Institutional arrangements for a new climate fund

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 However, the materials have been prepared for informational purposes only and may have been superseded by more recent developments.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.

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Date produced: 15/11/2010

1. Must a new Fund created under Article 11 of the Convention be established as an international organization, or could it be established under the domestic law of a Party to the Convention? What are the advantages and disadvantages of each approach, in terms of the process for setting it up, the functions it will serve, and the ability of the COP to decide on its policies, programme priorities and eligibility criteria?

2. If it is to be established as an international organization, what minimum elements/attributes must it have to acquire international legal personality?

3. Are there additional elements/attributes a Fund must have to enable it have full flexibility and capacity as a finance channel (i.e. receive sovereign contributions, issue bonds, enter and enforce contracts, etc.)

4. Assuming these elements/attributes are included, can a Fund be created by COP decision, or must it be done by treaty? What would be the significance of a COP decision “establishing” a new fund that did not include all of the essential elements/attributes?

5. If the Fund cannot acquire legal personality through a COP decision, can it achieve the same objectives by naming the World Bank or another existing entity as “trustee”?

6. What are the potential implications of the alternative language proposed in Para 2, Options 1a, 1b and 2 of the Facilitator’s Note (Annex 1, page 53)? In particular, with regard to the requirements of Article 11 of the Convention that the financial mechanism be under the “guidance and accountable” to the COP, and that the COP “shall decide on its policies, programme priorities, and eligibility criteria” what are the distinctions between (1a) establishing a “fund as an operating entity of the Convention;” (1b) establishing a Fund “under the Convention, with its Board as its operating entity of the Convention”; and (2) establishing a “new fund as an operating entity of the financial mechanism.”?

7. Do these options have different implications with regard to the requirement in Article 11 of the Convention that the operation of the financial mechanism “shall be entrusted to one or more existing international entities”?

8. Article 11(1) provides that the operation of the financial mechanism “shall be entrusted to one or more existing international entities.” In this context, what does it mean to “operate” the financial mechanism? Can it be fairly construed to refer only to the trustee function, or does it also necessarily include the secretariat and/or the Board?

9. What is the difference under international law between a fund that is “under the authority” of the COP versus a fund that is “under the guidance and accountable” to the COP? Do these phrases have independent meaning under existing precedents, or will the relationship of the COP to the Fund be determined entirely by the Funds constitutive agreements?

10. Other than explicitly stating ‘under the authority of’, what are the options for attributing authority to the COP over the financial mechanism a) where the mechanism is a new multilateral fund’ and b) where the mechanism is an existing fund under a different institution (e.g. allowing the COP to supersede the authority of the GEF over the LDCF)?

As a preliminary comment, the key question is what is the purpose of the Fund and how is it intended to interact with existing financial mechanisms and funds already established under the UNFCCC and the Kyoto Protocol. We have assumed that this question relates to the establishment of the Fund that will administer significant new and additional funds (being the initial 30 billion by 2012 and up to 100 billion per annum by 2020) that are to be distributed to assist developing countries with mitigation and adaptation. In this respect, the primary Fund will need to be international, with institutional and governance structures that reflect the interests of both donor and recipient states. This does not preclude the establishment of national funds that administer monies received from the Fund. However, the purpose of those funds will reflect the national priorities of the host country and the legal and institutional frameworks that exist in those states.

Whilst there is nothing at law to prevent the Fund being established as either an international entity or through the national laws of its host country, it is, in our view, unlikely that political consensus could be achieved to submit the Fund to the governing law of one state. If this consensus could be achieved, it would be necessary to consider the application of domestic finance, banking and tax law to the Fund – particularly if it were established at arms length from the government. If it were established through government agencies and institutions, then serious questions (and risks) regarding sovereignty may arise. This is discussed in more detail below.

Question 1 – International Institutions

The Funds (and more broadly financial mechanisms) that have been established to finance climate change and other environmental activities are the product of international law. In most instances, the funds are established either by treaty or by a decision of the Conference of the Parties to the relevant treaty (e.g. the UNFCCC COP). Those decisions provide detail of the institutional structure of the Fund, establish its mandate and governing principles and may provide further detail regarding operating procedures.

In order to operationalise the Fund arrangements need to be put in place to either (a) establish a new international institution to act as the Trustee of the Fund; or (b) enter into an agreement with an existing institution to act in that role. In deciding what type of institution to create or use, states will need to consider whether they wish to confer distinct legal personality on the institution or whether a more limited arrangement is preferable, but where the institution still retains a large degree of functional autonomy. By way of example, the World Bank is an organization with legal personality, but the Global Environment Facility (GEF) is not, despite being conferred with such powers necessary to perform its mandate. The risk with new institutions with legal personality is that they are often accompanied by a whole new bureaucracy.

The Adaptation Fund provides a useful example of how an international fund may legally operate. Decision 1/CMP.3 established the Adaptation Fund Board and Decision 1/CMP.4 operationalised the Fund, adopting Rules of Procedure for the Board, conferring it with legal capacity, as necessary, and appointing the Trustee and Secretariat to the Fund.

