Green Climate Fund Resource Mobilization – crowdfunding

Legal assistance paper

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Date produced: 01/07/2014

Can crowdfunding be a source of capital for the Green Climate Fund, if the Board decides so, or would there be legal concerns?

Summary:

There are no express legal restrictions on the use of crowdfunding as a source of capital for the Green Climate Fund. However, the application of domestic laws would need to be considered in the design of a crowdfunding mechanism.

Crowdfunding activities are consistent with the goal of attracting private sector investment and adopting a flexible, country-driven and innovative approach to funding. The Board has a number of options in the design of a crowdfunding mechanism, which include the establishment of a standalone crowdfunding platform. Alternatively, a crowdfunding mechanism could operate within or in association with the Private Sector Facility.

Existing crowdfunding activities have demonstrated that there are a number of risks associated with crowdfunding activities that would need to be considered.

Advice:

1. Resource Mobilization for the Green Climate Fund

The Conference of Parties (the COP), at its 16th meeting, established the Green Climate Fund (the GCF) and agreed that “funds provided to developing country Parties may come from a wide variety of sources …… including alternative sources“[1]. A key focus of the GCF is to leverage private sector investment in mitigation and adaptation financing. At its 17th meeting, the COP adopted the Governing Instrument of the GCF, which permits the GCF to receive funds from:

(a) developed country Parties; and

(b) a variety of other sources, public and private, including alternative sources.[2]

The Governing Instrument also states that the GCF was intended to be a “flexible” and a “continually learning institution“.[3] This reflects an intention to broaden the GCF’s funding base to include the public and private sector as well as potentially new, non-traditional sources of funding. These guiding principles provide scope for the inclusion of crowdfunding as a means of resource mobilization.

While accountable to the COP, the GCF Board has full responsibility for funding decisions and approving specific funding structures. The Governing Instrument is not prescriptive regarding the forms of financial inputs to the GCF. The GCF has flexibility in relation to the sources and the forms in which it can receive financial inputs. It is intended that, as the GCF develops, this flexibility should allow for innovation and ambition in the GCF’s resource mobilization strategy.

To date the focus of initial resource mobilization strategy has been on ad-hoc contributions by developed country Parties. However, the COP has also called upon the Board to “establish the necessary policies and procedures, which will enable an early and adequate replenishment process“.[4] The need for continuous replenishment of the GCF is consistent with the use of constant funding arrangements such as crowdfunding.

2. Key GCF Board Decisions

The Board has made a number of decisions that are relevant to considering the role that crowdfunding can play in leveraging private sector investment.

At its fifth meeting the Board considered a paper on Resource Mobilization.[5] It was decided that the GCF will maintain the flexibility to receive financial inputs on an on-going basis. While the Board confirmed that the GCF “will receive grants from public and private sources” it also decided that the GCF “may receive additional types of inputs at a later stage to be decided by the Board“.[6]

On a number of occasions, the Board has also recognized the need to consider the relationship between the forms of financial inputs received by the GCF and the form of financial instruments that the GCF uses to allocate its money. The alignment of financial inputs and financial outputs is an important consideration in the design of any crowdfunding model.[7]

The Board has also consistently reaffirmed that country ownership will be a core principle of the investment approach of the GCF.[8]

3. Private Sector Facility

The Governing Instrument requires the establishment of a Private Sector Facility that enables the GCF to directly finance private sector mitigation and adaptation activities.[9] This facility is designed to promote the participation of private sector actors, including small-and medium-sized enterprises and local financial intermediaries.[10]

Crowdfunding could be used as a tool by the Private Sector Facility to leverage private capital and participation in the GCF. The focus on small and medium sized enterprises aligns with crowdfunding which typically relies on local intermediaries and supports smaller enterprises which are unable to access traditional sources of funding.

The GCF is currently developing the rules for the establishment of a Private Sector Facility and policies to best expand private sector capital in mitigation and adaptation activities. In Board papers discussing these rules, crowdfunding has already been identified as one possible means of leverage. The Business Model Framework for the Private Sector Facility discusses the option of working with existing crowdfunding platforms to encourage private individuals to lend to mitigation or adaptation projects in developing countries.[11]

4. What is crowdfunding?

Crowdfunding is an Internet-enabled way for project proponents to raise money in the form of either donations or investments from multiple individuals. It allows individuals to pool their resources through an online crowdfunding platform to support a project that would otherwise not have adequate access to funds. Crowdfunding is a unique means through which to raise capital and has some key defining features:

(a) enables individual investors with limited means to pool their resources into meaningful amounts;

(b) enables individuals to select specific projects and proponents to invest in and track the progress of their investments;

(c) provides a low cost and efficient means to transfer private capital to projects in developing countries;

(d) leverages the internet, particularly social media, to market to individuals, provide a payment platform and hold recipients accountable; and

(e) provides a means for small to medium scale projects to attract investment at affordable rates.

Crowdfunding is typically either on a donation or investment basis. Donation based crowdfunding is often used for philanthropic activities that have no or limited means of generating revenue to repay funds provided. In the context of the GCF, donation based crowdfunding with individuals is analogous to grant based funding from States. While simpler to administer, as it does not require facilities to return funds to investors, it is doubtful whether a donation based approach would generate donations given the scale of adaptation and mitigation challenges.

