include: and board of directors for domestic trusts. For example, in Uganda, the MBIFCT trustees are a Having a two-tier board structure: a national or subset of the board of directors. In other cases, multi-national conservation efforts may consider regional boards to review local project proposals Biodiversity Series 27 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation and perform other relevant functions. The The structure of the board must maintain a regional boards would report to the national balance of interests in the long-run. This can board. be done through: Having ex-oficio board members: For example, Rotating membershipfor: Uganda's MBIFCT board will initially include * international donors. The representative five non-voting members who do not need to be could also aid in coordinating donor directly involved in trust decision-making, but policy. have a specific need for ongoing knowledge of * local private sector as donors to the fund trust operations (see Box 4.2). or subject to taxes and fees earmarked Using advisory groups or special committees: When for the fund. Representatives from Using ~~~~~~~~~~~~~concerned businesses and indushries there is need for special expertise to "round out" mightraid inform an f ndugood the Board, an advisory group such as a scientific will. and technical advisory panel or group of busi- nessmen and social leaders could be created as a permanent structure. When links to beneficiaries Sealting systems: need to be strengthened beyond the one or two gn certain membes veto e board members who represent them, a steering orust) committee comprised of local stakeholders, can rust) be constituted to report to the board periodically. issues Uganda's MBIFCT will have a formal Local Committe to ensue vital* using consensus, simple and weig:hted Community Steering majroities depending on the decisions interaction with local communities. required Uganda's MBIFCT Local Community Steering Committee The LCSC ensures that a significant part of decision making for the MBIFCT is carried out by those most directly concerned because they live and work in the project area. The LCSC will be one of the principle means by which the MBIFCT interacts with local communities: it will screen all proposals for grants for community development projects, approve small grants (up to $1000) directly and forward larger grant proposals to the board of directors for approval. The LCSC will also help raise awareness in the community and serve as a contact point and source of informa- tion about the Trust, as well as provide feedback from local communities to the board. To ensure linkage and continuity, three community representative members of the LCSC will be selected by the full LCSC to serve as voting members of the board. Like the board, the LCSC will include representation of the three main interest groups: government, local communities and NGOs. It's composition is designed to meet several key objectives: * To provide fair representation of the diverse communities and social groups in the MBIFCT catchment area. * To ensure balance of power among the various stakeholders. * To help mobilize community support for conservation generally and projects specifically funded by MBIFCT, to ensure that funded projects remain sustainable after MBIFCT funding is finished. * To help maintain the link between economic benefits from the Trust and conservation of the Bwindi Impen- etrable and Mgahinga Gorilla National Parks, by involving interest groups in the area who can make special commitments to support conservation efforts. * To retain sufficient flexibility to accommodate possible changes in local political structures and stakeholder groups. The operational guidelines of the Trust Administration Manual allow for flexibility in the process of selection of community representatives, geographic distribution of representatives and composition of representation. 28 Environment Department Papers Designing the Trust Box 4.2 Examples of Directors Structures Board of Directors Two Examples to Meet Different Needs A Domestic Trust and a Multi-National or Regional Trust will require different representation on the board of directors. A domestic trust board will have a broad representation and aim at balancing diverse local and regional interests by including: * Local representatives (regional, if the trust is national in scope) * Appropriate government agencies * Local NGOs * International NGOs active in each area * Research institutes active in each area A multi-national trust needs to strike a balance between the participating nations and include other representa- tives who transcend national interests. Such a board might be composed of: * Equal representation from each nation * International NGOs active in the region but headquartered outside of the involved countries * Research institutes active in the region MBIFCT: Eastern Carpathian Foundation: A Domestic Trust A Tri-national Foundation Board of directors comprises one representative Board of directors will comprise of the following: of the following: Category One Trustees - 4 Members appointed by each of the nations, - Uganda National Parks including: - The Forest Department - a representative of the Ministry of the - National Conservation NGO Environment - An International NGO - a local biological scientist - Research institution active in the area - a representative from the impacted - The private sector (tourism) national park or protected reserve -Residents of three districts surrounding the conservation areas Category Two - One member appointed by WWF Ex-oficio Members of the Board - One member appointed by the MacArthur - Ministry of Tourism, Wildlife and Antiquities Foundation - Ministry of Finance and Economic Planning - Solicitor Generals Office Voting - An active international donor All members vote, however, decisions require affirmative votes of seven members in the first Voting System: category and one in the second category. Trustees are voting members of the board with one vote per trustee. Biodiversity Series 29 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation By-Laws. The by-laws provide the operational * Guidelines for identifying, developing and guidelines and procedures for the trust, such as submitting proposals for activities to members' functions and responsibilities in be funded relation to decision-making, administration; Eligibility criteria (if a portion of the trust financial management including appointment * wibl fite cortity, NGO and monitoring of the asset manager, financial income will finance community, NGO reporting and auditing, review of documents through small grants) and reports, legal responsibilities, as well as procedures for meetings including voting * Project selection criteria systems. In many cases, the by-laws cover Financial recording, reporting and auditing explicitly the broad topics of the trust deed. The advantage of having the detail in the by-laws is * Disbursement arrangements and proced-ures that they are easier to modify than the trust deed, Procurement guidelines as they are created by the trust and do not have the public law status of the trust deed. * Monitoring and evaluation Trust Administration Manual. This document is Special Considerations for Community Sup- drafted under the guidance of the trustee and port Components. For those trust funds which lays out in detail the administration of the will support community, NGO or other conser- activities funded by the trust fund, the gover- vation institution activities, attention will need to nance of the trust fund, the interaction between be given to defining arrangements in the trust and the responsibilities of the various bodies and administration manual which ensure that funds parties involved in or benefitting from the trust reach field level. This is particularly problematic fund. Specific items covered might include: when support is being provided to remote areas. Experience with social funds and other projects Terms of reference for any special commit- incorporating community participation has tees, the trust administration unit, advisers shown that the inability to disburse small Eligibility Criteria In addition to funding recurrent costs of conservation areas, some GEF trust funds may also allocate a portion of their net income as small grants to support alternative livelihood and other community directed activities as well as conservation groups and institutions. In such cases, the trust administration manual may identity which groups could be eligible and how these groups are defined. Eligible groups might include: village councils, traditional associations, farmers' organizations, co-operatives, women's groups, community-based organiza- tions and other NGOs, scientific and technical institutions (research, data collection, training, education activi- ties) To ensure that a "group" can work together as such to implement a project successfully, definitions such as the following may be specified: NGOs: might be required to have a basic organizational structure or constitution, at least a year's experience with relevant activities, demonstrated capacity in project management, reporting and accounting capacity. Community Groups: might be required to have at least 10 members, a basic organizational structure and/or charter, and have been functioning as a group for a minimum of 6 months Source: "Criteria and Proceduresfor Choosing Projects Proposed by Community Groups and NGOs", The GEF NGO Small Grants Programme, UNDP 30 Environment Department Papers Designing the Trust amounts of funds in a timely manner at the field supported trusts, disbursements will comprise level to be a recurrent and pervasive problem. the net income from the invested assets of the Lessons drawn from experience with social trust fund. The income will be generated by: funds indicate that the following can be useful in * interest paid on bonds and bank deposits; ensuring that communities know how to access funds and that funds can reach the local level m divdn paion stocks a timely and effective manner: * captal appreciaton of bonds and stocks from an increase in market value. creating partnerships between communities Interest payments and most dividend payments and NGOs or established cooperatives can r i , , s, facilitate preparation of proposals, commu- usually on an annual basis. Therefore, the nications with the trust's administrative uulyo nana ai.Teeoeh flcationswith ofe f rundsta accounistrabii distribution of income generated in this manner body, flow of funds and accountability. can be easily planned and budgeted. Capital When substantial support is envisaged over gains are realized when a security is sold, and a relahively long period, the creation of aganarrelzdwnascuiysso,ad a*eltiey on prod ter also b e fluctuations in the market means that selling at a local trust admi-nistration unit could also be profit is not guaranteed. However, this should considered. not pose a problem for income distribution. * making appropriate sections of the trust Securities can be sold at any time, and the administration manual available to commu- proceeds can be held on deposit. Asset manag- anitistofuthera their understanding of the ers have clear strategies by which they decide nities to further anderstatins of when to capture capital gains by selling stocks. process, progeduresand. expecatios ofHowever, there will be periods of poor stock and bond market performance; and in these periods, * devising simple rules of management and capital gains may be more difficult to obtain. In *tdevisparengcsimple accordig tof h m ment athose periods, the need to distribute cash from community is accountable to the trust fund. the investments may lead to the selling of stocks or bonds for a loss and thus reduce available * working out modalities for disbursing funds income or erode the corpus of the trust. at the field level should be undertaken by How defined should the disbursement arrange- trust representatives and the task team as ments be? The frequency (eg bi-annual, annual) early as possible in the trust's life with the must be known for the asset manager to build a Trust Administration Manual recording the strategy. Most asset managers do not recom- details. nmend disbursements more often that quarterly. Distribution of Income Plan. The trustee wll The rigidity of disbursement requirements Dsthrizo odisbursements to the beneficiaries affects the risk strategy (see Chapter 7, Devising authorize dibreet otebnfcaisRisk Strategies, page 54). A balance must be (conservation area, programs, institutions) as stipulated in the trust deed. In general, for GEE- struck between keeping the periodicity of disbursements amounts flexible enough to bend Disbursements from Uganda's MBIFCT MBIFCT will establish a foreign exchange account at a bank in the nation's capital. This account will receive quarterly transfers of the income eamed from the off-shore account in the previous quarter or half year. The governing body of MBIFCT will allocate the income based on approved budgets covering the administrative cost of operating the trust and projects approved for MBIFCT funding. The selection of the local bank was based on the availability of branch banks outside of the nation's capital. The trustee will: * Authorize payments based on specific budgets and implementation schedules; * Ensure that expenditures are incurred only for approved project budget items; * Ensure correct procurement procedures are followed which are consistent with World Bank requirements. Biodiversity Series 31 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation to market conditions without adding risk to the If needs exceed net income available, various portfolio's performance, while being consistent strategies might be considered: and dependable enough to meet the needs of conservation activities and to build long-term * Activities eligible for funding could be confidence in the trust fund mechanisms. prioritized with a view to postponing or restricting lowest priorities in order to When establishing an income distribution fit within available net income. schedule, the parameters to consider include: *Funds might be raised from bilateral or * how often are funds needed to meet major other sources to cover any financing expenses approved by the board? gap. * what are the domestic (including local level) * A small portion of the annual return banking facilities? (i.e. 0.5%) or earnings in excess of the * will funds that are sent to the domestic targeted return can be set aside annu- accounts earn interest? ally to act as insurance for negative * what are the options for disbursement in return years. These funds would be periods of lower than target or negative reinvested with the corpus and only growth? "set aside" in accounting terms. * what are the consequences (financial political, legal) of invading the corpus of the * The corpus could be invaded, withdraw- trust fund? ing the amount required to meet * what might be the consequences for fulfill- disbursement needs. This solution ing the trust objectives if disbursements are could whittle away the corpus overtime delayed or missed? if there are a few negative years in a short time span or if the disbursement What happens in a lower than anticipated or needs are large in comparison to the negative return year? There will be years during shrinking corpus. The corpus will which the net returns to the investment fall short remain below it's original level until of expectations. The board of directors and/or interest earned on the assets exceeds trust adviser should work with the asset man- income and expenditure needs, and can ager to establish strategies for such situations "top up" the corpus. early in the life of the trust for recording in the by-laws. Spending Rules The amount to be spent on financing the trust's administrative costs, conservation activities and institutions can be determined by a "spending rule" designed to provide a sustainable and predictable stream of income over time. A conservative rule, tied to a moving average of the value of the fund, will smooth out variations in total return caused by market volatility, and ensure a steady level of available income to cover the aforementioned costs. For example, a spending rule might be that only five percent of the three year moving average of the value of the investment portfolio would be available for disbursement in any given year. Given that a moving average is based on the lagged values of actual portfolio size, expenditures for the first three years might be set at a conservative rate of five percent of the current value of the portfolio. Subsequently, the spending rule based on a moving average would be applied. Definition of a moving average spending rule not only gives the asset manager information critical to invest- ment management, but also helps dampen the effect of low return years, minimizing the need to resort to alternative strategies. 32 Environment Department Papers Designing the Trust * A high risk strategy would be to take a commercial loan to make the disbursement, Asset Management Agreement. This contract using the corpus as collateral. Interest between the trust (board) and asset manager will charges tend to be 1% above prevailing set out the basic understandings on: interest rates and such loans are usually not authority of the asset manager taken for amounts less than US$ 1 million. - can take all investment decisions Furthermore, this strategy invades the - can takehall se ntecons corpus. The corpus is held as collateral, and assnts may be called to cover the loan and due - can place orders with brokers, dealers interest. agents or issuers Trust Administration Un*it. This unit can handle the practices of the asset manager in carry day-to-day operation of the trust when the board ing out transactions is not in session and ensure a number of admin- - best execution" principle istatie ad ecrtaratfunctions for the trustee - respects all rules and regulations of the istrative and secretariat fntosorherueemarkets in which transacting and or/board. The unit might be staffed with an porkets ix administrator, one or more accountants, liaison/ * portfolio mlx administrative staff and support staff. Among liability insurance its duties could be: hafees anducarge *fees and charges * acting as central focal point to receive governing law proposals for funding, reviewing them for Trust Adviser. There are several tasks related to consistency and passing them on to the asset management which the board of directors appropriate review groups. needs to ensure are performed on a regular basis: * disbursing funds to beneficiaries * to provide specific advice on any changes in community relations the investment strategy; providirig informati* to verify that disbursements are sent and preparing proposals received; Z preparing the annual administrative budget * to communicate critical information to the * maintain local accounts and records and asset manager such as: * present the periodic financial and manage- - income requirements; ment reports to the board . . * ~ moiorn an evlatn fuddacii. specific details about disbursements; monitoring and evaluating funded activi- - advise if additional funds will be added ties, including the use of funds, implemen- to the assets; tation and impact of activities . - any change in the general investment Asset Manager. The asset manager is responsible requirement of the trust fund; for investing the trust fund assets in accordance * to audit performance to ensure that: with guidance provided by the trustee or board - the asset manager continues to follow of directors. The asset manager can also be the the agreed upon strategy; trustee of an offshore trust, or a co-trustee in a - the returns are competitive with two-tier trust arrangement (see Chapter 6, relevant market indicators or other Turning to the Private Sector to Establish the Trust similar funds; Vehicle, page 49). The asset manager can be - that required reporting is completed for domestic or offshore, and is usually an interna- the board of trustees or executive tional banking group or commercial investment committee. firm. The asset manager is expected to report to the board on a regular basis, and must be These responsibilities can be undertaken by accessible to meet with the board at least once a either the board of directors, a trust adviser year (initially, twice a year is recommended) to (permanent role with terms of reference and review investment strategy and performance. powers specified in the trust deed), an advisory The asset manager will receive instruction from committee, or an independent financial profes- the board of directors on risk, return, disburse- sional brought in on an "as needed basis". The ment and currency requirements. overriding