As AF Trustee, the World Bank manages the sale (“monetization”) of the CERs received by the AF in accordance with the guidelines developed by the World Bank and approved by the AF Board. The World Bank has established the AF Trust Fund to hold the funds – primarily cash proceeds from the monetization of CERs – and then disburse them for projects and programs as instructed by the AF Board. The World Bank also manages the investment of trust fund balances, accounting and financial reporting for the AF Trust Fund. The World Bank is accountable to the AF Board for the performance of its fiduciary responsibilities, in accordance with the Terms and Conditions of service agreed between the World Bank and the CMP.

The GEF provides secretariat services to the Adaptation Fund Board on an interim basis in order to support and facilitate its activities. The provision of those services is governed by a Memorandum of Understanding (MOU) between the CMP and the Council of the GEF.

There are a number of international organizations that have capacity to act as the Trustee of a new fund, including the World Bank, the United Nations Development Programme and The GEF. However, these organizations have been criticized in the past for their performance – hence the detailed rules adopted for the Adaptation Fund and the interim appointment of the Trustee and Secretariat.

National Funds

There are a number of national climate change funds being established to disburse funding for climate change projects. In many instances, these are established by national governments using existing financial mechanisms such as domestic development banks. Examples include: the China CDM Fund (established by a number of Chinese Ministries and operated by a Management Centre); the Indonesian Climate Change Trust Fund (operated by UNDP as interim manager); the Amazon Fund (administered by the National Social Economic Development Bank (BNDS)); the Brazil National Fund on Climate Change (established by the government of Brazil under the responsibility of the Ministry for Environment with BNDS as the Trustee of the Fund operating agent). The management and disbursement of monies from these funds is largely controlled by the national government agency(ies) responsible for the Fund and accounting, auditing etc is in accordance with national rules, noting that government agencies may be exempt from some of those rules (e.g. regarding taxation of the fund).

Funds can also be established privately and will be subject to the laws of the host country. As mentioned above, if a Fund is set up solely under national law, it will be subject to the banking and finance rules that apply to the jurisdiction it is established in. When private entities are establishing such funds, key matters for consideration will be the tax effectiveness of a jurisdiction, privacy and levels of oversight and regulation.

Question 2

International legal personality is conferred on an organisation such as a Fund by the express or implied will of member states. This may occur by direct reference to the organisation’s legal status or implied through the provision for certain powers relating to operations and activities granted to the organisation. Importantly, for any organisation to have international legal personality, it must have factual autonomy and effective independence from the member states. The states must, therefore, also grant the functional, material and organic means necessary so that the organisation functions on its own.

This has played out in the example of the COP, where the parties to the UNFCCC have not expressly confirmed or rejected whether the COP exists on the international legal plane as an international organisation, or if the COP is a series of intergovernmental meetings. The UN Office of Legal Affairs has given opinions recognising the “legal nature and functions of the UNFCCC bodies indicates that they have certain distinctive elements attributable to international organisations” however this has been nuanced and is not an express recognition of the COP. In practice, the member states and legal academics have accepted the COP has a presence as an international organisation.

The consequences of international legal personality is wide and varies from case to case. Specific effects of legal personality depend on the constitution and functions assigned to the organisation. Generally, however, international legal personality provides the right to be accepted as an international person and to express the organisation’s will through different legal ways in the international plane. It also provides rights to have relationships with external bodies.

Practically, if a Fund is granted sufficient autonomy from the COP to operate its own activities and takes on international legal personality, this could potentially mean the Fund could:

• participate in meetings

• take on liability

• enter into contracts eg supply arrangements or employee people

Question 3

Key elements of the Fund are (i) legal personality either of the Fund or the Trustee of the Fund, to enable it to establish and manage the financial flows into and out of the fund; and (ii) clear rules regarding how monies are received and disbursed and who is capable of making decisions regarding receipt and disbursement.

Question 4

There is nothing to prevent the Fund being created by a COP decision – the Adaptation Fund (described above) provides a clear precedent for this, as does the establishment of other funds such as the Special Climate Change Fund and the LDC Fund.

Question 5

As noted above, the COP can confer legal personality on the Fund. However, in order to establish the mechanics to operate the Fund, it may nevertheless be appropriate to appoint an external trustee with experience in funds management to act as Trustee.

Question 6

In all of the examples, the new Fund will be under the guidance of and accountable to the COP. The difference between the 3 options is who will be the operating entity and whether it is an operating entity of the Convention or of the financial mechanism. In Option 1(a) the operating entity is the Fund itself and is an entity of the Convention; in Option 1(b) it will be the Board of the Fund and again an entity of the Convention; and in Option 2 it will be the Fund as an operating entity of the financial mechanism.

By being an entity of the Convention, there is arguably more scope to use new organizations and structure, rather than relying upon the existing entities (such as the world Bank and the GEF). In addition, the mandate of the operating entity will be broader than solely Article 11 and finance (although will also encompass that). However, if the objective of the Fund is solely to provide finance for mitigation and adaptation (including TT and REDD etc), then being an operating entity of the financial mechanism would be sufficient.

