Climate Finance

Regulatory and Funding Strategies for Climate Change and Global Development

Richard B. Stewart, Benedict Kingsbury, Bryce Rudyk

• Publisher: NYU Press
• Year: 2009
• ISBN:
  9780814741436
• Topic: Jura
• Subtopic: Umweltrecht

Preventing risks of severe damage from climate change not only requires deep cuts in developed country greenhouse gas emissions, but enormous amounts of public and private investment to limit emissions while promoting green growth in developing countries. While attention has focused on emissions limitations commitments and architectures, the crucial issue of what must be done to mobilize and govern the necessary financial resources has received too little consideration. In Climate Finance, a leading group of policy experts and scholars shows how effective mitigation of climate change will depend on a complex mix of public funds, private investment through carbon markets, and structured incentives that leave room for developing country innovations. This requires sophisticated national and global regulation of cap-and-trade and offset markets, forest and energy policy, international development funding, international trade law, and coordinated tax policy.

Thirty-six targeted policy essays present a succinct overview of the emerging field of climate finance, defining the issues, setting the stakes, and making new and comprehensive proposals for financial, regulatory, and governance mechanisms that will enrich political and policy debate for many years to come. The complex challenges of climate finance will continue to demand fresh insights and creative approaches. The ideas in this volume mark out starting points for essential institutional and policy innovations.

Part I
Climate Change and Mitigation

Overview and Key Themes

Chapter 1
Climate Finance for Limiting Emissions and Promoting Green Development

Mechanisms, Regulation, and Governance

Richard B. Stewart

University Professor and John Edward Sexton Professor of Law, NYU School of Law

Benedict Kingsbury

Murry and Ida Becker Professor, NYU School of Law

Bryce Rudyk

Research Fellow, Center on Environmental and Land Use Law

Climate finance is a critical element of global climate policy that has received far less attention than emissions limitations and climate regulatory architectures. This book redresses this deficit. It focuses on what is required to meet the need for vastly increased funding for climate mitigation and green development in developing countries. It presents new proposals to generate climate financing from both private and public sources and to deliver funds through means that will engage developing countries, build mutual trust, and secure effective long-term emissions reductions. The book also examines the vital but often neglected regulatory, trade, tax, and governance elements of global climate finance. Its proposals and analysis are designed to enrich the political and policy debate, not only for the United Nations Framework Convention on Climate Change (UNFCCC) process but more broadly. The complex issues of global climate finance cannot be resolved in a single agreement or a single forum; they will continue to demand fresh insights and creative approaches like those presented in this volume.

1. Three Key Determinants of Climate Finance

Climate finance policies for limiting greenhouse gas (GHG) emissions and promoting green growth in developing countries are driven by three key sets of factors: climate science; the economics of mitigation and development needs and opportunities; and domestic and international political economy.

Climate Science Imperatives

Climate science, as set forth in the 2008 Intergovernmental Panel on Climate Change (IPCC) reports and confirmed by subsequent findings, demonstrates that we face serious risks of far-reaching climate damage unless greenhouse gas emissions growth is immediately sharply reduced. The reductions must steadily continue with the objective of stabilizing atmospheric GHG concentrations in the 450 ppmv CO₂-equivalent (CO₂e) range and thereby limiting warming to around 2°C over pre-industrial levels. (Oppenheimer, chap. 2.)

Financing Needs and Mitigation Opportunities

Even if developed country emissions are sharply curtailed, these climate targets cannot be met without very large reductions in developing country GHG emissions relative to business-as-usual (BAU) levels. Focusing on the period to 2020, a major study by Project Catalyst found that additional investments in developing country mitigation (over and above expected future increases in funding under existing official development assistance (ODA) programs and the Clean Development Mechanism (CDM)) in the order of€55–80 billion each year during the period 2010–2020 are required. A United Nations study using a different methodology estimated that the annual requirement by 2030 will be USD 92–96 billion. Significant additional amounts (estimated by Project Catalyst at€10–20 billion annually) will be needed for investment in developing country adaptation—a central issue for many African and Asian countries and small island states. We do not address it systematically in this volume because extensive further studies and innovation are required for adequate adaptation-focused financial mechanisms to be put in place. Given the limits to bilateral and multilateral ODA, which is sourced mainly in developed countries, very large amounts of private capital must be mobilized to meet the shortfall. Project Catalyst estimates that between €10–20 billion annually of private capital might be available. If this amount were used to finance mitigation actions through international credit offset markets at the market price in a single global market for all credits (with one tonne in credits for one tonne of reduction in emitted carbon-equivalents) in covered economic sectors worldwide, the reductions achieved would fall far short of that required to meet the climate targets. The conclusion is that carbon markets must be structured by governmental actions to leverage the private capital available in order to achieve significantly greater emissions reductions than would be produced by an open market, such as the current market for Certified Emissions Reduction (CER) credits issued by the CDM.

