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‘Forest carbon’ has taken centre stage due to the urgency to mitigate climate change. One possible avenue to conserve carbon storing forests is through “payments for ecosystem services” (PES) schemes, which are voluntary or conditional agreements between a seller and buyer of environmental services. This paper summarises current potential and challenges facing the development of PES as a means of promoting the sustainable management or conservation of tropical forests. These include the challenge of combining equity or poverty reduction objectives with environmental objectives, and the interaction of PES with broader forest sector and 'extra-sectoral' policies.

The paper discusses the following:

• forest carbon in regulatory markets (e.g. through the Clean Development Mechanism)
• forest carbon in voluntary markets (e.g. through voluntary carbon offsets)
• payment for watershed protection services
• biodiversity and landscape services

Overall, the paper highlights the following policy issues related to PES:

• PES have considerable potential for raising the viability of sustainable forest management (SFM) and conservation and delivering pro-poor benefits, but are not a panacea. PES should form part of a package of instruments, especially those which reduce the opportunity costs of SFM and conservation
• avoided deforestation or REDD (Reduced Emissions from Deforestation and Degradation) has most potential, but also faces a complex set of issues. It is hoped that the international commitment to climate change mitigation will prove sufficient to overcome these
• early PES experiences reveal some positive equity impacts like improved tenure security, community empowerment, organisational and social capital development
• governments (and donors) have a vital role in promoting equitable governance, secure tenure, an enabling policy, legal and institutional framework, capacity building of national PES providers, collective institutions and transparent PES monitoring arrangements.

The paper concludes that while PES for hydrological and biodiversity services are rapidly evolving, carbon PES have most potential due to the international commitment to climate change mitigation. REDD is particularly important for SFM in that it provides a unique opportunity as a market incentive for tackling some of the underlying policy and governance failures.

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