INNOVATIVE REPLANTING FINANCING MODELS FOR OIL … · KUD Koperasi Unit Desa – Village Cooperative System SME Small and Medium Enterprises TLFF Tropical Landscapes Finance Facility

DON JOHNSTON, HANS HARMEN SMIT, EELKO BRONKHORST, MEI-MEI VAN DORTH TOT MEDLER, IMELDE ADJAFFON, EDOARDO CAVALLO

INNOVATIVE REPLANTING FINANCING MODELS FOR OIL PALM SMALLHOLDER FARMERS IN INDONESIAPOTENTIAL FOR UPSCALING, IMPROVING LIVELIHOODS AND SUPPORTING DEFORESTATION-FREE SUPPLY CHAINS

AA Asian Agri

BAV Bahana Artha Ventura

FFB Fresh Fruit Bunches

FPSA Fund for Forest Protection and Sustainable Agriculture

FSP Financial Services Provider

GAP Good Agricultural Practices

GAR Golden Agri Resources

IDH The Sustainable Trade Initiative

KKPA Kredit Koperasi Primer untuk Anggota

KUD Koperasi Unit Desa – Village Cooperative System

SME Small and Medium Enterprises

TLFF Tropical Landscapes Finance Facility

TLGF Tropical Landscapes Grant Fund

TLLF Tropical Landscapes Loan Facility

AC

RON

YM

S

D . J o h n s t o n , H . S m i t , E . B r o n k h o r s t , M M . D o r t h , I . A d j a f f o n , E .C a v a l l o

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CONTENTSEXECUTIVE SUMMARY ....................................................................................................................................... 4

1. INTRODUCTION ............................................................................................................................................ 10

2. SUMMARY OF INNOVATIVE SMALLHOLDER FINANCING SCHEMES .............................................................. 12

2.1 CIFOR Research on Smallholder Financing Models: Scope and Approach ........................................... 12

2.2 CIFOR Research: Summary of Findings and Innovative Replanting Financing Schemes ............................ 12

3. REPLANTING PERSPECTIVES: MOTIVATIONS & CHALLENGES .............................................................................. 16

4. CASE ANALYSIS: PLANTATION COMPANY REPLANTING FINANCING SCHEMES ............................................. 21

4.1 Golden Agri Resources (GAR) .................................................................................................... 21

4.2 Wilmar ................................................................................................................................. 23

4.3 Cargill .................................................................................................................................. 26

4.4 Asian Agri ............................................................................................................................. 27

4.5RoleofCooperatives(KUDs),AdditionalIncome,andLandCertificatesandUse..................................29

5. INVOLVEMENT OF THE FINANCIAL SECTOR AND GOVERNMENT ........................................................................ 30

5.1 Commercial Banks .................................................................................................................. 30

5.2 Impact and other Investors ......................................................................................................... 31

5.3 Government Initiatives .............................................................................................................. 33

6. DISCUSSION ................................................................................................................................................ 34

7. CONCLUSIONS & RECOMMENDATIONS ........................................................................................................ 39

REFERENCES ..................................................................................................................................................... 43

ANNEX: GAR REPLANTING PROGRAM REQUIREMENTS .................................................................................... 45

LIST OF FIGURES AND BOXESList of figures

Figure1:AnnualYieldProfilefor20-yearOldTreesandReplanting................................................................................17

Figure2:CumulativeYieldProfilefor20-yearOldTreesandReplanting..........................................................................18

Figure3:Yieldperformancepertypeofsmallholder..................................................................................................19

Figure 4: GAR’s closed loop business model for smallholder replanting facilitation ................................................................... 22

List of boxes

Box 1. Harvesting and oil palm yield ............................................................................................................................ 16

Box 2. Better Management Practices (SNV & WUR) .................................................................................................. 20

Box 3. Golden Agri Resources (GAR) .............................................................................................................................. 21

Box 4. Wilmar............................................................................................................................................................ 23

Box 5. Cargill ..............................................................................................................................................................26

Box 6. Asian Agri Independent Smallholder Partnership Arrangement ............................................................................ 27

Box7.“AnotherPerspectiveonPartnership.”............................................................................................................29

Box8.KURLoans......................................................................................................................................................33

Box9.BadanPengelolaDanaPerkebunanKelapaSawitorCPOFund.........................................................................33

INNOVATIVE REPLANTING FINANCING MODELS FOR OIL PALM SMALLHOLDER FARMERS IN INDONESIA

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EXECUTIVE SUMMARY

Overthelasthundredyears,palmoil,whichhasitsori-

ginsinWestAfrica,hasbecomeasignificantdriver

for the economies of producing countries1. In Indonesia, the

world’slargestproducerofpalmoil,smallholderfarmerswork

on approximately 3.1 million hectares of oil palm, representing

40% of the overall planted area and yielding around 35% of

total crude palm oil production2.Atatimewhentheworld

demand for vegetable oil, including palm oil, is expected to

rise further, the issue of smallholders’ decreasing yields coupled

withincreasingdeforestationhasbecomeaconcernforplan-

tation companies, the Indonesian government and advocates

of sustainable agriculture3 4.

Smallholders’consistentlowyieldproductionisprimarilydriven

byalackofaccesstoqualityinputs,limitedknowledgeof

good agricultural practices and a lack of access to adequate

financing,inparticularforreplanting.Accesstolong-term

financeforreplantingisbecomingincreasinglycriticalforoil

palm smallholders in Indonesia, as a large number of smallholder

plantations are reaching the end of their productivity cycle due

to aging trees. Replanting is required to increase production

yields, to raise income levels and to improve the economic

livelihoods of smallholder farmers.

Inordertoevaluateexistingfinancingmodelsforoilpalm

smallholders and their potential to be replicated and scaled

up, to enhance rural livelihoods and to foster deforestation-free

farminginIndonesia,thisstudyhasreviewedcurrentsmall-

holderfinancingpracticesofTFA2020membersandrecent

research in this area. The starting point for the current study

wasaresearchpaperpublishedbyCIFOR(Bronkhorstetal,

October 2017) and a number of other publications. Also, the

studyhasanalyzedanumberofsmallholderfinancingprograms

developed by leading plantation companies and assessed the

35%total crude palm oil production

smallholder farmers yield

smallholderfarm

erswork4

0%

of the overall planted area


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role of commercial banks, (impact) investors and the Government

ofIndonesiainthisarea.Thefindingsofthestudyweregathered

throughextensivedesktopanalysisandinterviewswithsenior

managers and experts of some of the leading plantation com-

paniesandfinancialinstitutionsinIndonesia.

Moregenerally,thisstudyhasalsoreviewedthemainprevailing

challenges and issues related to oil palm replanting in Indonesia

from the perspective of smallholder farmers, plantation compa-

niesandothersupplychainactors,aswellastheIndonesian

government.

Fromafarmer’sperspective,thewillingnessandabilitytoreplant

dependsprimarilyonthefollowingfactors:

• Steadilydecliningyieldsofagingtreesresultsinlower

farmer income;

• Lowaverageproductionlevelsduetolowquality

planting material;

• No availability of additional land to expand oil palm

farming;

• Short-term horizon bias causing farmers to focus on

currentcashflowsratherthanpotentiallymuchstronger

future cash generation post-replanting;

• Lack of alternative income streams to cover the income

gapintheyearsbetweenreplantingandthetimenew

trees become productive;

• Risk-aversementalityoffarmers,whodonotwish

to become indebted unless their economic livelihood is

under threat;

• Lackofreplantingknowledgeandskillsoffarmers.

REPLANTING IS REQUIRED TO INCREASE

PRODUCTION YIELDS, RAISE INCOME LEVELS

& TO IMPROVE THE ECONOMIC

LIVELIHOODS OF SMALLHOLDER

FARMERS.

1 Teoh, Cheng Hai, 2010. “Key Sustainability Issues in the Palm Oil Sector,” Discussion Paper for Multi-stakeholder Consultations commissioned by the World Bank Group.2 Daemeter Consulting 2016. Indonesian Oil Palm Smallholder Farm-ers: Sustainability Challenges and Recommendations for the Design of

Smallholder Support Programs. Bogor, Indonesia: Daemeter Consulting,3 McNally, R., Enright A., Smit, H. 2014. Finding the Right Balance:Ex-ploring Forest and Agriculture Landscapes. SNV Vietnam4 FairhurstT,McLaughlinD(2009)Sustainableoilpalmdevelopmentondegraded land in Kalimantan. Washington, DC: World Wildlife Fund.


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Impeding factors to obtaining replanting loans include high levels

ofcurrentoutstanding(household)debtandnoorinsufficient

collateral,includinglandcertificates(whichareoftenimperfect,

notavailableorpledgedalreadytootherfinancialinstitutions).

For the Government of Indonesia, the promotion of large-scale

replanting programs for smallholders is a key priority, due to

the environmental and economic importance for the country.

FollowingtheextensiveforestfiresinSumatraandKalimantan

in 2016, there is a strong commitment from the Government of

Indonesia to avoid further deforestation and a ban on further oil

INDONESIA AIMS TO INCREASE ITS OIL PALM PRODUCTION TO 40 MILLION TONS PER ANNUM BY 2020

palmexpansionwasimposed5. As Indonesia aims to increase

its oil palm production to 40 million tons per annum by 2020,

up from 36 million tons in 2017, higher productivity through

intensificationofproductiononexistingplantationsisanimportant

condition to meet this objective6 7. Several initiatives, including

the establishment of the CPO fund and the expansion of the

KURloanprogramtoprovidelow-interestreplantingloansto

farmers,wereannounced,butduetoweakexecutionandlack

of institutional support, these programs so far have not been able

toreachsufficientscaletocreatemeaningfulimpact.

Fromaplantationcompanypointofview,theprincipaldriverto

actively promote replanting at smallholder level are the decreasing

FFBproductionlevelsandthelowqualityofFFBsupply.Replant-

ingoilpalmwithhigherqualityplantingmaterialswillleadto

higher production and better quality FFB, directly impacting com-

panyprofits.Forthesereasons,plantationcompanieswouldbe

inclinedtoworktowardsolutionsthatsupportlong-termfinancing

arrangementswithsmallholders,eitherviaplasmaschemesor

other partnership structures. The main current company-farmer

partnershipscanbecategorizedintotwodifferentmodels:


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Thistypeoflendingisusually,butnotalways,carriedoutwith

a corporate guarantee from the plantation company to provide

additional assurance to the banks. Continued dependence on

the corporate guarantee highlights a key limitation of this model

anditspotentialforscale,asevenlarge,financiallyhealthy

companies face limits in the total amount of corporate guarantees

theycanprovide,asthisconstitutesacontingentliabilitywith

potential balance sheet impact that must be accounted for and

disclosedintheirfinancialreports.

MODEL 2: DISTRIBUTED RISK PARTNERSHIP LENDING

The Guaranteed Partnership Lending model is being carried out

at present, but the need for corporate loan guarantees under

most examples drastically limits its applicability. There are many

potentially reliable medium-scale oil palm mills and companies that

wouldbeabletocreatepartnershipswithlocalfarmersbutare

notabletoprovidecorporateguaranteessufficientlyacceptable

to potential creditors. Also, from the lending side, there are still

manypotentiallenderswhich,becauseoflackofexperienceor

perceived credit risk, could provide stable, long-term funding but

donotwanttobearthefullcreditriskthemselves.

Thisprovidesakeypotentialspaceforfinancialserviceproviders

willingtobearthecreditrisk,particularlyinthepre-production

stages,topartnerwiththefundingbankinfinancingthefarmer–

company partnership arrangement. Such participants could include

foreign banks lacking a strong local funding base, development

banks,creditguaranteeprovidersorotherfinancialfunds/insti-

tutionswillingtoofferloanguaranteefacilitiesorothercredit

riskmitigationproducts,allowingthemtosharetheriskburden

withthelendinginstitutions.

FINANCING PERIODS WILL TYPICALLY BE FOR 11-13 YEARS, WITH THREE TO FIVE YEARS “GRACE PERIOD” FOR REPAYMENT OF PRINCIPAL AND, IN SOME EXAMPLES, INTEREST

5https://news.mongabay.com/2016/04/jokowi-announces-moratorium-new-oil-palm-min-ing-concessions/Accessedon22June20186http://www.undp.org/content/undp/en/home/presscenter/pressre-leases/2015/03/11/indonesia-government-addresses-deforestation-challeng-

es-in-its-aim-to-double-palm-oil-production-by-2020.html.Accessedon12June20187https://www.reuters.com/article/palmoil-outlook-mielke-idAFL4N1N537Daccessedon22June2018

MODEL 1: GUARANTEED PARTNERSHIP LENDING

Thisisafinancingschememostcommonlyobservedinpractice.

Whetherinthecontextofclassicplasma,“nearplasma”ornew

partnershiparrangements,theapproachtofinancingisalmost

identical. The core common element is that this partnership model

is the adaptation of key elements of the classic plasma model

in order to be more attractive to non-plasma smallholders and

previousplasmasmallholders,whosetermagreementshave

expiredorarenearexpiration.Underthismodel,financing

periodswilltypicallybefor11-13years,withthreetofive

years “grace period” for repayment of principal and, in some

examples,interest,whichmayvarywithinarangeof9-13%

per annum. This type of lending is almost invariably carried

outbyIndonesiandomesticbanks,usuallystate-owned,witha

stable,relativelylow-costrupiahfundingbaseandasignificant

ruralbranchfootprint,oftenwithinreasonableproximityofthe

plantationareasbeingfinanced.


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MODEL 3: FULL START-UP FUNDING FROM IMPACT INVES-TORS, TO BE FOLLOWED BY LOAN SALE OR REFINANCING

Inadditiontothetwobasicmodels–andinparticularifdomestic

banks’ appetite for Model 1 and Model 2-style lending proves

inpracticetobehighlyrestricted–thereisanotheralternative

partnership model that is currently being explored by a number

offinancialinstitutionsandhasinterestingpotentialforscale.

Rather than merely taking the early-stage risk, (international)

impactinvestorswouldfundthefullamountneededforreplanting

topre-qualifiedfarmersduringthefirst4-5yearsandsellthe

loantoapartneringcommercialbankpost-replanting,whenthe

farmer has started to generate income from replanted trees and

thereforecreditandenvironmentalriskhavesignificantlyreduced.

Thismodelsuggests1)alowerinterestrateontheloansin

thereplantingperiodwhencreditriskishighandfarmercash

flowsareminimal;and2)ahigherinterestratewhencreditrisk

andincomecashflowsareincreasingpost-replanting.Thetwo

phasescanbesummarizedasfollows:

• Replanting phase: The (impact) investor channels funds

to a local bank that acts as conduit; the (impact) investor

absorbsallcreditriskwhilethebankonlytakescounter-

party risk on the investor.

• Post-replanting/“sale”or“refinance”phase:The

(impact)investorsellstheloanwithaprofittoabank

after successful replanting in year 5.