Also critical is the character of mitigation opportunities in developing countries. Project Catalyst classifies these opportunities in three broad categories based on the costs of emissions reduction. (Metz, chap. 3; Bettelheim, chap. 9.) These are

• sectors where reductions can be achieved at negative cost (i.e., mitigation investments will earn a positive economic return), mainly in energy efficiency including buildings and transportation;

• sectors where reductions can be achieved at low to moderate cost, primarily in forestry and agriculture; and

• sectors with relatively high cost reduction opportunities, primarily in energy production.

In addition, there is a need to promote low-carbon development, including through investment in infrastructure and imaginative urban policy. (Mukhopadhyay, chap. 26.)

The Political Economy of Climate Policy

As the costs of achieving even relatively modest GHG reductions, and allied concerns about international competitiveness, become politically more salient in developed countries, and as developing countries begin to confront strong demands for emissions limitations commitments, domestic political and policy factors increasingly dominate global climate policies. If the economic and political stakes continue to rise in this way, as seems highly likely, it will not be possible to sustain the UNFCCC/Kyoto model of a single universal global climate regulatory and finance regime, although it may remain a long-term goal and regulative ideal. Domestic economic and political factors in powerful states and in the European Union (EU) are increasingly setting limits to (while also motivating) inter-state agreements on climate issues. The most basic elements of global climate finance architecture must be reasonably aligned with what is politically workable within the US and the EU, accommodating also any vital points for their prosperous allies such as Australia, Canada, and Japan. Similarly, domestic policy preferences in major emerging economies such as China, India, and Brazil are part of the foundation for their positions in international climate negotiations, where they can in effect exercise a veto on many issues. The less powerful countries, both developed and developing, also have bargaining power, because unwillingness by them to vigorously follow domestic policies that are needed for various international climate agreements actually to work may blunt the purpose of the agreements and unsettle the adherence to them of the more powerful states. From the standpoint of inter-state pre-agreement bargaining and post-agreement implementation, there is what might be called a “political cost curve” in national (or regional) politics that deviates substantially from the economic cost curves that dominate in climate policy analysis. Some economically and environmentally attractive global options will not be pursued because the domestic political costs (or internal bargaining problems in the EU) would be too great, while some measures that are neither economically efficient nor environmentally optimal may prevail because they are preferred for domestic political reasons, and therefore adopted in order to achieve agreement. In principle, a global cap-and-trade system covering all countries with significant emissions, with allowance allocations to ensure equity for developing countries, would be the best solution for all if fully workable, but establishment of such an arrangement is not likely in the near term.

For political and economic reasons, both developed and developing countries are demanding greater flexibility in their international climate commitments and arrangements and greater scope to manage climate mitigation on their own terms. They are demanding latitude to take into account their different national circumstances, views of international commitments, domestic political factors, legal and institutional back-grounds, and economic costs and competitive exposures. As a result, the global climate regime has begun to move from a top-down command approach, exemplified in the Kyoto Protocol, to a more flexible bottom-up approach and assume a more plural, decentralized, and even fragmented character. (Bodansky, chap. 4.) This tendency, which while controversial has received some endorsement in the Bali roadmap and the Copenhagen process, is likely further to intensify in the coming years.

The politics of ODA in developed countries and the demands of developing countries for much greater roles in its governance will make it extraordinarily difficult to achieve a unified multilateral climate ODA mechanism with funding at adequate levels. Arrangements for global private-sector climate finance will be strongly shaped by legislation in the EU, the US, and other countries defining their markets for offset credits from developing countries. But the major developing countries, which have many lower-cost mitigation opportunities, also enjoy substantial market power. The ultimate terms of trade will likely be set through partly decentralized negotiated arrangements with many accommodations of special situations, not unlike what has occurred since 1947 under the General Agreement on Tariffs and Trade (GATT) and related trade regimes. Recipient developing countries will demand stronger commitments of both public and private funding from developed countries as the price of their participation in mitigation, and greater voice in the governance of funding mechanisms and in how funds are used. They want latitude to devise, register, and receive credits for their nationally appropriate mitigation actions (NAMAs). The challenge for climate finance will be to accommodate these various and often conflicting demands, which will generate a plurality of financing mechanisms and market arrangements, while delivering sufficient mitigation funding through means that achieve effective climate protection and green development.

2. New Market-Based Carbon Finance Mechanisms

The coming years will see the emergence of a variety of new climate finance mechanisms using international emissions trading markets to attract private investment in mitigation activities in developing countries. Apart from a reformed CDM, these mechanisms will generally be established pursuant to cap-and-trade regulatory systems in developed countries that recognize international credit offsets. Ideally, they should be designed to support and not retard the future adoption by major developing countries of emissions caps.

