Mobilizing Climate Finance
A Paper prepared at the request of G20 Finance Ministers

October 6, 2011

Work on this paper was coordinated by the World Bank Group, in close partnership with the IMF, theOECD and the Regional Development Banks (RDBs, which include the African Development Bank, theAsian Development Bank, the European Bank for Reconstruction and Development, the European
Investment Bank and the Inter-American Development Bank). The IMF led the work stream on sourcesof public finance. The OECD contributed the analysis of fossil fuel support, monitoring and tracking ofclimate finance and other inputs. The IFC and EBRD led the work stream on private leverage, and theWorld Bank those on leveraging multilateral flows and carbon offset markets, with inputs from other
RDBs. Comments and information were kindly supplied by the International Civil Aviation Organization(ICAO) and the International Maritime Organization (IMO).
Detailed contributions and background papers are listed in Appendix I.
The findings and opinions expressed herein do not necessarily reflect the views of the partneringorganizations and of their member countries.

2

Table of Contents
Executive Summary ...................................................................................................................................... 5
1

Introduction ......................................................................................................................................... 10

2

Sources of Public Finance ................................................................................................................... 14
2.1

2.1.1

Carbon pricing policies ....................................................................................................... 14

2.1.2

Market-based instruments for fuels used in international aviation and shipping ............... 17

2.1.3

Fossil fuel subsidy reform ................................................................................................... 21

2.2
3

Other Revenue Sources ............................................................................................................... 24

Policies and Instruments to Leverage Private and Multilateral Flows ................................................ 25
3.1

Carbon Markets ........................................................................................................................... 26

3.1.1

Rationale for and recent trends in carbon offset markets .................................................... 26

3.1.2

Options to scale up carbon market flows to developing countries ...................................... 29

3.2

Other Instruments to Engage Private Finance............................................................................. 32

3.2.1

Current investment in climate related activity .................................................................... 32

3.2.2

Public policies and instruments to leverage private climate finance .................................. 34

3.2.3

Potential for leveraging private climate finance ................................................................. 39

3.3

4

Carbon-linked Fiscal Instruments ............................................................................................... 14

Multilateral Development Bank Leverage .................................................................................. 40

3.3.1

Leveraging shareholder capital ........................................................................................... 41

3.3.2

Pooling flows to support targeted concessional lending ..................................................... 43

Monitoring and Tracking Climate Finance Flows ............................................................................. 46

References ................................................................................................................................................... 49
Appendix 1. List of contributions and background papers ........................................................................ 51
Appendix 2. Learning opportunities for innovative climate financing: IFFIm and AMCs ....................... 53
Appendix Table 1: Matrix of fossil fuel support measures, with examples ................................................ 55
Appendix Table 2: Stylized Marginal Abatement Cost Curve, .................................................................. 56
Financial instruments and support mechanisms to facilitate energy sector investments ............................ 56

3

Tables, Figures and Boxes

Table 1: Illustrative Scenarios for Potential Elements of International Climate Finance Flows in 2020 * .. 9Table 2: Carbon Market Evolution, 2005-10 ($ billion) ............................................................................ 28
Table 3: AGF Scenario for Additional Private Climate Finance in 2020* ................................................ 40
Figure 1: Carbon Finance Provides an Additional Revenue Stream to Low-emission Projects ............... 27
Figure 2: Sustainable Energy Investment, 2010 ($Bn.) ............................................................................. 33
Figure 3: The Dimensions of Climate Finance .......................................................................................... 47
Box 1: Levies on Carbon Offset Markets .................................................................................................. 27
Box 2: Scenarios for Carbon Offset Market Flows to Developing Countries by 2020 ............................. 29
Box 3: Turning Carbon into Finance ......................................................................................................... 31
Box 4: Innovation, Capacity and Awareness for Greater Market Readiness ............................................. 32
Box 5: Bilateral Support for Action on Climate Change ........................................................................... 35
Box 6: National Development Banks and Climate Finance....................................................................... 35
Box 7: Scaling-up Partnerships through Climate Investment Funds ......................................................... 36