concern is that this role be undertaken Biodiversity Series 33 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Introduction * A tax-free status for the local entity which receives income and distributes it for the Each trust is a custom made agreement between a project may be accomplished by using settlor (the "owner" of the funds) and a trustee existing national regulations for charitable tailored to its legal setting and the needs of the organizations and foundations or by decree trust beneficiary(ies). There are numerous of law. Legal counsel, obtained locally, factors to be taken into account in establishing a should be sought on this issue as early as trust fund and defining the modalities which wil possible. make it work on a day-to-day basis. Some of the important design factors which constrain the * Tax exemption for the investment vehicle location of the trust fund and its assets, as well as may be achieved through a few different how the trust will operate are discussed below. means, all of which may affect the choice of the legal status and location of the trust Important Design Considerations fund vehicle. Four common options are as follows: The location of the trust or trusts, the location of - Ensure that the local entiity has chari the trust assets and the structuring of the board table legal status. This can be accom- of directors will be shaped by numerous factors, plished by using existing laws and among which the most constraining are: regulations for charitable trusts or * tax liability of trust assets and income foundations, or by decree of law. earned; - Trusts can be housed in a tax haven * risk of attachment from creditors of the countr, for example in the Channe:l client country; Islands, the Grand Cayman Islands, or * security of the trust assets the Netherlands Antilles Islands. In * precautions to prevent frustration of the these tax havens, the investments of objectives of the trust. irrevocable trusts are free from capital To date, no ideal solution has been found to gains taxes, other forms of income create a fully tax free trust, with no risk of taxes, and most have no or insignifi- attachment, full security of assets, and a guaran- cant other taxes. However, each tax attachment, ~~~~~~~~~~~~haven has particular limitations and, tee that the objectives will not be frustrated. Trade-offs must be made in such a way that the advantages which must be explored most critical needs are met and risk is manage- with the assistance of legal and finav- able. cial counsel, as a complete discussion of these is beyond the scope of this This section outlines the four issues in turn and paper. A major drawback if other analyzes how existing trusts have forged com- donor contributions are to be sought- promises and found solutions. could be that funds held in these areas have acquired a negative image of Taxation avoiding fiscal and regulatory respon- sibilities. Revocable trusts are usually In many locations, a trust fund may face taxation tax exempt if the primary tax status is of two types: first, on the local entity which non-taxable, which would be the case receives the income and distributes it, and for conservation trust funds. second, on the investment account. Taxation - In some countries, like the US, the poses two potential problems for the trust fund: investment income of a foreign govern- net yields to the trust fund will be reduced, and ment is tax exempt. A trust fund, if losses on the proceeds of trust fund assets characterized sufficiently as govern- through taxation may notbe acceptable to ment funds, can apply for tax exemp- donors. tion (e.g. under the U.S. Internal Rev- enue Code, Section 892). This requires a Securing a tax-free status depends both upon the ruling and has implications for the level legal status of the trust fund entity and its of government involvement in the trust location. operations. 36 Environment Department Papers Important Design Considerations - Trusts can be established under the exemption, may find those assets more suscep- auspices of an international organiza- tible to attachment as they are already recognized tion, such as UNDP, and therefore as belonging to the indebted government. To benefit from its tax-exempt status. escape both the tax and attachment constraints, the trust can be fully housed within the recipient Regardless of these options, some investments country with its assets invested in the same may still be liable to payment of withholding tax. manner as those of the government. However, For example, the US charges a withholding tax options for asset management will be greatly on stock dividends and on the interest payments diminished under such an arrangement, and from some bonds as these might be paid to the performance of the investments may be less trust. There are, however, ways of legally predictable in the long-term. The Peruvian Trust avoiding most of these taxes in tax haven ac- Fund, FONANPE, has adopted this strategy. counts: again, legal and financial counsel should be sought on individual cases as the many For offshore trusts, the degree of risk seems to possibilities are beyond the scope of this paper. depend partly on who donated the funds for the trust, how the trust is characterized, and what Risk of Attachment happens to funds upon termination or dissolu- tion of the trust. Along the risk continuum the The risk of attachment arises if creditors of an risk seems greatest if the funds are: insolvent government attempt to recover unpaid debt. If a law suit is successful, the court will * invested off-shore, seek to attach any vulnerable assets of that * partially funded or commingled with country to pay back the owners of the debt. funds granted by the recipient govern- While there is some risk that conservation trust ment funds established off-shore may be exposed to * granted first to the government and then being attached, to our knowledge, no conserva- passed on to the trust fund, tion trust funds have been successfully attached * heavily characterized as belonging to a by creditors to date. government organization. There is a continuum of risk associated with Furthermore, these attributes will affect the risk minimizing taxes and averting attachment, and levels of the various legal trust vehicles in differ- tradeoffs must be weighed carefully. For instance, ent ways. Legal counsel to advise on the risk of a trust whose income is recognized as income of a attachment is necessary for any trust fund that foreign government for the purpose of US tax will be established off-shore. Box 5.1 Examples of Trust Funds and their Taxation Situation Country and Trust Fund Location and Status Vis-a-Vis Taxation Mgahinga and Bwindi Impenetrable MBIFCT will be established as an independent, tax-exempt entity Forest Conservation Trust (MBIFCT) under Ugandan law. The assets will be held offshore in a tax haven. Fiduciary Account for the National The account is housed within FONAMA, a Government tax-exempt System of Protected Areas (CF/SNAP) umbrella fund, created by presidential decree. The assets would be managed in the US and may qualify as tax exampt investments of a foreign government (should there be a favorable US 892 ruling). Bhutan's Trust Fund for Nature (BTF) BTF was established as a tax exempt entity under the auspices of UNDP; UNDP is also the asset manager and affords the trust tax exempt investment income. Biodiversity Series 37 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Box 5.2 summarizes examples of factors which generally increase or decrease the risk of attachment. Box 5.2 Trust Fund Characteristics and Risk DECREASES RISK OF ATTACHMENT INCREASES RISK OF A1TACHMENT The assets are invested locally. The trust fund is established under a govemmental body ox, organization and funds are off-shore. Trust fund is supported 100% by non- The trust fund is partially funded or commingled with funds (recipient) govemment sources contributed by the recipient nation. The recipient government is removed from Government representatives have an active role in the board any control over the assets. of directors and can influence decisions by forming voting blocks. The change of ownership of the disbursed The GEF grant goes to the government first for subsequent income occurs in the recipient country, not transfer to the trust fund. at the site of the off-shore trust fund. Trust fund is irrevocable, or revocable to an Funds are revocable to the govemment. NGO or the GEF. Trust is established in the country in which Fund established as a tax free fund in the US (or any other trust funds are, by law, not vulnerable to country) under the IRS 892 ruling (or appropriate rules) as attachment as long as basic non-fraudulent investments of a foreign government. criteria are met. (e.g. Switzerland). Security of Assets A related concern is that the funds will be in- vested in a way which best responds to the The financial assets of the trust fund must be objectives of the trust fund. This can be done by maintained: ensuring that: * safe from risk of misappropriation and * The fund manager clearly understands the inappropriate investments, objectives of the trust fund; * secure from rapid erosion in real value due * The board of directors receives regular to high or hyper inflation, reports which determine whether the agreed * free from liquidity worries, and investment strategy is being implemented; * in a safe location. * Situations giving rise to obligatory consulta- tion are specified for the asset manager. For Appropriate investment of assets. The first area of example, the asset manager would agre(e to concern is that the assets are managed by a advise the board of directors or trust man- qualified asset manager. Chapter 7, Selection ager if the asset allocation of the investments Criteriafor Asset Managers, page 5.i, sets out needs to be changed beyond a previously criteria for selecting an asset manager, while M'Tat agreed range (e.g. 5-10%). is Total Real Return? and Devising Risk Strategies, Protectionfrom risk of inflation. This concerns provide guidance on establishing an investment primarily those trust funds which maintain a strategy. The selection of a qualified, experienced proportion of their assets in local currency. and reliable asset manager is a critical step in the Although interest rates on local deposits may be establishment of a trust fund, and due attention attractive in nominal terms, often above 20%, real should be given to this process. returns could easily be negative if those rates are 38 Environment Department Papers Important Design Considerations not adjusted regularly in line with inflation or are automatically transferred to another location devaluation is imminent. These risks must be should the situation become jeopardized. This counterbalanced against the benefits of maintain- detail should be examined before an account is ing a local account, in particular for a heavily opened in a potentially vulnerable country. indebted nation, and diminished risk of attach- ment. See Annex 3 for references concerning local Ensuring Trust Objectives Will be Met currency trust funds. Due to the long term nature of trust funds, there is Liquidity. Liquidity refers to the readiness of the justified concern that in future years management funds to be withdrawn from the account. For may go awry and funds used for other than their example, if an account is fully invested in stocks intended purposes. These concerns can be and bonds, and a cash disbursement is urgently reduced by incorporating various checks and needed, the asset manager must sell some of the balances in the trust fund design. This section stocks or bonds to generate cash. In OECD outlines how checks and balances can be intro- markets this poses no problems; a cash transfer duced in legal instruments, in structures or can usually be made within two working days of through the mechanisms listed below: the request. However, in some smaller stock and bond markets, a sell for cash cannot be made as * the legal instruments of the trust quickly due to local regulations or lack of a buyer * the board of directors, in the market. (A further complication of mutual * a revocability clause, funds is that some are only traded a few times * external monitoring and evaluation, each month.) Most asset managers will recom- * detailed provisions on accounting and mend setting aside a small percentage of funds in reporting and auditing. cash deposits to meet emergencies and to take No model for the formulation of controls is advantage of a change in market conditions. proposed here. Rather, legal expertise should be engaged as early as possible to advise on this Safety of the physical assets. The location of the aspect of trust fund design. trust vehicle and that of the physical assets may not be identical. Most international banks hold Legal documents establishing the trust. The trust their assets in OECD countries and are generally deed states the objectives of the trust and the considered 'safe'. However, some tax haven scope of activities which it may undertake. A locations may require that the funds be held in a precisely defined trust objective and scope of small country which, in the worst case scenario, activities: may become politically insecure. For this reason, most large institutions which operate in these * focuses the direction of the board of trustees, locations have "flee clauses", meaning the funds and Box 5.3 GEF Trust Funds and Strategies to Ensure Security of Assets TRUST FUND LOCATION AND STATUS VIS-A-VIS SECURITY OF ASSETS MBIFCT, Uganda Assets will be managed in hard currencies in an off-shore account to avoid inflation and to ensure top professional management. CF/SNAP, Bolivia Assets will be managed in US dollars by professional asset managers in the US. FONANPE, Peru Assets will be managed by a domestic asset manager in Peru. Modalities to be determined. BTF, Bhutan Assets are invested by UNDP in short term deposits and government bonds, as per UNDP's investment regulations. (See Chapter 4, Minimum Viable Size of a Trust Fund, page 24). Biodiversity Series 39 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation clarifies the specific goals by which activities An irrevocable fund, as the name implies, ex- to be financed by the trust fund can be cludes the possibility of reverting the funds to the evaluated, and selected. donors. However, the board of directors or a third party may be granted the power to effectively The legal documents should clarify if the trust freeze or dissolve an irrevocable trust fund and fund can accept earmarked funds from donors for transfer the monies to another project or trust with certain projects which may deviate from the compatible objectives. (See Chapter 3, Modification original scope of activities. If it can, the trust and Termination, page 19, on trust terminatioin). deed should explicitly state that the focus of the trust fund cannot be changed by such additional External monitoring and evaluation. Periodic in- funds. Criteria and limitations for accepting depth review by donors also provides an opportu- earmarked funds should be considered, for nity to check the effectiveness of trust fund example setting an upper limit on the percentage operation. The consequences of a less than of total assets that earmarked assets may repre- satisfactory review should be included in the trust sent in the trust fund. deed, and might include the delay of fresh capital being transferred to the trust fund. These reviews Structure of the board of directors: could be planned for one year into operation, two * Who is represented on the board? years into operation or as appropriate, and * How are they replaced? include a check on some or all of the following points: GEF supported trust funds are characterized by a * asset management performance vis-a-vis the broad representation of stakeholders on the board original financial objective; of directors. To maintain this principle and avoid * adequacy of sub-project selection criteria any one interest group gaining control over the and application, including impact of trust's activities, the by-laws should spell out activities financed; how members are to be replaced over time. (See * amounts disbursed at field (conservation Chapter 4 Designing the Trust Components-Putting area) level; the Parts Together, page 27, concerning boards of * representativeness of individuals serving the directors.) board of directors and committees. Revocability clause. Subject to the issues raised in Financial reporting and auditing. Detailed provi- Chapter 3, Distinct Rulesfor Public or Charitable sions should be incorporated in the trust deed on Trusts, Revocability, page 17, a clause may be accounting, reporting and auditing. It is reconm- added allowing the trustee to revoke the trust. A mended for audits that: revocability clause sets the terms under which a the trust engage an independent auditor; trust can be terminated and its assets redirected, * the local trust be audited annually, and if transferred or distributed, including return of deemed necessary, audited after the first six funds to the donors. Depending upon local law months of operation; and the intent of the founder of the trust, this * the offshore trust, if different from the asset clause could be triggered by: manager, also be audited annually; * a vote of the board of directors; * the asset manager make a report to the board * the trustee; of directors every 6 months for the first two * consent of the settlor and all beneficiaries; or years, and annually thereafter. * a third party. 40 Environment Department Papers Important Design Considerations Box 5.4 Design Features to Ensure Trust Objectives Will Not Be Frustrated Trust Fund Design Features MBIFCT, Uganda The World Bank will approve the board of directors' initial membership. The procedures for replacing members are contained in the Trust Deed and By- Laws. The Trust Deed and By-Laws cannot be modified without the World Bank's consent for the first five years. After that, a unanimous vote of the board is required. Independent audits will be held every six months during the first year, and annually thereafter. The structure of the Board of Directors balances interest groups and voting systems ensure no one party has control of the board. CF/SNAP, Bolivia FONAMA and a commercial bank in the U.S. will be co-trustees of the trust (The fund is one of several fund. All decisions taken by the board of the domestic trust will be chan- accounts under FONAMA, nelled through FONAMA to the co-trustee which also houses the trust an umbrella fund) account. BTF, Bhutan The voting strategy and membership composition of the board of directors guard against conflict of interest. The board comprises three government representatives, one from WWF, and one from UNDP. A majority vote of 4/ =ths is required for all decisions. Biodiversity Series 41 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation 42 Environment Department Papers 6 Diversity of Instruments This chapter outlines the possible combinations of trust vehicles and asset management arrangements which can be utilized for trust funds. The second section profiles the trust fund instruments which are available. The chapter ends with a look at employing the private sector to establish and manage trust funds. Summary of Main Points * The three major categories of locations for trust fund vehicles are: - Domestic trusts with domestic or off-shore asset management accounts; - Off-shore trusts with off-shore asset management in OECD Countries and tax havens; - Trusts based in multilateral aid agencies with asset management either by or outside the agency. * Domestic trusts can have their assets managed off-shore in one of two ways. The simplest is to estab- lish an asset management account in an OECD country or tax haven. The second option is a two-tier system which pairs an off-shore trust which holds the assets with the domestic counterpart. * Considerations when opting for a commercial bank managed asset account over a trust vehicle are indemnification, fees, and the bank's right to terminate the agreement. * Trust funds can be designed as sinking funds which disburse all assets over a fixed period of time. Key questions addressed by this chapter: * What are some of the key issues involved in deciding the location of a conservation trust fund? * What are the advantages and disadvantages of establishing a domestic trust fund and domestic asset management? * What are some of the options of establishing a trust under the auspices of a multilateral agency? * What are the alternatives for off-shore trusts funds in non tax haven countries? * What are some of the advantages and disadvantages of establishing a trust fund in a tax haven country? * How can a commercial bank help establish a trust fund? * What are the concerns for any commercial bank involved in establishing a trust fund? Biodiversity Series 43 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Introduction As discussed in the preceding chapter, the location of the trust and its assets will depend on a variety of factors. This chapter outlines the Decision Chart for Trust Fund criteria and issues involved in determining the Location best location for the trust and the trust assets. The three options for location are: This box provides useful questions for determining •Domestic trust with domesticortoff-shore trust location. Very few cases will have a clear asset management account outcome; the majority of cases will fall in between a wholly domestic or wholly off-shore solution. In * Off-shore trust with off-shore asset manage- those cases, a domestic trust fund with an offshore ment based in: asset management account or a two-tier system - OECD Countries may result in a workable compromise. - Tax Havens Is there: - a rationale for housing the trust in the * Trusts based in multilateral agencies with country? asset management either by the agency or by - a legal setting for trust funds or trust-like an outside asset manager (i.e commercial arrangements? bank) - only one country which will benefit from the trust fund? Domestic Trusts - the possibility of investing funds onshore? all yes-> local trust fund There are five basic questions which will help all no-> off shore trust fund establish if a domestic trust (charitable or with tax-free status) should be established: Alternatives for ambiguous cases If the answers are mixed, determine to what extent * Is there an established body of law regulat- the non-priority concems can be met by creative ing trust funds or charitable foundations? solutions and compromises. Multiple options should be examined before advancing into the • What are the specific legal requirements of design and structuring of a trust. establishing a trust fund? -absence of a clear rationale - establish a two- tier trust system or establish a trust under the * If there is no legal structure, what is required auspices of an international agency to establish a trust fund by governmental - absence of a legal setting - create a trust decree? vehicle by decree of law - more than one country to benefit from the * Is it desirable to use an appropriate "um- trust fund - establish a two-tier trust system brella" body or fund which already exists to or a trust under the auspices of an interna- house this new trust? tional agency - no or uncertain possibility of investing funds off-shore - seek exemption to invest funds * Are there regulations concerning off-shore off-shore asset management? There are often strong arguments for and against housing the trust fund locally. 