Thestudyconcludeswithanumberofkeyrecommendations,

whichareaimedatfurtherimprovementoftheexistingsmallholder

replantingfinancingmodelsandthedesignofmoresuitable

future models. These recommendations are:

AN INNOVATIVE MODEL SUGGESTS A LOWER INTEREST RATE ON THE LOANS IN THE REPLANTING PERIOD WHEN CREDIT RISK IS HIGH

1. THE INVESTMENT CASE FOR FARMER REPLANTING NEEDS TO BE MORE ATTRACTIVE.

a)Allcompaniesworkinginpartnershipwithsmallholders,whether

inplasma-stylemodelsorinpartnershipwithindependentsmall-

holders,shoulddeveloptheirownfinancialprojectionstoensure

thatthepropositionofferedtofarmersistrulyawin-win,and

inparticularthattheminimumreturnonreplantingisfinancially

attractive to farmers;

b)Similarly,allstakeholdersshouldworkonways-whethervia

moreefficientreplantingtechniques,moreproductiveplanting

stock,higherpremiumsforcertifiedproduction,governmentpolicy

changes, etc. - to improve farmers’ economic return on replanting;

c) Further research and analysis should be conducted to docu-

mentbothactualandbestpracticesintermsoffinancial(and

environmental) returns on replanting.


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2. CONTINUE TO EXPLORE AND DEVELOP EFFICIENT, INTE-GRATED “STRATEGIC” SUBSIDIES.

Inordertoensurethatreplanting,growingandharvestingare

carried out in a sustainable manner, farmers need to be able to

seeaneconomicbenefit.Workneedstocontinueondeveloping

and communicating to farmers the package of strategic subsidies

availableforsustainablereplantingaswellaspriceincentives

forachievingandmaintainingcertificationsforsustainablepalm

oil. Government, donors and impact investors need to gain an

understanding of farmers’ economic needs in order to design

apackagethataddstangibleeconomicbenefitsforfarmers.

3. CONTINUED DEVELOPMENT OF COMPANY-FARMER PART-NERSHIP MODELS.

Ofthecompaniesinterviewed,onlyone,AsianAgri,hasdemon-

stratedaclearappetite–andspecifictargets–forpartnership

withindependentsmallholdersoutsideofaclassicplasma-style

model.Meanwhile,somesmallercompanieswhicharemore

dependent on independent smallholders for FFB supply, are

moving rapidly to develop partnerships along the same lines.

Althoughthesemodelsarestillevolving,currentknowledgeabout

bestpracticesinpartnershipsshouldbesufficienttoguideand

encourageallpalmoilcompaniestopilotand/orscaleuptheir

partnership activities.

4. CONDUCT PILOT TESTING ON “MODEL 2” FINANCE AND MORE DETAILED DESIGN WITH PILOTING ON THE “MODEL 3” APPROACH.

Finding a risk partner, particularly from Development Finance

Institutionsandimpactinvestors,toblendwithdomesticRupiah

funding from local banks or insurance companies, is a natural

extensiontothecurrentmodelandshouldbepilotedwithone

ormorefinancialinstitutions.

STUDY CONCLUDES WITH A NUMBER OF KEY RECOMMEN-DATIONS, WHICH ARE AIMED AT FURTHER IMPROVEMENT OF THE EXISTING SMALL-HOLDER REPLANTING FINANCING MODELS

INVESTMENT CASE FOR FARMER

REPLANTING NEEDS TO BE MORE ATTRACTIVE.

EXPLORE & DEVELOP EFFICIENT,

INTEGRATED “STRATEGIC” SUBSIDIES.

CONTINUED DEVELOPMENT OF

COMPANY- FARMER PARTNERSHIP

MODELS.

CONDUCT PILOT TESTING ON “MODEL 2” FINANCE & MORE

DETAILED DESIGN WITH PILOTING ON

THE “MODEL 3” APPROACH.

Inthisregard,TFA2020couldfacilitatefollow-updiscussions

andcreateproposalsforinnovativepilotfinancingprojects.

5. EXPLORE EFFICIENT SMALLER-SCALE (LOWER COST AND REQUIRING LESS THAN 300 HA) REPLANTING SOLUTIONS.

Havinganefficient,smaller-scalesolutionwouldhelpresolve

someofthedifficultiesinorganizingthetypicallylargergroups

of farmers for replanting, as is currently often the case.

6. FINALLY, FOLLOW-UP WORKSHOPS SHOULD BE ORGA-NIZED TO ADDRESS BANKS’ CONCERNS ON OIL PALM SMALLHOLDER RISK ISSUES.

Otoritas Jasa Keuangan (OJK), the Indonesian Financial Services

Authority,hasshownakeeninterestinthefirstworkshopconducted

byTFA2020oninnovationsinsmallholderreplantingfinancing.

Due to their ability to access large local currency liquidity pools

in Indonesia, Indonesian banks can and should play a major

roleinthemobilizationandexpansionofreplantingfinanceto

oilpalmsmallholders.ForOJK,thisstudywouldrepresentan

interestingtheoreticalframeworkthancanlaythefoundation

for more implementation-oriented initiatives and regulations that

willacceleratebanklendingtosmallholderfarmersandenable

bankstoachieveOJK’sfinancialinclusiontargetsandtherecently

announcedsustainablefinanceobjectivesforfinancialinstitutions.


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1. INTRODUCTIONTHE REPLANTING ISSUE IN INDONESIA

InIndonesia,theworld’slargestproducerofpalmoil,smallholderfarmerspossessand/ormanageapproximately3.1million

hectaresofoilpalmwhichisestimatedtobe40%oftheoverall

planted area, yielding around 35% of total crude palm oil pro-

duction of the country. 8However,smallholderfarmersproduce

consistentlylowyields,oftenproducing45%lesscomparedwith

plantation companies. 9 This is explained mainly by a lack of

accesstoqualityinputs,limitedknowledgeofgoodagricultural

practices (GAP) and lack access to credit; especially the lack of

investmentcapitalforreplantingofaged,lowyieldingpalms,

leave farmers little choice but to expand into neighboring forests

withnegativeenvironmentalimpact.

Whileworlddemandforvegetableoilandthuspalmoilkeeps

rising,smallholdersarefacedwithdecreasingyields,putting

increasing pressure on the remaining forests and exacerbating

climate change. 10 To meet the rising demand for palm oil in the

comingdecadeswithoutincreasingdeforestation,smallholders

urgently need to replant and improve productivity on existing

plots by adopting more sustainable production practices. 11 12 13 14

Thousands of smallholder plantations are currently coming at the

endoftheiroilpalmproductivitycycle,withtheaveragetree

agebeingover20yearsold.Increasingproductionwithout

openingnewlandispossiblebyintensificationonexistingplots,

replantingoldtreeswithhigh-yieldingseedvarieties.

Thelarge-scaleagingofsmallholderplantationsexplainswhy

the replanting matter is even more urgent at the current moment in

time.Asmostfarmersdonothavethecapitaltofinancereplant-

ing, they are likely to encroach into forested or protected areas

to supplement the lost income from declining yields, if farmers

do not receive support to replant on their existing plantations.

Theselong-termfinancingneedsofsmallholdersprovideahuge

investmentopportunitytoinvestors,whocancontributetopro-

motingsustainabledevelopmentofthepalmoilsector,aswell

as increased livelihoods for farmers.

Replanting has the potential to increase incomes of smallholder

farmers,whoareproducingalargeshareoftheoilpalmpro-

duction nationally 17. Funding is urgently needed as it is expected

thatinthenext25years(2017–2041),around175,000haof

smallholderoilpalmplantationwillrequirereplantingeveryyear

whichcreatesalong-termfinancingneedofUSD700million

per annum 18. Although several models have been designed for

smallholderfarmers,thereareonlyfewexamplesofsuccessfully

implementedreplantingfinancingschemestodate.

THE LARGE-SCALE AGING OF SMALLHOLDER PLANTATIONS EXPLAINS WHY THE REPLANTING MATTER IS EVEN MORE URGENT AT THE CURRENT MOMENT IN TIME.

8. Daemeter Consulting 2016. Indonesian Oil Palm Smallholder Farmers: Sustainability Challenges and Recommendations for the Design of Smallholder Support Programs. Bogor, Indonesia: Daemeter Consulting,9. Molenaar J.W., Persch-Orth, M., Lord, S., Taylor, C., Harms, J. 2013. Diagnostic study on Indonesian oil palm smallholders Developing a better understanding of their performance and potential. International Finance Corporation. Indonesia.10. McNally, R., Enright A., Smit, H. 2014. Finding the Right Balance:Exploring Forest and Agriculture Landscapes. SNV Vietnam11.FairhurstT,McLaughlinD(2009)Sustainableoilpalmdevelopmentondegradedland in Kalimantan. Washington, DC: World Wildlife Fund.12. McNally, R., Enright A., Smit, H. 2014. Finding the Right Balance:Exploring Forest and Agriculture Landscapes. SNV Vietnam13. Smit, H., McNally, R., Gijsenbergh, A. 2014. Implementing Deforestation-Free SupplyChains–CertificationandBeyond.SNVIndonesia

14. Smit HH, Meijaard E, van der Laan C, Mantel S, Budiman A, et al. (2013) BreakingtheLinkbetweenEnvironmentalDegradationandOilPalmExpansion:AMethodforEnablingSustainableOilPalmExpansion.PLoSONE8(9):e68610.doi:10.1371/journal.pone.006861015. Daemeter Consulting (2015): Indonesian Oil Palm Smallholder Farmers: A Typology of Organizational Models, Needs, and Investment Opportunities. Daemeter Consulting, Bogor, Indonesia16. Selamat, F., Shibao, P. 2017. Financing Indonesia’s independent smallholders. Singapore Institute of International Affairs. Singapore17. Food and Agriculture Organization of the United Nations Data. 2016. Rome, Italy:FAO.Accessed12June2017.http://faostat3.fao.org/home/E18. Directorate General of Estate Crops. 2015. Tree Crop Estate Statistics of Indonesia 2014–2016.Jakarta,Indonesia:DirectorateGeneralofEstateCrops.

RESEARCH OBJECTIVES

The objective of this research is to evaluate existing innovative

financingmodelsforoilpalmsmallholders,andtheirpotential

to be scaled up, improve rural livelihoods and support deforesta-

tion-free smallholder farming in Indonesia. For this purpose, past

researchonexistingsmallholderfinancinghasbeenidentifiedand

analyzed. Also, the report has investigated in detail a number

ofsmallholderfinancingschemesofplantationcompanies,and

addresseshowfinancialinstitutionsandthegovernmentplaya

roleintheimplementationandscale-upofthefinancingmod-

els. This results in recommendations for an innovative, scalable

replantingfinancingmodelthatincorporatesthemainconcerns

of different actors analyzed.

THE OBJECTIVE OF THIS RESEARCH IS TO EVALUATE EXISTING INNOVATIVE FINANCING MODELS FOR OIL PALM SMALLHOLDERS, AND THEIR POTENTIAL TO BE SCALED UP

Thestartingpointfortheanalysisofexistingsmallholderfinanc-

ing models has been a CIFOR research paper (Bronkhorst et al

2017),towhichFinancialAccessandSNVcontributed.This

study investigated a number of innovative oil palm smallholder

financingschemesinIndonesiaandMalaysia.Thescopeof

theCIFORresearch,itsmainfindingsandproposedreplanting

financingschemearepresentedinchapter2.

In this study, a similar approach as in Bronkhorst et al (2017),

hasbeentaken;throughdesktopanalysisandinterviewswith

leadingTFA2020membersandfinancialinstitutions,information

wascollectedonthecurrentpracticesofplantationcompanies

andfinancialinstitutions.Inparticular,thisresearchinvestigated

which(innovative)financingmodelsorothertypesofsupport

for replanting are provided or made available to smallholders.

Basedonthecollectedinformation,anumberoffinancingmodels

havebeenselectedandpresentedtotheTFAmemberswhoare

partofthesmallholdertaskforce.Theirfinalfeedbackwillbe

incorporated,resultingintheidentificationoftwounderlying

financingmodels.

Thestructureofthereportisasfollows.Chapter2presentsthe

scopeoftheCIFORresearch,itsmainfindingsandproposed

replantingfinancingscheme.Chapter3discussesthedifferent

replanting perspectives of farmers, plantation companies and

government.Chapter4presentstheresultsfromtheinterviews

withtheplantationcompanies,includingtheirdifferentaccess

to(replanting)financeapproaches.TheTFAmembers’plantation

companiesinterviewedareGoldenAgriResources(GAR),Wilmar,

Cargill and Asian Agri. Chapter 5 discusses the involvement

ofthefinancialsectorandtheGovernmentofIndonesia.In

theDiscussioninChapter6,thedistinctfinancingmodelsand

smallholder approaches are compared, leading to the conclusions

of the research and recommendations for further development of

therecommendedfinancingmodelsinChapter7.


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19 Molenaar J.W., Persch-Orth, M., Lord, S., Taylor, C., Harms, J. 2013. Diagnostic study on Indonesian oil palm smallholders Developing a better understanding of their performance and potential. International Finance Corporation. Indonesia.

20 Vijay V, Pimm SL, Jenkins CN, Smith SJ (2016) The Impacts of Oil Palm on Recent DeforestationandBiodiversityLoss.PLoSONE11(7):e0159668.https://doi.org/10.1371/journal.pone.0159668

2.SUMMARY OF INNOVATIVE SMALLHOLDER FINANCING SCHEMES

2.1 CIFOR RESEARCH ON SMALLHOLDER FINANCING MOD-ELS: SCOPE AND APPROACH

Recognizing the crucial role of smallholders in both the contin-

uedgrowthofoilpalmproductionaswellasitssustainability,

in 2017 the Center for International Forestry Research (CIFOR)

commissioned Financial Access and SNV to conduct a study,

whichevaluatedcurrentpracticesandinnovationsinsmallholder

palmoilfinanceinIndonesiaandMalaysia.

In Indonesia and Malaysia, many smallholder farmers experience

important positive effects of the high returns of oil palm production.

Financing programs and policies on export taxes and subsidies

areimportantdriversofthestronggrowthofoilpalmplantation

developmentobservedinthetwocountries.Nonetheless,notall

smallholdersenjoythesebenefitsandatthesametime,plantation

development by both plantation companies and smallholders is

leadingtodeforestationandlanduseconflicts.

FortheCIFORresearchstudy,thefollowingactivitieswerecon-

ducted:

• Extensiveliteratureanalysisofpastandcurrentfinancing

models and practices for oil palm smallholders in Malaysia

and Indonesia;

• Fieldassessmentofinnovativefinancingschemesin

practice or under development in the oil palm sector in

Indonesia and Malaysia;

• Meetingswithrelevantstakeholdersregardingthe

needsandsolutionsrequiredtomoreinnovativefinancing

schemes in Indonesia, in particular for smallholder farmers;

• Desktop research.

Inordertoanalyzewhetheritispossibletosteerthepractices

of oil palm smallholders into more sustainable and responsible

directions,thestudysetoutwiththreeprincipalobjectives:

1. Toevaluatepastandcurrentpoliciesandfinancingschemes that have played a role in the development of

the palm oil industry in Indonesia and Malaysia

2. To evaluate the outcomes of these models for small-

holders and the environment, in terms of income security

and sustainable practices.

3. Toanalyzefinancingschemesthatcouldcontributetosustainablesmallholderoilpalmdevelopment;witha

viewtostabilizethesmallholdersupplyofFFBandenable

smallholderstoexpandwithimprovedsustainabilityprac-

tices, based on the lessons learned of past and existing

partnership schemes.

