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Review of the CDM and Other Existing and Proposed Financial Mechanisms to Transfer Funds from North to South for Mitigation and Adaptation Actions Silvia Magnoni January 2009 Discussion Paper January 2009

Disclamer This paper was produced as a reference paper to inform the discussion paper New Mechanisms for Financing Mitigation: Transforming economies sector by sector. The views expressed in this paper do not represent the views of WWF nor the agencies that committed financial support to carry out this project. Photo Credit Edward Parker / WWF-Canon

Review of the CDM and Other Existing and Proposed Financial Mechanisms to Transfer Funds from North to South for Mitigation and Adaptation Actions in Developing Countries Silvia Magnoni Consultant Paper prepared for WWF Macroeconomic for sustainable Development Program Office January 2009

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An Introduction to the Global Financial Mechanism Supporting Studies Series Beginning in mid-2008, at the request of several European governments, WWF led an analysis and dialogue on international financing arrangements to address climate change in developing countries. That meant, on the one hand, advancing a technically strong proposal capable of mobilizing the considerable public and private funds that may be needed to attain the below 2 degrees centigrade goal for climate change stabilization and, on the other hand, advancing an equitable proposal that could garner the support of the parties at COP15. The work approach is designed (a) to bring a bottom-up perspective to the to the current top-down discussion, based on a suit of developing countries sectoral studies that focus on what it would actually take to move whole economic sectors towards a low emission trajectory; (b) to focus on the operational requirements of an international financing scheme; (c) to engage leading experts on a critical review of relevant experiences and government proposals; (d) to convene experts and negotiators from South and North to discuss these issues; and (e) to present the project findings to key stakeholders and forums in the run-up to COP15. The program s main conclusions and proposals are in the document: Global Financial Mechanism. The Institutional Architecture for Financing a Global Climate Deal that can be downloaded from http://www.panda.org/what_we_do/how_we_work/policy/macro_economics/our_solutions/gfm/ In this Supporting Studies Series we are presenting a dozen reports that were used as inputs to the project. All these studies were commissioned to independent experts or institutions. Some are case studies of mitigation opportunities in different sectors of developing countries (e.g. cement and iron & steel in China and Mexico, coal based power generation in India, renewable energy opportunities in Morocco). Others are stock-taking reports focusing on critical issues for the global climate change financing (e.g. mapping new financing options for climate change, a review of sectoral mitigation proposals, a review of proposals to fund technology cooperation, etc.). Some of the ideas and proposals in these support series have been carried over to the project recommendations and have been summarized in the main document (either as short summaries, theme boxes, or pull quotes). Still, these documents have much more to offer, and for that reason we present them here in full. As usual, opinions in each document are the sole responsibility of its author(s), and should in no way be considered representative of WWF positions. Authors and titles in this GFM Supporting Studies Series include: 1. Michael Rock; (Bryn Mawr College) Using External Finance to Foster a Technology Transfer- Based CO 2 Reduction Strategy in the Cement and Iron and Steel Industries in China 2. Christine Woerlen (Arepo consult, Berlin) ; Opportunities for renewable energy in Tunisia: A country Study 3. The Energy and Resources Institute (TERI, Delhi) Strategies to reduce GHG emissions from India s coal-based power generation 4. Britt Childs with Casey Freeman (WRI, Washington DC) Tick Tech Tick Tech: Coming to Agreement on Technology in the Countdown to Copenhagen 5. Energia, Tecnologia y Educacion, SC (ETE, Mexico DF) Strategies to reduce Mexico s cement and iron & steel industry GHG emissions 6. Charlotte Streck (Climate Focus, Brussels) Sectoral Transformation Plans as Strategic Planning Tools 7. Charlotte Streck (Climate Focus, Brussels) Financing REDD a Review of Selected Policy Proposals 3

8. Charlotte Streck (Climate Focus, Brussels) Financing Climate Change: Institutional Aspects of a Post-2012 Framework 9. Silvia Magnoni Review of the CDM and Other Existing and Proposed Financial Mechanisms to Transfer Funds from North to South for Mitigation and Adaptation Actions in Developing Countries 10. Silvia Magnoni Sectoral approaches to GHG mitigation and the post-2012 climate framework 11. Weishuang Qu (Millennium Institute, Washington DC) Using the T21 computing model to forecast production and emissions in China s cement and steel sectors 12. Neil Bird et al (ODI, London) New financing for climate change. And the environment in the developing world 4

TABLE OF CONTENTS EXECUTIVE SUMMARY... 8 INTRODUCTION... 9 PART 1: EXISTING CLIMATE-RELATED FUNDS AND FINANCIAL MECHANISMS... 11 Introduction... 11 Objectives... 19 Geographical targeting of funds... 21 Financing and disbursement... 21 Governance... 23 Conclusions... 25 PART 2: PROPOSED FINANCIAL MECHANISMS... 26 Introduction... 26 Mexico World Climate Change Fund... 32 Norway Auctioning System... 34 G77 and China Enhanced Financial Mechanism... 35 Switzerland Global Carbon Dioxide Tax... 38 Registry of Nationally Appropriate Mitigation Actions (NAMAs)... 39 Other Submissions... 41 Conclusions... 42 PART 3: OTHER ENVIRONMENT-RELATED FUNDS... 43 Introduction... 43 Objectives... 49 Financing and disbursement... 50 Governance... 51 Conclusions... 51 ANALYSIS... 52 CONCLUSIONS... 55 REFERENCES... 57 Appendix I... 59 5