44 Environment Department Papers Diversity of Instruments Advantages of a domestic trust: to be identified on the basis of the criteria given • it will function under the laws of the country in Chapter 7, Selection Criteriafor Asset Managers, whose beneficiaries it serves; page 55. Special expertise is required to invest the funds in domestic capital markets which * the benefits of capacity building in trust may be vulnerable to liquidity problems and management accrue to the country and, if high volatlity. An alternative in such a case is assets are also held domestically, financial to grant the board of directors power to invest management capacity can also be strength- the funds in the same jurisdiction as government ened. funds, but to ensure there are guidelines and , thepercetionofntional"one p ,conditions on how the funds are to be invested. cothe perception ofrnationalw"ownershi" aThis, however, limits investment flexibility and could create greater awareness of and commitment to envirom-nental issue; .may not provide optimal investment returns under changing market conditions. Disadvantages of/a domestic trust: If domestic management of assets is strongly * a domestic trust might suffer from the desired in the long run, a compromise might perception that the funds belong to the entail an initial offshore asset management, with government and are therefore fungible; a clause in the trust deed to reassess the possi- * the risk of political instability may endanger bility of moving the asset management on-shore the objectives of the trust and, if assets are at the mid-term review or other appropriate hme. held domestically, the safety of the assets; * some donors may be hesitant to contribute given their perceptions of the above cited The advantages of offshore professional asset risks; management are many; namely, the assets can be invested in a hard currency, in a secure X there may be resrictions on non-profit market, in a secure location, and in an account foundatons contributing to such Trust which is tailored to the objectives of the trust Funds. For example, some US charitable fund. Chapter 7 discusses issues of asset organizations may require recipient organi- management. zations to have a certain legal status that a locally based trust would not meet. There are two mechanisms for offshore asset management. The simplest is a straightforward Domestic Asset Management asset management account, opened in an OECD As noted in Chapter 5, Taxation, page 36, and Risk country or a tax haven. Most simple asset of A ttachmen t, page 37, issues such as attachmet ,management accounts in OECD countries will 0/ Attachment, page 37, Issues such as attachmentbelaetopysmtxoniceered and tax liability may warrant creation of a be liable to pay some tax on mcome earned; domestic trust with domestic asset management. accounts in tax havens such as the Channel This option should be considered when the host Islands may therefore be more attractive. For country is heavily indebted and there is sufficient example, an asset management agreement can country is heavily indebted andbe settled with an international bank in London linkage between the assets and the host govern- ment for the assets to be deemed liable to attach- for an account held in the bank's Channel ment. One option is to invest the funds in the Island subsidiary. If this method is unsuitable samen One optionit invest the funds in the due to concerns of attachment, tax implications same safe jurisdiction In which the government frtedmsi mt rcnen firvcbl invests its funds. This arrangement keeps the for the domeshc hust, or concerns of irrevocabil- assets free from attachment and taxation con- ity of the assets, a two tier system might be more cerrns. appropriate. In a two-tier system, the domestic trust is a tax-exempt entity and is the sole beneficiary of the offshore trust. The offshore However, the domestic asset management optiontrsacssthinemntcoutndhul should only be considered when there is suffi- arust acts as the investment account and should cient in-country competence for an asset manager also be tax exempt. Biodiversity Series 45 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Charitable Trusts Established By a which was established as a Swiss Foundation in Multilateral Aid Agency Geneva. To date, no single country GEF sup- ported trust fund has been established offshore for the first two reasons cited above. Trust funds can be established under the aus- pices of a multilateral aid agency. For example, There are two approaches to selecting an off- the Bhutan Trust Fund for Environmental Conservation is established under the auspices of shore location for a charitable trust: UNDP. This affords the trust fund tax exemp- * Sometimes the location will be chosen due tion, protection from attachment, and security of to the relationship between the involved assets as the trust benefits from UNDPs legal countries. For example, are there estab- status covering these issues. The drawbacks to lished partnerships for the environment? Is such arrangements may include an external layer geographic proximity important? Are of administration and the continued involvement there political preferences? of and assumption of responsibilities by the multilateral aid agency. For certain donors, this omtimes the legal fram eworkstand solution~ ~ ~ ~~~~, ma.fodteavnae flctn options of the country where the trus-t will solution may afford the advantages of locating be established will be the critical factor. the trust funds in a tax haven without t There are some countries which have trust negative perception sometimes associated with Tr .ar some c ndtrie s whichh the latter, ~~~~~~~~~or foundation laws and traditions which suit the needs of the project or special The fund assets can also be managed by the requirements of donors. multilateral aid agencies (which is also the case for the Bhutan trust fund). However, if high returns are an objective, the agencies' conserva- tive investment practices and fee arrangements may not make this an appropriate solution (see Chapter 4, Minimum Viable Size for a Trust Fund, A Swiss Option to Trust Funds: page 24). An alternative to explore is whether the funds of a trust established under the aus- Swiss Charitable Foundations pices of a multilateral aid agency can be invested Switzerland is the home of many international with an outside asset manager. charitable trust funds. Its political neutrality, accessibility within Europe, and strong laws Charitable Trusts or Foundations regulating foundations have made it a choice Established Offshore location. In Switzerland, regulations governing founda- Offshore trust entities may exist ei-ther as a sigle tions vary from canton to canton [state to state]. entity trust or as part of a two-tier system. In Usually, the president of the board must be a either case, the choice of establishing the trust Swiss citizen. Swiss law firms or private indi- offshore and its specific design and structure will viduals can usually perform these services, reflect the concerns of attachment, taxation, however there is often a fee. Some cantons security of assets, and control systems. dictate that the board of directors meets in Switzerland. A single entity offshore trust might be created when a dmestic lgal systm cannotaccommo-One disadvantage is that all Swiss bank accounts when a domestac legal system cannot accommo- are levied with a federal stamp tax on every date a trust arrangement, risk to the trust iS security transaction. The Federal stamp tax is considered too high by establishing it in the 0.15%. Some cantons also levy a tax (eg Geneva country of the beneficiaries, or the trust is levies a 0.015% tax). created to benefit multiple countries. An ex- ample of the latter is the tri-national Foundation for East Carpathian Biodiversity Conservation, 46 Environment Department Papers Diversity of Instruments A Few Options for Trusts in OECD often can meet the exact needs. Legal advice Countries must be sought concerning a particular jurisdiction's regulations. The following section provides an outline of some of the options available in non-tax haven In the US, a charitable organization can be OECD countries to establish tax exempt trusts or granted special tax status, if it meets certain foundations. It is meant to be indicative and not operating rules, under section 501(c)(3) of the exhaustive. The legal, operational, and adminis- Internal Revenue Code. The most significant rule trative requirements of each jurisdiction vary for the charitable organization is that it pay out and therefore dictate engaging legal counsel to not less than 5% of the fair market value of the carry out a comprehensive examination of a trust's assets annually. In years during which the variety of options before the selection is made, trust's investments earn less than 5%, disburse- ments must be made from the corpus (i.e. the Charitable Trusts capital) of the funds. An excise tax of 1% or 2% is levied annually on net annual investment income. Most countries have mechanisms to grant charitable organizations special tax status. In Singapore, Section 13 of the Income Tax Act Charitable conservation trust funds can be set up exempts charitable institutions from income tax. in three different ways: The trust would be established by a trust deed which specifies the donors, the trustees, and the * as an autonomous charitable organization;puosofters. * with an international NGO negotiating the purpose of the trust. establishment of the trust and transferring In the Netherlands, a tax-exempt charitable the assets to it (i.e. acting as "settlor" of the foundation can be established if it can prove that trust); or it does not engage in activities which are in - under a restricted account of an existing competition with Dutch companies. A founda- charitable organization. tion may participate in business activities, and the support of "eco-ventures" should not be incom- establishing a charitable trust. Each country has its patible with a Dutch foundation. Furthermore, own regulations for establishing charitable due to the numerous tax treaties in place in the organizations but, in general, any such organiza- Netherlands, the investments of the charitable tion must be able to prove that it operates trust may be subject to significantly lower with- exclusively for charitable purposes and is not holding taxes on investment than other trusts merely a conduit for foreign funds. Some established elsewhere. The only other require- countries do not permit foreign organizations ment is that a Dutch citizen sit on the board of whose activities are solely foreign to qualify for directors, a task which a Dutch commercial bank charitable status. Most countries have some can perform. It should be noted that some administrative requirements such as the filing of financial institutions charge a V.A.T. (17.5%). annual reports, and will levy penalty taxes if those requirements are not met. NGO as Settlor In some countries there is no legal basis on which An alternative to establishing a charitable trust to establish trust funds. For example, civil law with a recipient government as settlor, is to countries usually do not recognize trust funds. engage an international NGO to take this role. However, charitable foundations in these coun- When an NGO acts as a settlor, a new trust entity tries may serve as a viable alternative. Switzer- is created. The grant could be made directly to a land, Austria, and Liechtenstein are three tax-exempt NGO which would in turn transfer countries which have a history of housing both the assets and complete any necessary legal charitable and private foundations. Foundations agreements to establish the trust fund. can be set up in similar ways to trust funds and Biodiversity Series 47 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Using a Restricted Account * The trust may be directed to other ends or the assets reverted to the grantor should the A third alternative for using a charitable trust objectives be frustrated. structure would be to establish the fund as a "restricted account" of an existing charity or * The grantor can change or recess beneficia- NGO. No new trust entity is created. This ries. would entail: Grantor's trusts may file for tax exemption under * finding a charity or NGO whose activities the rules governing the settlor. While this would are completely compatible with the pur- imply that the Bank's special tax status could be poses and activities of the GEF and the passed on to the trust fund and that there would trust; be almost no risk of attachment there would be a * appraisal of the charity or NGO; and loss of "ownership" by the client country. The Bank would also take on various obligations, in * negotiation of a satisfactory agreement for perpetuity: such an option has not yet been put trust management. to Bank management. The agreement with that charity would be A Few Options in Tax Havens structured to reply to the objectives and concerns Locations of the GEF and World Bank, the charity and or NGO, a situation likely to result in the loss of The second type of off-shore account is one that strong national ownership of the trust fund. is second spe of treat count is oca- is granted special tax treatment due to its loca- Foreign Government Tax Exempted tion. Locations which offer special tax treatment to accounts which are based there include the Accounts Grand Cayman Islands, the Bahamas, and the Some countries provide tax exemption for the Netherlands Antilles. Each location has its own investment income of foreign governments. For particular tax situation and regulations; and example, investment income generated for rules and regulations will vary locale to locale. foreign governments in the U.S. is tax exempt However an account placed in one of these under section 892 of the Internal Revenue Code. locations usually enjoys a virtually tax free This alternative has two major drawbacks. First, status. Most large international banks, and it requires that the Trust Fund be very closely many smaller specialized banks, have developed linked to the government, by which the indepen- expertise in these types of accounts and usually dence of the trust fund might be threatened. are represented in these locations. Secondly, by identifying the funds as govern- mental, they become vulnerable to attachment if The advantages of domiciling the account in a the country has creditors. tax haven include: * an easily obtainable tax free status (or U.S. Grantor's Trust (or Substantial virtually tax free); Owner's Trust) * accessibility of top professional asset managers; Under this option, the World Bank would act as settlor for a GEF grant being transferred directly * wide selection of investment opportunities to a trust fund. The trust would be structured so in bond markets which avoid withholding that two or more of the following conditions are taxes; met: * possibilities to invest in equity markets in a * It is not an irrevocable trust. withholding tax free condition; * The income may be withheld from the * security of assets in locations which offer a beneficiary if deemed appropriate by the "flee clause" to automatically transfer the grantor. assets to another location should the loca- tion become vulnerable. 