2.2 CIFOR RESEARCH: SUMMARY OF FINDINGS AND INNO-VATIVE REPLANTING FINANCING SCHEMES

Bronkhorst et al (2017) revealed that in the past, smallholder

supportschemeswereheavilydependentonstatefunding.How-

ever,inrecentdecades,thegovernmenthasgraduallywithdrawn

their support, enabling the emergence of more commercially


13

oriented investment models, often involving the private sector and

smallholders organized in cooperatives. Focusing on large-scale

plantationdevelopment,thecurrentmodelsdonotalwayseffectively

address the needs of oil palm smallholders. These schemes faced

various issues and challenges related to the implementation of the

underlyingfinancialmodels,includinglongdelaysinreceiving

the allocated land and credit, inaccessibility of allocated plots,

restrictions on traditional intercropping, and high land reclamation

costs 21;poorlymaintainedinfrastructure,weakdecision-making

powerandmanagementissueswithincooperatives,highcredit

interest rates, high installation costs 22; social and environmental

impactssuchasdeforestation,overexploitationofwaterresources,

and rising costs of living.23 24

Bronkhorstetal(2017)hasidentifiedseveralchallengesencoun-

teredbyfinancialservicesproviders(FSPs)relatedtooffering

affordablelong-termfinancingtoindependentsmallholderswhich

aresummarizedasfollows:

• Small loan sizes and limited ability of FSPs to mitigate

associated credit risk;

• Lackofcreditworthinessofsmallholders;

• High credit risk during the unproductive period after

replanting;

• Long loan tenor and limited ability to mitigate asso-

ciated risks;

• Currencyrisksassociatedwithlendingtosmallholders

in IDR by impact investors;

• Limited levels of aggregation of farmers;

• Limitedcapacitytocomplywithsustainabilitycriteria.

In response to the above-mentioned challenges, the study proposed

sixmechanismswhichwillallowFSPstoprovidecommercial

long-term replanting loans to independent smallholders:

1. Datacollection,miningandmonitoring:FSPscannowovercome the constraints and risks related to the limited

aggregation of farmers by outsourcing both data collec-

tionanddatamining,requiredforcashflowprojections

andindividualcreditscoringdecisions,aswellasloan

monitoringandevaluationasthesearemadeeasierwith

current technologies.

FOCUSING ON LARGE-SCALE PLANTATION DEVELOPMENT, THE

CURRENT MODELS DO NOT ALWAYS

EFFECTIVELY ADDRESS THE NEEDS OF OIL PALM

SMALLHOLDERS.

21 VermeulenSandGoadN.2006.Towardsbetterpracticeinsmallholderpalmoil production. Report. London, UK: IIED (International Institute for Environment and Development).22 Feintrenie L. 2013. Oil Palm Business Models. 4e Conférence Internationale BiocarburantsetBioénergies.2ie,CIRAD,21–23November2013.Ouagadougou,Burkina Faso: Ministère des Mines et de l’Énergie.

23VermeulenSandGoadN.2006.Towardsbetterpracticeinsmallholderpalmoil production. Report. London, UK: IIED (International Institute for Environment and Development). 24 Bissonnette J and De Koninck R. 2015. Large plantations versus smallholdings in Southeast Asia: Historical and contemporary trends. Conference paper No. 12. Chiang Mai University, Thailand.


14

2. Portfolio approach: FSPs can reduce loan distribution

lossesbyrelyingonagencydistributionagreementswith

KUDs (Koperasi Unit Desa, Village Cooperative System).

Branchlessbankingschemes,wherebyKUDsactasagents

for the bank, also offer the possibility of establishing digital

paymentsystems,therebyincreasingruralfinancialinclusion.

3. Supply chain approach: Investment schemes for sus-

tainabilitycertificationandreplantationcouldbedesigned

bymovingaportionofcreditriskdownthevaluechain,

ontolarger,morefinanciallysoundorganizations.Inthis

regard, mills and processing companies could act as

guarantors for smallholders, or as providers of offtake

agreementsbetweensmallholdersandbuyers,resulting

inmoreaffordablefinancingcostsforendborrowers.

Consequently,themillswouldthemselvesbenefit,froma

stable,RSPO-certifiedsupplyshed.

4. Incomediversificationsub-scheme:alternativeincome-gen-erating activities remain essential as smallholders face cash

shortagesduringtheinitial3–4-yearproductiongapafter

replanting. For this reason and because land clearing and

preparation for replanting require external labor, instead of

outsourcing these activities and related costs to a replanting

company,theloanfacilitycouldbestructuredinawayto

includeasalarycomponenttobepaidtofarmerstowork

ontheirownland.Othertextedexamplesincludelivestock

breeding and fattening schemes, the sale of tree trunks

and the intercropping of chili and cassava.

5. Cost of living stipend: In order to compensate for lost

income during the unproductive replanting period, banks

could elect to include a cost of living stipend in their loans

toqualifiedfarmers.

6. Sustainability criteria: many Indonesian banks have

been accused of lagging behind in terms of incorporating

sustainability criteria in their credit decisions. Key performance

indicatorsaddressingESGcriteria–regardingclimate,

ecosystem integrity and landscape conservation, species

protectionandimprovedlivelihoods–shouldbedefined

andincorporatedintothebanks’creditriskframeworks.

Bronkhorst et al (2017) presented an example of a potential

replantingschemewhichhasembeddedtheabove-mentioned

solutions although not implemented yet. Financial Access has

developedafinancialmodeltoestimatetheimpactofkeyfinan-

cial, household and production variables that determine the cash

flowsofoilpalmsmallholderhouseholds.

Thecashflowmodeltakesinaccountsupplychain,market

andagronomicdataaswellfarm-andhousehold-leveldatato

estimatethefinancingneedandpotentialrepaymentcapabilities

of each farmer. By means of statistical and scenario analysis,

variableswiththehighestimpactoncashflowareidentifiedand

ranked,whichinturnrepresentsthebasisforthedevelopment

of a non-historical credit scorecard.

BRANCHLESS BANKING SCHEMES ALSO OFFER

THE POSSIBILITY OF ESTABLISHING DIGITAL

PAYMENT SYSTEMS, THEREBY INCREASING

RURAL FINANCIAL INCLUSION.


15

Thismodelisexpectedtoresultinaccesstofinancingforselected

smallholderfarmersatlowerinterestrates.Italsosignifiesalow-

cost transformation of farmers’ bankability, facilitating access to

long-termcapitalandalow-cost,risk-mitigatedattractiveinvestment

opportunityforinvestorsandfinancialinstitutions.

Finally,Bronkhorstetal(2017)recommendsthefollowinginter-

ventions:

1. Smallholder farmers should be given support in order to:

filltheincomegapduringthereplantingperiod;increase

theiryieldsinasustainablemanner;acquiretheknowledge

andcapacityforcertification;formalizelanddocumenta-

tion;and/orgetaccesstomills,whichthemselvesshould

be incentivized to purchase their fresh fruit bunches under

mediumtolong-termsupplyarrangements.Thiswillreduce

smallholders’ income risk, and in turn improve the credit

risk for banks.

2. Financialinstitutionsshouldbegivensupportwiththedevelopmentofinvestmentcasestoallowfinancingto

smallholder farmers at a larger scale. This includes better

informationaboutsmallholderfinancingneedsandbetter

detailed credit and environmental risks assessment, through

useoffinancialtechnologyandimprovedanalytictools.

3. Smallholder organizations, such as cooperatives, should

begivensupportthroughtargetedinterventionsthatallow

them to enhance their management practices and trace

palmoilwithintheirsupplychain.Thiswillenablethem

to act as aggregators for data collection from, and loan

distribution to, smallholder farmers, as a result of the reduced

costs and risk for loan providers.

Thedevelopedreplantingfinancingschemeasdescribedabove

hasbeenusedasastartingpointforcomparisonwithcurrent

replantingfinancinginitiativesfromplantationcompanies,which

willbediscussedinchapter4.

ASSESSMENTS ARE BASED NOT ONLY ON THE CREDIT-WORTHINESS OF THE FARMER, BUT ALSO ON ENVIRONMENTAL RISKS

Assessmentsarebasednotonlyonthecreditworthinessofthe

farmer,butalsoonenvironmentalrisksassociatedwithreplanting,

forwhichdatacollectedviasatelliteanddroneimageryare

used. Once data has been collected and analyzed, farmers are

segmented. The intention is to select cooperatives and farmers

thataremostattractiveforcommercialfinancing,aswellasto

selectthosethatwouldmostbenefitfromtrainingandtechnical

assistance. Based on this segmentation, Financial Access focuses

onrealizingfinancingforthemostcreditworthyfarmers,andSNV

focusesonprovidingtechnicalassistanceprograms,specifically

designedtomeettheneedsoffarmerswiththepotentialto

become bankable over time. Financial Access presents pre-qual-

ifiedpoolsoffullyassessedloanapplicationstolenders(banks,

impactinvestors,investmentfunds).Theresultisthatlenderswill

beofferedalargepoolofprocessedloanapplicationswith

anattractiveriskprofile,whichsignificantlyreducescostsand

credit risk for lenders.

Another component of the model is a technical assistance offer

that includes not only training and support to improve agricultural

practices but also interventions to create additional income streams

for farmers during the replanting period.


16

3. REPLANTING PERSPECTIVES: MOTIVATIONS & CHALLENGES

This chapter presents the different replanting perspectives from

farmers, plantation companies and government, including the main

motivationsforreplanting,aswellaschallengesandissuesfaced.

THE DECISION TO REPLANT: FARMER PERSPECTIVE

Fromafarmerperspective,thereareseveralfactorsthatinflu-

ence the decision to replant or not. The main reasons for

replanting are:

1. Steadilydecliningyieldsofagingtreesresultsinlowerfarmer income;

2. Lowaverageproductionlevelsduetolowqualityplanting material;

3. No availability of additional land to expand oil palm

farming.

Regarding the second point above, farmers are motivated to

replant trees that have not reached the end or mature stages of

theirlifecyclebutareproducingverylowaverageyields.This

is usually due to poor quality of planting material, seed sources

areunknownoruncertified,andleadstolowaverageyields

during the entire lifecycle.

BOX 1. HARVESTING AND OIL PALM YIELD

With high quality seeds, oil palm trees can start to

producefruits30monthsafterplantationinthefields,

withcommercialharvestbeginningsixmonthslater.

Theoutputofanoilpalmtreeisrelativelylowatthis

stage.However,asthetreecontinuestomature,its

yield increases and it reaches peak production in 7 to

18years.Yieldwillstarttograduallydecreaseafter

18yearswhilethetypicalcommerciallifespanofa

tree is roughly 25 years.

Fullymatureoilpalmtreesshouldgenerate18to30

metrictonsoffreshfruitbunches(FFB)/hectare.The

yield depends on a number of factors, including age,

seed quality, soil and climatic conditions, quality of

plantation management and the timely harvesting and

processing FFB.


17

Also,ifthereisnoorlimitedemptyornewlandavailable,and

no other activities can be taken up to generate income, farmers

willbemoreinclinedtoreplant.

Themajorreasonswhyfarmersarecurrentlynotmotivatedto

replant are:

• Short-term horizon bias causing farmers to focus on

currentcashflowsratherthanpotentiallymuchstronger

futurecashflowspost-replanting;

• of alternative income streams to cover the income

gapintheyearsbetweenreplantingandthetimenew

trees become productive. After replanting, it takes about

2,5 years before trees become productive, and only after

year4treesaregeneratingsufficientfreshfruitbunches

(FFB)andcashflowstolivefrom.Theincomegapisa

demotivating factor for farmers, even more if they have

no/littlesavingsoralternativeincomesources.

Otherreasonsthatdeterminewhyfarmersreplantornotare:

• Risk-aversementalityoffarmers,whodonotwish

to become indebted unless their economic livelihood is

under threat;

• Lackofreplantingknowledgeandskillsoffarmers.

Incasethatafarmerdoeswanttoconductreplanting,there

areotherimpedingfactors,mainlyrelatedtofinancing.Current

outstanding debts, and issues related to collateral and land

certificates(pledgedalready/partly,oronnameofprevious

owner)arecomplicatingthepossibilitytogetanewloan.

Oneofthekeyresultsofthegenericfinancingmodelisthatfrom

afarmer’sperspective,replantingoftenshowsarelativelylow

return,withbenefitsonlytoberealizedfarinthefuture.Even

thoughwithimprovedplantingmaterialstreesmaybecomepro-

ductive earlier (after 3 instead of 5 years), this does not mean

thatfarmersperceivethisasmoreprofitableintheshortterm,

whichtheyaremostlyfocusedon.Thequestionthusariseswhat

makesreplantingworthwhileforfarmers?

BENEFITS OF REPLANTING FOR FARMERS

Themaindriverofreplantingistheincreaseinprofitsthatare

generated through much higher yields and therefore results in

higherprices(lowerornodiscounts).SeeFigure1and2for

graphsthatcomparetwosituations:thefrontendoftheyield

curveforreplantedtreeswithcertifiedplantingmaterialand

the back end of the current yield situation of 20-year old trees,

both on an annual and cumulative basis. The graphs assume

fullreplantingatoncewithoutanystaggeringovertime.The

justificationforreplantingdependsonthecurrentproduction

andonhowquicklythefarmerexpectshisincometodecline

as the trees age.

THE MAIN DRIVER OF REPLANTING IS THE INCREASE IN PROFITS THAT ARE GENERATED THROUGH MUCH HIGHER YIELDS AND RESULTS IN HIGHER PRICES

FIGURE 1: ANNUAL YIELD PROFILE FOR 20-YEAR OLD TREES AND REPLANTINGSource: Financial Access based on data from Azman I. and Mohd N. M. (2002)

35, 00

0, 00

0 8 16 244 12 20 282 10 18 266 14 22 301 9 17 255 13 21 293 11 19 277 15 23 31 32

5, 00

10, 00

15, 00

20, 00

25, 00

30, 00

Yield (Tons)

Year

Yearly FFB Tons (without Replant) | Yearly FFB Tons (with Replant)


18

Fromayieldpointofview,thesetwographsrevealthat:

• Annualproductionwithreplantingbeginstoexceed

non-replanting in year 5 (and year 10 for cumulative

production).Thismeansthatfarmerswouldonlyhaveto

forego 5 years of income from the old plantations if they

decide to engage in full replanting. The fact that farmers

arereluctanttostartreplantingwhiletheycanstillmake

money out of their existing plantations makes the option

of‘staggeredreplanting’moreappealingasitwould

assure that they do not lose all potential income from old

farmswhilenewplantations’yieldsarestillbelowtheold

plantations yields.

• Although old plantations may still be productive after

27years,theiryieldswillsteeplydecreasefromthe29th

year. Then, given that harvesting becomes very hard for

trees older than 27 years because of their height, and the

fact that fertilizer application should cease 1 to 2 years

before replanting, the replanting decision should be made

latestwhentreesreachage27(year7onthegraph).

Takingastepbeyondthesegraphs,therearetwoimportantfactors

whichwillpushbackevenfurtherthepointatwhichyieldsto

farmers under replanting exceed the non-replanting case yields:

• First,sincereplantingisasignificantinvestment,yields

to farmers need to be calculated net of interest and principal

repayment. In this case, achieving the same yields net of

principalandinterestmeansthatthebreak-evenyearwill

be pushed further back, perhaps to year 6 on an annual

basis and year 13 on a cumulative basis.

