Special Report Kyoto and the carbon markets S19www.carbon-financeonline.com

Carbon finance

The next 10 years

Carbon finance is facing an uncertain future. Only two years remain before the end of the first commitment period of the Kyoto Protocol, and the future shape of

the international community’s commitment against climate change is still unclear – affecting investment decisions and slowing the growth of market mechanisms.

The Clean Development Mechanism (CDM), by far the most successful flexibility mechanism established by the Kyoto Protocol, is suffering from a lack of regulatory clarity. The time it takes to validate or register a CDM project, or to verify and issue certified emission reductions (CERs), has dramatically increased over the past four years, and with it CDM transaction costs. A persistent lack of trust between the Designated Operational Entities (DOEs) charged with auditing CDM projects, and the CDM Executive Board (EB), which regulate them, is generating duplication and delays.

In some ways, today’s situation is somewhat similar to where we were 10 years ago when the World Bank launched the Prototype Carbon Fund – the world’s first global carbon fund – at a time when the Kyoto Protocol had not yet en-tered into force, and the rules governing its flexibility mech-anisms still had to be agreed upon.

Yet market mechanisms took root and it has been dem-onstrated that they can complement and leverage other resources to unlock low-carbon investment by overcoming barriers, driving innovation and creating a revenue stream that sustains projects over time. Between 2002 and 2009, CDM and Joint Implementation (JI) transactions led to an impressive $27 billion of carbon finance flowing to emission reduction projects – and leveraged more than an estimated $100 billion in related financing. Market mechanisms are bringing to bear the entrepreneurship, creativity and finan-

cial resources of the private sector in the fight against cli-mate change. The advantage we have today is that the inter-national community has a much better idea of what works and does not work, and of the new directions in which car-bon finance must now move.

Public funding is still needed to complement capacity-building efforts, correct market imperfections and target ar-eas overlooked by the market. But the size of future financ-ing needs for climate change mitigation leaves no doubt that carbon markets and related instruments will remain a key tool for channelling private sector financing and entre-preneurship towards greenhouse gas mitigation activities. Strengthened by the deep experience gathered over the past decade, and convinced of the need to continue its support for mitigation actions, the World Bank proposes to embark on its next 10 years of carbon finance by continuing its work to expand the scope, scale and range of climate change miti-gation activities in various sectors of its clients’ developing economies.

To do so successfully, carbon finance should grow in three main areas: it must ‘change gears’ by moving beyond a pure project-based offsetting mechanism; contribute to carbon sequestration by helping to underwrite sustainable man-agement of forests in developing countries; and respond to

the needs of the world’s poor-est. These three priorities will guide the World Bank’s in-volvement in the coming years.

First, carbon finance can and should contribute to support-ing low-carbon growth strate-gies in developing countries at a greater scale. Piloting of pro-grammatic and sector-based

approaches using today’s carbon finance framework has already started with the Carbon Partnership Facility (CPF), which is developing emission reduction programmes build-ing on a framework of policy-linked and technology-based actions defined by country-specific circumstances and ca-pacities. The CPF – which has attracted €100 million so far for its carbon fund – is utilising the CDM programme of activities model, in conjunction with World Bank lending operations, to scale up low-carbon investments into pro-grammes of projects, using a range of renewable energy technologies, and in solid waste management. The CPF is also piloting city-wide carbon finance programmes and tar-geting areas that have not been reached effectively by the CDM in the past, such as energy efficiency.

Moving beyond the instruments already in place, there remains a lack of agreement on which mech-anisms could and should be employed to scale up

carbon finance flows further. The fact that there has been little testing of the various concepts put forward raises ques-tions on the practical challenges of implementing the pro-posed new market instruments on the ground. Moreover, a lack of technical and institutional capacity – such as reliable emissions databases, legal and policy frameworks, and cred-ible measurement, reporting and verification (MRV) sys-tems – in many developing countries further hinders their ability to move from a project-based mechanism such as the CDM to any form of scaled-up instrument.

The Word Bank’s proposed Partnership for Market Readiness (PMR), expected to be launched in December in Cancún, is intended to help address these issues by creat-

The current uncertainty about the future of the global carbon market mirrors that of 10 years ago – and now, as then, the World Bank’s carbon finance unit is pioneering new public-private partnerships to help develop the market, says Joëlle Chassard

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Today’s situation is somewhat similar to where we were 10 years ago when the World Bank launched the world’s first global carbon fund

Special Report Kyoto and the carbon markets S21www.carbon-financeonline.com

Carbon financeing a platform to enable policy-makers from both developed and developing countries, practitioners, and public and pri-vate sector entities to share experiences and information on elements of market readiness, thereby creating a body of knowledge regarding market instruments that could be tapped for country-specific requirements. The PMR, which has a target size of $100 million, plans to: provide grant fi-nancing to participating countries in building ‘infrastruc-ture’ for market readiness; pilot, test and sequence new concepts for market instruments; and share lessons learned, including with the bodies of the UN Framework Convention on Climate Change (UNFCCC).