48 Environment Department Papers Diversity of Instruments The disadvantages of tax haven trust funds are centered around issues of perception and Asset Management in Tax Havens: include: A Few Facts * Some recipients and donor nations may be Minimum size: sensitive to the image that tax havens are Each bank has mninimum account size require- used to avoid fiscal and regulatory respon- ments. Due to the fee structure, accounts under sibility. This perception is particularly US$ 1 million are usually not viable. Fees are acute for Caribbean based tax havens. usually calculated as a percentage of assets, and for asset management services start around 1%. * Fees for establishing a trust fund in these locations can be higher than for accounts Taxation: domiciled in the US or UK. This is a rough Many of the tax havens have no income or capital generalization, and exceptions are easily gains taxes at all, however other taxes may be found. Furthermore, the savings in taxes levied, for example: may easily justify a slightly higher manage- * On the Isle of Man and Netherlands ment fee. Antilles, there is a potential chargeable V.A.T. on services; Turning to the Private Sector to Establish the Trust Vehicle * On the Grand Cayman Island, there is a one time stamp tax of US$ 40.00. Many commercial banks and trust companies Withholding Tax: can add value to the process of establishing a Accounts or some portion thereof are sometimes conservation trust or a foundation, bringing liable for withholding tax depending on how years of highly specialized trust experience their funds are invested. This is dictated by the gained from servicing other non-profit groups withholding tax laws of the source country. For who have similar income distribution and tax- example: exemption requirements as conservation trust * There is withholding tax on US Domestic funds. For legal counsel, the commercial bank Bonds issued before 1984 and on all US will usually introduce the client to a specialized Stocks traded in the US; trust lawyer with whom they often work. * Bonds purchased in the Eurobond market (including US bonds) are not subject to Setting up trust funds and foundations is a withholding tax; profitable venture for commercial banks. Most internatonal invstment bnks havedepart-* Equities, including US equities, which are part of a mutual fund based off-shore are ments which specalize in trust management, not liable for U.S. withholding tax. both for trusts established in their home country and for trusts in tax haven locations. The * possibilities to invest in equity markets in a incentive for these firms to undertake trust withholding tax free condition; management is that they would become the asset * security of assets in locations which offer a manager for the trust, an activity which usually "flee clause" to automatically transfer the generates substantial revenues for the firm. Asset assets to another location should the management fees are usually levied in addition location become vulnerable. to fees for the trust management. Banks charge a fee to manage assets, and they also benefit from economies of scale in trading securities and Box 6.1 Example of a Domestic Trust with using that capital as collateral. A common Offshore Asset Management Account strategy for banks is to charge low annual fees to establish and maintain the trust (i.e. 0.10% of the Uganda's MBIFCT is a domestic tax exempt trust asset value), to provide a package of legal and with no restrictions on holding assets off-shore. accountancy services to help the client, and to asset manager in the U.K. who will manage the manage the assets. The benefit to the client is assets from London. To avoid U.K. income taxes that a comprehensive service is usually advanta- on the trust's assets, the account will actually be geously priced and negotiations are easier if the held in the bank's Channel Island branch. Biodiversity Series 49 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation same banking group manages the offshore trust as trustee or against the trust. Banks might seek and financial assets. indemnification from the World Bank, UNDP or UNEP, because indemnification from the trust The basic steps for engagin a bank as a trusteeitefmyntbsuicn. are: itself may not be sufficient. * Create the non-profit corporation or chari- Second, banks expect to earn fees for their table trust entity which will have certain services, be it through the trust fund manage- powers over the assets. ment or asset management. As mentioned * Select the board of directors. above, the incentive for banks to establish trust * Elect the officers of the board. funds is to manage the assets. Usually trusts are * The bank and board of directors negotiate managed by banks for an annual fee of about the terms of the trust deed and contract to 0.10% of assets, plus any extra expenses (eg establish the bank as trustee. communications, legal). Asset management fees There are three concerns for the commercial bank should be negotiable. Some banks calculate a flat with regard to establishing a trust vehicle for fee based on expected work load related to the clients: indemnification, fees and ability to trust. terminate the agreement Third, banks need to be able to step away from First, most firms wil seek indemnification from the agreement and annul their responsibilities at their clients against the potential legal fees any time. If banks are no longer confident that arising out of a law suit. In other words, they they can carry out their responsibilities as need a guarantee that as long as they perform trustees, they need to terminate the relationship. their duties properly, theywinotThis is a standard clause in trustee agreements. their duties properly, they Will not be financiallyBakcnalotritesetmaget liable if there is a law suit brought against them Banks can also termmate asset management agreements at any vime. 50 Environment Department Papers Diversity of Instruments Box 6.2 Offshore Trusts GEF Supported Trust Funds Using Off-shore Trust Arrangements A Swiss Solution for a Tri-National Using a Local Umbrella and Offshore Under the Auspices of an International Fund: Foundation for East Trust: Bolivia's CF/SNAP Agency: Bhutan's Trustfor the Carpathian Biodiversity Environment (BTF) Prime Concern: Prime Concern: Prime Concern: Find a neutral but close location Use existing umbrella institution in Establish a tax free status and a Bolivia (FONAMA) location agreeable to donors. Background: Background: Background: The Foundation needs a trust Two-tier system with domestic BTF was established under the outside yet close to the 3 involved trust under FONAMA and offshore auspices of UNDP to assure a safe countries. commercial bank serving as co- and tax free vehicle which would trustee as well as managing the permit the assets to be managed assets. outside of Bhutan. The assets are managed by UNDP. Advantages: Advantages: Advantages: * Switzerland is close by and offers Assets can be managed in a tax-free Although tax haven options were a convenient legal setting for situation yet the funds remain considered, this option was taken non-profit foundations. closely tied to Bolivia and to avoid the perception of 'hiding * A co-donor to the trust fund has FONAMA assets'. established banking relation- ships in Switzerland. Disadvantages: Disadvantages: Disadvantages: * There is a tax on all security FONAMA has direct contact with Due to internal regulations, UNDP trades made in Swiss accounts of the asset manager; the board of has a limited range of investments 0.165%. directors does not. Furthermore, it can make for the fund's portfolio, * A Swiss citizen must serve on the Board is not defined in the and it will be difficult to obtain a the Foundation's board of Trust Agreement between wide diversification in the asset directors FONAMA and the Bank. mix. Biodiversity Series 51 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation 52 Environment Department Papers 7 Asset Management This chapter introduces asset management principles and is divided into three sections which focus on: issues of return/volatility, criteria for selection of an asset manager, and other issues on investments. Summary of the Main Points * The investment strategy must be consistent with the trust fund's objectives and guidance provided to the asset manager on risk, return, disbursements (liquidity) and currency. * Volatility in a portfolio can be reduced by: (1) a longer time horizon and more flexibility in the disburse- ment schedule since this decreases the risk of being forced to sell securities at a loss and (2) diversifica- tion in assets. * The selection of an asset manager should take into account: (1) investment capability, (2) experience and reputation, and (3) ability to guarantee the safety and stability of the invested assets. * Fees should not be an over-riding factor in the selection of an asset manager. * Other investment issues covered are location of an asset manager relative to performance in different financial markets, investing in emerging markets and socially responsible investment. Key questions addressed in this chapter: * What is the risk/volatility relationship of a portfolio and how might it be decreased? * How does diversification affect volatility? * What criteria should be used for selecting an asset manager? * Should fees be a factor in asset manager selection? * Under what conditions might emerging markets be an investment avenue for trust fund assets? * What is socially responsible investing? Biodiversity Series 53 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation What is Investing? 0.1% is a safe estimate. Furthermore, if the trust fund is to maintain its real value over time, Investing means purchasing securities on a stock income must be plowed back into the corpus to exchange with the intention of holding them to compensate for inflation. Therefore, when earn dividends or selling them later for a profit. planning an investment strategy, differentiation should be made among gross returns, real returns e Buying a stock for a trust fund means that (inflation adjusted) and real net returns (inflation the trust fund is a shareholder in that adjusted minus fees, administrative and tax company. The board of directors needs to charges). decide if they will be active or passive shareholders, or perceive any social or For example, if an investment account earns 1-1 % ethical responsibility with that role (see in one year and inflation is 3%, the net real return Other Investment Issues, page 59, on socially to the account is likely to be 11% - 3 % -1.1% and environmentally responsible invest- (management fees) = 6.9 %. ments). Devising Risk Stkategies * Bonds, or "fixed income securities" are the debts of either a government, corporation, or Although there are no inviolable rules for estab- multinational agency which have been lishing a level of risk in a portfolio, there are two packaged and sold on the market to raise factors which tend to decrease risk: long-term money for the issuer. The price of the debt horizons and diversification. Both of these need to and interest rate will depend on the overall be assessed for each trust fund. economic climate, but also on the risk that Long-term Horizons. Timing becomes an important the debtor will default on the loan. A rule of issue when funds must be distributed at regular thumb is: the higher the yield over current intervals. Scheduled disbursement might fall a,t a usually rated for risk. The two standard time when there is a decline or negative growth in usuallysrteds ford ris. .Tertwonstadard the portfolio's value. There may also be periocLs of rating systems used internationally are Moodys and Standard and Poors. Most high growth when total returns exceed disburse- conservation trust funds will want only AA ment needs. The more flexible the distribution or better rated bonds. schedule, the longer the recovery period afforded a portfolio after a period of poor market perfor- o When deposits are purchased, the bank withi mance before having to distribute income. (See whom they are deposited usually loans the Chapter 4, "Distribution of Income Plan", page 31, money to other lenders (in simplfied terms). on income distribution plans and disbursements.) Therefore, it is necessary to ensure that the Diversification. Moderate diversification within bank does not have a credit risk, or that the the portfolio is perhaps the most effective tool to deposits are insured federally. decrease volatility. Diversification of assets refers to: WVhat is Total Real Return? * The classes of asset (stocks, bonds, bank Investments grow through interest paid on bonds deposits) and bank deposits, dividends paid on stocks and * The breadth of investment (moderate interna- capita gains on bonds and stocks from an in- tional diversification, quality of assets, use of crease in market value. These asset classes tend derivative products) to perform differently. The difference between the classes of assets is The gross return of an investment will be reduced outlined at the beginning of this chapter. The by any management fees, adminstrative fees, or breadth refers to the geographic spread, quality taxes which are charged against the account. As differences, and use of spin-off or derivative outlined in Annex 4, a rough guide to asset products. For conservation trust fund portfolios, management fees suggests that a management fee the latter two are less important because a conser- of 1% plus custodial fees and other expenses of vative strategy rules out any lower quality assets' 54 Environment Department Papers Asset Management and derivative products which tend to be volatile. * seek maximum growth with no distribution for (N.B. not all derivative products are high risk, but the first five years, after which steady income a discussion of these products is beyond the flows are required; scope of this paper. Any large international asset require absolute secure income distribution management group or bank can provide this for the first five years, after which the dis- information.) bursements might become more flexible; Investments in global markets have increased * seek maximum growth and have flexible, significantly in recent years. The US stock market rolling disbursement schedules. now represents only 3840% of the world's capital market. As capital markets grow internationally, Different investment strategies are required in the the importance of "not putting all your eggs in three cases. GEF supported conservation trusts are one basket" increases. A moderate diversification also likely to have needs which change over time. of investments among a few markets has de- Therefore the asset manager will periodically creased performance volatility and increased require updated information and feedback from the performance over a one-market portfolio. The trust management (trustee/ board of directors). chart on page 56 (Box 7.1) shows that for inves- Once the risk/ return and disbursement needs have tors based in the US dollar, for the period of 1960- been established, the asset manager should 1992, a portfolio with 70% US investments and indicate the asset mix expected to be used in the 30% foreign investments had the lowestvolatility portfolio. It should be stipulated that either the (roughly 7.5%) and slightly higher return board or the asset manager can reopen the discus- (roughly 8.25%) than a portfolio with 100% US sion on investment strategy. investments (which had an 8.25% volatility and 7.0% return). This chart also shows that moving Selection Criteria for Asset Managers away from diversification leads quickly to higher volatility, and increased returns. Each trust fund will have a unique set of require- ments for asset management. Therefore, it is not The major source of volatility in internationally possible to set out a matrix of criteria for all trust diversified portfolios comes from the currency funds to follow. The criteria need to cover a wide fluctuations. A rule of thumb is that in a global range of factors, including the institution's finan- bond portfolio, currency fluctuations make up cial record, asset management performance record, roughly 50% of the total return. In a global stock staffing, organization and reporting, investment portfolio, currency fluctuations make up around philosophy, total costs and any other special 25 % of the total return. Therefore, extensive attributes specific to the needs of the trust fund. diversification for a very conservative bond portfolio may not be recommended. However, for Criteria generally fall into three categories: invest- funds with some equity positions, international ment capability, experience and reputation and diversification should be considered for a small ability to ensure the safety and stability of assets. percentage of the assets. Alternatively, the impact of currency fluctuations could be minimized by Investment Capability holding a portion of the fund assets in currency options or tying a portion of the assets to a major * Powers - The asset manager has the capabil- currency in use in the country where the trust will ity and flexibilty to invest so as to reach or operate (US$ for Latin America, FF for exceed established benchmarks francophone West Africa). - Performance Record - Should be consistently The range of acceptable risk and impact of (10 years or more) above or in line with volatility will also in part depend on the objec- relevant general and specific benchmarks.2 tives of the trust fund and anticipated administra- - Capacity - Has the experience and capacity in tive costs and disbursements for board-approved construction of balanced protfolios consisting conservation activities, programs and institu- of significant proportions of long-term fixed- tions, and must be clearly spelled out to the asset income instruments, equities and cash, and manager. For example, a trust fund may: has indpendent research and analysis capability. Biodiversity Series 55 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Box 7.1 Chart of Diversification, Risk and Return 12- S 7 3 ~~~~~~~~~~~~100% n-US stocks ~11 U, 6 m 7 8 9 10 11 12 Volatility (%) C ~ ~ ~ ~ ~ ~ ~ ~ Box 7.2 Examples of Asset Management Affangements and Investment Strategies Trust Fund Asset Management Arrangement Investment Strategy MBIFCT, Uganda UK commercial asset manager Low risk, emphasis on reliable yield of a set minimum of income, mix of stocks and bonds BTF, Bhutan UNDP treasury department Very low risk: US Dollar short term deposits and government bonds FONANPE, Peru Domestic asset manager Same as govemment funds are invested 56 Environment Department Papers Asset Management * Cost -The asset manager is cost-effective use of hedging instruments, and capability relative to other asset managers with similar and flexibility to diversify investments responsibilities. across countries and asset types. When selecting from among several asset manag- Experience and Reputation ers, care must be taken that relevant performance * Experience - Extensive in terms of years, records are compared. For example, a ten year foreign and local clients, and specific asset track record in bond management does not types which are relevant to the trustee's provide information about the manager's ability needs and objectives. to manage stocks. Track records should be made available upon request. These are usually * Reputation and Rating - Based on reference comparisons to either the performance of the checks, reputation is excellent; international entire market, for example all international stocks rating is top (AAA or AA) and has high in a weighted index (e.g. Morgan Stanley Interna- client retention rates. tional Capital Index) or relevant sectors of the * Management and Staff - Are competent, market (e.g. only AAA rated bonds). Past perfor- highly professional and compatible with mance, however, may be a guide but is no guaran- foreign and local investors; generate signifi- tee of future performance. Many asset manage- cant business volume, ment groups are wholly owned subsidiaries of major international banks. To check the financial * Social and Environmental Responsibility - soundness, credit ratings of the bank and parent Asset Manager can offer options to adapt institution should be easily obtainable from the the portfoho to criteria the chent may pro- asset manager. The history of the company can pose regarding issues of social and environ- also be indicative. Has the group existed 5 or 50 mental responsibility. years? In some countries, insurance on bank deposits may be obtained, sometimes automati- Safety and Stability cally. * Safety and Stability - The asset manager The use of a banking group with a regional and/ maintains investment philosophy and or international exposure may also help attract portfolio which minimizes exposure to risk, large corporate donors who are active investors in as demonstrated by historical and current the region of the project. Often a banking group portfolio; has no history of legal difficulties, which is well established in a developing country can ensure that assets are protected from serves as the link between the corporation and the being used in any way than that intended; is developing countries. Thus, a trust fund associ- not affiliated with financially unsound ated with such a bank may be able to solicit institutions or politically vulnerable coun- corporate donations. Furthermore, the bank may tries. actively help the trust fund raise funds from * Liability - The asset manager has a fiduciary corporate donors. responsibility and is held legally responsible Selection of Asset Management for a "standard of care" which ensures that funds are not misused; and is not eligible for Services and Fee Structures any indemnity from the Trustee (or at most, only indemnity for losses due to Trustee The selection of a trust fund asset manager does negligence). not fit neatly into the Bank's Guidelines for the selection and employment of consultants3 How- * Risk Management Systems - The asset ever, many of the same principles and practices, manager has capability and flexibility to appropriately adapted, should be applied. invest in long-term assets, regularly employs Selection should be based on competition among mechanisms (e.g. automatic stops) for pre-qualified asset managers. The competing avoiding losses due to large movements in banks or firms should be provided the same markets, capability and flexbility regarding information about the trust objectives and income Biodiversity Series 57 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation needs, as well as the criteria serving as the basis for selection, and asked to prepare written Uganda MBIFCT - Asset Manager proposals. Fees, which are discussed below, Selection while a factor in selection, are not easily compa- To assist the Ugandan trust design team in rable, and therefore should not be included T sitteUadntutdsg emi the, .form selec non ce itcau lob selecting an asset manager, the services of an among the formal selechon criteria. It may also be independent financial adviser (an individual) advisable to engage an independent financial were engaged. Terms of reference for the expert to advise on the selection process as was financial adviser specified the information the done for the Uganda MBIFCT. adviser was to obtain from each firm; this formed the basis for the criteria used to Is there a correlation between location of the prequalify and select the asset manager. asset manager and performance in the different markets? It depends