• Also, certain aspects of FFB pricing push back this

break-evenpoint.Buyers(mills)willoftenpaydiscounted

rates to FFBs from young trees, due to immature palm

kernels. Also, FFBs from older trees may be discounted.

The net effect of these factors is that the economic returns to farm-

ersfromreplanting,whilepositive,ismuchlower(andfurtherin

thefuture)thantheapparentshiftinyieldcurveswouldsuggest.

As part of the Partnership model, farmers improve their agronomic

knowledgewhiletheyareassistedduringthereplantingprocess

and receive ongoing training on good agricultural practices, a

keybenefit.

Whenlookingatthecostsofreplanting,thefollowingcosts

shouldbetakenintoaccount:directcosts,timetofirstharvest

andfinancingcost(interestandfees).Directcostsarecostsfor

purchasing seeds, inputs, and payment for all tools and equipment

required for the replanting activities, including all input costs until

thetimeoffirstharvest(assuminghigh-qualityvarietiesthisisin

general in year 3).

IMPORTANCE OF ASSISTANCE ON IMPLEMENTING BETTER MANAGEMENT PRACTICES

Due to limited access to information and technical assistance,

independent smallholders typically perform relatively poor in

terms of productivity. This is mostly due to the planting material

FIGURE 2: CUMULATIVE YIELD PROFILE FOR 20-YEAR OLD TREES AND REPLANTINGSource: Financial Access based on data from Azman I. and Mohd N. M. (2002)

Cumulative FFB Tons (without replant) | Cumulative FFB Tons (with replant)

900,00

0, 00

300,00

600,00

100,00

400,00

700,00

200,00

500,00

800,00

0 8 16 244 12 20 282 10 18 266 14 22 301 9 17 255 13 21 293 11 19 277 15 23 31 32

Cumulative Yield (Tons)

Year


19

and plantation management. See Figure 3. This yield gap is

estimated about 40% compared to a good agricultural practice

scenario. In order to address this yield gap Molenaar et al (2013)

recommends: “ The single, most essential activity to increase

smallholder productivity in the long term is technical assis-

tance, including awareness building and training. It should

be the foundation of any attempt to increase smallholder

sustainability performance.” Molenaar et al (2013)

Through replanting plantations, the quality issue of planting material

shouldbeaddressedthroughprocuringcertifiedseeds.Inorder

for the replanted plantations to achieve their maximum potential

yield,however,providingappropriatetechnicalsupportonplan-

tation management is critical. In addition to yield and income

benefits,introductionofBetterManagementPracticesleadsto

more adequate use of fertilizers and other agrochemicals, thereby

decreasingnegativeimpactsontheenvironment(soil,water,air).

Throughprovidingsupportonintensificationofoilpalmproduc-

tion on existing plots, agreements are made, and incentives put

in place to motivate farmers to conserve the remaining nearby

forests. An example of an extensive training program currently

being implemented by SNV is described in Box 2.

MANAGING FARMER CASH FLOWS

Duringtheunproductiveperiodfollowingreplanting,farmersneed

supportinmanagingtheircashflows.Anumberofoptionsare

available to achieve that:

• Alternative income: farmers may conduct other (tempo-

rary)activitiesthatgenerateadditionalcashflows,suchas

paid labor, or can generate income from small businesses,

through other agricultural activities or other existing oil

palm plots that are not being replanted;

• Savings and Cost of Living Stipend: in case farmers have

savings, these may be used for household expenses and

otherfinancialneeds.However,theamountandcapacity

to live from household savings differs per farmer. Another

option is to include cost of a living stipend into the loan,

inwhichfarmersreceiveamonthly“salary”fortheirbasic

householdneeds,whichisaddedtothetotalloanamount.

THE DECISION TO REPLANT: COMPANY PERSPECTIVE

Plantation companies’ main focus is on securing a reliable, stable,

long-term supply of FFBs. From a plantation company perspec-

tive, the main reasons to stimulate replanting at the smallholder

levelarelowproductionlevelsandqualityofsupply.Replanting

withimprovedplantingmaterialsallowsincreasedproduction

andhigherprofitabilitysincehigheroilextractionrateswillbe

achieved,whichwillincreaserevenues.

Giventheneedforstablesupply,plantationcompanieswilltend

tofavorsolutionsthatsupportlong-termpartnershipswithsmall-

holders,whetherviaplasmaschemesorpartnershipfinancing.

Althoughcompanieshaveaclearbenefitofthereplantingof

smallholder plantations, at the same time some companies face

significantlimitsontheirwillingnessandabilitytoprovidethe

corporateguaranteesmanybankswouldprefer.

FARMERS MAY CONDUCT OTHER ACTIVITIES THAT GENERATE ADDITIONAL CASH FLOWS, SUCH AS PAID LABOR, OR CAN GENERATE INCOME FROM SMALL BUSINESSES

YIELD PERFORMANCE

TYPE OF SMALL-HOLDER

POOR MEDIUM GOODTIED 4% 46% 49%

TIED + 10% 49% 41%

INDEPENDENT 24% 49% 27%

ALL 16% 48% 36%

FIGURE 3: YIELD PERFORMANCE PER TYPE OF SMALLHOLDERSource: Aidenvironmant, Global Sustainabilty Associates and Triodos facet, 2013, results of smallhoders survey


20

THE DECISION TO REPLANT: GOVERNMENT PERSPECTIVE

At a national level, the reasons to replant are primarily driven by

environmental and economic considerations. For the Government

of Indonesia, the promotion of large-scale replanting programs

for smallholders is a key priority, due to the environmental and

economicimportanceforthecountry.Followingtheextensive

forestfiresinSumatraandKalimantanin2016,thereisastrong

commitment from the Government of Indonesia to avoid further

deforestation and, in 2015, a ban on further oil palm expansion

wasannounced.26 As Indonesia aims to increase the oil palm

production volume to 40 million tons per annum by 2020 from

36.3 million tons in 2017, higher productivity through intensi-

ficationofproductiononexistingplantationsisanimportant

condition to meet this objective.27 28 The productivity gain is to

be made mainly at the smallholder plantation level. Increasing

productivity levels can support the government’s policy to increase

oilpalmproductionandwithoutopeningnewlandforoilpalm

plantations.Large-scalereplantingofaged,lowproductivity

smallholder plantations therefore is also a key focus of attention

for the government, and several initiatives to support smallholders

havebeendesigned.Themostwell-knownaretheestablishment

of the CPO fund and KUR-loans for replanting. Their implications

willbefurtherdiscussedinchapter5.

Thenextchapterwilldiscussthevariouscasesofplantationcom-

paniesandtheirapproachestosmallholderreplantingfinancing.

BOX 2. BETTER MANAGEMENT PRACTICES

(SNV & WUR)

SNVtogetherwithWageningenUniversitydevelopedanextensive

training program that has been tested in Indonesia. Key topics

that are addressed are:

1. Grading, Harvesting and Transport

2. Maintenance

3. Plantation design

4. Fertilization

5. Pest and diseases

The training program is using a High Impact Training approach

and is based on adult learning, recognizing participants have

existingknowledgeandexperience.Thelessonsaredesigned

inawaysothatparticipantscanbenefitquicklyfromtheir

implementation; and the materials match education and literacy

levels of smallholders. The material is simple and highly visual

to reinforce learning and activity-based methods engage par-

ticipants,resultinginhigherknowledgeretention.

The materials used to support the effective delivery of the train-

ing are:• Trainingmanuals–detailedtechnicalcontent

• TrainerGuide–explaininghowandwhattotrain

• Flipfile–visualcentrepiece,tobeusedinthefield

• Tips&Tools–hand-outswithguidelinesandtools (e.g. Yield Recording sheet)

• Trainerkits–withflashcards,stationery, equipment, tangible examples

• Onlineportal–AtaAKVOPediaportal, all the agro-nomical guidance is made available: https://akvopedia.org/wiki/Sustainable_Oil_ Palm_Farming

26https://news.mongabay.com/2016/04/jokowi-announcesmoratorium-new-oil-palm-mining-concessions/Accessedon22June201827http://www.undp.org/content/undp/en/home/presscenter/pressreleases/2015/03/11/indonesia-government-addressesdeforestation-challenges-

in-its-aim-to-double-palm-oilproduction-by-2020.html.Accessedon12June201828https://www.reuters.com/article/palmoil-outlook-mielkeidAFL4N1N537Daccessedon22June2018

INCREASING PRODUCTIVITY LEVELS CAN SUPPORT THE GOVERNMENT’S POLICY TO INCREASE OIL PALM PRODUCTION AND WITHOUT OPENING NEW LAND FOR OIL PALM PLANTATIONS.


21

4. CASE ANALYSIS: PLANTATION COMPANY REPLANTING FINANCING SCHEMES

BOX 3. GOLDEN AGRI RESOURCES (GAR)

GAR is the largest plantation group in Indonesia and

second largest globally in terms of planted area. The

company’s plantations are in Indonesia and they manage

more than 502,000 hectares of oil palm plantations

(including smallholder farmers).

Foundedin1996,GARwaslistedontheSingapore

Exchangein1999andthecorporateofficeisbased

inSingapore.GARhasseveralsubsidiarieswhich

include PT SMART Tbk, a business operating in Indo-

nesia; Victory Tropical Oil, a distribution business in

EuropeandtheUS;PTDamiMasSejahtera,acertified

DxPseedproducerandsupplier;aswellasvarious

businesses in China.

4.1 GOLDEN AGRI RESOURCES (GAR)ACCESS TO FINANCE APPROACH

GAR (Box 3) has developed a partnership program that includes

farmersandcooperatives.GARmakesagreementswithboththe

individualfarmers,whoreceivetechnicalassistanceforinstituting

Good Agricultural Practices, and the Cooperative (for managing

the land and off-taking the FFB from farmers). GAR enters into an

offtakeagreementthroughoutthepartnershipintwoways:both

the farmer and the cooperative agree to sell to the company,

verymuchinlinewithaplasmaschemearrangementwherethe

companywillmanagethelanduntiltheloanispaid.Farmers

poolcontroloftheirlandforthetermofthepartnershipwiththe

cooperative. The Partnership Agreement might have a term of

20years;GARwouldliketoextendthistoalongerperiodthan

theprevious/existingplasmamodel,whichrunsfor12-13years

basedonfinancingterm.

IntheGARapproach,anagreementneedstobemadewitha

cooperative,whichisalsoinlinewithgovernmentrecommen-

dations or requirements. Although this could be considered an

additional risk factor, in the model it is a critical channel to deal

withsocialissues,aswellasrelationsbuildingandadministration.

See Figure 4 for GAR’s closed loop business model.


22

REPLANTING ACTIVITIES

InRiauandJambi,430farmersarepartofaschemewithGAR

whichcovers1200ha.AnotherprojectinRiauisongoingwhich

targets1000ha.Thetargetfor2018istohave5000hectares

replanted. So far a total of 3500 hectares has been reached

and is ready for replanting in Jambi, Riau, South Sumatra, and

North Sumatra.

For these schemes the investment cost is about USD 7500 per

hectare. Out of this, USD 5000 is for replanting activities, this

includeslivingallowance(Livingallowance,USD35/haper

monthfor48months),andanotherUSD1000forloaninterest

paymentsduringthefirst4years,andtherestisforinterestduring

production. The interest rate offered is typically about 11-12.5

%. For replanting schemes, GAR typically needs a minimum block

around 100ha. A key driver for GAR in this effort is the need

tosecureFFBsupplyinthefaceofgrowingcompetitionfrom

strategically-located independent mills.

FINANCING PARTNERS

GARisengagedinSmallholdersReplantingwiththePartnership

ModelwithSyariahMandiriandBRIAgro.BankSyariahMandiri’s

offer uses a corporate guarantee from GAR. GAR has investigated

whetherinternationalinvestorscouldcomein,buttheyarenot

abletocompetewithIndonesianinvestors.

ThemainbenefitsofGAR’sprogramare:

• High-quality seeds provided;

• Good Agricultural Practices implemented professionally;

• Landcertificationbygovernment(BPN)toachieve

freehold title (SHM);

• Higher yields leading to increased incomes;

• SustainabilitycertificationbyISPO.

During replanting, the management is taken over by GAR to

dothereplantingworkandtheharvesting.Thecompanyoffers

farmerstheopportunitytobecomeanemployeeontheirown

land generating additional income for them. Also, farmers receive

the dividends generated by GAR’s use of their land.

Before farmers can join the program GAR conducts an assessment

on various aspects. The main requirements for participation in

theschemearerelatedtotheavailabilityoflandcertificates,

applicantprofile,generalrequirements(cooperativemembership,

linkage to bank), and land provisions related to status of land

and proximity to forested areas. See Annex 1 for the full list of

requirements.

GAR’sprimaryfocusistoengagewithfarmerswhoownclean

andclearstatus.However,GARiskeentoworkwithfarmers

whohaveoutstandingdebtsinordertoscaleuptheprogram.

Thiswouldneedbiggerfundingastofinancethereplantingas

wellastorestructurethedebt.Thepricing/interestrateforthis

scale up needs to be carefully calculated so that farmers are still

abletopay.GARalsoseekstopartnerwithCPOfundandKUR

loans. To be able to collaborate some requirements need to be

adjustedtoensurethatcooperativesreceivesupport.However,

GAR sees a potential problem in having different schemes for

smallholders in close proximity, because they might complain

that terms are different, unfair, etc.

FIGURE 4: GAR’S CLOSED LOOP BUSINESS MODEL FOR SMALLHOLDER REPLANTING

FACILITATIONSource: “Replanting Program Through Innovative Financing

forIndependentSmallholders”-Syafaat(2018)

1 2

4

3

1. SmallholderswithinCooperative(leglaentity)2. Cooperative & Partnered Company sign Partnership Agreement 3. Cooperative apply credit facility to Bank4. Allocation of crops to repay the credit, operational cost, & as farmers’ income.

GAR SEES A POTENTIAL PROBLEM IN HAVING DIFFERENT SCHEMES FOR SMALLHOLDERS IN CLOSE PROXIMITY, BECAUSE THEY MIGHT COMPLAIN THAT TERMS ARE DIFFERENT, UNFAIR, ETC.


23

Thisisduetothefactthatwithnon-Rupiahsourcesoffunds,

investors are not able to reach competitive rates and loan ten-

ure.GARhasalsoexploredworkingwithinternationalsocial

investorsandothers,buttheywerenotabletocomeupwith

competitive terms either.

4.2 WILMARACCESS TO FINANCE APPROACH

Wilmar (Box 4) has been actively exploring options for develop-

ingmechanismsforsmallholderstoobtainaccesstofinancefor

replanting. Since 2016 Wilmar has seriously pursued options

basedonseveralproposalswithinternationalbanksforsupport-

ing smallholder replanting. In the end the efforts have not been

successful because of the reluctance of potential international

investorpartnerstocometotermswithpotentialcreditrisks.The

main obstacles have been the long tenure of loans for oil palm

replanting (i.e. 5 years before any return to investment may be

expectedandloanstenureexpectedtobebetween10–12

years), and the hedging costs of foreign currency to IDR. The

additionalriskpremiumsmadetheofferingsuncompetitivewith

theofferingsalreadyavailablefromlocalbanks,hencewere

notworthpursuinggiventhatthisdidnotcreateadditional

accesstofinance.