LIST OF ACRONYMS AAUs ADB AFB APCF AWG-LCA CAF CDM CEF CEFPF CERs CIF CMP COP CPAs CPF CTF DMCs DNAs DOEs EB EBRD EC EIB EIF ERPAs ERPFs ETF-IW ETS EU FCPF GCCA GDP GEEREF GEF GET GFIC GHG GNP IFC IMF IPCC KfW Assigned amount units Asian Development Bank Adaptation Fund Board Asia Pacific Carbon Fund Ad Hoc Working Group on Long-term Cooperative Action under the UNFCCC Convention Corporación Andina de Fomento Clean Development Mechanism Clean Energy Fund (Asian Development Bank) Clean Energy Financing Partnership Facility (Asian Development Bank) Certified emission reductions Climate Investment Fund UNFCCC Conference of the Parties (COP) serving as the Meeting of the Parties UNFCCC Conference of the Parties CDM Programme Activities Carbon Partnership Facility Clean Technology Fund Developing member countries (Asian Development Bank) CDM designated national authorities CDM designated operational entities CDM Executive Board European Bank for Reconstruction and Development European Commission European Investment Bank European Investment Fund Emission reduction purchase agreements Emission reduction purchase facilities (International Finance Corporation) Environmental Transformation Fund International Window (UK) Emission-trading scheme European Union Forest Carbon Partnership Facility (World Bank) Global Climate Change Alliance (of the EC) Gross domestic product Global Energy Efficiency and Renewable Energy Fund Global Environment Facility Global Environment Trust Fund Global Initiative on Forest and Climate (of the Australian Government) Greenhouse gas Gross national product International Finance Corporation International Monetary Fund Intergovernmental Panel on Climate Change KfW Bankengruppe 6

KP LAC LDC LDCF MAF MCCF MDB MDG CF MDGs MF MRV NAMAs NAPA NCCF NORAD ODA ODS OECD PEF PLAC PoA PPCR RAF REDD SCCF SCF SEF SFM SME TF-CC TFA UNCBD UNDP UNEP UNFCCC UNIDO WB WCCF WEO Kyoto Protocol Latin America and Caribbean Region Least developed country Least Developed Country Fund Multilateral Adaptation Fund (Switzerland Global Carbon Dioxide Tax) Multilateral Carbon Credit Fund Multilateral Development Bank MDG Carbon Facility (United Nations Development Programme) Millennium development goals Multilateral Fund for the Implementation of the Montreal Protocol Measurable, reportable, verifiable (emissions reductions) Nationally appropriate mitigation actions National adaptation plans of action National Climate Change Fund (Switzerland Global Carbon Dioxide Tax) Norwegian Agency for Development Cooperation Official development assistance Ozone-depleting substances Organisation for Economic Co-operation and Development Poverty and Environment Fund Asian Development Bank Latin America Carbon Program Program of activities Pilot Program for Climate Resilience Resource Allocation Framework (of the GEF) Reducing Emissions from Deforestation and Degradation Special Climate Change Fund Strategic Climate Fund Sustainable Energy Facility (International Finance Corporation) Sustainable forest management Small and medium-sized enterprises GEF Trust Fund Climate Change Tropical Forest Account (of the GEF) United Nations Convention on Biological Diversity United Nations Development Programme United Nations Environment Programme United Nations Framework Convention on Climate Change United Nations Industrial Development Organization World Bank World Climate Change Fund World Economic Outlook 7

EXECUTIVE SUMMARY The objective of this review of existing and proposed financial mechanisms is to define the potential and shortcomings of the current (or projected) financial regime and put this in relation to the creation of a new improved financing scheme that could transfer sufficient resources from North to South in an efficient, transparent, and participatory way. International climate change negotiations are indeed now working in this direction, and the regular submissions from parties and civil society to the Ad Hoc Working Group on Long-term Cooperative Action (AWG-LCA) reveal the desire of governments and organizations to achieve an innovative climate change agreement that could overcome existing weaknesses in the global financial structure, while providing nations with suitable tools to handle the adverse consequences of climatic modifications. The starting point is, obviously, the identification of problems and distortions in current funding schemes. In order to understand why results have not been proportional to initial efforts, it is essential to categorize difficulties and troubles, which represent the working base for further improvements. The latest submissions to AWG-LCA demonstrate common perceptions in terms of more urgent problems and outline of the improved climate change agreement. Some shared elements among the analyzed proposals show the preferred post-2012 direction: new and additional funding, more involvement and representation of developing countries, open and transparent governance, increased resources for technology transfer and adaptation, a polluter-pays principle, and an enhanced policy-based approach. In view of all these considerations, improvements toward an enhanced financial regime might account for 1. UNFCCC framework: It is clear that the United Nations Framework Convention on Climate Change (UNFCCC) is the most participatory environment for carrying out climate change negotiations. Any new financial scheme outside it would not be perceived by all countries as the outcome of open and transparent talks. 2. New and additional funding: The current available funding is not sufficient for tackling the adverse consequences of climate change on an adequate scale. The latest proposals work in this direction and not only suggest more significant pledges from governments but suggest market-based mechanisms and private sector involvement as possible fundraising areas, as well as advocate for contributions from developing countries (in measure of their capacity). 3. Improved governance: Governance is a critical element in structuring financial funding, and it is fundamental to build a new scheme that takes into account everyone s interests (both industrialized and nonindustrialized nations). Good governance allows for an equitable and balanced representation of constituencies, provides easier access to funding from developing countries, accelerates procedures, and ensures open and transparent operations. Without these elements, any new financial mechanism may just not make any durable impact in favor of the global environment (and people). 4. Policy-based action: Recent negotiations under the UNFCCC have focused on a gradual shift from project-based activities to programs of action and cooperative sectoral approaches. The latest proposed financial schemes all adopt a programmatic/sectoral perspective to overcome the limits of project-targeted actions, which are not able to reach the scale necessary for effective impacts. On the other hand, programs, broadly defined, could become good vehicles to tackle sector, subsector, or systemwide emissions. 5. Long-term outlook: Given the need for carrying out significant mitigation and adaptation actions, whose impact can create lasting, sustainable benefits, any new financial scheme should work under a long-term perspective, so as to allow for the implementation of 8