on the basis of comparison. The adviser first issued a general enquiry to 29 For general equities and fixed income securities, prequalified interational banks/firms to which there is usually not a significant difference in 12 responded to which 11 responded by submit- capability in asual t manasignifint difference m r ting detailed proposals. The adviser evaluated capability in asset managemnent between major the proposals, identified the 3 highest ranked international banks. Most international asset banks/firm and ranked them in turn. A detailed managers have offices and research bases in all report of his evaluation was provided to the major markets and regions. Furthermore, all Ugandan team. investment companies buy research on markets and securities from locally based banks. For Funded by a GEF Project Preparation Advance, example, a Swiss bank may have a branch in New the Ugandan team interviewed the top 3 ranked York which does some research onUS stocks, but banks/firms with the financial adviser and it wlfl also buy research on US markets from established their own ranking. American firms. Any US management firm will also buy research on US securities, even though it Results worth noting: has its own capacities for in-house research. This * The Ugandan team's ranking of the firms is true for all major markets. was not identical to that of the financial adviser. This was nonetheless acceptable as For some derivative products (e.g. options, all three firms were considered to be of high mortgage guaranteed securitits, ftureopts, tc)caliber with only minor differences. The mortgage guaranteed securities, futures, etc) financial adviser stressed the importance of which are only traded in the US markets, an a comfortable working relationship as a American based firm may have an advantage due factor in the selection, with the interview to familiarity with the product. However, these process being a key factor in establishing specialized products are not likely to be common this. features of conservative portfolios such as conser- * Fee estimates were included in the informa- vation trust funds. tion to be obtained by the financial adviser, but they were not a deciding factor in the In conclusion, the asset management needs of a selection. The selected firm's fees were the conservative trust fund will most likely be met by second lowest, rather than lowest in cost of any large international, top ranking banking the 3 candidates. group or investment firm, regardless of location * The financial adviser was kept on retainer and national origin. while the banks/firms were preparing their proposals which was useful to answer Management Fees inquiries from the banks/firms. Keeping the adviser on retainer throughout the Although asset management fees are an impor- interview and selection process is highly tant criterion in selecting an asset manager, they advisable. should not be an overriding concern. Quality of investment service and security of assets are the most important factors. Furthermore, in today's largely deregulated markets, most management services are competitively priced. It is also difficult to compare exact total costs of asset 58 Environment Department Papers Asset Management management due to the wide variety of fee across a range of countries. A global emerging structures offered. Annex 4 provides the basis for market fund offers perhaps the greatest advantage establishing fees and various examples. of growth and supports a wider range of capital markets. The asset manager should build the Other Investment Issues investment strategy, incorporating the percentage that will be managed in a mutual fund. For Investing in Emerging Markets and the example, for a portfolio which may have 25% of Use of Mutual Funds its assets invested in global equities, the fund manager may decide to allocate 3% to an emerg- Should part of the funds be invested domesti- ing market fund. The remaining 22% are invested cally or in the region of the Trust Fund? As in other markets accordingly. (See Annex 4 for a outlined above, diversification refers both to the listing of recent performance of mutual funds type of security, the quality of the security, and the invested in regional emerging markets.) home market and currency of the security. Global diversification refers to the distribution of invest- The major disadvantage of mutual funds is the ment over a range of markets. "Emerging Mar- lack of personally tailored management. The kets" refers to the capital markets in developing funds are pooled, and client's individual needs countries. It is sometimes possible to invest in the are not taken into consideration. Therefore, it may markets of country or region served by the trust not be appropriate for the entire portfolio, nor fund bringing an additional benefit to the country large portions of it, but is not a serious limitation of the trust. A full discussion on the benefits of for small percentages of the portfolio. The other and issues concerning investing trust fund assets disadvantage of mutual funds include the extra in local capital markets is beyond the scope of this management fee, which can be up to 7% of the paper. It must be noted that volatility tends to be assets invested. Fees can be waved or greatly high in these markets, and other risks do exist. reduced if the mutual fund purchased is managed However, a brief outline of the main benefits of by the same company who is managing the trust investing a small portion of funds in emerging fund portfolio. Therefore, it may become a markets is warranted: criterion for asset management selection that the * Many regional emerging equity markets have company offer competitive, top ranking mutual been stellar performers and are expected to funds. continue outperforming OECD equity The second situation in which a trust fund may consider using mutual funds is if the trust fund is • "Emerging market funds" support and managed outside of the United States. A tax- strengthen regional capital markets. exempt mutual fund may be used to invest in US stocks. Certain restrictions apply, but the options These markets require intensive specialized should be considered for those non-US based professional asset management skills which are trust funds which desire a small portion of US very different than those required to manage the equities. rest of the portfolio. Mutual funds may be a good What is socially and environmentally option for those trust funds which desire invest- r i ments in emerging markets. Mutual funds are responsible investing? pooled assets which are professionally managed One of the most challenging tasks facing today's for a fee. The advantage is professional manage- business leaders is the development of effective ment for a specific investment goal and economies responses to our rapidly evolving social, eco- of scale because the funds are pooled. Mutual nomic, and geo-political surroundings. The funds usually follow a specific investment theme, modern business corporation is generally per- invest in a specific industry or geographic region, ceived to be legitimate because it appears to fulfill or provide tax-break benefits. They can be ideal its implicit contract with the public: to produce investment vehicles for small quantities of money. the goods, services, utilities needed for the Furthermore, mutual funds reduce the risk of high provisioning and prosperity of society. It is volatility by widely diversifying the investments Biodiversity Series 59 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation further validated by the products of those activi- These funds might invest in industries which ties, including dividends and capital gains have better than average environmental track investors, employment, and development of new records or are improving equal opportunity technology. But 'business as usual' can no employment practices. longer be conceived in such clear cut terms, and many outputs of business activity (e.g. pollution, The third route is active participation by share- deforestation) can no longer be considered holders to call upon companies to improve their beneficial. social and/or environmental record. Although Socially and environmentally responsible invest- this method is slowly making an impact on ing recognizes that capital markets are not neutral companies, it is not a practical route for the and have a role to play in promoting sustainable trustees who will be unable to attend annual development. All investors, including passive shareholders meetings which are mostly held in investors who hold pension plans or endow- the US and Europe. ments are stockholders who can 'vote with their share' in at least three ways. The use of social and/ or environmental screens does not necessarily hurt the performance of the An estimated $650 million is not invested in the investments. On the basis of performance of a US following some range of social, environmental, socially responsible investment index (Domini and ethical criteria.4 Pension funds, trade unions, Social Index in the U.S.), there is no indication educational and religious organizations have that broad social screening leads to under perfor- been among the first to demand that their social or mance or has a great impact on the performance environmental concerns be reflected in their of a fund. However, it does appear that these investments. types of funds can be slightly more volatile. The most common method of socially and envi- Conservation trust funds may consider the use of ronmentally responsible investing is to establish investment screens. There are numerous socially investment screens. Screens are a list of criteria, be and environmentally responsible mutual funds it ethical, social, or environmental, through which which are traded on the US and UK stock market. all investments must pass before they are allowed However, it is unlikely that the investment to be purchased. This is known as a 'negative' screens employed by any of the mutual funds will method, because it results in investments not match exactly the concerns of the conservation flowing to certain types of companies. Some of the trust fund. The board of directors can devise an flowng t cetaintype ofcompnies Soe oftheapproach and work with the asset manager to most commonly employed negative screens work implemend It ith th at trust t.o to exclude investments in the defense and tobacco implement it. It is recommended that trust funds industries. wait until the mid-term review to consider employing investment screens. Devising the right The "positive" method focuses investments on screens is a laborious project, and should not companies which are found to be doing some- distract from the main concerns of the board of thing beneficial for society or the environment. directors in the first few years. I "Quality" assets are defined as securities of companies listed on major stock exchanges and highly rated bonds. 2 For example, the Standar and Poors 500 or Wilshire 5000 indices for intemational and emerging markets, US interna- tional bond funds, published "track records" of major fund managers. 3 Guidelines: Use of Consultants by World Bank Borrowers and by the World Bank as Executing Agency (Washington, D.C., World Bank, August 1981) 4Tennant, T., Campanale, M., "A Long-Term Investment", Environmental Strategy Europe, 1991 60 Environment Department Papers 8. The World Bank's Role in GEF Trust Fund Design and Supervision This chapter sets out the role of the Bank throughout the life of the GEF project and beyond and provides guidance on the composition of the task team needed to design a trust fund. Summary of Main Points Functions of the Bank will include: * reviewing the alternatives to and the prerequisites for a trust fund and making the case for a trust fund should the conclusion be that this is the most appropriate mechanism; * assembling a task team of specialized expertise covering the special biodiversity, legal and financial aspects of trust fund design; * assisting the client government and/ or local trust fund design committee in the design of the trust fund, including identification of the activities which would be financed from the trust fund; * reviewing and commenting on acceptability of key legal instruments and design features (trust deed, by-laws, investment strategy, asset manager selection process, procedures for procuring goods and services using trust income) * supervising implementation of the project to which the trust fund is attached; * ensuring that the goals of the GEF are met in the long run (i.e. beyond the "project life"). Biodiversity Series 61 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation The first responsibility of the task manager is to engaged and report to the government or trust review the alternatives set out in Section 2.3 of design committee such as legal counsel or a this paper to determine whether a trust fund is the financial expert). most appropriate means of meeting the conserva- tion challenge in the country. The case for a trust The key trust fund design issues which should be fund should be put forward in the initial GEF-PID satisfactorily resolved for the Bank: taxation (IEPS). Once this has been reviewed and the (Chapter 5,Taxation, page 36), attachment (Risk of decision to proceed taken, the prerequisites for a Attachment, page 37), security of the assets (Secu- trust fund outlined in Chapter 2, page 15, should riht of Assets, page 38) and elements which ensure be fully discussed with the client government and that the trust objectives will be met (Ensuring Trust the composition of a local trust design committee Objectives Will Be Met, page 39). Input from sketched out competent and experienced legal counsel early in the preparation stage is critical. For the design and structuring of a trust fund, the task manager should be supported by a team The trust funds established with GEF support including biodiversity specialists, a financial will, in almost all cases, continue operations after analyst who inter alia, will project income needs the life of the "project" which normally designs to aid in determining the size of the trust fund and vests the trust fund. The "project life" is an and minimum acceptable return, legal counsel on arbitrary period of sufficient length that it allows domestic and off-shore legal issues (most often in the Bank and donors to determine whether the addition to the country lawyer), and possibly trust is operating as designed and use of funds is financial expertise to aid the client with selection consistentwith the donors' requirements. In of an asset manager (in some cases, this expertise addition to standard supervision, a mid-term or can also provide the needed financial analysis). other period review should be a standard feabtre Funding required above and beyond the task of trust fund design. Even after the "project life", manager's administrative budget for the project there should be provision for periodic consulta- can be sought from Consultant Trust Funds or the tion with the main parties concerned (govern- GEF project preparation facility, the 1'PA (the ment, trustee(s), board of directors). latter in particular for experts who should be 62 Environment Departmnent Pap?ers The World Bank's Role in GEF Trust Fund Design and Supervision Box 8.1 Examples of the Role of the GEF-World Bank in Designing and Supervising Trust Funds Examples from Uganda and Bhutan Uganda: MBIFCT The World Bank task manager was instrumental in encouraging a very broad representation of Ugandan interests in the design of the trust fund. The World Bank will approve the board's initial membership and oversee the procedures set out in the Trust Deed and By-Laws for replacing board members. The Trust Deed and By-Laws can not be modified without the World Bank's consent during the first five years. The World Bank also prefers if the Trust Manual is not modified without their approval. The World Bank, as Trustee of the GET, has declined to be represented on the Trust Management Board but may participate as an observer. Bhutan Trust Fund: BTF To ensure that the funds are used for purposes consistent with GEF, that BTF has adequate guidance over the long term and that resources are adequately managed, the World Bank had reviewed the Memorandum of Understand- ing which provides for a management board to oversee BTF activities, the organization and management of the trust's governing body, and the financial management arrangement with UNDP. The World Bank also reviewed the proposed program of activities to be implemented over the first five-year period. GEF is represented by UNDP on the Board of Trustees. The supervising task team has been instrumental in advancing the establishment of the administrative framework for BTF management and ensuring that systems for accounting, disbursement and reporting on asset management are instituted. A decision to extend supervision beyond the 5-year project life could be taken if progress in achieving objectives is slower than anticipated. Even after the project life, the Bank could request the return of the GEF contribution if trust objectives are not being met. Biodiversity Series 63 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation 64 Environment Department Papers 9. GEF Umbrella Fund (GUF) This chapter introduces the concept of a single umbrella trust fund, either created under under the GEF- World Bank or as a separate entity. Summary of Main Points * A "GEF Umbrella Fund" (GUF) could be created to house new conservation trust funds. * Each trust fund could benefit from tax exemption, freedom from attachment and security of assets. Advantageous asset management arrangements would also be possible. * There are a number of legal, resource and practical considerations which need to be considered before deciding to proceed with an umbrella fund. Key questions addressed by this chapter: * What is a "GEF Umbrella Fund"? * What would be the major advantages of such a fund? • What considerations remain to be examined before deciding to proceed with a GUF? Biodiversity Series 65 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation The GEF Umbrella Fund (GUF) - eased communications between the board of directors and asset manager. An "umbrella fund" could be used to house * Disbursement would be easier to monitor. individual conservation trust funds which are supported by GEF financing. Options might Important Considerations include establishing the umbrella fund either as a separate trust fund under the auspices of the * The establishment and operation of a Bank or GEF, or as a separate legal entity. Each separate entity to run GUF may require individual trust fund could be a restricted sub- significant resources. However, in the long account with its own purpose, beneficiary(ies) run, there may be major resource savings and local governing body - operating at the local when compared to establishing many level as a separate and independent trust. individual trust funds. Advantages and Considerations * The legal implications would need to be fully Advantages and Conslderatlons explored, particularly as these relate to goals and structure of the Global Environment The GUF trust funds would benefit from the Facility. Bank's tax exempt status, and would not be vulnerable to attachment. The assets could be * Some countries may perceive a loss of securely invested with top quality professional ownership as well as "loss of control" over asset managers (in-house or from the private their trust fund if it is housed under a central sector). The funds could be revocable to GEF, and umbrella, possibly centrally invested and therefore concerns of frustrating the individual revocable to the GEF. trust fund objectives could be minimized. Because There might be some loss of capacity build- several important design issues could be resolved ing in financial management if the GUF has expeditiously, the time and resources required to the major role in asset management deci- set up a multitude of customized trusts would be sions. This might be lessened by ensuring greatly reduced. Furthermore, GEF funds might be the integration of client country experts inlto used more effectively to leverage other financing: the GUF or structuring the GUF around a donors might find such an arrangement more family of specialized funds, similar to reassuring owing to reduced risk and system- mutual funds, in which trust managers atized financial reporting and auditing. could place and then move trust fund assets. In addition: * Control systems could be somewhat stan- The potential benefits of a GUF warrant further dardized, and centrally evaluated. examination. Many of the difficult issues (tax liability, attachment) and time intensive design * ommingling would allow for: factors (customized trusts, selection of asset - creaion of smaller funds (under US$ y manager) which now absorb resources and 5 million) initially. lengthen considerably the time required to - economies of scale and lower transac- establish a trust might find a simpler, more tions costs, and a likelihood of better expedient resolution. However, the "costs" of returns with lower volatility; establishing and operating a GUF must be examined and careful thought needs to be given - greater possibiliies to invest in emerg- to designing a GUF which could maintain many ing markets and socially responsible of the secondary benefits of trust funds which funds; accrue to client governments. 