Overall,Wilmarisstillexploringpotentialsuccessfulways,as

initsfirstexperiencetheissuewaspoorlyunderstoodfromthe

investor’s side. Many of the proposals still focus on a corporate

guarantee from Wilmar to mitigate risk. Also, most international

investorswereonlyinterestedinticketsizesaboveUSD20

million,whichisneitherapplicabletoindividualfarmers,nor

typical groups of smallholder farmers. Outside of typical micro

financingoptions,manyinvestorsthatWilmarhaddiscussions

withwereoftennotpreparedtodealwithindividualfarmers.

Finding a plausible group of smallholders that had the institutional

capacitytoprovideoptionsforaggregationwasdifficult,and

attempts to create such entities have not been successful due to

internal social problems in the communities.

BOX 4. WILMARWilmarInternationalLimitedwasestablishedin1991

and headquartered in Singapore. Wilmar is currently

Asia’s leading agribusiness group. Its business activities

include oil palm cultivation, oilseed crushing, edible

oilsrefining,sugarmillingandrefining,manufacturing

of consumer products, specialty fats, oleochemicals,

biodieselandfertilizersaswellasflourandricemilling.

Wilmaristhelargestpalmoilrefinerandpalmkernel

and copra crusher, specialty fats, oleochemicals and

biodiesel manufacturer in Indonesia and Malaysia.

Wilmar is also one of the largest oil palm plantation

ownersglobally.In2013,Wilmarbecamethefirstpalm

oil company to launch a No Deforestation, No Peat

andNoexploitationpolicythatcoverednotjustitsown

operationsbutthatoftheirthirdpartysuppliersaswell.

WILMAR BECAME THE FIRSTPALM OIL COMPANY TOLAUNCH A NO DEFOREST-ATION, NO PEAT AND NO EXPLOITATION POLICY


24

One reason might be that banks have different reasons for lending

tosmallholders(profitabilityratherthansocialimpact/smallholder

development),andthereforearenotwillingtotaketheriskrelated

tofinancingthisgroup.

Wilmar also highlighted that under the national plasma devel-

opmentprogram,whereplasmaholdershaveindividualcon-

tractswithpalmoilmillsthathavefinancedtheirinitialoilpalm

development, plasma holder farmers are legally bound to their

plasmacontractsuptotheendofthefirstcycle,i.e.uptothe

firstreplanting.Thisisthecaseevenwhereplasmaholdershave

paidbacktheirloansandreceivedtheirlandcertificates(where

itwasheldbythecompanyascollateral).Developedbasedon

government guidelines, plasma contracts have requirements that

arebeneficialtothefarmer,typicallythatthemillmustpayabove

FFB market price for all crop, and that companies must provide

development funds to the farmers, etc. These requirements are

in place for the smallholders to then send 100% of crop to the

companythatfinancedtheinitialoilpalmdevelopment.Due

tothisarrangement,thereisanattractivenesstostaywithina

plasma structure. Given that the international investor community is

largely interested in investing in independent smallholders, having

existing plasma programs can be a deterrent. Additionally, there

arealsomanycaseswhereaftertheinitialplasmaloanispaid

back,andfarmershavereobtainedthelandcertificate,thesale

ofthelandcanhappen,oftenunofficially,andwithnochange

inthenameonthelandcertificate,soastoenabletheselands

toremainofficiallyintheplasmaprogram.Asaresult,itisnot

clearwhoownstheland,whichcanbecomeadeterrentto

qualifyingforloans,astheownershipofthelandisoftenthe

basis for collateral.

Thereisanothermodelofplasma,whichisbasedonthesetup

of a cooperative entity, the Kredit Koperasi Primer untuk Anggota

(KKPA)scheme.TheKKPAisalegalentitywhichholdstheplasma

contractsandthereforeadministersallfiscalresponsibilitieson

behalf of their individual farmer members. Typically, this meant

that the companies entering into plasma agreements and contracts

woulddealwiththeKKPAandnotwiththeindividualfarmers.

While this seems to meet many international investors preference

for an aggregated group of smallholders, the reality is more

complicated.First,thereisariskofbaddebtorswithintheKKPA

membership. Removing the bad debtors from a KKPA grouping,

wouldthereforepotentiallyraiseconflictswithinacommunity.

Secondly, there is doubt of some KKPA’s ability to manage loans

appropriately.Whileplasmacontractsaredonebetweenthe

company and the KKPA, the mill effectively controls payments,

as it has the role of buying the FFB from the farmers. Hence,

in the KKPA plasma model, the companies are responsible to

ensure that loans are paid back.

MANY INVESTORS THAT WILMAR HAD DISCUSSIONS WITH

WERE OFTEN NOT PREPARED TO DEAL WITH INDIVIDUAL

FARMERS.


25

Giventhatreplantingwouldmeanplasmasmallholderseffec-

tively become independent of the mill and companies, Wilmar’s

experience found that many KKPA expected to directly manage

theloan,whilestillexpectingthatanypotentialdefaultswould

be resolved by the company. This lack of capacity to manage

loans and their repayments constitutes an additional complication

andbarriertoaccessfinancing.

Settingupanewentitymaybeascomplicated,becauseit

needstohavethefarmersallindividuallybuyingintothenew

entity.Withanewstructure,therecouldbeasmallerpoolof

farmers,andhenceasmallerareaofreplanting,whichreduces

the attractiveness to international investors. There is also the real

riskoflimitedcommitmentofthememberswhosignup,which

could pose additional risks for loan repayments, as members

may feel they are not responsible for the debt of the entity. In

thecaseofWilmar,asmallholdergroupthatwassetupfrom

a collective of KKPA, fell apart because farmers didn’t feel they

haddirectownership,andthattherewasinfightingwithinthe

groupsonwhoshouldassumeleadership.Settingupabrand

newentityjustforthesakeofareplantingloan,thereforecan

be very risky as there is a large risk of the group disbanding,

and then potentially defaulting.

Giventherelativelylongwindowfromreplantingtofirstharvest

(typically 4-5 years), there is also the question of farmer liveli-

hoods. This is an issue that is important to many international

investors. Any loan program is likely to include this requirement.

The original plasma loan programs in Indonesia accounted for

the livelihood question by increasing the tenure of the loans,

hence these are typically for 12 years repayment period or

longer. This accounted for farmers’ livelihoods by allocating a

certain amount to be provided cash in hand to the farmer in the

initialreplantingphase,andrepaymentswerepaidonlywhen

cropwasbeingproduced.

Manyrecentinternationalinitiativeshowever,tendtofocuson

“alternativelivelihoods”withinthefirstphase,andtypicallyexplore

the farming of other non-palm crops. Wilmar is not against the

developmentofothercrops,however,theirviewisthat,introducing

newcropsdoesinvolvetheriskthatfarmersaredistractedfrom

the management of their main crop, oil palm.

Notingthatmanysmallholdersarefirstgenerationfarmers,there

is a real concern that alternative annual crops could end up

competingforfertilizerinputsthatarecriticalintheearlygrowth

phase of the oil palm for long term productivity. Therefore any

introduction of alternative annual crops needs to also provide

strong technical agricultural assistance, in addition to having key

agricultural support on oil palm best management. In traditional

plasma agreements, the agricultural support has been provided

by the company.

CURRENT SITUATION

Wilmar is currently focusing on encouraging smallholders to

replant.Nodirectfinancialincentiveisprovidedtoreplant,

exceptnotingthatnoreplantingwillseeacontinueddeclineof

production from old palms. One avenue Wilmar is exploring is to

recreatesmallholderschemesinareaswithoutplasmaprograms;

as independent smallholders are not part of existing schemes,

these provide an avenue for innovation in partnership.

GIVEN THAT THE INTERNATIONAL INVESTOR COMMUNITY IS LARGELY INTERESTED IN INVESTING IN INDEPENDENT SMALL-HOLDERS, HAVING EXISTING PLASMA PROGRAMS CAN BE A DETERRENT.


26

4.3 CARGILL

Cargill (Box 5) sources from 37.000 ha of smallholder

plantation(allplasma).Theirownmanagedplantations

(inti)coversabout80,000hectares,soabout40%oftheirsupply

comesfromsmallholders(9mills,3crushers).Ineveryfinancial

reviewforCargill,theperformanceofsmallholdersisthusvery

important for the overall performance of the company.

REPLANTING ACTIVITIES

Cargill has different models for replanting. In particular around

their Hindoli mill Cargill is looking for schemes to help small-

holderswiththeirreplanting.Thisistobedoneinphases,and

from a Cargill perspective they have been trying to help them

forafewyearsnowtoimprovetheirmanagementandprepare

them for replanting.

WithintheCargillsupplychainthefirstsmallholderswereRSPO

certified,theonesthatarealsosourcingtoHindolimill.These

farmersarefairlywellorganized,fairlywealthy,somehavetheir

ownoutreachprogramsandevenmanagedtoimplementtheir

owndroneprograms.

When it comes to loans, different banks have approached Cargill

to see if they can help provide loans to the farmers. In the end,

Cargill has a preference for loans that can be provided locally

at competitive rates. Cargill reported that some loan providers

areaskingcomplexreportingrequirements;likereportsongrowth

progress,additionalityandprofits.Eventuallyitbecameclear

thatthosefinancierswanttohaveashareintheprofits.Inthe

end it looked more expensive and needed to put a value on the

smallholderrequirementsaswell,sowasnotaccepted.

Even though Cargill doesn’t provide a corporate guarantee

butonlyofftakeagreements,banksarewillingtogiveloansto

Cargill smallholders.

In South Sumatra, Cargill is looking at setting up plasma type

programswithfarmersagain,butsomesmallholdersbelievethat

theycanmakemoremoneyindependently.Itdoesnotalways

seem easy to keep systems in place after they have been set up.

So far, 45 smallholders have been supported in getting RSPO

certification.However,afteroneyear,farmersdidn’twanttocon-

tinuebecausetheybelievethatbenefitsonthecertifiedproducts

arenotsufficient.Farmersmayunderestimatethevalueofmarket

EVEN THOUGH CARGILL DOESN’T PROVIDE A CORPORATE GUARANTEE BUT ONLY OFFTAKE AGREEMENTS, BANKS ARE WILLING TO GIVE LOANS TO CARGILL SMALLHOLDERS.

BOX 5. CARGILL

CargillbegandoingbusinessinIndonesiain1974by

establishing a feed mill in Bogor, West Java. Today,

Cargill,headquarteredinJakarta,isoneoftheworld’s

leading merchants of grains and oilseeds. Cargill con-

nects producers and users of grains and oilseeds around

the globe. Its oilseeds business is based on palm oil,

coconut oil and related derivate products from Indonesia.

access,andthebenefitsthecompanyprovides,andtheydon’t

seemtohavethelongtermview.InWestKalimantantheremay

besitesthatcouldbeinterestingtolookintoforreplantingfinance

(there are some KKPA schemes up for replanting).

4.4 ASIAN AGRI

Smallholders are considered an essential part of Asian Agri’s

business,contributingtoasignificantproportionofthe160,000

hectares of oil palm plantations that they manage. Since 2017,

Asian Agri has announced a 1:1 commitment: for every one

hectareofownmanagedplantationstheyaimtomatchitwith

onehectareownedbysmallholders.Currently,about40percent

ofthelandmanagedbyAsianAgri,isownedbysmallholders.

40% of Cargill’s supply comes from smallholders


27

AsianAgriwasoneofthefirstcompaniesinvolvedinthegov-

ernment’s PIR-Trans scheme and aims to provide an on-going

support to raise living standards and boost yields. Asian Agri

also supports smallholders having alternative sources of income

–suchascattleorfishfarming–whenoilpalmsreachtheend

of their productive span and must be replanted.

TARGETS

AsianAgriaimsforapartnershipwithsmallholderstomatch

thecompany’sownplantationarea,bothtargetedforapprox.

100,000hectaresbyend-2018.Thetotalpartnershipareais

approximately91,000hacurrently,composedof60,000ha

of plasma and the rest of independent smallholders. Moving

smallholderstowardsustainableagriculturalpracticesisonly

possible if there are also increases in yield of smallholder farmers.

Asian Agri has 31,000 ha of independent smallholders in their

supply chain that are already organized in groups. Their inde-

pendentsmallholdersarereadytodoreplanting,howeverthe

replanting fund cannot be delivered directly by the loan provider

but it has to engage bank institution as regulated by government.

BOX 6. ASIAN AGRI INDEPENDENT SMALL-HOLDER PARTNERSHIP

ARRANGEMENT

Started: 2012

Scale:31,000haofoilpalmplantationowned

by independent smallholders, on top of 60,000 ha

of plasma

Location: Jambi, Riau, and North Sumatra

Duration: Same as the term of the loans, currently 13 years

Objectives/Activities: GAP, traceability,

supportfarmerKUDcertification(ISCC,RSPO,etc.),

replanting

Organization: Farmer groups

Farmer Finance: Loan term is for 13 years (5 years “grace”)

Corporate Guarantee: Yes, subject to terms and conditions

Future Plans: Expectedtogrowbyend2018to:100,000 ha (plasma smallholder 60,000 ha and independent smallholder 40,000 ha)


28

AsianAgri’stotalpartnershipareaof91,000hacomposedof

60,000 ha of plasma and

31,000 ha of independent smallholders

THE LOAN TERM IS 13 YEARS WITH A 5-YEAR GRACE PERIOD AND FOLLOWED BY A

8-YEAR REPAYMENT PERIOD.THE GRACE PERIOD WILL

COVER THE COSTS FROM THE PREPARATION, REPLANTING,

MAINTENANCE, ETC., TO EARLY PRODUCTION STAGE.ASIAN AGRI PARTNERSHIP MODEL

AsianAgrihasalreadybeenworkingonreplantingwithsmall-

holders.Smallholderscontributetheirownlaborformaintenance,

whileforharvesting,thecompanyprovidestraining,guidanceand

supervision. In the partnership, technical assistance is provided

by AA personnel. Partnership scheme is a key part to ensure that

smallholdersourcingistraceable,inthiscasetotheknownand

approved production areas of the smallholders (in practice, this

means that farmer’s FFB sales are consistently monitored to match

withtheirplantedareaandestimatedproductivity).

AsianAgriisalsowillingtosupportandprovideacorporate

guaranteeoverloanstoallofitssmallholderswhoparticipatein

partnership agreements. Individual farmers pledge their land as

collateral. Asian Agri partnership agreements last for the term of

the loans and continue further to engage and assist smallholders

tomaintaintheirproductionyield.Thecostsforreplantingwill

followtheregulationsetbygovernment,representedbytheMin-

istry of Agriculture through the Directorate General of Plantation.

Asian Agri provides assistance in helping farmers resolve their

loanproblems.Atpresent,theloantermis13yearswitha5-year

graceperiodandfollowedbya8-yearrepaymentperiod.The

graceperiodwillcoverthecostsfromthepreparation,replanting,

maintenance, etc., to early production stage. To repay the loan,

therewillbeaportionofpaymentdeductionfromthefarmer’sFFB,

currently set at 35%. With the current FFB prices, the percentage

covers the cost of principal and interest.

‘ONE TO ONE’ PARTNERSHIP MODEL

AsianAgri’sOnetoOnecommitmentwillseethecompanymatch

eachhectareofitsownlandwithonehectareoflandownedby

smallholdersbytheendof2018.TheOnetoOnecommitment

not only protects the traceability of palm oil, but also increases

the capability of the smallholders to achieve optimum results.

