Adaptation funding, institutions and private sector

Legal assistance paper

All reasonable efforts have been made to ensure the accuracy of this information at the time the advice was produced. However, the materials have been prepared for informational purposes only and may have been superseded by more recent developments. They do not constitute formal legal advice or create a lawyer- client relationship. To the extent permitted any liability is excluded. Those consulting the database may wish to contact LRI for clarifications and an updated analysis.

Print Friendly, PDF & Email

Date produced: 07/06/2010

1. What are the institutional arrangements around providing the $100bn additional funding? Which body/bodies will decide how funding is organised and who will allocate it?

2. What is the role of the private sector in the new $100bn funding? How will the role of the private sector be regulated? Specifically will it be subject to independent financial auditing and will the Equator Principles apply? 

Summary:

The detail surrounding the institutional arrangements of the US$100 billion funding is one of the key issues being discussed at the current Bonn negotiations.  The Copenhagen Accord (“the Accord”) did not make concrete plans for institutional arrangements and this is one of the major hurdles to making funding available.  The Accord did provide for a Copenhagen Green Climate Fund to be established to act as the operating entity of the finance mechanism and through which a “significant portion” of the new multilateral funding should flow.  However, what this actually means in practice and who should administer it is not clear at present.

This is an extremely complex area, for example, there are already 21 climate funds. At present, there are many questions being raised and many suggestions being put forward by different parties as to how the US$100 billion should be provided, how any new fund (ie the CGCF) will interact with the existing funds and which bodies should administer the funding. This advice summarises the existing financial institutions and sets out some of the suggestions for how the funding should be administered.

The Accord and the AWG-LCA negotiating text (FCCC/AWGLCA/2010/6) (“the LCA text”) both refer to the provision of the US$100bn funding coming from “a wide variety of sources, public and private”. It is not clear how such funding will be split between public and private sector, but the private sector is envisaged to play an important role.

Question 1 – Provisions in the Accord and LCA text

There are three paragraphs in the Copenhagen Accord which deal with adaptation / mitigation finance. They describe the creation of a Copenhagen Green Climate Fund (para 10), a High-Level Panel to look at possible sources of funding (para 9), and commitments to provide funding of $10 billion per year for 2010-2012, and to mobilise $100 billion per year by 2020 (para 8). These key provisions have been carried forward into the draft LCA text currently being discussed at Bonn (see paras 23, 27 and 29 of the LCA text).

The “new multilateral funding for adaptation” is a key provision coming out of paragraph 8 of the Accord and “a significant portion” of this funding will flow through the Copenhagen Green Climate Fund (“CGCF”). However, neither the Accord nor the LCA text specify how much this funding is to be, nor what the “significant portion” is.  In addition, how the CGCF is to be administered and who by is the subject of much debate. Although it should be noted that there is express provision that the CGCF will be governed by a structure “providing for equal representation of developed and developing countries”.

Under paragraph 9, the Accord establishes a “High Level Panel”. An Advisory Group on Climate Change Financing (“AGF”) has since been established by the UN Secretary General whose purpose it is to develop practical proposals on how to scale up long-term financing for mitigation and adaptation strategies in developing countries.  The AGF is expected to produce its final report on finance (which should discuss the institutional framework) by September 2010.

The lack of any concrete proposals on the institutional governance around finance has been a major hurdle in the negotiations to date.  The Copenhagen Accord contains no detail on institutional arrangements and this is one of the key issues being negotiated at Bonn: principally in the LCA but also in a review by the Subsidiary Body of Implementation (SBI) of the financial mechanism and a separate review of the Kyoto Protocol Adaptation Fund (administered by the UNFCCC).

Institutional arrangements

This issue of institutional arrangements is a very complex one and there is no clear answer. There are currently 21 multilateral and bilateral climate funds.  The multilateral funds include World Bank administered funds (the Climate Investment Funds (“CIFs”)) and the UNFCCC or other UN body administered funds (such as the Kyoto Protocol Adaptation Fund and the Global Environment Facility (“GEF”) which administers the GEF Trust Fund, the Strategic Priority on Adaptation, the Special Climate Change Fund and the Least Developed Countries Fund).  How the CGCF is to fit with these and how it is to be administered is the subject of much debate.  There are many different questions being posed and proposals being put forward for how to structure the institutional arrangements around funding, including suggestions around whether the existing funds should be consolidated, how a new fund would interact with the existing ones and who would administer any new fund.