The difference between appointing the Fund as the operating entity or its Board is not entirely clear. Neither the G77 nor the EU propose the Board being the operating entity, however, both envisage both a Board playing a management role and, in our view, this is more appropriate than appointing the Board as the entity itself.

Question 7

Only Option 2 is clearly proposing to establish the Fund within the framework of the existing financial mechanism in Article 11. In this regard, Article 11 para 1 states that the operation of the mechanism shall be entrusted to an existing mechanism. A literal interpretation of this may exclude the establishment of a new operating entity and effectively limit the choice of entity to the World Bank, GEF, UNDP or other existing institutions.

Options 1(a) and (b) are not limited to existing international entities and could conceivably entrust the operation of the Fund to a new international entity or to a national entity.

Question 8

The term “operate” refers to carrying out the functions of administering the fund or mechanism. This includes the functions that may be performed by a Board, a Trustee and a Secretariat – each with a clear set of roles and responsibilities. In the context of Article 11(1) and having regard to the financial mechanism more broadly, the GEF was effectively carrying out all operational functions under the guidance of the COP. That is, there is currently no equivalent of a Board and the GEF has historically taken on that role in addition to the trustee and secretariat roles. What is proposed for the Fund is different, insofar as a series of different roles are contemplated.

Question 9

The difference between under the authority of and under the guidance of the COP (or COP/MOP) relates to the level of oversight that the COP and the Parties have over the body / financial institution. By way of example, the GEF, which is the operating entity of the financial mechanism of the UNFCCC and a number of other Conventions has memoranda of understanding (MOUs) with the COPs of those Conventions whereby the COPs provide guidance to the GEF on policy, strategy, programme priorities and eligibility criteria for access to and utilisation of the financial resources. Whilst there is some debate as to the GEF’s performance in following that guidance, the key point is that provided the GEF is following that guidance, it can act relatively independently. In addition, the GEF will be subject to the direction of its own governing council (note that the representation of countries on that council is not directed by the COPs for which it manages funds and that a key element is that large donor countries may have a greater say on that council).

In contrast, there are other mechanisms established under the UNFCCC and Kyoto Protocol which are subject to the authority and guidance of the COP or COP/MOP, such as the clean development mechanism (CDM). Rules and procedures to operationalise the CDM and to establish the Executive board of the CDM have been taken by the COP/MOP and as such, are directly determined by the Parties. In addition, the composition of the EB is comprised of representatives nominated by the Parties based on regional and country grouping representation.

In the financial context, the multilateral fund for implementation of the Montreal Protocol (MLF) is established by article 10(4) of the Montreal Protocol which states that the MLF “shall operate under the authority of the Parties which shall decide on its overall policies”. Further, article 10(5) states that the Parties shall establish an executive committee (EXCom) to develop and monitor the specific operational policies, guidelines and administrative arrangements, including the disbursement of resources, for the purposes of achieving the objectives of the MLF. The ExCom members are selected on the basis of a balanced representation of the Parties.

Decision 10/CP.7 which decided that an adaptation fund (AF) should be established decided that the AF “shall be operated and managed by an entity entrusted with the operation of the financial mechanism of the Convention, under the guidance of the COP/MOP”. This was revised in Decision 5/CMP.2 which decided that the AF “should operate under the authority and guidance of and be accountable to the COP/MOP which shall decide on its overall policies.”

The operationalisation of the AF has included the establishment of the AF Board, which is appointed as the operating entity to supervise and manage the AF. The AFB has 12 key functions, including developing strategic priorities, rules of procedures and legal and administrative arrangements for the AF for the adoption by the COP/MOP. As with the CDM EB, the AFB is comprised of representatives nominated by the Parties based on regional and country grouping representation.

In summary, where a mechanism is under the authority of the COP or COP/MOP there is more direct Party engagement in the management of the mechanism, in particular influencing the strategic direction and priorities of the mechanism.

Question 10

For new mechanisms, a number of the proposed options in Non-Paper 34 (financing) refer to new mechanisms being subject to or under the authority and guidance of the COP. Variations include (i) “establishing a fund with funding windows under its governance” (ii) that the fund “shall function under the guidance of and be accountable to the COP” and (iii) that a convention adaptation fund “function under and be accountable to the Financial Mechanism”.

For the existing financial mechanism, the existing MOU between the COP and the GEF may preclude significant changes to their operation during the term of that MOU. The MOU was annexed to Decision 12/CP.2 and as such, has the status of a COP decision. There is nothing to prevent the COP taking a further decision to provide additional guidance to the GEF, indeed, the GEF is required to report to the COP and regularly review the effectiveness of the financial mechanism. The GEF shall provide its 4th review to COP 16. However, as the financial mechanism itself is mandated by Article 11 of the UNFCCC, which requires it to operate under the guidance of and be accountable to the COP, it would require an amendment to the Convention to alter the governance structure of that mechanism.

In order to achieve the clearest engagement of all Parties in a representative manner, using language such as “under the governance or authority” of the COP is most likely to achieve this outcome.