Most crowdfunding platforms use an investment based approach, which use either lending or equity based models. For example, Kiva allows individuals to make small loans to micro-entrepreneurs in developing countries. These loans are channelled through local microfinance institutions which are responsible for accrediting loan recipients, distributing funds and collecting repayments. Kiva has been extremely successful in leveraging private capital investment into developing countries, channelling over $ 400 million from over 900,000 individuals into projects which have a repayment rate of over 98%. This funding model enables individuals to relend funds that have been repaid and creates a self-replenishing cycle.

5. Crowdfunding applied to the GCF

The Governing Instrument of the GCF expressly provides for flexibility and encourages innovation in the way that resources are mobilized by the GCF to support mitigation and adaptation activities in developing countries. In 2013, global crowdfunding volumes increased by 81% to $5.1 billion. As one of the fastest growing sources of private capital, crowdfunding has the potential to be a contributor to the work of the GCF.

As mentioned, crowdfunding aligns with a number of the key principles of the GCF and the Private Sector Facility. Examples like Kiva demonstrate crowdfunding’s ability to adopt a country-driven approach which directly funds local actors, including small-and-medium-sized enterprises and local financial intermediaries. In addition, investment based models could potentially leverage the significant private savings in the developed world towards mitigation and adaptation projects in the developing world. The energy efficiency or productivity gains associated with mitigation and adaptation activities could provide a means of repaying loans.

Using crowdfunding to contribute to the general funds of the GCF is unlikely to be successful as the impetus behind crowdfunding is that it allows individuals to contribute towards specific projects. However, there are other options for the GCF, and particularly the Private Sector Facility, to use crowdfunding as a means of channelling private sector investment into mitigation and adaptation in developing countries.

One option would be for the GCF, perhaps through a subsidiary, to develop its own crowdfunding operation to provide a platform for private sector investment into specific projects in developing countries. In keeping with the country-driven approach, national DNA’s could establish eligibility frameworks and rules, which determine what kinds of projects would be eligible to be placed on the platform. Existing microfinance institutions would then act as the financial intermediaries between the GCF and individual projects. In line with the Kiva model, individual donors would be able to track how their money was spent and nationally appropriate reporting obligations would hold individual projects accountable. In the case of mitigation activities, the crowdfunding platform could provide a means for the GCF to track emissions reductions achieved by investments.

Alternatively, the Private Sector Facility could be utilized to support existing crowdfunding activities which have a particular mitigation or adaptation benefit. It could play an important role in enabling better distribution and access to crowdfunding sources for developing countries. For example, the following actions would be within the scope of the Governing Instrument:

(a) investing in capacity building activities including training project developers in developing countries on how to access crowdfunding and design attractive projects;

(b) providing seed funding to establish microfinance institutions in developing countries that are committed to funding activities linked to mitigation and adaptation;

(c) establishing a mechanism for evaluation and accreditation of existing crowdfunding; and

(d) creating a portal that gives developers and private investors access to existing crowdfunding platforms.

Additionally, GCF funds could be leveraged to directly assist relevant crowdfunding activities. For example the Private Sector Facility could provide guarantees or other de-risking facilities to support private investment into mitigation and adaptation activities, especially in developing countries with higher risk profiles.

6. Risks associated with crowdfunding

There are a number of risks associated with crowdfunding that need to be considered in the context of the GCF.

A concern for the GCF is the unpredictability of funding associated with crowdfunding activities. The ability for projects to gain funding through a crowdfunding platform is dependent on their ability to market themselves and attract individual investment. As a result, it is difficult to ensure even investment across regions and different mitigation and adaptation activities. It should be noted that the Board has an obligation to balance the allocation of resources between adaptation and mitigation activities.

As the donor is often anonymous, there are also concerns associated with money laundering and fraudulent activities. These must be considered in light of the continuing development of accountability mechanisms and social safeguards.

7. Application of domestic laws

In recent years, a number of countries including the USA, Canada, France and the Netherlands, have introduced legislation to facilitate but also regulate crowdfunding activities. These would need to be carefully considered in the design of any crowdfunding mechanism.

Crowdfunding is well established in Korea with large investment flows. We are not aware of any restrictions or laws in Korea that would prevent the GCF conducting crowdfunding activities. However, there is a regulatory framework in place that may need to be considered. It should also be noted that the GCF does have the benefit of certain immunity provisions in article 9 of the Headquarters Agreement.

In developing countries, crowdfunding based on a Kiva model would have the benefit of existing regulatory frameworks and local familiarity associated with microfinance practices to support the distribution of funds and oversight of projects.

8. Next steps

In order to examine the opportunities associated with crowdfunding climate finance, the Board may wish to include a consideration of crowdfunding in the future papers prepared for the Board on resource mobilisation.

_____________________________

[1] Decision 1/CP.16, para 102

[2] Decision 3/CP.17; Governing Instrument of the Green Climate Fund, para 29 and 30

[3] Ibid para 3

[4] Decision 3/CP.17, para 9

[5] GCF/B.05/18 Resource Mobilization

[6] GCF/B.05/24/Rev. 01 Report of the Fifth Meeting of the Board, 8-10 October 2013

[7] GCF/B.05/24/Rev. 01 Report of the Fifth Meeting of the Board, 8-10 October 2013

[8] GCF/B.06/05 Policies and Procedures for the Initial Allocation of Fund Resource

[9] Governing Instrument of the Green Climate Fund, para 41

[10] Ibid, para 43

[11] GCF/B.04/07 Business Model Framework: Private Sector Facility