relevant initiatives that can bring about transformational change. This is particularly important if efforts scaling up is put in place through policy-based, programmatic approaches. With these elements in mind, some directions and suggestions already exist for defining an improved global financial architecture. How it would be structured is still not fully clear because of the many interests and perspectives at play. But the Conference of the Parties (COP) 15 has given the climate change political agenda a high priority, and key agreements and new directions are expected to come out of this meeting. INTRODUCTION With the recent increasing awareness of climate change and its potential disruptive effects on ecosystems, the environment, and, as a consequence, the economies of countries, an intense and wide debate at the global level has focused on how important having appropriate access to finances is in prompt and relevant intervention in this field. The consequences of what has been defined by many as the main challenge of the 21 st century are felt most strongly by the poorest and least developed nations, which rely on the natural environment for their livelihoods. For these countries in particular, it is much more difficult to tackle global warming at a national level, as any action toward greenhouse gas (GHG) mitigation or even more relevant for developing countries adaptation requires well-planned, well-implemented, and well-managed projects, as well as sufficient and secure financing, to develop and run activities that could lead to less GHG-intensive and more sustainable development paths. Various forms of financial support have been developed with the aim of transferring monetary resources from industrialized nations to poorer countries, while helping to leverage the potentially significant benefits of environmentally friendly technologies for the developing world. Many of the existing funds employ market-based mechanisms to address environmental issues, including the use of mandatory and voluntary emission offsets in the area of climate change. The existence of these instruments is decisively delivering positive benefits to both participants (donors) and recipients (beneficiary countries) of funds: While complying with their quantified emission limitations and (mandatory/voluntary) reduction commitments, the former are transferring critical amounts of money to the latter, with a forward-looking view of achieving sustainable development based on the use of renewable energy. The transfer of environmental technologies and know-how that should come as a by-product of these financial instruments, the diversity in the assistance schemes (grants, concessional loans, etc.), the global coverage and attempted conciliation of national interests, and the linking of financial support to technical assistance and capacity-building programs have made the current financing system a critical and necessary element for developing nations in addressing climate-related issues. However, the present situation requires further efforts and consistent improvements in the design and implementation of the financial instruments currently in place, as it has become more and more apparent that they are not able to properly tackle the environmental issues that bear most directly on poverty reduction in poor nations. The current financing system is not sufficient to confront a global challenge of the scale of climate change, since the majority of existing funds 1. are insufficient in scope by the amount of money mobilized, 2. are structured around a governance scheme, which limits the inclusion of the perspective of potential recipient countries (if at all considered), 3. are working on a short-term time frame (generally until 2012), consequently cutting out bigger (and longer) projects/interventions that might still contribute to more sustainable paths, and 9

4. are not working in synergy with other funds/financial mechanisms, therefore adding further fragmentation and inefficient duplications to the current financing system. In view of these elements, there is common agreement at the global level on the urgency of creating a more inclusive and predictable mechanism that guarantees financial stability and sustenance, while allowing for direct and immediate actions to counteract climate-related challenges. With the aim of participating in the climate change debate and showing good intentions and commitments, governments and international institutions worldwide have come up with various financial solutions and schemes, without thinking in true global terms and collaborating toward the creation of a multinational, comprehensive strategy that each country could contribute to according to its own possibilities, capacities, and, perhaps, historical responsibilities for global warming. As a consequence, the current financing context presents weaknesses and flaws that make the existing instruments inappropriate tools to deploy in the fight against negative climate change effects. Market mechanisms and any other forms of economic incentives instead need to be appropriately designed and matched by an adequate regulatory capacity, in order to play a key role in mobilizing financing for development with environmental benefits. The pressing need for a suitable global financial scheme has led to much fervor in both donor and recipient countries, especially in the view of the upcoming Conference of the Parties (COP) 15 (in Copenhagen in December 2009), which has as its main target the definition of a renewed post-kyoto Protocol (KP) financial mechanism. Many proposals for innovative market mechanisms under the United Nations Framework Convention on Climate Change (UNFCCC) have been advanced by various governments and country groups as submissions to the Ad Hoc Working Group on Long-term Cooperative Action (AWG-LCA) under the convention. 1 Despite the different structures and procedures of the submitted schemes, common determinants can be found in the aims of overcoming the weaknesses and distortions of the current financing system, while supporting systematic programs of investments, expanding the use of risk management products, offering market continuity and predictability, and lowering transaction and implementation costs. The present paper aims at reviewing the current financial instruments, within and outside the UNFCCC framework, so as to underline strengths and weaknesses and investigate potential improvements toward an enhanced financing system that could be (1) more inclusive of beneficiary countries views, (2) more efficient in channelling (significant amounts of) money and technologies from North to South, and (3) more inclined to programmatic or wholesale approaches rather than project-by-project ones. The study also reviews recent proposals (AWG-LCA submissions) for improved funds and financial mechanisms and covers relevant environment-related funds that would complete the overview of the overall financing system targeting climate and environmental issues. The paper is consequently structured into three sections that examine the three categories of funds reported above, followed by a final section of discussion, suggestions, and pertinent conclusions. 1 In this paper, references to the convention mean the UNFCCC. 10

