//Material prepared for the IR Capstone Exercise, Maxwell School. As philosopher David Lewis wrote, “All possible worlds are equally real; only one of them is actual.” This is not an actual report!//
________________________________________________________________________________________________________________
Models for the Financial Mechanism of the Convention: A Global Climate [Fund][Facility]
James P. Bennett. American Enterprise Institute
Prepared for the 16th COP to the UN Framework Convention on Climate Change, Cancun, November 30, 2010
Introduction
The Copenhagen Accord, which was merely “noted” by COP-15 of the UNFCCC, does not mention a specific institution to manage the “fast start funding” to be used for adaptation and mitigation in developing countries. It is expected that this funding will reach USD 100 billion by 2020. For three reasons the choice of a Financial Mechanism is critically important to the overall success of the efforts of the UNFCCC.
The sums involved are large: their timely and efficient disbursal may significantly mitigate the effects of global warming. On the other hand, if they are squandered, dispersed among unsound but politically popular investments, or applied too late, then the desired adaptation and mitigation will not be achieved, and developing countries will suffer adverse effects.
Effective application of “fast start funding” is likely to enhance the enthusiasm for and legitimacy of the UNFCCC – with net benefits for the developing countries which are unlikely to be achieved through any other vehicle (such as bilateral aid agreements). On the other hand, if the Financial Mechanism lacks transparency, inclusive participation, and streamlined management, follow-on efforts by the international community may dissipate, with the predictable result that the brunt of the negative impacts of global climate change will fall upon the poorest peoples of the world.
Regardless of the design of the Financial Mechanism, it is likely to function as a powerful precedent – whether positive or negative – upon for future efforts by the international community. Thus is it important that a solution for short-term financing not compromise the ability to build a fair and effective architecture for longer terms efforts.
Terms of Reference Reference submitted to the American Enterprise Institute designate the following as criteria to be applied to the design and/or selection of any institution to serve as the Financial Mechanism:
(a) The Financial Mechanism to be governed by a Finance Board, under the guidance of and accountable to the Conference of Parties.
(b) The Finance Board to have an equitable and balanced representation of all Parties within a transparent system of governance (per Art. 11, para. 2 of the Convention).
(c)The Finance Board to recommend a balanced allocation of funding across thematic areas of the operating entities of the financial mechanism based on the information provided by all operating entities.
(d) The Finance Board to set norms and procedures for measuring, reporting, and verifying support to developing countries.
(e) The Financial Mechanism of the Convention to be the Climate [Fund][Facility], governed by a Board of Members with equitable and balanced representation of developed and developing country Parties.
Below we refer to the Financial Mechanism as “the Climate [Fund][Facility]” because the latter entity has not yet been agreed upon.
(f) The Climate [Fund][Facility] to be serviced by a trustee and a secretariat.
(g) An existing or a new organization or institution to serve as the Climate [Fund][Facility]. If an existing organization or institution is selected, it may be extended in function and/or altered in governance by mutual agreement between itself and the member Parties acting through the Finance Board.
(h) The Climate [Fund][Facility] to demonstrate, to the fullest extent possible, openness, transparency, efficiency, and expertise relevant to accomplish its purposes.
The American Enterprise Institute was further charged with evaluating alternative architectures for the Climate [Fund][Facility], with presenting a balanced appraisal of each, and if justified by the analysis, recommending a new or existing organization or institution.
Five existing organizations are examined. Each offers key merits. But each is flawed in some respects.
The International Bank for Reconstruction and Development of the World Bank Group. Although it created Climate Investment Funds (CIF) to fulfill exactly the purposes of the Financial Mechanism, these have “sunset clauses” to take effect as soon as an effective mechanism is in place. The Bank is burdened with large investments in fossil fuels which compromise its ability to mitigate climate change. Its mechanism of governance is seen my many Parties as inequitable and overly opaque. Its record of imposing conditionality to its loans and minimizing environmental consequences of its projects undermine its legitimacy for the purposes at hand.
The CIFs have been implemented with progressive features, such as civil society observers on governing boards. They have encompasses integrated sets of projects, which tends to minimize economic externalities implicit in most project-oriented development schemes. It is possible, however, to implement CIF-like efforts within differing organizational structures.
Funded by contributions from several wealthy countries, the Pilot Programme on Climate Resilience (PPCR) requires recipient countries to take loans to support adaptation—an activity forced upon them by the greenhouse gas pollution of wealthier nations. This initiative by the World Bank thus falls outside the Terms for a Financial Mechanism.
United Nations Development Programme, Focus on Development Cooperation and Finance. UNDP has substantial experience as a facilitator of development efforts in developing countries. It administers several projects supported by funding from the Global Environment Facility. But it lacks experience managing and evaluating investments of the scale envisioned. Additionally, its operational style and lack of transparency are frequently criticized. To adapt it to serve as the Financial Mechanism would require growing what is an informal “focus” on Development Cooperation and Finance into a large operating programme in a very short period of time.
