Finance section in climate legislation

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 However, the materials have been prepared for informational purposes only and may have been superseded by more recent developments.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: 18/02/2019

Can you advise on the general subject areas that the finance section in overarching new climate legislation should cover and provide some explanations on why they would be useful? 

Advice:

The effective implementation of new legislation on climate change will be possible only with the support of adequate financial resources. This pertains to adaptation and mitigation action but also to the establishment and operation of new entities (commissions, committees, agencies, departments etc.) tasked to shape law, policy and activities under such legislation. The Kenyan Climate Change Act 2016, for example, could not be operationalized because of a lack of financial resources to create the envisaged Council and Directorate.

The mobilisation, management and targeting of climate finance may, therefore, be an important part of new climate legislation and be addressed in a separate (finance) section. In this context, some countries have also established a designated (climate) fund to raise, manage and distribute financial resources. In general, a new act could address several potential sources for climate finance including the following:

  1. Government budget

Climate change response measures as well as the institutional governance framework to address climate change could to some extent be part of a country’s annual financial statement. They could be included as estimated expenditures – in most jurisdictions – subject to approval by parliament. Such national budget allocations provide a degree of certainty but are also limited by state revenues, a country’s economic realities and other development priorities.

  1. Fees and charges

Financial resources could also be raised via fees for public services provided; charges levied on assets, goods and services linked to climate change adaptation and mitigation; or monetary penalties for non-compliance with greenhouse gas emission restrictions or other statutory requirements. To increase energy efficiency and to reduce carbon emissions the UK, for example, applies an additional tax (climate change levy) on the energy used by businesses.

  1. International public climate finance

Without recognizing a legal obligation to do so, industrialized countries have promised to channel significant amounts of climate finance for climate change mitigation and adaptation to developing countries. This can take a variety of different forms such as project funding, grants, loans, or contributions to the Green Climate Fund and other climate funds (e.g. the Least Developed Countries Fund hosted by the Global Environment Facility or the Adaptation Fund). All multilateral development banks (African Development Bank, World Bank etc.) also have dedicated financial resources for climate change projects and programmes. Under the Paris Agreement developing country parties can document their adaptation efforts (Art.7 para.3) and indicate their financial needs (Art.13 para.10).

  1. International private finance

The private finance sector increasingly views climate change as a “business opportunity” and has developed a variety of related products. This includes, for example, loans availed from banks with an end-use restriction related to environment-friendly projects or purposes. The loan documents specify that the money borrowed must be used for projects that have clear environmental benefits. They may require sovereign guarantees or guarantees from state owned entities.

Green or climate change bonds used to finance green projects are similar to a loan. However, when the bond is issued, money is lent to the entity issuing the bond, which then promises to repay the principal and interest through to the bond’s maturity. Depending on the restrictions in national legislation, a company, a municipality or a government can issue bonds. In October 2017, Fiji issued a sovereign green bond, for private capital seeking investment opportunities in climate resilience and adaptation.[1]

In the future there may also be opportunities under the market-based mechanisms envisaged under Art.6 of the Paris agreement (cooperative approaches involving the transfer of mitigation outcomes and a mechanism to support sustainable development). For the time being, however, how and to what extent developing countries will be able to generate tradeable and/or sellable units remains an open question.

  1. Initial observations

The finance section could in very general terms reference the above avenues for climate finance. In addition, it may be useful to consider setting up a national climate finance mechanism that enables blending or combining different climate finance resources. In this context, “combining” is the bundling of different types of resources through a national financial mechanism within a single project or programme (i.e. resources are allocated side by side – grants as well as loans).

“Blending” in comparison is more complicated as it involves the use of one resource to restructure the terms of another (e.g. lowering interest rates or extending the repayment period for a loan) with financial terms renegotiated. This requires banking functions and so restricts the type of institutions at the national level that can be involved.

In broad terms, law-makers can utilise a two-fold typology of regulatory options to mobilise climate finance: ‘financial mechanisms’ and ‘facilitative modalities’.[2] Financial mechanisms are hard financial instruments that directly mobilise or leverage private finance such as blended finance (grants, loans, guarantees and insurance, green investment banks, climate trust funds, clean development mechanisms and public-private partnerships); carbon pricing (tax or trade); tax credits and incentives; green bonds; feed-in tariffs and subsidies; and by removing fossil fuel subsidies.

In contrast, facilitative modalities are non-financial initiatives that complement financial mechanisms to help indirectly mobilise or leverage private finance by enhancing capacity building, knowledge transfer, and project pipeline. This includes enhancing governance structures, prudential regulation, corporate reporting, matchmaking and training schemes, renewable energy targets, and taxonomies for defining ‘green’ investments. Both types of regulatory options are essential and complementary for creating a regulatory environment that can enable public and private climate finance.

  1. Additional considerations

As a preliminary step, in analysing financial requirements and potential sources of climate finance as well as using reporting opportunities under the Paris Agreement the government may benefit from identifying the following:

  • Cost of proposed climate change response actions in the short and medium term – and resources available;
  • Potential entry points for relevant finance institutions (domestic and foreign); and
  • Accountability mechanism over the use of climate change related finance.

Some of the following components may help to inform the process and subsequently the wider climate change financing framework:[3]

  • The potential loss and damage (“L&D”) arising from climate change (i.e. vulnerability);
  • The effectiveness of climate finance in reducing L&D and greenhouse gas emissions;
  • Classification of expenditure according to the degree of climate change relevance;
  • Past expenditure patterns, covering budget and off-budget sources;
  • Financing scenarios for all sources of climate finance;
  • Financial allocations for future climate change relevant actions; and
  • Aggregate impact of climate change finance in reducing L&D and greenhouse gas emissions.[4]

 

________________________________________

[1] See e.g. https://www.worldbank.org/en/news/press-release/2017/10/17/fiji-issues-first-developing-country-green-bond-raising-50-million-for-climate-resilience

[2] Megan Bowman, Legal Readiness for Public-Private Climate Finance: An Options Paper for UN Environment, 102pp (February 2018, peer reviewed); Megan Bowman and Katrien Steenmans, Climate Finance Law: Legal Readiness for Climate Finance (King’s College London and UNEP, July 2018), available at: https://www.kcl.ac.uk/law/research/centres/climate-law-and-governance/climate-law-and-finance.aspx

[3] Kit Nicholson, Thomas Beloe, Glenn Hodes, Charting New Territory: A stock take of Climate Change Financing Frameworks in Asia-Pacific, UNDP, 2017, available at: https://www.climatefinancedevelopmenteffectiveness.org/sites/default/files/publication/attach/Hard%20Choices%20-%20Integrated%20Approaches.pdf

[4] For a more detailed set of components of climate finance readiness and associated capacities see: Veerle Vandeweerd, Yannick Glemarec and Simon Billett, Readiness for Climate Finance A framework for understanding what it means to be ready to use climate finance, The United Nations Development Programme (UNDP), March 2012 available at: http://www.tr.undp.org/content/dam/turkey/docs/Publications/EnvSust/UNDP-Readiness_for_Climate_Finance.pdf.