PART 1: EXISTING CLIMATE-RELATED FUNDS AND FINANCIAL MECHANISMS Introduction A broad variety of environmental funds are available at the global level, with different specific purposes, recipient targets, monetary amounts, and operational structures. This ample availability may at first sight indicate that considerable effort is being taken to carry out effective actions for GHG mitigation and adaptation, thanks to an international financing scheme that offers many opportunities to choose from. However, the situation is far more complicated and far less effective. Duplication of efforts, bureaucratic burdens, insufficient funding, and inappropriate governance are some of the most relevant weaknesses of existing funds that need to be addressed in order to improve the financial systems currently in place. As indicated in Table 1 and 2 below, the existing funds offer different solutions and approaches (i.e., carbon markets, carbon funds, climate financial initiatives) to similar problems and objectives. Overlaps can be easily found, and the financial system s fragmentation suggests that individual governments and multilateral institutions, in the rush of showing their immediate commitment toward climate change, have preferred to recur to different funds, rather than articulating single actions/initiatives into a global strategic and politically coherent framework. Even the Clean Development Mechanism (CDM), which has a global coverage and should represent an effective, united, UNFCCC-supported mechanism for financing climate-related projects, presents critical weaknesses in its design and implementation procedures (Environmental Defense Fund, 2007). A common global call (UNFCCC AWG-LCA 2008) recently arose for an enhanced financial mechanism that could achieve more immediate impacts in the mitigation and adaptation areas. Additional goals include concrete transfers of resources and know-how from North to South, while promoting programmatic funding modalities and increased volumes of disbursed amounts. This need is particularly felt by the poorer countries that are largely vulnerable to the effects of climate change, which sense that the current financing system based on governance schemes that have not much included developing countries participation does not address their relevant concerns and urgent needs in an appropriate way. This section reviews the existing financial mechanisms and carbon funds as reported in the tables below. The first table concentrates on the bigger mechanisms administered by multilateral institutions (e.g., Global Environment Facility, World Bank), while the second table focuses on some existing carbon funds/facilities that operate at a minor scale at the international or regional level. 11

Table 1: Existing climate-related funds and financial mechanisms (1) Questions CDM GEF TF-CC GEF SCCF GEF LDCF GEF AF WB CF WB CIFs Creation and proposal Based on proposed CDF; included in KP in COP 3, 1997. Successor of GET, 1994. COP 7, 2001; operational in 2005. COP 7, 2001. COP 13, 2007. World Bank, 2000 (Prototype Carbon Fund). World Bank, 2008. Fund sources Developed countries and companies, as forms of bilateral models or funds. Donor countries, every four years. Donor countries, voluntary contributions on a continuous basis. Donor countries, voluntary contributions. Financed with a share of proceeds (2%) from CDM project activities and donor contributions. OECD countries, private/public partnership. Contributions from donor countries by MDBs; new and additional to ODA. Annual and total amounts In 2007: US$7.4B/yr for primary CDM; US5.4B/yr for secondary purchase transactions. By 2030: US$5B-US$25B/yr (low est.) US$100B/yr (high est.). US$250M/yr; cofinancing leverage of three times. Total resources so far: US$90.3M, incl. new pledges. Initial voluntary contributions amount to US$172.84M so far. 2008-2012: US$80M- US$300M/yr. By 2030: US$100- US$500M/yr (low est.) to US$1B- US$5B/yr (high est.). Predictability. Total funds pledged so far: US$2.19B. Not predictable. No polluter-pays principle. Target size US$5- US$10B of total resources. Purpose of the fund Sustainable development and compliance with emission limitations. New and additional financing for development, climate change mitigation, and adaptation. Global environmental benefits. Support activities and programs complementary to GEF TF-CC, focus on adaptation and technology transfer. Reduce vulnerability to climate change in LDCs. Support the preparation of NAPAs. Finance concrete adaptation projects and programs in developing countries that are parties to the Kyoto Protocol. Purchase of project-based GHG emissions reductions in developing countries and countries in transition. Creation of targeted programs on climate change, transfer, and deployment of clean technologies. 12