Asian Agri has been building a partnership encompassing 60,000

hectares of land under the government’s plasma smallholder

scheme, and another 40,000 hectares belonging to independent

smallholders,makingAsianAgrithefirstpalmoilcompanyin

Indonesiawithsuchacommitment.

Thecompanyprovidesitssmallholderpartnerswithtraining,

assistance and modern equipment to help them increase their

yieldsandearnsustainabilitycertification.


29

BOX 7. “ANOTHER PERSPECTIVE ON PARTNERSHIP.”

Another partnership approach has been observed at Prosympac.Thiscompanyisrelativelynewandheavilydependentonitsrelationshipswithsmallholdersformillsupply.

Prosympac seeks to carry out its replanting activities in partnershipwithfarmergroups(kelompoktani).Itutilizeshigh-qualityseedlings,withsomeadjustmentofseedvarietyforlandtype(especiallyrelativelywetland).One kelompak tani may contain 60 farmers on aver-age. Several kelompok tani together can form a KUD. Prosympacwillpayforcertificationwhilepricepremiumsforcertificationwillbedistributedbacktothefarmers.Arrangements for output delivery to the mill are made byKelompokTaniwhichalsomakesarrangementsforharvestingandotherlaborifthefarmersdon’twanttodo it themselves (for the most part, farmers do not harvest theirownFFBs).

In the Prosympac partnership, prospective loan terms (not yet launched) may be for either 10 or 15 years; theywillsettleonthelongerloantermiffarmersdecidethattheywanttobuilduplong-termsavingsforthenextreplanting. The repayment period is therefore 6-11 years, a bit shorter than is seen at larger companies. During therepaymentperiod,loansarerepaidinfixedmonthlyinstallments. Unlike other loan types observed, there is no cost of living component for years 0-4. These farmers are “not that poor;” they have multiple plots (most farmers stagger their replanting to the extent they can), have an opportunityforintercroppingandtoworkascontractworkersforthekelompoktaniortheplantationiftheyneed to.

Toservearadiusofapprox.15,000smallholder-ownedhectares,Prosympachasateamofapproximatelytwenty(20) persons as “Tim Kemitraan,” agents representing the company,providingtechnicaltraining/assistance,andsolvingproblemsinthefield.

4.5 ROLE OF COOPERATIVES (KUDS), ADDITIONAL INCOME, AND LAND CERTIFICATES

Whether it is a plasma or independent smallholder partner-

ship,cooperativesplayimportantrole,withfinancial,

administrative and legal (but not marketing) responsibilities. For

partnerships, consolidating farmer groups into farmer associations

(Gapoktan, Gabungan Kelompok Tani) is an option, although

KUDstatusisbetterfromalegal/administrativeperspective,

both because the ability to participate in loan and other agree-

ments is clear and because the government strongly favors and

supports cooperative development among farmers.

THREE KEY FUNCTIONS OF KUDS HAVE BEEN IDENTIFIED:1. Partnershipagreements–Farmerssignagreementsgranting cultivation rights to the KUD, giving it the authority

to make long-term partnership agreements. The KUD then

makesthe(long-termpartnership)legalagreementwiththe

plantation company.

2. KUDs control sale of members’ FFBs to AA using letters

ofsaleaspartoftraceability,whichalsohelpstomaintain

certificationsattainedattheKUDlevelwithsupportfrom

AA (RSPO, ISPO, ICC, designation as Kosher, etc.)

3. Distribution of Sales Revenue and Price Premium Rev-

enuerelatedtocertification–currentpracticeisthatprice

premiumrevenueisusedforlocal/villageinfrastructure

or other projects

ADDITIONAL INCOME GENERATING ACTIVITIES

Intercropping on replanted land (this does not include ground

coverplantsintendedtofixnitrogeninthesoil,whichispartof

good replanting practice) can have a negative impact on tree

development and is not recommended.

Farmersneedtofillincashflowgapinotherways,including:

1. Household savings,

2. Livingexpenseborrowingcomponentfortheloans,

3. Havingmultipleoilpalmplots(twohectaresplotsmaybe registered in other names but controlled by a single

farmer/farmhousehold),

4. Plantationorotheremployment,and/or

5. Household enterprise or other agricultural activities

(on different land).

LAND CERTIFICATES AND LAND USE

Insomeareas,includingRiauprovince,therearesignificant

problemswithsmallholderlandstatus,whichcanaffectfarmers’

abilitytoqualifyforpartnershipandfinance.

InRiau,therearesmallholderfarmerswhohavealreadyreceived

landcertificates,buttheirlandhasbeenreclassifiedas“for-

ested”. Spatial use information appears to be out of date and

contains gaps.

Under partnership (kemitraan) arrangements, substandard FFBs are

returned to the farmers. Under the plasma system, substandard

FFBsareusedwhilethemillpaysadeeplydiscountedprice–this

is seen as less fair and less transparent.


30

THE LACK OF EXPERIENCE WITH LENDING TO SMALL-HOLDERS ALSO MEANS THAT CREDIT RISKS IS PERCEIVED TO BE RELATIVELY HIGH FOR THE BANK.

5. INVOLVEMENT OF THE FINANCIAL SECTOR AND GOVERNMENT

5.1 COMMERCIAL BANKS

Interviewswithanumberoffinancialinstitutionswereconductedtoassesstheirwillingnessandcapacitytodeveloporexpand

lending to oil palm smallholder farmers.

RABOBANK INDONESIA

Traditionally,Rabobankfocusesprimarilyonagriculturalfinancing

to corporate customers; for Rabobank Indonesia, sustainable oil

palmcultivationisakeyareaofinterestandfitswithinthebank’s

strategy to support their corporate clients in their aim to develop

sustainable supply chains. Rabobank Indonesia has experience

withfinancingtheoilpalmsector,butcurrentlydoesnothave

anydedicatedoilpalmsmallholder-relatedfinancingactivities.

InpracticeRabobankfacessomesignificantpracticaldrawbacks

vis-à-visthestate-ownedbankswhichdominatelendinginthe

sector.Inparticular,Rabobanklacksabranchnetworkinrural

areasandalow-cost,stableRupiahfundingbase.Thelackof

experiencewithlendingtosmallholdersalsomeansthatcredit

risks is perceived to be relatively high for the bank. Furthermore,

state-ownedbanksalsofacepressuretosupporttheGovernment

of Indonesia’s announced policy of supporting smallholder replant-

ing.However,Rabobankcontinuestobeinterestedinexploring

possibilities, largely because they maintain corporate banking

relationshipswithmanylargeoilpalmplantationcompanies,

tradersandbuyersandarewillingtoexploreinnovativefinancing

structures to accelerate smallholder oil palm replanting through

their corporate customers. Rabobank Foundation is also offering,

atlimitedscale,financialservicestosmallholders.Althoughits

loan portfolio is currently relatively small, Rabo Foundation has

extensiveexperienceworkingwithcooperativesinIndonesia

and has the potential to expand its activities.

Further, Rabo International Advisory Service (RIAS) provides tech-

nicalassistancetofinancialinstitutions,whichincludesstrategic,

risk management, operational and other support.

BANK MANDIRI

BankMandiriisaState-ownedbankandaleadinglendertopalm

oilplantations,withaIDR48.9trillionloanportfolio(approximately

9%ofitstotalloanportfolio)exposedtothepalmoilindustry.29

The bank mainly focuses on large plantation companies but also

provides short term products to plasma farmers through partnership

programs. Kredit Pengembangan Energi Nabati (KPEN) and

RevitalisasiPerkebunan(RP)aretworeplantationcreditfacilities

thatBankMandiriofferswithgovernmentsubsidizedinterest

rateinaperspectiveofcoveringthelong-termfinancingneeds


31

BRI AGRO HAS DESIGNED A CONSUMER BUSINESS FACILITY TO SUPPORT SMALLHOLDERS WITH OIL PALM RE-PLANTING IN THE FRAME OF THE KKPA AND THE KUR PROGRAM.

29 Bronkhorst et al. 2017. Current practices and innovations in the smallholder palmoilfinanceinIndonesiaandMalaysia:Longfinancingsolutionstopromotesustainable supply chains. Bogor, Indonesia: Center for International Forestry Research.30 Bronkhorst et al. 2017. Current practices and innovations in the smallholder palmoilfinanceinIndonesiaandMalaysia:Longfinancingsolutionstopromotesustainable supply chains. Bogor, Indonesia: Center for International Forestry Research.

31http://www.briagro.co.id/en/aboutus/historyAccessedon18June201832 Bank BRI. 2016. Board of Directors report. Jakarta, Indonesia: BRI. Accessed 1 July2017.http://bri.co.id/assets/files/E.3.20–1.PDF33 Bronkhorst et al. 2017. Current practices and innovations in the smallholder palm oilfinanceinIndonesiaandMalaysia:Longfinancingsolutionstopromotesustainablesupply chains. Bogor, Indonesia: Center for International Forestry Research.

requiredtobridgetheproductiongapbetweenreplantationand

firstproduction.30ThefacilitywhichisofferedthroughtheKUR

program, requires for example a plantation business license,

corporate guarantees and eligible collateral.

BRI AGRO

BRIAgrohasbeenfoundedin1989andtodayhasaprominent

and strategic role in the agribusiness sector in Indonesia.31 The

bank has a high exposure to the palm oil sector as the largest

micro and small business loans provider under the KUR program

in 2016.32

BRI Agro has designed a consumer business facility to support

smallholderswithoilpalmreplantingintheframeoftheKKPA

and the KUR program. Similar to Bank Mandiri, BRI Agro’s facility

appliesa‘step-up’interestrateallowingfarmerstobearless

interestchargeswhenreplantedtreesarestillimmature,before

changing to the commercial rate by the time trees have achieved

full production. In order to meet daily expenses during the produc-

tiongap,farmerswouldreceiveacompensationfeeofaround

IDR500,000ha/month,althoughthelegalentityresponsible

tofillthisincomegapisundetermined.33

5.2 IMPACT AND OTHER INVESTORSINTERNATIONAL IMPACT INVESTORS

Targeting to reduce the negative effects of deforestation, an

increasing number of international impact investors are offering

financialproductssuchasgreenbonds,loanguaranteesand

investments in environmentally sustainable projects. Investments

in (portfolios of) eligible oil palm smallholders may provide these

investorswithanattractiveeconomicreturnaswellassocial

and environmental impact.

In 2017, Rabobank and the UN Environment have announced to

allocateuptoUSD1billionforfinancingofsustainableagricul-

ture initiatives via the Fund for Forest Protection and Sustainable

Agriculture (FPSA). IDH, The Sustainable Trade Initiative, and

FMO are adherence partners of the fund.

The FPSA Fund’s mission is to mobilize capital of commercial

banks and other eligible partners to actively prevent deforesta-

tion,stimulatereforestation,contributetoefficientsustainable

agricultural production, decrease carbon emissions and improve

rural livelihoods in emerging markets. The Fund is comprised of

a Finance Fund and a related Technical Assistance (‘TA’) Facility.


32

BAHANA ARTHA VENTURA IS 100% OWNED BY THE INDONESIAN GOVERN-

MENT THROUGH THE MINISTRY OF FINANCE,

AND IT’S MAIN GOAL IS TO GROW SME BUSINESSES IN

INDONESIA, BY PROVIDING FINANCING TO SMES AND

COOPERATIVES

$250FINANCE FUND

TARGET

MILLIO

N

AsofMay2018,theFinanceFundhasatargetofUSD250

millionwhiletheTAFacilitytargetsUSD50million.Themain

objectivesoftheFundarethefollowing:

• To contribute to sustainable land use practices at scale;

• To provide credit enhancement tools (such as grants,

soft loans, guarantees) to catalyze private funding from

commercialbanksandtheireligiblepartnerstoqualified

initiatives;

• To stimulate initiatives that contribute to existing and

innovativebestpracticesinordertoloweragriculture’s

footprint and restore land use for agriculture and forestry;

• To reach local farmers and smallholders as priority

beneficiaries;

• To yield substantial, measurable environmental and

social (‘E&S’) impact.

VENTURE CAPITAL COMPANIES1- BUMDES

BUMDESor‘VillageOwnedEnterprise”fallsundergovernment

regulation on Permendes No.4 2015, Badan Usaha Milik

Desa.Itisfullyorpartlyownedbythevillageandmanages

thevillage’sassets,servicesandotherbusinesswiththeaimof

improvingwelfareofthevillagecommunity.Itreceivesannual

budgetbasedonvillagesize(DanaDesa)–onaverageIDR75

million. BUMDES is envisioned to perform activities as:

• LimitedCompany:conductbusinessactivitieswhere

capitalispartiallyownedbyBUMDESinaccordancewith

legislation on Limited Liability Companies.

• MicroFinanceInstitution:where60%ofsharesare

heldbyBUMDES,inaccordancewithlawsandregulations

applicable to MFIs.

BUMDESmaywellbeanalternativetocooperativesasithasa

more appropriate legal structure and less legacy systems, although,

thelegalframeworkforBUMDEStoactasMFIoragentforbanks

stillneedstobefullyfinalized.Mostimportantly,BUMDESis

currentlyagovernment-ledinitiativeandtheextenttowhichthis

institutionwillbeequippedwiththenecessaryentrepreneurial

skillsetrequiredtoliaisewithfarmersanddeveloprelationship

withfinancialinstitutionsstillneedstobeproven.

2- BAHANA ARTHA VENTURA (BAV)

BahanaArthaVenturaisastate-ownedventurecapitalcompany,

establishedin1973.Itis100%ownedbytheIndonesiangov-

ernmentthroughtheMinistryofFinance.Itsmaingoalistogrow

SMEbusinessesinIndonesia,byprovidingfinancingtoSMEsand

Cooperatives.Inpractice,however,BAVfunctionsmainlyasa

holding company for regional venture capital companies (BMVD)

aswellasanintermediaryforlendingtoselectedcooperatives.

At present, BAV’s existing funding sources are dominated by bank

borrowingonrelativelyshortterms,limitingtheirabilitytooffer

loanswithtenorsexceeding3years.


33

STIMULATE INITIATIVES THAT

CONTRIBUTE TO EXISTING AND

INNOVATIVE BEST PRACTICES IN

ORDER TO LOWER AGRICULTURE’S

FOOTPRINT AND RESTORE LAND USE FOR AGRICULTURE

AND FORESTRY;

BOX 8. KUR LOANSThe Indonesian Government has released a special policy onKURwithaninterestrateof7%forplantationcommuni-tieswhichisaimedatoilpalmfarmerswiththemaingoalofoilpalm,tobeimplementedasfrom1January2018.Total KUR IDR 4 billion is allocated for replanting.

TwoKURschemesforreplantingoilpalm:1. Loanceilingmax.IDR25millionwithoutcollateral2. LoanaboveIDR25millionwithlandcertificate(maxIDR500 million)

• For individual farmer group members• Canalsobeusedforcowfattening, andforfishingcommunitiestobuyboats

The scheme aims to help farmers for costs of living during unproductive period after replanting up to 5 years, at IDR 1 -1,5 million per month.

• Condition:ownmax.4hectares• Oncetreesbecomeproductive,betweenyear 3-4 years, they can start to repay their KUR loan

BNIwillbethebankthatwillsupportthegovernmentinexecuting the KUR program for replanting.