The following are three examples of proposals put forward which demonstrate some of the different possibilities:

  • No new institutional arrangements for organising and allocating funding, but better coordination between existing institutions and funding sources. At most, this type of arrangement would mean reforming the existing Clean Development Mechanism Executive Board (CDM Board), World Bank Global Environment Facility or Adaptation Board so that they performed a broader role.
  • A new international fund (operated by the COP) into which all funding is paid, and which has control over all decisions about how funding is then used.
  • A new international fund (operated by the COP) into which all funding is paid, but which pays funding to national funding bodies set up in each developing country. These national funding bodies then decide how funding is used in their country. Under this model each developing country can take decisions on its own spending.

There is debate around whether the CGCF is administered by a UNFCCC body or whether it should come under the World Bank’s auspices. Some developing countries do not want the World Bank and multilateral development banks to be involved in climate finance, and would prefer to see consolidated climate financing mechanisms under a Global Climate Fund with UNFCCC authority (as a G77 + China proposal demanded). Criticisms of the World Bank tend to revolve around the fear of unwanted conditions put on the money given out by the banks or concern about the high administrative fees taken out by the banks.

Another argument is that the direct spending of the resources is best carried out by internationally accountable institutions with experience in development. This would point to existing development institutions and to the regional development banks (eg the African Development Bank) as they would be in a position to blend and mingle different sources of finance. Another potential arrangement is to have two types of funds: one for activities with clear revenue streams and others that depend on grant finance.

Of the existing climate funds, the main institutions being examined as potentially taking on the US$100 billion funding are:

  • Kyoto Protocol Adaptation Fund: Funded through the Kyoto Protocol Clean Development Mechanism, the Adaptation Fund is unique in having a governing board dominated by developing countries. It is pioneering “direct access” to finance for recipient countries, (ie without mediation of a UN agency) and should have distributed its initial grants before Cancun.  Note that it is for Kyoto parties only.
  • World Bank Pilot Program on Climate Resilience (“PPCR”): Funded by contributions from several wealthy countries, the PPCR is piloting a new approach to integrating adaptation into broader development decision-making.  Some have criticised it as unjust because it calls for recipient countries to take loans to support adaptation (an activity forced upon them by the greenhouse gas pollution of wealthier nations) and these loans often have conditions and interest associated with them.
  • Global Environment Fund (“GEF”): This is the traditional repository for funds associated with the UNFCCC, and has been supporting adaptation projects for years. The operation of the financial mechanism of the UNFCCC is currently assigned exclusively to the GEF, subject to a review by the COP every four years. However, recipient governments have expressed frustration with the slowness of the GEF, as well as to the extent to which UN agencies hold the reins on its projects and developed countries have expressed doubt about the ability of the GEF to scale up project financing.  It may be unlikely that the GEF will house the CGCF under its roof.

In addition to the debate on institutions for adaptation finance, there is debate over the more general institutional design for reform and governance of the financial mechanism of the UNFCCC (established under Article 11 of the Convention).  Currently, there are two principal institutional innovations as set out in the LCA text:

  • The Copenhagen Green Climate Fund (“CGCF”) (paras 6-11 LCA text): A new fund as an operating entity of the financial mechanism, setting out key principals, functions and modalities of support including direct access, and composition and appointment of the Board of the Fund.  The language of the Accord suggests that the CGCF would not replace the GEF, but function in addition to it.  If the CGCF is to operate under the Convention’s financial mechanism, a formal COP decision is needed, with agreement of all the parties.  Until this is reached, money may be pledged under the Accord, but it will not be distributed and managed with UNFCCC oversight and guidance.
  • The Finance Board (para 4 LCA text): A Finance Board of the financial mechanism of the UNFCCC as a whole, which would oversee all funding arrangements under the UNFCCC as well as review modalities of operating entities such as the GEF, and set out powers and functions and procedures for appointment of the Board’s members. If the CGCF is not established under the authority of the COP, then it would be more necessary for the Finance Board to have broader powers to make recommendations and have influence over this fund, as well as financing channels.

Question 2

It is not clear to what extent the US$100 billion will include private sector finance. The Accord is very vague in stating that a “wide variety of sources” will be used, including “public and private”. The Accord provides no details as to what proportion of funding will be private or what sources this will include, it only states that private-sector financing will “supplement” the public resources and it is not clear what this will mean in practice.