Governance Authority of CMP having guidance over CDM. Aim of accessible and universal governance. Criticism for lack of transparency, unpredictability of EB decisions, and right of recourse. Not easily accessible. Representative - GEF Council (16 from developing countries, 14 from developed countries, and two from countries with transitional economies). Decisions by consensus. Still, weak role from developing countries. Administered by GEF, accountable to the COP and subject to its guidance. Criticism in terms of lack of predictability of resources. Appropriate, with funding for adaptation in the form of grants. Administered by GEF, accountable to the COP and subject to its guidance. Accessible: better access to GEF resources from LDCs - project cycle streamlined and no need to demonstrate global environmental benefits. The AFB works under the authority and guidance of the CMP. Transparent. Representative/AF B, consisting of 16 members and 16 alternates, in representation of diverse constituencies (majority from LDCs). Appropriate: grants. Managed by the WB, there are governance issues related to lack of transparency in practice, representation, accessibility, and conflicts of interest with traditional lending from WB Group. A Trust Fund Committee oversees the operations. Representative: It consists of eight representatives from donor countries and eight representatives from eligible recipient countries. Decision making by consensus. Relation to UNFCCC framework One of the flexible mechanisms of the Kyoto Protocol. Financial mechanism of the UNFCCC. Special fund within UNFCCC, managed by the GEF, accountable to COP. Special fund within UNFCCC, managed by the GEF, accountable to COP. Established under the KP of the UNFCCC, the AF acts under guidance of the CMP. The WB Carbon Fund Unit oversees project-based transactions of CDM and JI carbon market. Actions to address climate change should be guided by the principles of the UNFCCC. Management Administered by CMP and EB. Implemented through DNAs and DOEs. GEF Secretariat for project and programs implementation; GEF agencies for managing projects; NGOs to assist project operations. Administered by the GEF separately from the GEF Trust Fund, with its own operational rules and procedures. Administered by the GEF separately from the GEF Trust Fund, with its own operations and administrative costs. Administered by the AFB, serviced by a secretariat (GEF) and a trustee (WB) on an interim basis, to be reviewed after three years. Trust funds administered by the World Bank, which oversees the management of the funds. To be governed by a Trust Fund Committee, subcommittees (for SCF), and serviced by an MDB committee, an administrative unit, and a trustee. 13

Criteria to allocate funds Sustainability; additionality compared to business as usual; financial additionality; real, measurable reductions; feasibility. No equal distribution. Developing countries and economies in transition. Projects must reflect national/regional priorities and improve global environment. All non-annex I countries are eligible. Countrydriven project; transparency; scientific merit and financial sustainability. Focus on equity and sustainable development. All least developed countries that have prepared NAPAs are eligible. Focus on equity and sustainable development. Prioritization of most vulnerable countries. Vulnerable developing countries parties to the KP. Allocation as for vulnerability; balanced access to the fund; maximizing multi- /cross-sectoral benefits. Equity in distribution. In general, consistency with national sustainable development priorities and, under CDM rules, real, measurable, verifiable, and additional. Based on ODA eligibility and an active MDB country program. Investment criteria focused on the potential for GHG reductions for CTF. For PPCR- SCF, priority given to vulnerable LDCs. Programmatic and sectoral approach GHG reductions are also achieved through CPAs, project activities under a PoA. Endorses programmatic perspective. Support to both activities and programs. Envisioned programmatic approach, through the identification of priority actions within NAPAs. Finances both projects and programs. The new initiatives (FCPF and CPF) involve incentive programs and programmatic approaches, respectively. Creation of programs is supported in CIF. PPCR-SCF provides programmatic finance for country-led development plans. Time frame Until 2012. Fourth replenishment: 2006/2010. Programming and needs defined until 2009 and on a three-year time frame. Programming and needs defined until 2009 and on a three-year time frame. Until 2012. Funds can purchase carbon until 2015. Clauses for termination of operations based on new UNFCCC financial architecture. 14

GHG emissions reduction accounting CERs as the difference between baselines and actual emissions. GHG emissions lifecycle analysis (direct and indirect emissions reductions). N/A (adaptation measures). N/A (adaptation measures). N/A (adaptation measures). Linked to the CDM project-based, baseline emissionrelated methodologies. CTF: methodology to be developed to encompass direct and potential projects emissions savings. Performance 551 MtCO 2 e for finalized primary CDM transactions in 2007. 1192M CERs expected from existing projects (2008/2012). Exceeded GHG reduction targets set by 3 rd Replenishment ($92B, >200m tonnes). No adequacy in funding. N/A Projects in pipeline still have to be operatively implemented. As of May 2008, 32 NAPAs have been completed, and 10 have been approved for LDCF funding. N/A Not fully operational. Performance linked to the ability of monetizing CERs. New and additional. 102 ERPAs signed. 207 million tco 2 e committed in signed ERPAs with options on several million tonnes. Still to be fully implemented. 15