Second, the World Bank will continue to support the growing consensus about an increased role for forests in de-veloping countries in reducing carbon emissions from defor-estation and forest degradation, and through conservation and the sustainable management of forests and the enhance-ment of forest carbon stocks – the so-called ‘REDD+’ list of activities. The $300 million Forest Carbon Partnership Facility (FCPF), established in 2008, provides technical as-sistance and supports 37 forested developing countries in the tropics in their efforts to develop national strategies and systems for REDD+. It is based on a strong partnership of 50 countries and a broad range of international and national stakeholders, building not only capacity, but also trust and confidence among partners, and has proven helpful in mov-ing the REDD+ agenda forward.

Looking ahead, the FCPF will continue to strengthen its role as a forum to move REDD+ forward, providing techni-cal assistance and grants to support strategies that promote forests as a mechanism of climate change mitigation. The FCPF also plans to launch its carbon fund – with a target of $200 million – in the near future to provide performance-based incentives that test and demonstrate how emission re-duction programmes generated by REDD+ activities could work, ahead of the full elaboration of a REDD+ mechanism. Furthermore, the FCPF is enhancing its coordination with other relevant initiatives, including the UN-REDD Pro-gramme and the World Bank’s Forest Investment Program. These three initiatives are preparing joint papers and means for cooperation among multilateral REDD+ institutions that might, for example, create a joint platform for sharing policy discussions, country experiences and lessons learned.

Third, the World Bank will facilitate the development of market mechanisms in support of the needs of the poorest developing countries, especially in Af-

rica. This requires action in two areas. On the one hand, land-use change is responsible for about 20% of annual greenhouse gas emissions, so it is important that sustain-able climate change mitigation should include activities that improve land management. The sale of carbon assets may be an opportunity for rural populations to compete in a global market by improving the way they manage their natural resource base. Rewarding carbon sequestration can also help in the fight against desertification and the protection of biological diversity, creating multiple benefits. It also cre-ates incentives for better natural resource stewardship, and improves rural livelihoods.

Agriculture and forestry are areas where climate change mitigation also supports adaptation to climate change. Greenhouse gases will be removed from the atmosphere and stored in vegetation and soils, and the resilience of com-munities and ecosystems to adjust to climate change will be increased as activities are undertaken which both sequester carbon and restore land fertility, contain desertification, re-duce the impact of floods, etc. Current trends in the negotia-tions for land use, land-use change and forestry ( LULUCF) rules post-2012 are leading to interesting areas for addition-al work, even though agriculture remains at an early stage of discussion. The World Bank has been a leading actor in these areas since 2003 with the creation of its $90 million

BioCarbon Fund. It intends to pursue this engagement by supporting pioneering work, such as ecosystem restoration projects that sequester or conserve carbon in forest and agro-ecosystems and have a strong emphasis on poverty re-duction and improvements in rural livelihoods.

Outside the LULUCF domain, the poorest countries can also benefit more from carbon markets to meet their energy access needs through clean energy and

implementing other carbon mitigation initiatives in sectors such as transport or waste management, provided that the regulatory framework evolves to reflect their situation bet-ter. In particular, regulators need to simplify procedures for project approval and CER issuance to reduce transaction costs and delays, something that is vital for making small-scale projects viable.

Furthermore, monitoring procedures and requirements to demonstrate that projects are ‘additional’ to business as usual need to be adapted to smaller projects with less ca-pacity and less available data; CDM methodologies must be adjusted to reflect real energy demand (not just historical grid-connected energy supply) for meeting basic needs in least-developed countries, and further development of pro-gramme rules and capacity-building is needed. The World Bank has significant experience of implementing carbon finance in the poorest countries through its $129 million Community Development Carbon Fund. It intends to build on this experience, working with developing countries, the UNFCCC, the CDM Executive Board and other stakehold-ers to help turn the necessary CDM reforms into reality and channel carbon market resources to the low-carbon poverty reduction strategies of the poorest countries.

As a participant committed to making carbon markets work for sustainable development, the World Bank will continue to contribute through its capacity-building activi-ties, its ability to mobilise financial resources and informally build bridges between stakeholders. Using its experience as a market maker in the early days of carbon finance, and as a contributor to the global experiment that marks the first commitment period of the Kyoto Protocol, the World Bank recognises that the best opportunity to use carbon markets to achieve successful large-scale greenhouse gas mitigation in the future will be a partnership of all countries involved. That is why the World Bank intends to continue facilitating discussions and the exchange of views between all market stakeholders in a variety of formal and informal settings. EF

Joëlle Chassard is the head of the carbon finance unit of the World Bank, based in Washington, DC. E-mail: helpdesk@carbonfinance.org

Carbon finance needs to respond to the needs of the world’s poorest