66 Environment Department Papers Annex 1 Profiles of GEF- Supported Trust Funds Slovak Republic Biodiversity Protection Project Poland Forest Biodiversity Ukraine Trans-Carpathian Mountains Biodiversity Protection Project Foundation for Eastern Carpathian Biodiversity Conservation Objective of the Foundation: The Foundation will be established to fund joint transborder ecosystem management and protection activities and the establishment of research and monitoring capabilities within the participant countries. Size of Fund: Initial Size: US$ 600,000 Growth Objective: not specified Role of GEF: The GEF will provide one of two initial contributions of US$ 300,000 each to vest the fund. Other Donors: The MacArthur Foundation financed assistance from WWF to design the Trust Fund and provided the second of the initial contributions. Status of Trust Fund: A framework agreement to establish the Foundation was signed September 16,1993 by the three Governments, the MacArthur Foundation and WWF. The Deed and By-Laws have been agreed by the five parties and registra- tion is anticipated for May 1994. Special Design Features: No part of the Foundations's initial capital may be withdrawn to fund activities, and a maximum of fifteen percent of income can be used to cover administrative costs. The foundation will be established in Switzerland as a charitable organization and must have a Swiss citizen on its board of directors. The board of directors will comprise 14 other members: four appointed from each country, one from WWF, and one from the MacArthur Foundation. Decisions will require affirmative votes from 9 of the government appointed members and one of the NGO members. Day-to-day activities will be conducted by an executive committee which is a balanced sub- set of the board. Biodiversity Series 67 Annex 1 Uganda: Conservation of the Bwindi Impenetrable National Park and the Mgahinga Gorilla National Parks Mgahinga and Bwindi Impenetrable Forest Conservation Trust (MBIFCT) Objective of the Trust: The trust beneficiaries are two forests in Uganda which are among the most biologically diverse forests in East Africa. The main objective is to provide reliable, long-term financing for incremental support for park manage- ment and research and to help local community groups develop economic activities which will provide alterna- tive means of meeting needs which were traditionally met by harvesting forest resources. Size of Trust Fund: Initial Size US$ 4 million Growth Objective: not specified Role of GEF: The GEF financed through a preparation advance of about US$ 165,000 community consultation and technical assistance to design the fund and provides the initial funding of US$ 4 million. Status of Trust Fund: The Trust Fund was established on February 22,1994. Special Design Features: MBIFCT will be established as an independent body under Ugandan law. The assets will be managed by an offshore professional asset manager . The governance has been carefully arranged so that the interests of the local communities are addressed. A Trust Management Board (TMB), consisting of representatives from the National Parks, the Forest Department, national and international NGOs, a research institute, the private sector, and residents of the three affected districts, will serve as Trustees of the funds. A local steering committee will serve as the main liaison between the TMB and the communities. A trust administration unit and technical advisory committee (including ecological/environmental sociologist, economic expertise) will be established. 68 Environment Department Papers Annex 1 Bolivian Biodiversity Conservation Project Cuenta Fiduciaria para el Sistema Nacional de Areas Protegidas (CF/SNAP) Objective of the Trust: The trust fund will finance the recurrent costs of the management and operations of the priority protected areas belonging to the National System of Protected Areas (SNAP), the central support programs of the SNAP and the National and Regional Directorates of Protected Areas. Size of Trust Fun&s Initial Size: US$ 1 million Growth Objective: US$ 35 million by end-1997 Role of GEF: A GEF project preparation advance of US$ 40,000 was granted to finance legal counsel to identify an appropri- ate legal structure for the fund to achieve its objectives and with regard to potential tax and attachment issues. Status of Trust Fund: The fund was created June 17, 1993 and received an initial contribution of US$ 1 million from the Swiss Devel- opment Cooperation. Special Design Features: The fund is part of the structure of the Fondo Nacional para el Medio Ambiente (FONAMA), the Govemment environmental umbrella fund. Morgan Guaranty Trust Company is Co-Trustee and asset manager. The fund is governed by an administrative council established under the by-laws of FONAMA. Objective of the Trust: The proposed trust/sinking fund would support recurrent costs of long-term activities designed or identified during the initial phase of the Brazil Biodiversity Project to produce long-term gains in biodiversity conserva- tion through public and private sector partnerships. Biodiversity Series 69 Annex 1 Brazil Biodiversity Project Size of Trust Fund: Initial Size: US$ 20 million Growth Objective: To be determined Role of GEF: The GEF supported project will finance the design of the sinking fund and contribute US$ 20 million. The project will also finance efforts to seek additional contributions to the fund. Status of Trust Fund: Establishment expected in mid-1995. Special Design Features: The trust will be organized as a sinking fund with a life of 20 years to be managed by a Foundation assisted by an Executive Secretary, the asset manager, and an administrative agent and technical committees.. It is expected that the principal of the fund will be held offshore and invested by a professional asset manager, with oversight by a board of experienced financial experts. A portion of the income and principal of the fund would be used each year to support projects approved by the Foundation's Board of Governers. 70 Environment Department IPapers Annex 1 Bhutan Trust Fund for Environmental Conservation (BTF) Objectives of the Trust: The main objective is to assist the Royal Government of Bhutan (RGOB) in conserving its forests and preserving their rich biological diversity. The income generated during the first five years will fund the establishment and management of a national system of protected areas and the development of institutional capacity and human resources to manage the system. Size of Trust Fund: Initial size: US$ 9.5 Million Growth Objective: US$ 20 Million Donors: GEF 7,000,000 WWF-US 1,000,000 Norway 586,725 Netherlands 948,163 Role of GEF: The GEF contributed US$ 7 million to vest the fund. An additional US$ 3 million would be added when actions are met relating to reform of key institutions and the protected area system. Special Design Features: The trust was established under the auspices of UNDP which ensures a tax-free status. The funds are invested by UNDPs Treasury Section. WWF-US and UNDP both sit on the Board of Directors with three representatives of the RGOB. Decisions will be adopted by a four-fifths majority of full membership The World Bank will formally supervise the fund for the first five years of its operation or until the second tranche is released, which- ever comes later. Status of Trust Fund: The fund was established March 6,1991. Biodiversity Series 71 Annex 1 Seychelles Biodiversity Conservation and Marine Pollution Abatement Project Seychelles Island Foundation Objective of the Foundation: The Foundation manages two World Heritage Sites: Aldabra, the world's largest coral atoll and the Vallee de Mai National Park. Size of Trust Fund: Initial Size: Undetermined (assets were transferred from the Royal Society when the SIF was created to replace it) Role of GEF: Through the GEF project, SIF management and scientific capabilities will be significantly strengthened. Status of Trust Fund: In 1979 SIF was established as a public charitable trust under the laws of the Republic of Seychelles. Special Design Features: The President of the Republic is the Patron of the SIF. The Foundation enjoys a tax exempt status.The Board of Trustees has 14 members who serve for no more than three years and are both local and international. Not less than three represent the interests of the Seychelles's government and not less than five represent organizations concerned with conservation. Currently the Board of Trustees is comprised of half locally based professionals, representing community development, tourism, Ministry of the Environment and of Education, a local NGO and UNESCO. The overseas member represent large conservation agencies and NGOs such as IUCN, Society for Nature Conservation, ORSTOM, the Smithsonian, as well as individuals serving in their own capacity. The Foundation is currently operating as a revolving fund, based on annual receipts from the Vallee de Mai National Park. 72 Environment Department Papers Annex 1 Congo Wildlands Protection Project Objective of the Trust Fund: The Trust Fund would support a portion of the recurrent costs of the protected areas whose improvements will be financed by the GEF supported project. Size of Trust Fund: Initial Size: To be determined Growth Objective: To be determined Role of GEF: The GEF will provide US$ 300,000 under the Wildlands Protection Project to design, establish, and promote the trust fund. Status of Trust Fund: It is expected that the trust fund will be established by year three of the GEF project, i.e. sometime in 1996. Biodiversity Series 73 Annex 1 Lao PDR Wildlife and Protected Areas Conservation Project Objective of the Trust: Long-term financing of recurrent costs for operating and managing the Lao PDR protected areas system and other conservation activities. Size of Trust Fund: Initial Size: To be determined Growth objective: To be determined Role of GEF: The Wildlife and Protected Areas Conservation Project provides for six months of expertise for the design of the administrative, legal and financial aspects of a conservation trust fund, as well as its establishment. Status of Trust Fund: It is expected that the Trust Fund will be established two to three years after the start of the project. 74 Environment Department Papers Annex 1 Ukraine Danube Delta Biodiversity Project Objective of Trust: The Trust Fund would fund the recurrent costs of the expanded protected areas in and around the Ukraine portion of the Danbue Delta. Size of Trust Fund& Initial Size: To be determined Growth Objective: To be determined Role of GEF: The GEF Danube Delta Biodiversity Project provides US$ 12,200 for technical expertise to design the legal, administration and financial constructs of the trust. Status of Trust Fund: The trust fund will be prepared in year 3 of the project. At that time a realistic estimate of annual recurrent costs will be possible from which the size of the trust fund can be defined. Biodiversity Series 7 5 Annex 1 Peru Trust Fund for Conservation Units Fondo Nacional para les Areas Protegidas por el Estado (FONANPE) Objective of Trust: The goal is to provide sustained and predictable funding for Peru's key protected areas to ensure survival o.f a representative, viable sample of Peru's biodiversity. The income generated would finance park management, and upgrade the training and development of management plans. Size of Trust Fund: Initial Size: US$ 4 million Growth Objective: US$ 20 million after five years Donors: GTZ: US$ 1.5 million (outside of trust) Role of GEF in Trust Fund: The GEF will vest the fund with a $4 million contribution with the expectation of additional donor funds being made available after a three-year "proving" period. The GEF also made available preparatory funds of about US$ 19,000 for legal counsel on trust design. Status of Trust Fund: The Decree Law creating FONANPE and PROFONANPE was issued December 29,1992 and the Supreme Decree setting out the regulations governing them onJuly 16,1993. Special Design Features: FONANPE was created as an intangible trust fund. PROFONANPE is a not-for-profit entity under private law which administers FONANPE. The latter is governed by a management board consisting of: three representa- tives from the government, two from Peruvian NGOs and one from an international NGO. The board is advised by an independent technical committee of scientists and natural resource professionals. The funded protected areas will have their own advisory board, composed of local NGOs, local government officials, and indigenous groups where appropriate. The funded protected areas will have their own advisory boards, composed of local NGOs, local government officials and indigenous groups. Funding from GTZ is being used to finance conservation activities and operating expenses of FONANPE/ PROFONANPE for the first two years, until the trust fund is vested and has built up some income. 76 Environment Department Papers Annex 1 Belarus Biodiversity Protection Project Belovezhskaya Primeval Forest Foundation Objective of Trust: The objective of the trust fund would be to sustain the biodiversity protection program for the Belovezhskaya primeval forest. Size of Trust Fund: Initial Size: To be determined Growth Objective: To be determined Role of GEF in Trust Fund: US$15,000 in included in the Belarus Biodiversity Protection Project to develop the legal and financial frame- works as well as operating procedures for the trust. Status of Trust Fund: Design work will begin in 1994. Biodiversity Series 77 Annex 1 78 Environment Department Papers Annex 2 Profiles of Other Biodiversity Conservation Funds Structured as Trusts or Foundations Belize Protected Areas Conservation Trust (PACT) Objective: The fund will support and help coordinate the nationwide effort to establish, operate, maintain, and enhance protected areas, and other natural and cultural protected resources for the propose of conservation and mainte- nance of biodiversity. Size of Fund: Initial Size: $ 2 million per year Growth Objective: To be determined Role of International NGO: An international NGO representative will be on the Board of Directors, Advisory Council, and Honorary Board. Status of Fund: Recent change in the government has slowed down progress in developing the fund. Special Design Features: Funding for this revolving fund will come from a $20 per person fee collected from foreign tourists. In addition, it is expected that 20% of all site entry fees, recreation related licenses and permit fees as well as concession fees to be collected at individual protected areas will be put in the fund. Funds can be invested in the short term, but it is expected that 95% of the funds raised in a given year will be spent in the following year. The Board of Directors will consist of nine members: one from a conservation NGO, one from a rural develop- ment organization, one from village councils, three government representatives, and one member at large elected by the other members of the board. PACT's Financial Secretary and Executive Director will be non- voting members of the board. A majority vote is necessary for decision making. An "Honorary Board" of three to five persons will help enhance and portray the role of PACT; members may include public figures and repre- sentatives of prominent international NGOs. An Advisory Council, consisting of 11 representatives of relevant public sectors, NGOs and one at large member will prepare a five year National Strategic Plan to outline policies and direction for PACT. Biodiversity Series 79 Annex 2 Colombia Ecofondo Objective of Tnrst Fund: To strengthen the capacity of NGOS to implement projects and promote co-management of the protection of Colombia's natural resources at a regional level between government agencies and NGOs. Size of Fund: Initial Size: $ 6 million Growth Objective: To be determined Role of NGOs: NGOs were instrumental in creating the fund and will have majority membership in the Board of Directors, Status of Trust Fund: The statutes of Ecofondo were approved in a constitutional assembly on February 6,1993. Special Design Features: The fund is structured as a private, non-profit corporation and is intended to operate as an endowed fund. The initial contribution to the fund was received through the Enterprise for the Americas Initiative. The governing structure will include a General Assembly of 300 representatives of NGOs and State agencies. The General Assembly will elect Board members, define statutes and approve the budget. The Board of Directors will have seven members, five from the NGO community and two permanent representatives from Government, and will set policies and guidelines and establish the basic framework of the operations. The governance structure also includes technical committees, up to 12 regional advisory boards and an office of the Executive Director to manage fund logistics. 80 Environment Departrnent Papers Annex 2 Guatemala Fideicomiso para la Conservacion en Guatemala (FCG) Objective of the Fund: To support conservation activities, strengthen both governmental and non-governmental organizations and promote sharing of responsibilities between those two groups. Size of Fund& Initial Size: US$1 Million Growth Objective: US$ 10 Million Donors: US Commercial Bank, Whitley Foundation (UK), WWF Role of International NGO: WWF was instrumental in creating the trust and vesting it. Status of Trust Fund: The trust was created in April 1991 by three Guatemalan NGOs, WWF and the Banco del Quetzal. The first review of projects to determine eligibility for financing tool place in June 1993. Special Design Features: 80% of annual income will finance conservation projects with the remaining 20% reinvested. The FCG is governed by a five-member Administrative Committee comprised of four voting members (3 local NGOs and WWF) and a non-voting member from the National Parks Commission. The Committee can be expanded to nine voting members, including public and private sector representatives. Biodiversity Series 81 Annex 2 Honduras Fundacion VIDA Objective of the Foundation: To promote and contribute to the conservation of Honduras' biological and cultural heritage by securing financial and technical resources to channel to organizations implementing programs of conservation, educa- tion and sustainable development. Size of Fund: Initial Size: About $4.5 million Growth Objective: To be determined Donors: Govemment of Honduras, USAID, UNDP, National sources Role of NGOs: Funds are given to locally based projects developed by Honduran NGOs and which respond to the following priorities: (1) conservation of ecosystems and protection of biological diversity; (2) environmental and ethno- cultural education; (3) conservation and sustainable management of watersheds; and (4) pollution control. Status of the Foundation: The foundation was granted legal status on April 2,1992 by Presidential Resolution. Special Design Features: Fundacion VIDA finances the implementation of environmental projects through other organizations. The highest level goveming body is a General Assembly which is made up of dues-paying associates acting either in their individual capacities or as representatives of institutions. The General Assembly elects the Board of Directors which is composed of prominent individuals and institutions from different parts of the country who are working in the enviromnental field. The Board of Directors then select an Executive Director who hires a technical and financial administrative team. 82 Environment Department Papers Annex 2 Jamaica Environmental Foundation of Jamaica (EJF) Objectives: The goal of the foundation is to fund projects in the areas of restoration, protection or sustainable use of marine environment, animal and plant species, parks and reserves; development and implementation of sound systems of natural resource management and conservation programs; development of training programs to strengthen conservation institutions, generate knowledge and increase public understanding and commitment to conserva- tion; and support agriculture related activities and farming approaches to benefit the environment. Size of Fund: Initial Size: About $ 2 million Growth Objective: $ 21.5 million over 10 years Role of NGOs: Two Jamaican NGOs, the Jamaica Conservation and Development Trust and the National Environmental Society Trust, were involved in developing the framework agreement for the fund. Status: The fund was established in December 1991 as the result of a bilateral debt reduction agreement. The first project grants were made in August 1993. Special Design Features: The EJF is a limited liability company with membership open to NGOs with interest in the environment and child welfare. Funding is by interest payments from renegotiated debt under the Enterprise for the Americas Initiative. It is expected that the fund will operate as an endowment. The EJF is governed by a Board of Directors. All funds are held in Jamaican Government securities. A professional investment portfolio manager will eventually be hired to manage the assets. Biodiversity Series 83 Annex 2 Jamaica National Park Trust Fund Objective of the Trust: To support the operations of the national park system. Size of Fund: Initial Size: $ 447,956 Growth Objective: To be determined Donors: USAID, Conservation Trust of Puerto Rico, The Nature Conservancy, Jamaican Commercial Bank Role of International NGOs: The Nature Conservancy is one of the original contributors to the trust fund. Status of the Trust: The trust was legally established in January 1991. Special Design Features: The JNPT is the vehicle for all eligible funds to the park system, whether public or private. The trust is governed by a Board of seven persons, including three from the Jamaica Conservation Development Trust which administers the JNPT. The four other members are appointed by the Natural Resources Conserva- tion Authority of the Government of Jamaica and include private sector and university representatives. A professional portfolio manager has been contracted to manage the Fund's investments. 