Table 2: Existing climate-related funds and financial mechanisms (2) Questions IFC ERPFs UNDP MDG CF APCF EIB-KfW MCCF PLAC Creation and proposal IFC and the Dutch government, early 2000s. UNDP in partnership with Fortis Bank, 2007. Fund sources Dutch government. The MDG CF does not provide underlying finance to its projects. Annual and total amounts Purpose of the fund Governance US$135M until 2012. Purchase of carbon credits for the benefit of the Dutch government under KP. The governance structure of the CDM market applies to projects producing CERs against KP compliance, then Not a fund, but the facility can help leverage carbon finance through UNDP and Fortis. Broadening access to carbon finance for developing countries and promoting pro- MDGs emission reduction projects. Accessible to a broad base of poor countries. For each emission reduction project, the facility s services are ADB, 2007. EIB and KfW, 2007. EIB and EBRD, 2006. Corporacion Andina de Fomento, 1999. Contributions from governments. Acceptance of participation closed on 30 June 2007. US$151.8M as total commitments. Increase clean energy projects in DMCs, capitalize increased investments and provide additional source of finance to developing countries. The Board of Directors consists of donor countries. Developing countries not involved in the decision-making process. Weak Commitments initially provided equally by EIB and KfW. Participant companies make contributions of at least 500,000. 100M of total commitments. Purchase program for project-based emission certificates under KP; focus on compliance for European SMEs. Initiative under EIB and KfW. No involvement of development countries in decision making. Weak representation and transparency. Contributions from six countries and six companies. Total resources: 150M for the Project Carbon Fund and 40M for the Green Carbon Fund (governmentgovernment trade in AAUs). Expand the supply of carbon credits in Central Europe and Central Asia; carbon purchase for participants compliance. Initiative under EIB- EBRD and carbon managers. No involvement of development countries in decision Dutch government. Total resources: 45M. Consolidation of carbon markets and adoption of clean tech in LAC region, support national climate change institutions, and buy CERs. Representation: CAF s shareholders are countries from the Andean and non- Andean region. CAF governance is based 16

purchased by the IFC on behalf of the Dutch government. Weak representation. governed by a number of contractual arrangements. Weak representation. representation and transparency. making. Weak representation and transparency. on high-level political representation at the Board. Relation to UNFCCC framework The IFC bridges compliance buyers with project developers under the CDM KP scheme. The MDG CF operates within the framework of the CDM (and JI). Operates within the framework of the CDM. It provides upfront co-financing to CDM projects in ADB s DMCs for future delivery of CERs. Operates within the framework of the (JI and) CDM. Operates within the framework of the (JI and) CDM. Possibility of government-togovernment trade in AAUs under Article 17 of KP. Operates within the framework of the (JI and) CDM. Management The IFC facilitates access to carbon markets and manages carbon funds on behalf of the Dutch government. UNDP and Fortis as managers of the facility. Project proponents should contact UNDP for first information. Managed by ADB on behalf of fund participants. ADB is the trustee of the APCF. EIB and KfW jointly oversee fund management activities. Intermediate structure involving three independent private sector companies (the carbon managers ), which do negotiating, contracting, and monitoring of transactions. Managed by CAF, as part of its specialised environmental programs. Criteria to allocate funds The main criteria include location, likely project closing, amount of credits, environmental and social impacts, host country approval, and independent verifications results. Open to emission reduction projects in developing countries (CDM projects) that have ratified the Kyoto Protocol (JI also accepted). Priority for underrepresented countries in carbon markets. Be located in a DMC that is a CDM-eligible country; be financially supported by ADB; generate permanent CERs (no reforestation). Project-based carbon credits may be acquired from projects in any EIB country of operation that has ratified the KP and where the credits are eligible under the EU-ETS. Project-based carbon credits may be acquired from projects financed by the EIB or EBRD in any country that has ratified the KP. Other criteria include project viability and sustainability, integrity, and The fund is destined exclusively for purchase of CERs. Criteria include commercial viability, sustainable development, investment risk, and qualification under the CDM process. 17

corporate governance. Programmatic and sectoral approach No. Project based only. Time frame Through to 2012. 2008 2012. Until 2012. However, there is an intention to create a post-2012 carbon fund. GHG emissions reduction accounting Performance IFC has concluded 12 transactions to purchase emissions reductions from more than 40 projects. IFC will guarantee delivery of 1.75 million credits from CDM projects. No information available. Being a recent fund, there are no concluded projects yet. CDM baseline emission reduction accounting methodology. The potential carbon value in ADB s project pipeline is estimated to be about 42 to 63 million tco 2 e to the end of 2012. It is estimated that over 80 projects in the ADB pipeline have potential carbon credit content. Purchase target of 9 million tonnes CO 2 e per year (incl. post- Kyoto purchase). The option to acquire post-2012 carbon credits is offered only in certain cases. Estimates around 10 million tonnes of carbon. Until 2012. CAF facilitates the purchase of up to 10 Mt of emission reductions from Latin American and Caribbean countries. 18