The International Monetary Fund. A recent proposal by Managing Director Dominique Strauss-Kahn to create a global “pool” of resources to address harmful effects of global warming would go a long way to fulfill the activities envisioned by the Financial Mechanism. But the IMF has its hands full with current financial crises and, like the use of the UNDP, would require a major institutional overhaul to fulfill the criteria set out above. Because we require a mechanism for short-term funding, the IMF should not be selected.
The Global Environment Facility. The GEF partnership includes 10 agencies: the UN Development Programme; the UN Environment Programme; the World Bank; the UN Food and Agriculture Organization; the UN Industrial Development Organization; the African Development Bank; the Asian Development Bank; the European Bank for Reconstruction and Development; the Inter-American Development Bank; and the International Fund for Agricultural Development. The GEF also serves as the financial mechanism for three international conventions dealing with bioldiversity, persistent organic pollutants, and desertification, in addition to the UNFCCC. Since 2008 the World Bank serves as the trustee of the Facility.
However, the GEF is not accountable to the UNFCCC. It has historically been insensitive to guidance from the COP. In the absence of decisions taken by consensus, it uses a complex schema of weighted votes, which many observers sympathetic to concerns of developing countries feel gives undue influence to the wealthier members. Other observers note that the GEF has been slow to make decisions.
On balance, one can easily imagine renegotiating a relationship between UNFCCC and the GEF which might address these concerns. If such can be achieved quickly, a reformed GEF might be adequate.
The Adaptation Fund with an expanded mandate. The Adaptation Fund has been funded by the Clean Development Mechanism under the Kyoto Accords. It pioneered the use of certified emission reduction credits (CER), which ultimately depend on the private sector for their valuation. In order for the Adaptation Fund to serve as the Financial Mechanism, its sources of funding would have to be greatly expanded.
The Adaptation Fund Board complies with most or all of the desiderata listed above for governance.
Four new organizational designs are examined:
The Copenhagen Green Climate Fund. This is mentioned in the Accords, but without further information. Since its first wave of funding has yet to be allocated, one cannot say much about its suitability for the Financial Mechanism. Quite likely, the Green Climate Fund will be folded into whatever organization or institution is chosen for the Financial Mechanism.
An umbrella of NGOs might satisfy the criteria for governance and supply much if not most of the expertise for project identification, appraisal and evaluation. For instance, the Finance Board might contract with an NGO such as the Center for Global Development to coordinate investments. Still, it is difficult to envision how such an organization alone could satify all the needs for the Climate [Fund][Facility]. A more promising architecture would be to require that any Finance Mechanism be open to involvement by NGOs in both analytical and operational capacities.
Harnessing the private sector. The Finance Board engages in competitive placement of capital with private firms ranging from Goldman Sachs and Bechtel Corporation. The Board, assisted by a yet-to-be designated Analytic Support Office, might develop performance and cost criteria on a project basis, then let these to competitive bid by entities in the private sector. Efforts would be required to involve a diversity of contractors so that not merely a handful of the largest firms undertook all the adaptation and mitigation efforts. The principal potential advantages would be speed and efficiency, since no intermediate level of organzization would exist between the Finance Board and the entities working in the field. Since the investments envisioned under the UNFCCC are not intended to return a profit, the suitability of any 'contracting model hinges on development of an adequate bidding process and an adequate post-contract evaluation. At best, the time and thought required for preparing such an organization precludes its use for short-term efforts as envisioned in the Terms.
The model of Sovereign Wealth Funds. Some observers have noted that the magnitude of funds to be expended compare in scale with those of large sovereign wealth funds. Sovereign wealth funds vary enormously in purpose and organization. Some seek profitability; others seek to conserve capital. Most engage in portfolio investments; those which have pursued direct foreign investment or illiquid investments (such as real estate) have generally proved less resilient to changing global currents. Nevertheless, if an intermediary organization between the Finance Board and the private sector operations were sought, an organization such as that of the Government Pension Fund – Global, of Norway, has much to recommend it.
Recommendations
New organizational designs would be too slow in development and implementation to satisfy the need for short-term adaptation and mitigation. Although it would be prudent for COP-16 to undertake further investigation of such forms for longer term service, adoption or adaptation of an existing organization or institution better serves the present needs.
We believe that the negotiators at Copenhagen astutely avoided creating a new mechanism since two promising but relatively untried mechanisms have recently begun operating. Of the two, the Global Environment Facility holds greater promise than does the Adaptation Fund under the Kyoto Protocol if only because the former is more open to coordination with other organizations and because its mandate more closely satisfies the present needs. But one must acknowledge the risks deriving from lack of experience in large-scale projects with each of these mechanisms. If a less risky but more immediately responsive alternative is sought, particularly if the Finance Board can have confidence of on-going influence with operations, then one might turn to the World Bank, at least until its track record with CIFs becomes clear. We acknowledge that the Bank's system of weighted voting fits poorly with the exercise of effective influence by developing nations which will be recipients of its efforts.