The European Commission has stated that out of a nominal EUR100 billion required by 2020, international public finance would account for approximately EUR22 to 50 billion (roughly US$28-63 billion), with the remaining finance being generated from the international carbon market and domestic finance in developing countries themselves (EC COM 2009).

There is no doubt that private finance will be part of global climate finance commitments, however, there are serious questions around what sources this includes and whether this should be counted as “new and additional”. There is a concern that including private sector funds could dilute any commitment by developed countries for public funding.  This is because public funds often trigger or facilitate the production of private investments. For example, if US$1 billion of public funding means that US$9 billion of foreign direct investment moves away from coal to renewable energy, is this actually US$10 billion of public and private sources?

In a preparatory paper for the AGF, Lord Nicholas Stern distinguished between:

  • Foreign direct investment arising from sound policies in a developing country. Stern suggests that this should not count as part of the US$100 billion.
  • Private financing for an investment in which an International Finance Institution (such as a regional development bank, World Bank, IMF) have participated via a risk sharing and guarantee agreement together with its own funds.  Stern suggests that an element of this is new private funding which would not otherwise have taken place and so part (not all) of this could be counted as private finance.
  • In relation to CDM projects, Stern analyses that this only very little of this will count, as most of it is developed country obligation to reduce emissions, rather than additional support to developing countries.  The part that can count is the intra-marginal rent, that is, the excess of payment over the actual costs incurred in developing countries, and then only in part.

It is likely that public finance will be needed to incentivise the investment of the private sector. In order to attract private investment, it is important that investment opportunities offer excellent risk/return ratios and a strong financial system to channel funds. One way to encourage private sector involvement may be through the creation of a fund of funds, made up of sovereign wealth funds. This would be financed by the private sector and managed by a private fund manager. Other incentives include investment guarantees, such as those offered by the World Bank’s Multilateral Investment Guarantee Agency (“MIGA”).

Apart from private direct investment, the revenue of carbon trading may be included in finance commitments.  There is some concern around this because carbon credits bought from developing countries by developed countries are only to comply with targets set by the developed countries, and are not seen as triggering “new and additional” emission-reductions, and so the money raised by selling the credits should not be considered new either.

Currently, private finance is thought to make up the single largest flow of investment, estimated at approximately $7 to $10 billion per year of funding in renewables and energy efficiency. If investment remains at present levels, private sector finance would therefore amount to 7% to 10% of the $100 billion global total.

The figure of US$100 billion is at the lower end of estimates of what is needed for mitigation and adaptation.  For example, the World Bank estimated that the needs for adaptation and mitigation per year by 2030 is closer to US$275 billion, whilst the International Climate Action Network suggests that in public finance alone, a figure closer to US$195 billion would be required.

It is generally agreed that there is a need for transparency within the system of governance (Article 11.2 of the Convention). However, there is currently no agreement as to how the involvement of the private sector should be regulated with respect to the US$100 billion funding.  This would need to be addressed if double counting and other malpractices are to be avoided. Stern warns that a system for monitoring, reporting and verifying of flows of climate change financing will be fundamental to their credibility.

Banks are independently audited, however, this is an audit of the organisation itself and not specific projects. Specific investment projects will not be independently audited unless there are specific contractual provisions for that to be done.

Private sector investment from public sector leveraging would probably only be regulated under the rules for any such scheme.  Public sector investment will only be the catalyst for this type of private investment if sufficient mechanisms are put in place to make the investments less risky, such as the MIGA scheme.  If such guarantees are given to projects, then they will be subject to performance criteria associated with the bank providing the financing (such as the MIGA performance criteria, or the IFC’s performance criteria).

If private multinational banks decide to invest in projects via institutional funds etc then whether or not those banks are subject to the Equator Principles will depend on whether the bank itself has signed up. The Equator Principles tend to be used for large-scale project finance  (ie more than US$10 million). The Equator Principles require the banks to categorise projects according to social and environmental impacts, and to screen projects according to a number of social and environmental criteria, before any money is given out. Depending on categorisation, there are requirements on borrowers to carry out impact assessments, environmental management plans and to comply with various reporting requirements.  However, the Principles are voluntary and are not legally binding.

The World Bank is not subject to the Equator Principles but has its own environmental and social safeguards and procedures which can be found in the World Bank document: the Trust Fund Handbook.