Objectives The CDM, as one of the flexible mechanisms of the KP, was established in order to (Article 12, KP) assist parties not included in Annex I in achieving sustainable development and in contributing to the ultimate objective of the convention, and assist parties included in Annex I in achieving compliance with their quantified emission limitation and reduction commitments under Article 3. The twofold targets describe the intentional inclusive nature of the mechanism, which is supposed to help both industrialized and developing countries in contributing to GHG mitigation and, ultimately, sustainable development. A subtarget of the CDM is the transfer of environmental technology and know-how: Through the implementation of projects in developing countries, the mechanism should contribute to capacity building in the recipient countries and the spread of environmentally friendly technologies in place of traditional ones. Despite complex procedural hindrances in the project life-cycle management, the CDM has proved to be a successful tool, with a market of 551 MtCO 2 e (metric tonnes of carbon dioxide equivalent) for finalized primary CDM transactions in 2007 (Capoor and Ambrosi 2008), equaling US$7,426 million of capital flows. However, the CDM s ability to achieve the settled objectives is hampered by many aspects: 1. The additionality (compared to business as usual) of projects is rather difficult to prove with a high degree of accuracy. There are too many factors and side effects to be considered, which can never be assessed or measured. The CDM s project-level crediting and the extensive requirements that must be met to prove real and additional reductions (and therefore concrete mitigation actions) represent a significant limitation for the mechanism. 2. The geographical distribution of projects suggests that the target for sustainable development is likely to refer to some countries/regions only among non-annex I nations (Fenhann et al. 2008). Investments in the CDM tend to concentrate on a small number of developing countries usually the richer among them (e.g., China, India) that already attract the largest share of foreign direct investments. It seems too costly for small countries to participate. 3. The sustainability target appears more rhetorical than operational. The CDM has the explicit objective of promoting sustainable development (in the Kyoto Protocol this target is, in fact, stated before the target of reducing greenhouse gas emissions). This implies that environmental, social, and economic aspects all have to be considered. However, it seems that so far the mechanism has been predominantly driven by economic interests above all. There are no economic incentives that give any importance to the other aspects. Carbon markets are also the central arena for the various World Bank (WB) carbon funds that were established in order to purchase project-based GHG emission reductions (including Reducing Emissions from Deforestation and Degradation, land use, and forestry projects) in developing countries and countries in transition. Overall, 207 million tco 2 e has been committed in signed emission reduction purchase agreements, with options on several million tonnes, from the year 2000 (operational year of the Prototype Carbon Fund) till now. However, less than 10 percent of money spent so far is going to new renewable energy, with only one fund, the Community Development Carbon Fund, focusing on funding local sustainable energy projects. Further, less than 10 percent is linked to funds going to community development (Capoor and Ambrosi 2008). 19

With the recent introduction of the Climate Investment Fund, the WB has developed a specific focus on the deployment, diffusion, and transfer of clean technologies and has started offering financing for climate-change-related targeted programs, while including adaptation in the targets scope. Another institution that has recently increased its interest in adaptation financing is the Global Environment Facility (GEF). The GEF Trust Fund has been created to provide new and additional financing for projects and programs that would address development needs and at the same time protect the global environment (climate change mitigation and adaptation). The GEF s main potential impact is its contribution to catalyzing the sustainable transformation of markets and programs such that GHG emissions are reduced or avoided in the long term. According to the GEF III Overall Performance Studies (2005), in the climate change area, the GEF portfolio has performed satisfactorily (given its limited resources), exceeding its interim GHG emission reduction targets set by the Third Replenishment Agreement (200 metric tonnes) in an increasingly cost-effective manner. For closed projects with data, estimated avoided direct and indirect emissions amounted to 224 million tonnes of CO 2 at an incremental cost of US$194 million (GEF 2005). The particularity of the GEF funding is that on the recipient side, the funds can only be used for projects that give global environmental benefits. This is the GEF s major limitation and has caused opposition from third world governments and nongovernmental organizations (NGOs), as it leaves out many of the problems directly faced by the South, such as desertification, soil erosion, and the dumping of toxic products. With the creation in 2001 of the Special Climate Change Fund and the Least Developed Countries Fund, as well as the establishment of an Adaptation Fund at the climate meeting in Bali, the GEF has put much emphasis on the need to implement adaptation measures in developing country parties to the KP. Many carbon funds and carbon facilities have also been implemented by other multilateral institutions acting at global (International Finance Corporation [IFC], United Nations Development Programme [UNDP]) and regional levels (Asian Development Bank [ADB], European Investment Bank, European Bank for Reconstruction and Development [EBRD], Corporación Andina de Fomento [CAF]). These funds purchase carbon credits under the international emission reduction transfer rules of the KP, with the objectives of assisting funds participants in satisfying their legally binding emission reduction commitments under the KP broadening access to carbon finance by enabling a wider range of developing countries to participate strengthening the use of renewable and alternative energy technologies Regional organizations carbon funds, for their part, specifically focus on expanding the supply of carbon credits in Central Europe and Central Asia (EBRD), the Asia-Pacific (ADB), and the Latin America and Caribbean (LAC) region (CAF). The international offer consists also of carbon facilities (as the one launched by the UNDP) that do not provide underlying finance to projects but can help leverage carbon finance (through technical assistance and financial networking). These funds have contributed at different levels to the purchase of emission reduction credits, with a potential carbon value of 42 to 63 MtCO 2 e to the end of 2012 by the Asia Pacific Carbon Fund, an annual purchase target of 9 MtCO 2 e (including post-kyoto purchase) for the European Investment Bank-KfW Bankengruppe (EIB-KfW) Carbon Fund, and over 17 MtCO 2 e from projects currently in the evaluation portfolio for the Latin America Carbon Program (PLAC). 20