Emissions Trading Systems, Not GHG Taxes

There has been considerable debate over whether GHG emissions taxes (including carbon taxes) or a cap-and-trade system, supplemented by offset credit trading, should be used as the basic regulatory tool for limiting GHG emissions. Powerful policy and political considerations show that trading systems are superior to taxes. Caps focus political attention on environmental objectives and have the potential to ensure that they will be met. The option of issuing allowances gratis rather than auctioning them may be critical in gaining political support for climate regulation without sacrificing efficiency or effectiveness. In the international context, developing countries would never agree without compensation to impose the same level of taxes as developed countries. This would result either in differences in tax levels, creating serious leakage and loss of competitiveness in developed countries, or in the need for compensatory financing by massive transfers of ODA from developed countries. Use of international trading with generous allowance allocations to enlist developing countries is politically more feasible and more efficient in achieving mitigation.¹ Trading systems have already begun to dominate. The EU is operating a cap-and-trade system with international offset credits, the US is poised to adopt such a system, and many other developed countries will likely follow suit. (Keohane, chap. 5; Batchelder, chap. 34.)

A Plurality of Market-Based Climate Finance Mechanisms

The plural character of the emerging global climate regime will require diverse new climate finance mechanisms to accommodate the differing circumstances and objectives of both developed and developing countries. Because of the dominance of emissions trading systems for climate regulation, the inclusion of international credit offsets in developed countries’ domestic legislation, as well as the CDM and its successor(s), the mechanisms for private investment will generally involve some form of climate/carbon markets. These markets will not, however, arise spontaneously, nor will they operate autonomously; they must be created, structured, regulated, and governed in order to meet the objectives of developed countries, developing countries, and investors and to protect the climate. The suite of potential climate finance mechanisms using private investment includes the following:

A REFORMED AND EXPANDED CDM

Even harsh critics of the CDM—who complain of maladministration; lack of environmental integrity in credits; failure to tap energy efficiency, renewable energy, and forestry and land use mitigation opportunities; and failure to promote long-term sustainable development—accept that some successor version of the CDM will still be needed to provide private climate finance for the least developed countries. Others believe that the CDM can be reformed so that it continues to play an important, if no longer predominant, climate financing role. The proposed reforms include changes in its governance, strengthened administrative capacities, mechanisms to promote accountability to non-state actors, steps to enhance the environmental integrity of CDM credits, removal of barriers to program-matic CDM projects, and removal of limitations on forestry, agricultural, and land-use projects. (Streck, chap. 6).

SECTORAL APPROACHES

Major developing countries have refused to assume economy-wide caps, of the type envisaged in the Kyoto Protocol model, in part because of the risk of crimping their economic development. This refusal, coupled with the limitations of the project-based CDM, has sparked wide interest in sectoral agreements under which internationally tradable offset credits would be awarded for limitations achieved in a given economic sector such as electric power generation or cement manufacture. One promising version of this approach is sectoral no-lose targets (SNLTs), under which the host developing country receives credits if it succeeds in reducing sector emissions below the target (typically set by negotiation and expressed either in terms of absolute emissions or emissions intensity) but assumes no obligations and suffers no consequences if it fails to do so. Other sector-based modalities include technology-based emissions limitations, NAMA crediting, and cooperative ventures between developed and developing country industries including technology sharing. (Ward, chap. 7.) Sector-specific targets reduce risks of unnecessarily limiting growth and better address competitiveness issues, although they of course fail to deal with emissions in sectors not covered by agreements.

Sectoral crediting, however, poses the important and investment-deterring problems that arise when one (or more) of several individual mitigation actions within the sector fails, with the result that the overall sectoral target is not fully met. From a private investor standpoint, two solutions are proposed. Host governments could indemnify participants with successful projects for any credit shortfalls. Alternatively, they could devise sector programs that specify each participant’s share of the reductions needed to meet targets; credits would be awarded to those participants who achieve their share of reductions even if others do not. (Kraiem, chap. 8.)

CREDIT TRADING SYSTEMS FOR FORESTRY AND AGRICULTURE

Project Catalyst analysis reveals abundant relatively low cost mitigation opportunities in forestry and agriculture. Nearly half of the developing country mitigation opportunities during the period to 2020 fall into these categories, but most of them are not eligible for CDM credits due to CDM restrictions on these sectors. Belated recognition of these opportunities has generated proposals for forestry credits. Reducing emissions from deforestation and forest degradation (REDD), a prominent example, would award internationally tradable credits to countries that reduce historical deforestation rates. The US Waxman-Markey climate legislation envisages large volumes of credits for forest sector mitigation in developing countries. However, more is needed to sustain existing forests than just reducing deforestation rates, and the agriculture sector continues to be neglected. In order to succeed, forestry and agriculture crediting programs must recognize that a large portion of emissions are driven by the struggle of the rural poor to survive. Progr...