84 Environment Department Papers Annex 2 Philippines Foundation for the Philippine Environment, Inc. Objective of the Foundation: The Foundation will support the sustained management of natural resources and the preservation of biodiver- sity in the Philippines. To meet this objective, the Foundation will provide technical, managerial and financial support to NGOs, people's organizations, communities and other environmental protection, sustainable development, and conservation groups. In particular, the Foundation will support Philippine NGOs who lack resources of sustainable funding and technical assistance. The Foundation will also support eco-tourism efforts. Size of the Fund: Initial Size: US$ 9.2 Million (Peso equivalent of US$ 9 Million from a debt-for-nature swap funded by USAID and US$ 200,000 from a debt-for-nature swap donated by the Bank of Tokyo. Growth Objective: To be determined Role of International NGO: WWF executed the debt-for-nature swap which generated the initial US$ 9 million contribution. WWF is also a member of the Board of Directors. Status: The Foundation was incorporated in 1992. Special Design Features: This is a non-stock, non-profit corporation under the laws of the Philippines. Not more than 20% of the assets can be used for administrative purposes. The assets are invested in Philippine government securities earning market rate of interest. The Foundation is governed by a Board of Directors who represents a broad spectrum of development NGOs, environmental NGOs, business groups, governmental representatives, and WWF. There are Regional Committees based in major provincial centers. These committees will establish regional guidelines for priorities for foundation funding. The committees will develop monitoring and evaluation capabilities and review grant proposals. Biodiversity Series 85 Annex 2 Dominican Republic Fondo Integrado Pro Naturaleza (Pronatura) Objective: PRONATURA serves as a liaison among national organizations from the public and private sector that are committed to the conservation of natural resources, preservation of biodiversity and environmental protection by providing technical and financial assistance as well as facilitating information exchange. Size of Fund: Initial Size: NA As of May 1994, PRONATURA had disbursed $5.8 million. Growth Objective: NA Donors: Puerto Rico Conservation Trust, MacArthur Foundation, The Nature Conservancy/U.S. Agency for Interna- tional Development (Parks in Peril), UNDP/GEF Small Grants Programme. Role of NGOs: The seven-member Board of Directors is elected from representatives of NGOs. Status of the Fund: PRONATURA was established on January 30,1990 and began disbursing in 1991. Special Design Features: PRONATURA currently operates as a sinking fund. Donations are converted to national currency at the official exchange rate as they are received and immediately deposited in separate accounts for each project. PRONATURA 's governance structure includes a General Assembly, formed by its governmental and nongov- ernmental organization founding members. The General Assembly meets annually to elect the Board of Direc- tors 86 Enviromnent Department Papers Annex 2 Indonesia Indonesian Biodiversity Foundation (IBF) Objective: IBF has four stated goals: (1) to strive for conservation of natural resources, (2) to promote the emergence of policies, programs and efforts for the conservation, utilization, management, study and maintenance of biological resources and their diversity, (3) to initiate and promote regional, national and international cooperation among NGOs, scientific, research and educational institutions; the business community; and government agencies and (4) to foster and improve the capabilities of society and its institutions to play an active role in efforts for the conservation and utilization of biodiversity in a fair, equitable and sustainable manner. Size of Fund. Initial Size: $20 million Growth Objective: To be determined Donors: USAID, Japan, Biodiversity Support Program Role of NGOs: Seven members of the 23 member Board of Trustees represent NGOs Status of Fund. The Foundation was legally registered on 28 February 1994. The endowment fund is expected to be transferred by USAID to IBF on an installment basis between the end of 1994 and early 1996. Special Design Features: Although no current statutory definition exists in Indonesian law for a foundation, foundations have a long history in the country and are able to enter into contracts and civil actions. Biodiversity Series 87 Annex 2 Mexico Fondo Mexicano Para la Conservacion de la Naturaleza Objective: The main objective is to support and strengthen the capacity of Mexican NGOs through mid- and long-term financing of their biodiversity conservation activities and in the search for alternatives for sustainable use of natural resources. Size of Fund: Initial Size: $ 30 million Growth Objective: $ 100 million over five years Donors: USAID, Government of Mexico Role of NGOs: NGO led activities will be financed from income earned on the fund's assets. Status of Fund: The Fund has been established and in 1994, was vested by the Government with $10 million. Special Design Features: The Fund has been established as a non-profit NGO operating as an endowment. The Board of Directors is composed of representatives fro scientific institutions, conservation, development, grassroots organizations, the private sector and the government. Four technical committees (evaluation, planning, administration and international), comprised of international and national conservation experts, advise the Board. 88 Environment Department Papers Annex 2 Panama Fundacion Natura Objectives: The fund's goals are to invest in the protection of natural resources and biodiversity in Panama, to initiative development of sustainable use systems and to contribute to the strengthening of NGOs. Size of Fund: Initial Size: $ 25 million Growth Objective: To be determined Donors: Government of Panama, USAID, The Nature Conservancy Role of NGOs: NGOs are represented on the seven-person Board of Directors. Small technical assistance grants will also be made to NGOs to strengthen their capacity. Status of Fund: The Foundation has been created. In anticipation of activation of the fund, small grants have been made to local NGOs to help train staff. Small-scale conservation activities were also funded with additional USAID financ- ing. Special Design Features: The Foundation is a private, nonprofit association. Biodiversity Series 89 Annex 2 Papua New Guinea National Conservation Trust Fund for Papua New Guinea Objective: The fund will protect the environment and conserve biodiversity for the collective benefit of the people of PNG and their resources. Size of Fund: Initial Size: The goal is 20 million Kina (equivalent to $ 22 million) Growth Objective: To be determrined Role of NGOs: NGOs are likely to be members of the Board of Directors. Donors: Funds will be sought from the Government of Papua New Guinea, GEF and bilateral donors Status of Fund: The legal structure is under consideration. 90 Environment Department Papers Annex 2 Sri Lanka Wildlife Trust of Sri Lanka Objectives: The fund's objectives are to conserve and enhance environmental and economic values of Sri Lanka's natural heritage, to enhance wildlife and environmental education activities, to support elephant conservation, to support programs that compensate damage caused to human life, crops and property by elephants, to develop and sustain environmental tourism policies and programs, and to improve wildlife and protected area laws and regulations. Size of Fund: Initial Size: $500,000 Growth Objective: NA Donors: USAID Status of Fund: The Wildlife Trust of Sri Lanka was established in 1991 according to existing regulations governing charitable trusts in Sri Lanka. Special Design Features: The Trust has a Chairman and a Board of Trustees with eight members, of which three are from the private sector. The Trust also maintains profit-making tourism infrastructure in the Rendenigala/ Rantambe Sanctuary. The 1993 work plan called for fund-raising efforts through sales of souvenirs and from a membership drive. Endowment funds are invested in established commercial banks. Biodiversity Series 91 Annex 2 92 Environment Department Papers TABLE 3: PORTFOLIO DISTRIBUTION BY FOCAL AREA Number of Projects FY92 FY93 FY94 FY95 FY96 No. % of No. %of No. % of No. % of No. % of of Proj. Total of Proi. Total of Proj. Total of Proj. Total of Proj. Total Climate Change 1 20.0 2 22.2 6 35.3 5 38.5 2 13.3 Biodiversity 3 60.0 6 66.7 9 52.9 5 38.5 6 40.0 International Waters 1 20.0 1 11.1 2 11.8 2 15.4 1 6.7 Ozone Depleting Substances - - - - - - 1 7.6 5 33.3 Multiple - - - - - 1 6.7 Total 5 100.0 9 100.0 17 100.0 13 100.0 15 100.0 Commitment Value (US$M) FY92 FY93 FY94 FY93 FY96 % of % of % of % of % of Value Total Value Total Value Total Value Total Value Total Climate Change 3.3 4.5 35.5 50.8 59.1 52.0 42.5 42.7 10.1 8.0 Biodiversity 39.5 54.3 29.6 42.4 54.9 24.4 37.9 38.0 73.3 58.1 International Waters 30.0 41.2 4.8 6.8 23.8 20.8 17.0 17.0 2.7 2.2 Ozone Depleting Substances - - - - - 2.8 2.3 2.3 35.7 28.3 Multiple - - 4.3 3.4 Total 72.8 100.0 69.9 100.0 137.8 100.0 99.7 100.0 126.1 100.0 Annex 3 References for Additional Material Reference Material for Debt-for-Nature Swaps: Hansen, Stein, "Debt for Nature Swaps: Overview and Discussion of Key Issues", Environment Department Working Paper No.1, The World Bank, February 1991 Rosebrock, Jens and Sondhor, Harlad, "Debt for Nature Swaps: A Review of the First Experiences", In Intereconomics, March/April 1991. Tammes, Gerrit, Debt for Nature Conversion: What Limits Their Further Growth?, in: International Environmen- tal Affairs, No. 2, 190, p. 154. Weatherly, Paul, "Guidelines for the Africa Bureau of the Agency for International Development for Program- ming Local Currency Endowments", A report to AID/AFR/ ARTS, October 1991 References for Social Funds: Marc, Alexandre, Social Funds: Issues and Prospects; From the Alleviation of the Social Costs of Adjustment to the Support of Local Participation" Draft World Bank Paper, 1993 Marc, Alexandre, Graham, Carol; Schacter, Mark,"Social Action Programs and Social Funds", A Review of Design and Implementation in Sub-Saharan Africa", Fondation de France, Reperes a Travers le Monde des Fondations Fondation de la France, November 1992 The World Bank, "Socio-Economic Development Funds: A Guideline for Design and Implementation", Social Dimensions of Adjustment and Development Unit, Africa Region, February 1991. The World Bank, "Staff Appraisal Report, Arab Republic of Egypt: Social Fund Project", May 29,1991, The World Bank Report #9561-EGT Reference for Local Currency Trust Funds: Weatherly, Paul "Guidelines for the Africa Bureau of the Agency for International Development for Program- ming Local Currency Endowments", A report to AID/ AFR/ ARTS, October 1991 Reference for Endowments: USAID, " Guidelines: Endowments from Appropriated Funds" (Draft version), February 17,1994 Reference for Disbursement Issues: "Tackling Procurement and Disbursement Issues in Bank Financed Projects with Community Participation, World Bank, April 14,1994 Biodiversity Series 93 94 Enviromnent Departmnent Papers Annex 4 Asset Management Strategies and Management Fees This annex has 2 sections. The first looks at some of the possible asset management strategies for investment accounts. It offers as examples a few alternatives among the wide variety of options. The information pre- sented is purely informative and not intended for the task team to use in advising the domestic trust design team or trust officials. It may be useful to engage professional financial counsel to assist the trust in the development of its investment strategy and interpretation of recommendations or options put forward by the asse manager. The second section of this annex presents some "typical" fee structures for asset management. Portfolio Construction The construction of a portfolio should always serve the investment goals and risk tolerance of the client. Once an asset manager has been selected (see selection criteria, Section 7.4 of Chapter 7), he or she will prepare a detailed investment strategy based on discussions with the client. The following issues must be clarified at that point: * What are the main investment objectives: growth in market value, preservation of capital, income genera- tion, or a blend? * What is the time horizon for the investment account? * What is the risk tolerance? * What are the income needs? How often will income be transferred? (e.g. annually, bi-annually, quarterly) * What will be the base currency? (e.g. US dollars, UK pounds, Swiss francs) * Will the investments include stocks, bonds, or both? * Will the investments be diversified outside of the base currency? Strategies should be adaptable. As the client's needs change over time, so must the investment strategy. Chap- ter 7 discusses examples of changing risk and income strategies. Asset Mix. In general, there are four broad categories of "asset mixes" for investment accounts. The first con- tains only bonds and bank deposits and is considered the most conservative and risk adverse. The second is a blend of stocks and bonds, but with usually less than 30% stocks. The third is a "balanced" account and is roughly evenly split between stocks and bonds. The last category is a stock account with close to 100% stocks. The blends and objectives are generalized below: Biodiversity Series 95 Annex 4 * Bond Portfolio: The primary objective is preservation of capital. A secure level of current income can be generated: 80-100% Bonds 0-20% Bank Deposits * Conservative Mixed Portfolio: The primary objective is safety of principle and limited portfolio volatility with a high and secure level of current income. 60-80% Bonds 10-30% Stocks 0-20% Bank Deposits * Balanced Portfolio: The primary objective is to earn a total rate of return which, over the long run, is in excess of short term interest rates available in the base currency. Current income is not a goal. 40-50% Bonds 40-50% Stocks 0-20% Bank Deposits * Stock Portfolio: The primary objective is capital growth. This implies a willingness to assume a certain level of risk and income generation is not a goal. 80-100% Stocks 0-20% Bank Deposits Over the long term, equities have been better investments for protecting against capital erosion by inflation. Since 1980, equity returns in the U.S. have averaged 11.7% in real terms. In the last 55 years, U.S. stocks have returned an average of 8 % in real terms. In contrast, since 1980 the U.S. bond returns have been equivalent to 8.2% in real terms. However, taken over a longer period of time, the last 55 years, they only yielded an average of 0.3% in real terms. Benchmarks. The performance of the portfolio should be evaluated using an internationally recognized stan- dard. The components of the portfol[io can also be broken down and examined vis-a-vis relevant measures. The standard international sources of comparison are: * The Morgan Stanly Capital International World Index (for globally invested stocks) * The Salomon World Government Bond Index Uganda MBIFCT Investment Strategy The investment goals of the trust are: adequate income, protection of real capital value, and a conservative strategy to maximize the long-term sustainablity of the project. Therefore, the following strategy was proposed: * bonds for income (30-60%) * stocks for protection against inflation (30-60%) * a small amount of cash for liquidity(0-10%) Bonds and stocks should be restricted to high-grade investments. Bonds should be AAA or AA+, and stocks should be in 'safe' markets. Source: Lloyd, R.G. 1993 96 Environment Department Papers Annex 4 * The Barclays de Zoete Wedd Portfolio Management Limited (BZW) World Index (for level of inflation worldwide) * Relevant performance of stocks and bond markets such as the Standard and Poor's 500 (S&P 500) for U.S. stocks or the Wilshire 5000. Investment Philosophies Each investment bank has a unique investment philosophy by which it selects the individual stocks and bonds to place in the client's account. There is no hard and fast rule about which approach produces the most reliable results. The client should always understand the approach to investments used and feel comfortable with the general philosophy. The following outlines five basic applied approaches. For Stocks - * Top Down - The use of fundamental data (usually macro-economic) to make an initial allocation decision by country, then by economic sector, under a wide range of economic scenarios. (e.g. 50% to U.S. markets, 30 % to European markets, and 20% to Asian markets) Once appropriate weighting have been identified, individual securities (stocks) are analyzed on a relative value basis and selections made, usually based upon the expected highest total rate of return and low performance volatility. * Bottom Up - The focus on individual companies and sectors of the economy is primordial to the macro economic and market specific situation. The focus is on relative stock value and selection criteria (e.g. long- term earnings growth). Asset mix, country allocation, and economic sector allocation are well defined, but secondary criteria. Value Oriented Investing- Either Top Down or Bottom Up is applied, but the actual stock selection criteria is focused on choosing companies which are undervalued relative to the industry in the market, using criteria such as price to earnings ratios. Quantitative Analysis - The movements of the markets and individual stock prices are measured and analyzed to predict future performances. There is a wide variety of quantitative analysis available. It is common for qualita- tive methods (top up, bottom down) to apply some sort of quantitative analysis as a second filter for stocks and sometimes market selection. For Bonds - There are basically two major concerns for bond allocation: currency fluctuations and interest rate movements. Quantitative and qualitative analysis can be applied to both. Interest rate expectations usually shape the lengths of matures of bond positions, for example, whether to hold a two, five or ten year bond. There are two ways to analyze currency fluctuations and interest rate movements. Separation of Currency/Interest Rates - The two are subjected to separate fundamental analysis. Comparison of interest rate differentials between countries are assessed net of anticipated currency fluctuations to determine optimal country/currency allocations. Blended Analysis - The two concerns are analyzed jointly to determine the optimal allocations. Quantitative analysis can also be applied. Management Fees Management costs usually depend on the asset mix and size of the account. The larger the account, the lower the fees as a percentage of the account size. An account of 100% bonds will also usually have lower