BOX 9. BADAN PENGELOLA DANA PERKEBUNAN KELAPA

SAWIT OR CPO FUND

The Agency for Oil Palm Plantation Funding (Badan Pen-gelolaDanaPerkebunanKelapaSawitorBPDP-KS)asanallocationofRp400billionanually.However,thedisburse-menthasbeenchallengingandoverthelastfewyearslessthan 5% has been disbursed. The government projects the replanting efforts to cost aroundRp50-60million/haandtheremainingcostswillbe funded by bank loans. BPDP-KS provides grants for replanting funds of Rp25 million per hectare. This should amount to 16 thousand hectares of oil palm plantations. The main conditions are:

• For the submission of individual farmers, the broadtermsofoilpalmplantationsthatwillreceiveareplanting fund is only four hectares. For the group, the total area of land should be at least 300 hectares up to800hectares• Oil palm farmers should have the availability of remaining funds for replanting. According to calcu-lations BPDP-KS, required replanting funds are Rp60 million per hectare. The remaining Rp35 million per hectaremustbeclosedbyfarmerswithprivatefundsor bank credit loans. • Oil palm farmers should at least have the potential togetcertifiedIndonesianSustainablePalmOilSystem(ISPO), this means it cannot be ministry of forestry land or peat, and not land cleared through burning. • The legality of the land should be clear, and the ownerneedstohavetherightlegaldocuments.

Currently,BAVviewsbothitscapacityandappetiteforlong-

term oil palm lending fairly negatively. In general, it seems that

Indonesianventurecapitalcompaniesarenotwellpositioned

toparticipateinfinancing,duetotheirshort-termlendingability

and the nature of their investments.

It appears that there is a need that the Government of Indonesia

provides the enabling conditions (interest rate subsidies, loan

guarantees, policy and other measures) in order to encourage

thefinancialsectortodevelopandscaleuplendingandthus

supportsmallholderstomeetthefinancingneedsrequiredforoil

palm replanting. The government initiatives to support replanting

arediscussedbelow.

5.3 GOVERNMENT INITIATIVES

Inlinewiththegovernments’interestsmentionedinchapter3,therearetwomaininitiativesthatsupportsmallholderreplanting:

CPOfundandKUR-loansforreplanting.SeeBox8andBox9

for a summary of KUR-loans and CPO-fund respectively.


34

6. DISCUSSION

THE GROWING VALUE OF PARTNERSHIP (KEMITRAAN)

Asitgrows,thesmallholderoilpalmsectorappearstobe

evolving beyond the plasma-dominated approach to farm-

er-companyties,whicharerootedintheIndonesiantransmigration

experiencedatingbackseveraldecades.Forfinancialinstitu-

tionsconsideringwhethertofinancesmallholderreplanting,itis

thereforebecomingcrucialtoevaluatethecreditworthinessof

thepartnershipbetweenpalmoilcompaniesandsmallholders.

Whilemostofthecompaniesinterviewedstillappeartoprefer

astraightforwardplasma-styleapproachwherepossible,there

simplymaynolongerbeenoughwillingfarmerstomeetsupply

targets through this type of relationship alone.

Instead, competitive pressures and farmer preferences are lead-

ingtopartnershiparrangementsfeaturingshorterfinancingand

agreementterms,nowoften10-15yearsratherthan20-25years

under the classic plasma model. In addition, most of the part-

nership models observed feature labor provided by the farmers,

rather than hired and managed by the company.

Althoughallcompaniesinterviewedeitherhaveattemptedor

are currently undertaking partnership arrangements of some sort,

therearesignificantdifferencesinthedetailsofthepartnerships,

commitment of resources by plantation companies, and results

achievedtodate.Clearly,though,afewcompanies’partnership

approachesareemergingasworthyofcloserevaluation.

Successful smallholder oil palm farmers have gained substantial

knowledgeandexperienceovertime,andmanyhavebeen

abletosuccessfullyexpandtheirlandholdingsaswell.However,

mostsmallholderswithagingplantationsrecognizethatthey

lack the resources and expertise to successfully replant on their

own–andthatreplantingwillbenecessaryinthenearfuture.

Forthesefarmers,themosteffectiveandefficientwaytoboost

bothlong-termproductivityandFFBpriceswilllikelybetowork

inpartnershipwithanoilpalmcompany.

FINANCE-READY PARTNERSHIPS

Inordertobeabletopresenttheirpartnershipsasfinance-ready,

palmoilcompaniesshouldpresentevidenceofthefollowingto

financialinstitutions:

• Plantationcompany/millwithaproventrackrecord

andstrongfinancialperformance,

• Willingness to provide a corporate guarantee for

bank loans to smallholders (some banks may not require a

corporateguarantee,dependingontheirconfidenceinthe

company and the strength of the partnership arrangement),


35

REPLANTING ITSELF NEEDS TO BE CARRIED OVER AN AREA OF APPROXIMATELY 300 HA AT A TIME IN ORDER TO BE EFFICIENT IN THE USE OF HEAVY EQUIPMENT.

• Working partnership model (plasma, independent

shareholder,orsomethinginbetween)coveringmanage-

ment of replanting including quality guarantee, ongoing

technical assistance, FFB purchase, payment and loan

paymentdeductionarrangementsbetweenfarmergroups

and the company, usually via special-purpose KUDs,

• Replanting approach meeting all regulatory require-

ments, including price ceilings and, ideally, accessing

available subsidies,

• Significantcompanyhumanresourcesinthefield

dedicated to partnership support,

• AssistancefromthecompanytotheKUDs/farmer

groupsinachievingandmaintainingsustainability–and

price—boostingcertifications,includingICC,ISPO,etc.,

• Land titles on the replanted land of participating farmers,

whichwillbepledgedascollateral,

• Generallygoodfarmercredithistory–Becausereplanting

occurs en masse over a particular area, some participating

farmerswillinevitablyhaveproblematiccredithistories

whichthecompanyandKUD/farmergroupmayneed

toworktorescheduleorresolve.Oneintervieweereported

that, given the strength of the guarantees and payment

arrangements,thebanktheyusedwasopentolending

tofarmerswithpastcreditproblems.

CASH FLOW AND RETURNS ON INVESTMENT IN REPLANTING

Although results vary from case to case, an important result to

emerge from initial estimates of returns on investment from replant-

ing is that, despite major technological advances in the quality

of planting material, returns do not appear to be particularly

high. Compared to other moderately risky, long term activities,

estimatedreturnsarefeasiblebutmodest–notmuchhigher

thantheinterestrateschargedforfinancingreplanting.Further

research into returns on investment needs to be undertaken in

ordertobetterunderstandwhetherthisisanaccuratedepiction

ofthesituation–and,ifso,whatcouldbedonetoimprovethe

efficiencyandprofitabilityofinvestmentinreplanting.

Althoughindividualcashflow-basedlendingtooilpalmfarmers

already happens regularly, it appears that a plasma or partner-

shipapproachtoreplantingfinancewillcontinuetobeneeded

–forthesimplereasonthatreplantingitselfneedstobecarried

over an area of approximately 300 ha at a time in order to be

efficientintheuseofheavyequipment.

CREDIT RISK UNDER PARTNERSHIP LENDING

Underthepartnershipapproach,thereareseveralwaysofallo-

cating and mitigating credit risk, including:

• Corporateguarantee–puttingthefullriskonthe

company,

• Land titles on replanted farmland, and

• Partialmitigationofriskthroughoperationaldesign/

execution, including:

» Quality guarantees and supervision of replanting

byfieldstaffofthepalmoilmills/companies,

» Loan installment deduction at the mill or KUD

» Ongoing technical assistance to farmer groups, and

» SustainabilitycertificationattheKUDlevel,giving

farmers greater incentive to sell through the KUD in

order to earn the price premium.

Fromtheinterviews,financingofsmallholderoilpalmreplanting

canbecategorizedintotwodistinctmodels:

MODEL 1: GUARANTEED PARTNER-SHIP LENDING Thisisthetypeoffinancecurrentlyobservedinpractice.Whether

in the context of classic plasma arrangement, “near plasma”

partnership,ornewpartnershiparrangementsthatfeatureshorter

agreement terms and rely more on farmer labor, the approach

tofinancingisalmostidentical.

Partnership Arrangements

While there are almost as many variations on partnership models

as there are companies implementing them, the core common

element is that partnership models learn from and adapt the

classic plasma model in order to be more attractive to non-plasma

smallholdersandpreviousplasmasmall-holderswhoseterm

agreements have expired or are near expiration. After years of

experience and observation, these farmers tend to be much more

capableandindependentthanwouldhavebeenthecasetwo


36

COMPARED TO OTHER MODERATELY RISKY,

LONG TERM ACTIVITIES, ESTIMATED RETURNS ARE

FEASIBLE BUT MODEST – NOT MUCH HIGHER

THAN THE INTEREST RATES CHARGED FOR FINANCING

REPLANTING.

decades ago. Because farmers are under no obligation to sign

suchagreements,thefinancialtermsandvalue-addingfeatures

ofpartnershipsmustbesufficientlyattractivetoconvincegroups

of smallholders (expected to be organized into KUDs) to make a

medium-to-longtermcommitmenttoworkingwiththeCompany.

The Company provides technical training and assistance to the

KUD and farmer groups, and in most cases farmers provide all

post-replanting labor, including harvesting. In at least one case,

though, the Company continues to provide and supervise labor

for maintenance, fertilizing, etc.

Despitethedifferencesinpartnershiparrangements,financing

characteristics are basically the same under all variants.

Terms of Finance

Underthismodel,financingwilltypicallybefor11-13years,

withthreetofiveyears’“graceperiod”onrepaymentofprinciple

and,insomeexamples,interest.Interestratesmayvarywithina

rangeof9-13%perannum,relativelylowwhenoneconsiders

bank lending rates for other activities and the relatively long terms

of replanting loans. Some partnerships prefer to include a “cost

of living” stipend to the farmer during the grace period, though

thiswasnotalwaysfelttobeneeded.

Types of Banks

This type of lending is almost invariably carried out by Indonesian

domesticbanks,usuallystate-owned,withastable,relatively

low-costrupiahdepositbaseandasignificantbranchfootprint

withinreasonableproximityoftheplantationareasbeingfinanced.

State-ownedbanksgetanextraincentivefromtheirshareholders

to lend in support of the Government of Indonesia’s replanting

objectives.

Lending to Finance-Friendly Partnerships, usually including Cor-

porate Guarantees

Thistypeoflendingisusually,butnotalways,carriedoutwitha

corporate guarantee to provide additional assurance to the banks.

For at least one respondent, Cargill, existence of a proven stable

partnershipcombinedwithguaranteesonreplantingqualityand

purchaseofoutput,wasdeemedsufficientbythelendingbank

whencoupledwiththeotherfeaturesandrequirementsoflending.

Continued dependence on the corporate guarantee highlights

akeylimitationofthismodel–evenlarge,relativelyhealthy

companies face real limits in the total size of any corporate

guarantee they can provide. Such guarantees constitute a con-

tingent liability that must be accounted for and disclosed, and

well-runcompanieswouldnormallyalsoneedtocalculatea

capitalchargerelatedtothepractice,whichcouldaffectboth

the capital requirement and the target return on capital for the

company. Even if they had plans to scale up their partnerships

to the level needed to cover most smallholders (something that

isnotshowninthecurrentresearch),companieswouldsimply

not be able to provide corporate guarantees to smallholders on

the scale required.

PhasingDowntheCorporateGuarantee–LimitingtheTerm,

Adding Cash Collateral from Farmers

Companiesshouldofcoursestrivetofollowtheexampleof

Cargill,whereatleastsomebanksapparentlyhaveenough

confidencetolendwithoutaguarantee.Therearealsosome

additional steps that could be taken in order to reduce the need

fororamountofacorporateguarantee,includingthefollowing:

• As an intermediate step, companies should be able to

negotiatewithbankstoendcorporateguaranteesafter,

say,year5.Atthispoint,farmersandcompanieswill

have been able to demonstrate the success of replanting

andtheworkingoftheirrepaymentsystembasedonthe

farmer’s FFB sales to the company. Banks should be open

to bearing at least part of the remaining risk at this point.


37

• Carefully evaluate the real need for the “cost of living”

component. For reasons mentioned earlier, many farmers

may have the ability to partially mitigate the gap in income

via other means, including additional oil palm plots, “small

footprint”intercropping,orabilitytoengageinwagelabor.

• Anotherpotentialoptionthatmaybeworthyoffurther

investigationwouldbetoencouragefarmerstocontribute

asmallportionoftheirownsavingstothetotalinvestment

cost,creatinga“sinkingfund”thatwouldbepaidinterest

by the bank and could be used to offset a small (but

continuouslygrowing,sincetheloanoutstandingwould

be decreasing) portion of the farmer’s outstanding loan

tothebank.Thisapproachwouldalsohavetheeffectof

modestly increasing the bank’s yield on lending. Funds of

this type are also sometimes referred to as “cash collateral”

or“simpananwajib”(compulsorydeposits)andmighttotal

5-10% of the initial loan amount.

• As part of the loan agreement, farmers could also be

asked to make a modest addition to the sinking fund once

their loans have reached peak productivity.

• If the KUD has the ability to build up capital or require

farmerstodeposit“simpananwajib,”theKUDitselfmight

offerasmall“firstloss”fundtobanksforloanstofarmers

in its area. More importantly, the KUD could become

involved, via the partnership agreement structure, in tak-

ingovertheoperationofplotswhichareproductivebut

forwhichfarmershavefallenbehindintheirpayments.

• Finally,itisworthwhiletoreturntoconsiderationof

howthecollateralvalueoftheproductiveplotareacanbe

mademoreeffective.Inmostcases,theplotswillalready

havelandcertificatesandshouldqualifyaslegalcollat-

eral.Clarityofhowanorderlytakeoverorsaleprocess

wouldbeconductedcouldconceivablybeincludedin

thecultivationrightsagreementbetweenthefarmersand

the KUD. Technically, GPS mapping of the boundaries

ofeachplotmightbeusefulaswell.

MODEL 2: DISTRIBUTED RISK PART-NERSHIP LENDINGThe Guaranteed Partnership model is being carried out at present,

but the need for a corporate guarantee under most examples to

date drastically limits its applicability.

PartnershipPotentialandWillingnesstoLendGivenSufficient

Credit Risk Cover

There are many potentially reliable medium-scale oil palm mills

andcompaniesthatwouldbeabletocreatepartnershipswith

local farmers but are not able to provide a corporate guarantee

sufficientforpotentialcreditors.Also,fromthelendingside,

therearestillmanypotentiallenderswhich,becauseoflackof

experience or perceived risk, could provide stable, long-term

fundingbutdonotwanttobearthefullcreditriskthemselves.

Thisprovidesakeypotentialspaceforfinancialserviceproviders

willingtobearthecreditrisk,particularlyinthepre-production

stages,topartnerwiththefundingbankinfinancingthefarmer


38

IMPACT INVESTORS WOULD STILL NEED LOCAL PARTNERS TO ADMINISTER THE LOANS AND CARRY OUT OPERATIONAL ASPECTS.

–companypartnership.Suchparticipantscouldincludeforeign

banks lacking a strong local funding base, development banks,

creditguaranteeprovidersorotherfinancialfunds/institutions

willingtoofferguaranteefacilitiesorotherproductsallowing

them to bear more of the risk burden.

