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Climate-smart forestry (CSF) is considered a promising approach for climate change adaptation and mitigation strategies, as highlighted in several European policy documents. This paper describes a prospective approach to introducing an incentive-based scheme to facilitate the implementation of CSF through a case study in Iceland. It is argued that the payments for ecosystem services (PES) scheme allows for effective CSF management and long-term sustainability if introduced in compliance with local, cultural, and social values. In a case study of an Icelandic afforestation programme, we conducted an institutional analysis of the PES scheme and assessed its effect on the sustainable provision of forest ecosystem services for the long term. We provide preliminary findings on the application of CSF in the 30-year-old Icelandic afforestation programme scheme. The perspectives of forest and policy experts, as well as local farmers participating in the scheme, were crucial for assessing the effectiveness of PES scheme performance in Iceland.