fees than a balanced or stock account. Some common annual fee structures include: * management fees cover all transaction costs and range from 0.25% to 1% of assets; * management fees as above plus all related commissions on trades in the portfolio are charged; Biodiversity Series 97 Annex 4 * management fees as above plus all related commissions on trades in the portfolio plus a fee for collection of interest income and dividends, and possibly for each transfer from the account; * any of the above arrangements, with management fees linked to the performance of the portfolio. Additionally, custodial fees for the safekeeping on the securities and cash, as well as their documentation and registration are charged by the bank which holds the assets. Custodial fees run between 0.05% to 0.15% of the assets. The custodian is almost always the same banking group as the asset manager, which keeps the custo- dial fees at the lower end of the scale. Commissions on trades of securities or bonds are very difficult to estimate. The commissions depend upon: * which stock exchange did the trade occur; * which company physically tradled the shares on the stock market floor. Often banks must commission another broker to make the actual trade on the stock exchange floor. When this happens, commissions paid by the client are usually slightly higher to cover this additional cost. A typical fee schedule, excluding commission expenses, may be as follows: Should the asset management fees be linked to performance? Most asset managers charge a fixed fee, as outlined above. However, there is a growing trend for asset managers to link the fees charged to the perfor- mance of the client's portfolio. For example, if the annual return is 10%, the fee is higher than if it were 8%. The advantages: • there is a clear incentive for the asset manager to perform well; * net returns are easy to estimate. The disadvantages: i performance incentive may pro:mpt a more aggressive management style which can lead to higher risks (especially in difficult markets); e managers are penalized in periods of overall poor market performance and rewarded in periods of high market performance, regardless of the "value added" of their services; A compromise solution is to set performance goals below which a fixed fee is paid, above which an additional fee is paid. This fee structure can work well for aggressive stock portfolios. However, for portfolios with a large fixed income component, the realistic performance goals are difficult to establish and again may lead to undes- ired aggressive management. In conclusion, the benefits of a performance ranked fee structure appear to outweigh the negative side-effects for long-term conservative portfolios. Fee as % of Total Assets Account Size in US$ millions 10 20 50 100 Stock and Balanced Accounts 0.875% 0.75% 0.56% 0.47% Bond and Deposit Accounts 0.50% 0.40% 0.30% 0.23% 98 Environment Department Papers Annex 5 Alternatives for Funds Under US$ 5 Million This annex outlines two options for the asset management of "small" trust funds. Portfolios under US$ 5 million may wish to consider alternatives to individually managed portfolios. Although private firms can and will invest smaller accounts, the fee structure and limited diversification in the account may make commingled or mutual funds a more attractive alternate. There are two general options for this type of account: * Selection and trading of mutual funds in a private sector account; * Management by a multilateral agency in a commingled account. For the first option, a portfolio manager can manage a mix of three or four mutual funds in one account to get the exact blend of diversification desired. Fees for this type of arrangement are usually rather low. Care must be taken to purchase mutual funds that are easily traded and for which commissions can be negotiated or waved. For information on mutual funds, see Section 7.6 of Chapter 7. The following briefly outlines the current arrangements for the second option for management by UNDP and the World Bank. UNDP currently manages the US$ 9.5 million for the Bhutan Trust fund as a separate account. UNDP manages only two such funds, the other being a United Nations fund for small grants. The management of these funds is guided by the investment policy of UNDP, which restricts investments to top quality government debt and bank deposits. No commissions or fees are charged on placing funds. The World Bank manages well over 300 trust funds (although no GEF supported Trust Funds) and is currently reorganizing these funds to standardize and commingle as many of the indi- vidual funds as possible. There are some disadvantages or draw-backs in using a multilateral agency such as the UNDP or World Bank as an asset manager. Current funds are managed with a short-term investment objective and the average duration of all investments can not be more than 48 months. Conservation trust funds, being created in perpetuity, may find it advantageous to maintain a portion of their assets in longer term investments which have higher returns. Funds managed by the World Bank also have investment limitations which suit that institution, but eliminate good investment possibilities for trusts with long term growth as an objective. In the Bank's case, limits investments to government guaranteed non- corporate debt and deposits. No investments are made in stocks or corporate. Also, the agencies' invest- ment strategies are geared towards very large portfolios and may not be flexible enough to handle accounts as small as 5-10 million for individual investments. The advantages relate to commingling the funds and negotiable management fees. Due to large size of investments, commissions are usually not paid on trades. If more funds are established and a com- mingled fund is allowed, returns to scale would allow for greater diversification and most likely a higher rate of return over the long run. Biodiversity Series 99 Annex 5 100 Environment Department Papers TABLE 2: GEF-BANK PORTFOLIO DISTRIBUTION BY REGION, FY92-FY95 FY92 FY93 FY94 No. % of Commitment % of No. % of Commitment % of No. % of Commitment % of Region of Total Value Total of Total Value Total of Total Value Total Proj. (US$M) Proj. (US$M) Proj. (US$M) Africa 1 20 3.3 4.5 3 33.3 19.0 27.2 - - - - EastAsia 1 20 30.0 41.0 1 11.1 9.5 13.6 5 29.4 72.2 52.4 South Asia 1 20 10.0 14.0 1 11.1 26.0 37.2 - - - - Europe & Central Asia 1 20 4.5 6.2 2 22.2 6.1 8.7 4 23.5 6.3 4.6 MiddleEast&NorthAfrica - - - - I 11.1 4.8 6.9 3 17.7 29.5 21.4 Latin America& Caribbean 1 20 25.0 34.3 1 11.1 4.5 6.4 5 29.4 29.8 21.6 Global - - - - - - - - - - - - Total 5 100.0 72.8 100.0 9 100 69.9 100.0 17 100.0 137.8 100.0 FY95 FY96 No. % of Commitment % of No. % of Commitment % of Region of Total Value Total of Total Value Total Proj. (US$M) Pro?j. (US$M) Africa 4 17.5 East Asia 1 17.9 South Asia Europe & Central Asia 4 36.8 Middle East & North Africa 2 10.0 Latin America & Caribbean 2 17.5 Global Total 13 100.0 99.7 100.0: Annex 6 Other Financial Mechanisms: Debt-for-Nature Swaps and Social Funds There are a few mechanisms to set up monies for long term funding of conservation projects or trust funds. This section gives a brief background on debt-for-nature swaps and Social Funds, both of which can be used to meet objectives similar to those of a conservation trust fund, despite some obvious differences. Debt-for-Nature Swaps Proceeds from a debt-for-nature swap can be used to establish a large sum of local currency for conserva- tion work. This mechanism leverages donors' funds and reduces hard-currency debt of a nation and can result in a sizable amount of either local currency, bonds, or other assets to be invested for environmen- tal ends. Debt-for-nature swaps originated from the idea that the developing world should be relieved of some of its debts if, as a quid pro quo, it pledges to implement various environmental protection measures. The concept recognizes that the debt crisis and the environmental problems in the developing world are inter-linked. The goal is to reduce hard-currency indebtedness of developing countries and make critical investments in the environment. The execution of a debt swap can be seen as a four step process. First, the donor (usually an interna- tional NGO) negotiates with the government of the debtor country to establish a framework for the swap. Second, the donor purchases uncertain debt from the original creditor or on the secondary debt market, but pays only a fraction of the ordinal value of the debt. The donor is now the new title holder and can apply to convert the debt. Third, in accordance with the conditions negotiated with the govern- ment, the debt is converted into local currency or government bonds or other assets. Usually, the donor pays a levy of 10% to 30% to the debtor country's central bank, thus sharing the original discount with the government. And finally, the donor can use the funds to implement the intended conservation project. One of the most serious obstacles is the risk of inflation and devaluation decreasing the real value of the local currency fund. Second, debt conversions are time consuming, complex and in many cases contro- versial transactions. The negotiations between the donor (who holds the debt) and the debtor govern- ment to establish the exchange rate for the debt can be sticky and lengthy. Third, if the money would have been donated in any case to environmental projects, the leverage effect of purchasing the debt on the secondary market may implicitly represent a benefit to the donor (or a forced subsidy). Fourth, the conversion of hard-currency debt into local currency will raise the money supply in that currency and may create an inflationary effect. Therefore, it may be preferable to convert debt into government bonds in the recipient country instead of cash. This may result in a lack of flexibility in the spending of the funds. Fifth, there is no legal means to ensure that the objectives of the debt-for-nature swap are met. This problem applies both to agreements negotiated directly with governments and to those made with local Biodiversity Series 101 Annex 6 recipient organizations. Finally, there may be a shortage of debt on the secondary market. The secondary market is volatile and the volume is estimated to be only $40-50 million. Furthermore, there are only 20 countries whose debt are traded regularly. Social Funds Social Investment Funds, or Socio-Economic Development Funds, are funds that seeks to improve the living conditions of the poor through financing small, grassroots development projects. The fund is generally disbursed as small grants or loans. Social funds are generally sinking funds which distribute the funds for five to seven years. To the extent that GEF supported trust funds are not limited to co;nser- vation area recurrent cost financing, but also include a community support component, there are val-u- able parallels to be drawn between social funds and conservation trust funds. The following briefly outlines some of the features of social funds which may also be common characteristics to "community support" components of conservation trust funds. Social funds are demand driven; they neither identify nor directly implement projects, but respond to requests coming from communities, NGOs, and local government for support to alleviate the costs of economic reform or support development activities in the social sectors, rural development an the envi- ronment. While social funds work through government agencies, thereby strengthening institutions involved in the design and implementation of social projects and policy, communities generate project ideas. The social fund appraises the project, then supervises and evaluates its implementation. Social funds have funded mainly rehabilitation and/or construction of basic infrastructures. Key objectives are rapid implementation and support of institutions and individuals that usually have very limited access to government funds, such as NGOs. This is accomplished by distributing small amounts of funds and employing procurement and disbursement mechanisms which correspond with local level managerial capacities. 102 Environment Department Papers Glossary Article of Incorporation: The articles are legal documents which establish an entity, either as a for profit or charitable entity. Some off-shore trust funds will require an article of incorporation for the domestic organization for which the trust fund has been established. The document usually outlines the scope of activities, management structure and relationship to the assets. AssetAllocation of Investments: Assets invested in an account will purchase various types of securities (bonds, stocks, deposits) in various markets all over the world. 'Asset allocation' refers to the distribution of those assets into the different types of securities, different markets and currencies. Board of Directors: Also referred to as Board of Trustees, Management Board, Executive Committee, etc. This body governs the trust fund. Bonds: The debt of corporations or governments sold in units (usually units of 1,000) on different stock exchanges in the world. Bonds usually pay annual interest payments (sometimes called the coupon). The face value of the bond is paid ('redeemed') to the holder of the bond upon its maturity. Equity: Equity, also know as common stocks, are rights to a certain portion of a company's earnings and assets which are traded on different stock markets. See stocks. By-laws: By-laws provide the operational guidelines and procedures for the trust, such as members' functions and responsibilities in relation to decision-making, administration, financial management including appoint- ment and monitoring of the asset manager, financial reporting and auditing, review of documents and reports, legal responsibilities, as well as procedures for meetings including voting systems. Corpus of the Trust Fund: The trust assets. The original corpus may be enlarged by further donations to the trust fund. Dissolution Clause: A clause of the by-laws and/or trust deed outlining the actions to be taken with respect to the assets of the trust fund upon its closure. Biodiversity Series 103 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Foundation: A trust-like arrangement used in civil law countries where there is no legal setting for trust funds. Grant Agreement: The legal document which sets out the terms and conditions under which a grant is made by the grantor (e.g. the World Bank or other donor) to a recipient (e.g. the client government or trust). Grantor: The person or organization who makes a conveyance (grant) in legal form. Irrevocability: The inability of the settler to annul or revoke the trust income. Irrevocable trust: A trust which may not be revoked after its creation (see revocability). Liquidity: Liquidity of assets refers to the readiness of the investments to be available in cash form, either for with- drawal and disbursement or re-investment in another vehicle. Location of Assets: Locale where the assets are physically domiciled. Location of Trust Fund: The situs of the trust entity. Mutual Funds: Organizations which invest the pooled funds of many savers, thus obtaining economies of scale in invest- ing and reducing risk by diversification. The client purchases units of the funds, which can be sold on the stock market or redeemed directly to the company. Mutual funds and their objectives are varied to meet a vast range of investment needs. Plozwback: That portion of investment income returned to the corpus in order to maintain its value in real terms. Principal offund: The assets of the trust fund. See corpus. 104 Enviromnent Department Papers Glossary Revocability: The ability of the settler to annul or revoke the trust instrument by taking back power provided to the trustees. Revocable trust: A trust in which the settler reserves the right to revoke. Revolving Fund: A revolving fund has new assets added each period (e.g. annually) to the fund. It disburses its existing funds and income in each period. Risk: The probability that actual future returns will be below expected returns. Securities: Securities is a collective term for stocks, bonds, and equities. Settler: The one who creates a trust; one who furnished the consideration for the creation of a trust, though in form the trust is (or can be) created by another. Sinking Fund: A fund which is designed to disburse its principle plus income earned, over a designated period of time. Stock: The subscribed capital of a company is called a share when it is divided into portions of uniform amount. These shares, or "stocks" are traded publicly and can be bought on stock exchanges. Some companies pay out dividends (cash or more stocks) to its shareholders. The owner of a stock (the stockholder) may having voting rights depending on the class of stock owned. The most typical classes are common stock and preferred stock which generally refer to the priority given over assets owned by the company and voting rights. Volatility: Wide fluctuations in the stock market prices of stocks, bonds, and other financial instruments. Withholding Tax: Governments often exact a tax on dividends, bond interest payments, and capital gains on securities which are registered in that country and/or traded there. Most often this tax is taken, or withheld, at source. Biodiversity Series 105 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation 106 Environment Department Papers Bibliography Frothingham, Eric and Dillenbeck, Mark, "National Environmental Fund Country Profiles", IUCN/The World Conservation Union, March 9,1994 Hansen, Stein, "Debt for Nature Swaps: Overview and Discussion of Key Issues", Environment Department Working Paper No.1, The World Bank, February 1991 Larson, Jeri," Financial Mechanisms for Sustainable Conservation", AFTES Working Paper No. 1, The World Bank, May 1993 Marc, Alexandre, Social Funds: Issues and Prospects; From the Alleviation of the Social Costs of Adjustment to the Support of Local Participation" Draft World Bank Paper, 1993 Marc, Alexandre, Graham, Carol; Schacter, Mark,"Social Action Programs and Social Funds", A Review of Design and Implementation in Sub-Saharan Africa", The World Bank, Technical Department, African Region, June 1993 Fondation de France, Reperes a travers le Monde des Fondations, Fondation de France, November 1992 Global Environment Facility NGO Programme, "Guidelines for National Coordinators and Selection Commit- tees in Pilot Countries: Criteria and Procedures for Choosing Projects Proposed by Community Groups and Non-Governmental Organizations", Global Environment Facility, August 1992 IUCN, "Report of the First Global Forum on Environmental Funds", Santa Cruz, Bolivia, May-June 1994. Rosebrock, Jens and Sondhor, Harlad, "Debt for Nature Swaps: A Review of the First Experiences", In Intereconomics, March/April 1991. Schmidt, Mary and Marc, Alexandre, "Social Funds" (Working Draft of Participatory Handbook Chapter), March 15, 1994 Spergel, Barry, "Trust Funds for Conservation", WWF-US, January 1993 Sutton, Brenda, The Legitimate Corporation: Essential Readings in Business Ethics and Corporate Governance 1993 Tammes, Gerrit, Debt for Nature Conversion: What Limits Their Further Growth?, in: International Environmen- tal Affairs, No. 2,190, p. 154. Tourreilles, Francisco, "Establishing a Trust Fund", Background Paper for ATFES Workshop on Financial Mechanisms for Sustainable Conservation, July 1992 Biodiversity Series 107 Issues & Options in the Design of GEF Supported Trust Funds for Biodiversity Conservation Weatherly, Paul, "Guidelines for the Africa Bureau of the Agency for International Development for Program- ming Local Currency Endowments", A report to AID/AFR/ARTS, October 1991 Wells, Michael, "A Summary of the Benefits, Costs and Risks of Using Environmental Trust Funds for Biodiver- sity Conservation", paper prepared for the Workshop on Conservation Fiance at the Worlds Parks Congress in Caracas, February 1992 Wells, Michael, "Trust Funds and Endowments as a Biodiversity Conservation Tool", The World Bank Environ- ment Department Divisional Working Paper No. 1991-26, November 8,1991 The World Bank, "Socio-Economic Development Funds: A Guideline for Design and Implementation", Social Dimensions of Adjustment and Development Unit, Africa Region, The World Bank, February 1991. The World Bank, "Staff Appraisal Report, Arab Republic of Egypt: Social Fund Project", May 29,1991, The World Bank Report #9561-EGT World Resources Institute, "Naturali Endowmenti Financing Resource Conservation for Development", September 1989 108 Environment Department Papers Er -rer, Deprtrment W'e VVorad Bank 8'1 & I Street, N.W Washington, D,C. 20433 202 473 3641 202 477 0565,FAx Printed on 1 00% post-consumer recycled paper