MODEL 3: FULL STARTUP FUNDING FROM IMPACT INVESTORS, TO BE FOLLOWED BY LOAN SALE OR REFI-NANCINGInadditiontothesetwobasicmodels–andinparticularif

domestic banks’ appetite for Model 1 and Model 2-style lending

provesinpracticetobehighlyrestricted–thereisanalternative.

Rather than merely taking the early-stage risk, impact investors

could fund the full amount needed for replanting. As part of this

process,theimpactinvestorswouldstillneedlocalpartnersto

administer the loans and carry out operational aspects. Depending

on the region and the circumstances, this might be a bank, or a

non-bankfinancialinstitutionsuchasaventurecapitalfund,or

a different arrangement might be feasible.

Impactinvestorsandtheirlocalpartnerswouldthenlaythe

groundworkforrefinancingorsaleoftheloansoncetheyhave

entered the repayment period and established a repayment record.

Impactinvestorswilltendtofacesomewhathighercostsduring

thetimetheirfundsarefullyinvested,sotheywillneedhigher

returns for this period (up to 4-5 years). Since farmers’ ability to

paywillbesignificantlyconstrainedduringthisperiod,asolution

willneedtobedesignedintothesecond,“saleorrefinance”

phase.Thus,thismodelsuggests1)alowerinterestrateonthe

loansinthereplantingperiodwhencreditriskishighandincome

cashflowsarelow;and2)ahigherinterestratewhencredit

riskandincomecashflowsarehigher.Thetwophasescanbe

summarizedasfollows:

• Replanting phase: (Impact) investor channels funds

to a local bank that acts as conduit, the (impact) investor

takesallcreditriskwhilethebankonlytakescounterparty

risk on the investor.

• Post-replanting/“saleorrefinance”phase:(Impact)

investor sells loan to bank after successful replanting in

year 5.

Thenextchapterwillpresenttheconclusionsoftheresearchand

interviews,andprovideafewrecommendationsthatcanallow

theimprovementofexistingsmallholderreplantingfinancing

models or the design of more suitable models.


39

7. CONCLUSIONS & RECOMMENDATIONS

PALM OIL COMPANIES ARE WORKING ON ALTERNATIVES, MOST FEATURING SHORTER PARTNERSHIP TERM, GREATER FARMER AUTONOMY, AND SIGNIFICANT COMMITMENT OF RESOURCES BY THE COMPANY TO TECHNICAL ASSISTANCE AND SUPPORT TO FARMERS, FARMER GROUPS, AND KUDS

CHALLENGES TO DEVELOPING EFFECTIVE FARMER-COMPANY PARTNERSHIPS

1. Limited Scope for Further “Plasma”-Style Partnerships:

Although most companies appear to prefer this approach

wherefeasible,indirectevidencefromtheinterviewsindicates

thattherearenotenoughfarmerswillingtosignup(again)

for a long-term, plasma-style partnership arrangement.

Buttomeetgovernmenttargetsandtoensuresufficient

traceable,sustainableFFBsupply,mostcompanieswill

needtoexplorenewtypesofpartnershipwithfarmers.

2. More Innovative, Short-Term Partnerships may be a

necessityifsmallholdersaretoretainasignificantrole

in palm oil production: many palm oil companies are

workingonalternativestotheplasma-styleapproach,

withmostfeaturingacombinationofshorterpartnership

term,greaterfarmerautonomy,andsignificantcommit-

ment of resources by the company to technical assistance

and support to farmers, farmer groups, and KUDs. The

alternativescenariowouldbetoseesmallholdersstuckin

lower-productivity,lesssustainableagriculturalpractices,

potentially increasing pressure on area expansion and

encroachment on protected areas.

3. “Best-practice” partnership models remain very much a

workinprogress.Althoughtheinterviewsrevealedseveral

promising approaches to farmer-company partnerships,

developmentofeffective,efficient,win-winpartnership

models is still in its early stages overall. One respondent,

Asian Agri, has reached the “post-pilot” stage and is sys-

tematically scaling up its partnership program according

to internal targets.

4. Uniformity of Coverage: Precisely because companies

are still developing their smallholder replanting models,

replantingfinanceschemesofferedtosmallholders,where

they exist at all, are often perceived by farmers as incom-

plete and inconsistent. Different schemes for smallholders

in close proximity can lead to complaints about differences

intermsandaccess,whichmayresultinfarmersdistrusting

companies’ intentions.

5. Land Titles: Landcertificatesremaincrucialinany

financingscheme,bothfromtheperspectiveoftheplanta-

tioncompany(inordertotracefruitstoapprovedgrowing

areas)andfromthefinancier’spointofview.Itiscritical

tohaveagoodunderstandingoftheownershipstatusof

theland,toavoidanyconflictsinthefuture.Challenges

remain in ensuring that farmers’ land is titled and that titles

reflectthetrueowners.


40

RESEARCH AND YIELD/INCOME

ESTIMATES TO DATE INDICATE MODEST, NOT HIGH, YIELDS

AND INCOME TO FARMERS.

CHALLENGES TO DEVELOPING ONE OR MORE “BEST PRACTICE” FINANCING MODELS

1. Financial innovation; furtherworkneedstobedoneto

developanddemonstrateafullyviablefinancingapproach

toreplantingwithoutusingacorporateguarantee,beginning

withabasicvalueproposition.Researchandyield/income

estimates to date indicate modest, not high, yields and

incometofarmers.Mostlikely,thismeansthatworkneeds

to continue on both the research documenting farmer-level

returnsoninvestmentaswellasworkingtoimprovefarmer

returns (especially short-term returns) via improvements in

replanting partnerships.

2. Potential value of “strategic subsidies”: strategic subsidies

canreducereplantingcosttothefarmerwhileensuring

more sustainable replanting practice, but farmers need

access to clear information in order to understand their

obligations and be able to access subsidies and enter

intosubsidyagreementswithconfidence.

3. Potential for legacy credit issues: this challenge exists

inpreviouslendingschemes(particularlywithpastfarmer

non-repayment situation under KKPA) and should be dealt

withonbothagroupandindividualbasis.

4. Aggregation of farmers: In order to reach scale advan-

tagesandattractfinancing,farmersneedtobesufficiently

organized. While this may be challenging, ensuring farmer

“ownership”ofnewentitiesiscritical.

5. Hedging costs: Internationalinvestors,withnon-Rupiah

sourcesoffunds,arenotabletocompetewiththepricing

offeredbylargedomesticbanks.Workingwithinterna-

tional social investors and others has been explored, but

a solution has not yet been found that contains competitive

pricing using international funding sources.

6. Financing requirements: there appears to be limited

understanding of the issue by (international) investors,

therefore loan requirements may not meet farmer needs.

For example, ticket sizes are often too large and corporate

guarantees are in general still needed.

7. Role of cooperatives: ideally, the set of tasks to be

carriedoutbycooperativesshouldbelimitedandwell-de-

fined.Althoughafewcooperativeshaveproventobe

imaginativeandsustainable,ingeneraltheinterviewees

feel it is better to specify a limited set of functions, usually

operational or administrative in nature, that need to be

taken care of.

8. Minimum land size for replanting: for replanting schemes,

GAR reported that it needs a minimum farmland area of

around 100ha; other plantation companies require up a

minimum size of upto 300ha;

9. Incentive for companies: a key driver for processing

companies to support smallholders in this effort is the need

tosecureFFBsupplyinthefaceofgrowingcompetition

from strategically-located independent mills.

10. Availability of government programs: the CPO fund

isperceivedbyfarmersaspotential“freemoney”.However,

at present it requires an extensive application process -

farmersarewillingtoacceptlongleadtimes,although,

evenifthereisonlyaslightchancethattheywillqualify.

Meanwhile,replantingschemesandloanproductsoffered

in partnership models usually demand higher (commercial

or near-commercial) interest rates than KUR rates. Because

farmersarefamiliarwithlowKURinterestratesandare

oftennotfullyawareofthequalificationcriteriaitmakes

it more complicated to convince farmers to apply for long-

term replanting loans loan at commercial rates.


41

WORK NEEDS TO CONTINUE ON DEVELOPING AND COMMUNICATING TO FARMERS THE PACKAGE OF STRATEGIC SUBSIDIES FOR SUSTAINABLE REPLANTING AS WELL AS PRICE INCENTIVES (PREMIUM) FOR ACHIEVING AND MAINTAINING CERTIFICATIONS FOR SUSTAINABLE PALM OIL.

RECOMMENDATIONS

Basedontheresearchandinterviewstodate,theteamrecom-

mendsthefollowing:

1. The investment case for farmer replanting needs to be

more attractive.Researchandyield/incomeestimatesto

date indicate modest, not high, yields and income to farm-

ers.Withmoderateorrelativelylowreturnsoninvestment,

farmers are more likely to be deterred by risks and be

attractedtotheideaofwaitingforpotentialsubsidies,which

willlimiteconomicsustainabilityandfinancingatscale.

Wethereforerecommendthat:1)Allcompaniesworking

inpartnershipwithsmallholders,whetherinplasma-style

modelsorinpartnershipwithindependentsmallholders,

developtheirownfinancialprojectionstoensurethatthe

dealofferedtofarmersistrulywin-win-andinparticular

that the return on replanting investment is high enough to

befinanciallyattractivetofarmers;2)Similarly,thatall

stakeholdersworkonways--whetherviamoreefficient

replanting techniques, more productive planting stock,

higherpremiumsforcertifiedproduction,governmentpolicy

changes, etc. - to improve farmers’ returning on replant-

ing; and 3) Further research and analysis be conducted

to document both actual and best practice in terms of

financialreturnstoreplanting.

2. Continuetoexploreanddevelopefficient,integrated“strategic” subsidies. In order to ensure that replanting,

growingandharvestingarecarriedoutinasustainable

manner,farmersneedtobeabletoseeaneconomicbenefit.

Work needs to continue on developing and communicating

to farmers the package of strategic subsidies for sustain-

ablereplantingaswellaspriceincentives(premium)for

achievingandmaintainingcertificationsforsustainable

palm oil. Government, donors and impact investors need

to gain an understanding of farmers’ economic needs

in order to design a package that true adds economic

benefitforfarmers.


42

SMALLER COMPANIES WHICH ARE MORE DEPENDENT ON INDEPENDENT SMALLHOLDERS FOR FFB SUPPLY ARE MOVING RAPIDLY TO DEVELOP PARTNERSHIPS ALONG THE SAME LINE.

3. Continued development of company-farmer partnership

models. Ofthecompaniesinterviewed,onlyone,Asian

Agri,hasdemonstratedaclearappetite–andspecific

targets–forpartnershipwithindependentsmallholders

outsideofaclassicplasma-stylemodel.Meanwhile,

somesmallercompanieswhicharemoredependenton

independent smallholders for FFB supply are moving rapidly

to develop partnerships along the same line. Although

thesemodelsarestillevolving,currentknowledgeabout

best practice in partnerships should be enough to guide

andencourageallpalmoilcompaniestopilotand/or

scale up their partnership activities.

4. Conductpilotingon“Model2”financeandmoredetaileddesignwithpilotingonthe“Model3”approach.Finding

suitable risk sharing partners, for example Development

Finance Institutions and international impact investors, to

pairwithdomesticRupiahfundingfromlocalbanksand/

or insurance companies, is a natural extension to the cur-

rentpartnershipmodelandshouldbepilotedwithoneor

morefinancialinstitutions.Inthisregard,TFA2020should

facilitatefollow-updiscussionswithpotentialqualified

partnersandpromotethedevelopmentofpilotfinancing

projects that have the potential to be replicated and scaled

5. Exploreefficientsmaller-scalereplantingsolutions.Havinganefficientsmaller-scalesolution(atlowercostand

requiringlessthan300ha)wouldhelpresolvesomeofthe

difficultiesinorganizinggroupsoffarmersforreplanting,

as at present.

6. Finally,follow-upworkshopsshouldbeorganizedtoaddress smallholder risk-related concerns of banks. In the

TFA2020workshopwhichwasorganizedinconjunction

withthisstudy,OJK,theIndonesianFinancialServices

Authority,hasshownakeeninterestinthecontinueddevel-

opment of innovative replanting solutions for smallholder

farmers. For OJK, this study represents an interesting the-

oreticalframeworkthancanlaythefoundationformore

implementation-orientedinitiativesandprogramsthatwill

enable banks to become more acquainted and comfortable

withthecreditandotherrisksofthistypeoffinancing

activity.Moreover,theactiveengagement,financialand

environmental commitment from the Indonesian banking

sector is a critical condition to be able to successfully

addressthelargeandgrowingreplantingneedsofoil

palm smallholder farmers in Indonesia. Due to their ability

to access large local currency liquidity pools in Indonesia,

Indonesian banks can and should play a major role in

themobilizationandexpansionofreplantingfinanceto

oil palm smallholders.


43

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WEBSITES


45

ANNEX: GAR REPLANTING PROGRAM REQUIREMENTS

SOURCE: POWERPOINT “REPLANTING PROGRAM THROUGH INNOVATIVE FINANCING

FOR INDEPENDENT SMALLHOLDERS”- SYAFAAT (2018)

TERMS OF PARTICIPANTS

GENERAL REQUIREMENTS

LAND PROVISIONS

• FarmersmusthaveidentificationCard(KTP)andFamilyCard(Kartu

Keluarga). Farmer’s minimum age is 21 year-old married

• Farmersmustsubmitoriginallanddeeds(SKT/SKGR/SHM)

• FarmersarewillingtosignMembershipAffidavitLetterofthe

Innovative Financing program freely according to FPIC***

• Farmers obtain Registered Planting Permit (STD-B) and Environment

Permit (SPPL) issued by Local Government.

• Farmers must form a Cooperative as their legal entity

• Farmers are managed by Partnership System*

• Replanting program using Investment loan from bank **

• Signing a notarized Partnership Agreement between farmers,

cooperative, and partner company

• Cooperative must sell FFB to partner company dan the partner

company must buy the FFB

• Farmers’ land is located outside Forest Concession Area

• Farmers’landislocatedwithinaradiusof<30kmfrompartner

company’splantation/millinonecontinousplotoflandof

1,000 Ha or farmer’s land is located along the border of partner

company’s plantation

• Farmers must have land deeds (SKT/ SKGR/ SHM) that is not

being collaterized by any institution or anyone and free of

ownershop overlapping and free of legal problems.

ABOUT TFA 2020

TheTropicalForestAlliance2020isaglobalplatformforpublic-privatecooperation,workingtohelporganizationsachievetheir

deforestation-free commitments. The mission of TFA 2020 is to help producers, traders and buyers of forest- risk commodities achieve

theircommitmentstodeforestation-freesupplychains.Italsohelpsgovernmentsoftropicalforestcountriestorealizebettergrowth

throughsustainableruraldevelopmentinpartnershipwithcivilsocietyandindigenouspeoples.

TFA2020worksbyconveningstakeholdersattheglobalandregionalleveltoformpartnerships,whicharedesignedtotransform

land use practices and supply chains.

www.tfa2020.org

Documents

INNOVATIVE REPLANTING FINANCING MODELS FOR OIL … · KUD Koperasi Unit Desa – Village Cooperative System SME Small and Medium Enterprises TLFF Tropical Landscapes Finance Facility