Geographical targeting of funds The reviewed funds can be categorized into two main geographical categories: international funds and geo-focused ones. The former category consists of the CDM, WB and GEF funds, as well as the IFC and UNDP Carbon Facility. These instruments endorse a global perspective and have (or should have) a balanced geographical representation of both donors and recipient countries. However, notwithstanding the intent of opening the funds to any country, some inequitable distribution in the funds allocation or in the contributions from participating donors can be spotted. As already mentioned, the growing CDM market shows an inclination toward a concentration of projects in a group of host countries (China, India, Mexico, Brazil), with smaller countries finding themselves excluded from the list of most popular destinations. The GEF Special Climate Change Fund (SCCF) is a good example of imbalances in both participants contributions and project implementation countries: Not only do the contributions come mainly from European countries, but, despite the fact that the SCCF targets all non-annex I countries, funding has so far primarily been directed to low-income countries in Africa, Asia, and Latin America. The traditional carbon finance role played by the WB is also characterized by definite funds (Danish Carbon Fund, Italian Carbon Fund, etc.) created on purpose for purchasing project-based greenhouse gas emission reductions in developing countries and countries with economies in transition on behalf of the specific contributor. For the remaining carbon funds, which are geo-focused, similar tendencies can be found: The IFC buys solely on behalf of the Dutch government; the Asia Pacific Carbon Fund (APCF) receives contributions from European countries only and targets developing member countries (DMCs) as host countries. The EIB-KfW buys credits on behalf of European Union (EU) companies and intermediaries, without specific host country preference, while the Multilateral Carbon Credit Fund (MCCF) specifically targets credit supply in Central Europe and Central Asia. The PLAC Purchase Facility, finally, operates on behalf of the Dutch government, specifically targeting carbon credits generated in the LAC region. Financing and disbursement A high degree of variety in the monetary amounts making up climate-related funds can be found at all levels (global or geo-focused funds). Particularly relevant are differences from what the literature suggests as recommended mitigation costs for GHG stabilization, as well as for adaptation investments. The Intergovernmental Panel on Climate Change report (IPCC 2007) suggests values of US$108 billion to US$1,350 billion annual mitigation costs, amounting to 0.2 percent to 2.5 percent of current world GDP (IPCC 2007) which is around US$54 trillion by 2030 2 (World Economic Outlook 2008). Similarly, the Stern Review estimates annual costs of cutting total GHG to a 550 ppm level at an average of approximately 1 percent of current GDP 3 (about US$540 billion) (Stern 2006). Further, the McKinsey Global Institute (2008) uses cost curve analysis to estimate that it is possible to stabilize global greenhouse gas concentrations at 450 ppm to 500 ppm CO 2 e with macroeconomic costs in the order of 0.6 percent to 1.4 percent of global GDP by 2030 (US$324 billion to US$756 billion). As far as adaptation is concerned, recent estimates from the UNDP suggests US$86 billion to US$109 billion per year by 2015 2 For a median stabilization level of 535-590 ppm CO 2 e. 3 Under an assumption of GDP growth at a 2.5 percent rate. 21

for adaptation activities in developing countries, while the UNFCCC envisages a cost of adaptation of US$28 billion to US$67 billion per year by 2030. 4 This amount is expected to rise to US$44 billion to US$166 billion per year if global adaptation activities (not restricted to developing countries) are considered (Agrawala et al. 2008). By analyzing the summary tables (tables 1 and 2), it is clear that the current amount of financing is not matching the required investments as suggested by the literature, neither for mitigation nor for adaptation. The amounts spent on GHG stabilization and adaptation measures are not comparable to the far bigger recommended figures, and most of the reviewed funds handle limited financial amounts to cover multiple years of operation. The WB valued the global carbon market at US$64 billion in 2007 (Capoor and Ambrosi 2008). This is certainly a considerable figure, but it also includes domestic/regional emission-trading schemes (e.g., EU-ETS, New South Wales, Chicago Climate Exchange) that do not have a link with the global trading market 5 and, consequently, do not contribute to technology transfers and green projects implementation in developing countries. In 2007 such schemes accounted for US$50.4 billion out of the US$64 billion with a key role played by the EU-ETS (US$50 billion) therefore, only minor amounts were left for project-based mechanisms involving developing countries. The CDM is currently the biggest financial mechanism. In 2007, an active CDM market registered capital flows as high as US$7,426 million for primary CDM transactions and US$5,451 million for secondary purchase transactions (Capoor and Ambrosi 2008). After the EU-ETS, this is the second largest segment of the global carbon market. Analysts estimate global CDM trading to reach US$5 billion to US$25 billion per year under low estimates and some US$100 billion per year by 2030 under a high estimate of compliance demand (UNFCCC 2007). Approximately 50 percent represents capital invested in unilateral projects by host country project proponents. Renewable energy and energy efficiency projects account for 90 percent of the overall investment. Fund disbursement is based on precise criteria for both the host country (it has to have ratified the KP, has to have identified a national CDM authority, and is not to be listed in Annex B of the KP) and for projects themselves (they should generate sustainable, additional, measurable, real, and feasible emissions reductions). All the other funds examined in tables 1 and 2 show different monetary amounts, but they are all smaller figures than the CDM s. The eligibility requirements for funds disbursement are also variable, with a combination of host country criteria and project-related ones. Many of the existing carbon funds purchase certified emission reductions (CERs), therefore their selected projects are subjected to both the fund s specific eligibility criteria and the CDM regulatory framework. Again, the additionality aspect is a critical one: While it is fundamental that credited emissions would not have occurred in the absence of the certified project activity, it is also true that it is difficult to prove the additionality of CO 2 reductions. In this respect, the WB puts this criterion under a twofold analysis: Barrier analysis: The project faces barriers that prevent its implementation, such as commercial finance and technology. Investment analysis: The project is economically or financially less attractive than other alternatives (relatively simple for projects that generate no financial or economic benefit other than the sale of emission reductions). Most of the analyzed carbon funds include in their criteria the temporal generation of credits. The IFC emission reduction purchase facilities (ERPFs), for example, require projects to reach financial 4 Different estimates are explained by different methodologies used in accounting for adaptation costs. 5 In phase II of the EU-ETS (2008-2012), linking with the KP international emission-trading mechanism is operational. 22