4

Mobilizing Sources of Climate Finance
Executive Summary
1.
This paper responds to the request of G20 Finance Ministers in exploring scaled up financefor climate change adaptation and mitigation in developing countries. In so doing it builds upon andextends the work of last year‘s U.N. Secretary-General‘s High Level Advisory Group on Climate Change
Financing (AGF). Its starting point is the commitment made in the Copenhagen Accord and Cancun
Agreements on the part of developed countries to provide new and additional resources for climatechange activities in developing countries. This commitment approaches $30 billion for the period 201012 and $100 billion per year by 2020, drawing on a wide range of resources, public and private, bilateraland multilateral, including innovative sources.
2.
While there is no precise internationally agreed definition of climate finance at present, theterm broadly refers to resources that catalyze low-carbon and climate-resilient development. It
covers the costs and risks of climate action, supports an enabling environment and capacity for adaptationand mitigation, and encourages R&D and deployment of new technologies. Climate finance can bemobilized through a range of instruments from a variety of sources, international and domestic, public
and private. Consistent with the focus of the Copenhagen and Cancun understandings, this paper
concentrates on climate finance flows from developed to developing countries.1
3.
Both public and private flows are indispensable elements of climate finance. Competitive,
profit-oriented private initiatives are essential in seeking out and implementing least cost options forclimate mitigation and adaptation. The dominant scale of global private capital markets and growing
fiscal challenges in many developed economies also suggest that the large financial flows required forclimate stabilization and adaptation will, in the long run, be mainly private in composition. Public policy
and finance nonetheless play a crucial dual role: first, by establishing the incentive frameworks needed tocatalyze high levels of private investment in mitigation and adaptation activities, and second, bygenerating public resources for needs which private flows may address only imperfectly.
4.
A starting point could be the removal of wasteful subsidies on fossil fuel use. New OECDestimates indicate that reported fossil fuel production and consumption supports in Annex II countries
amounted to about $40-60 billion per year in 2005-2010.2 Over 250 individual producer or consumer
support mechanisms for fossil fuels are identified in the inventory. Not all these mechanisms are
inefficient or lead to wasteful consumption and, as such, governments may wish to retain some.
Nevertheless, if reforms resulted in 20 percent of the current level of support being redirected to public
climate finance, this could yield on the order of $10 billion per year. As noted in a separate G20 paper,
there is also considerable scope for reforms of fossil fuel subsidies in developing and emerging
1

In this paper developed countries are understood as Annex II countries, those which have pledged to provide Fast
Start Finance for adaptation and mitigation activities in developing countries. They comprise the 27 EU member
states, Australia, Canada, Iceland, Japan, New Zealand, Norway, Switzerland and the United States. Though it has
pledged to provide Fast-Start Finance, Liechtenstein is not listed under Annex II.
2
Note that G20 Leaders agreed in 2009 to ―rationalize and phase out over the medium term inefficient fossil fuelsubsidies that encourage wasteful consumption‖. The OECD inventory takes stock of a very broad range of
mechanisms that may effectively support fossil fuel production or use; further analysis of the impacts of the different
mechanisms would be needed to determine which may be inefficient and encourage wasteful consumption.

5

economies. While such reforms are often politically not easy to implement, experience shows that welltargeted safety net programs can help address distributional concerns.
5.
Comprehensive carbon pricing policies such as a carbon charge or emission trading withfull auctioning of allowances are widely viewed as a promising option. A carbon price of $25 per tonof carbon dioxide (CO2) in Annex II economies – corresponding to the medium damage scenario in the
AGF – could raise around $250 billion in 2020 while reducing their 2020 CO2 emissions by about 10
percent compared to baseline emissions in that year. Allocating 10 percent for climate finance would meeta quarter of the $100 billion funding committed for climate change in 2020. The economic costs of a $25
price are expected to be modest – less than 0.1 percent of GDP on average – if domestically retained
revenues are applied productively, for example to cut taxes that distort incentives for work or capital
accumulation, or for fiscal consolidation, a major concern in many advanced economies. Comprehensive
carbon pricing policies are more efficient at raising revenue than broader fiscal instruments whenenvironmental benefits are accounted for. They are also more effective at reducing emissions, providing
incentives for clean technology development and promoting international carbon markets than othermitigation instruments. A variety of options are available to address concerns about the impact on lowincome families and competitiveness (e.g. adjustments to the broader tax and benefit system andreductions in other less environmentally effective taxes).
6.
Market-based instruments (MBIs) for international aviation and maritime bunker fuels
have been proposed as an innovative source of climate finance. A globally coordinated carbon chargeof $25 per ton of CO2 on these fuels could raise approaching $40 billion per year by 2020, and would
reduce CO2 emissions from each sector by perhaps 5 percent, mainly by reducing fuel demand. Charges
on fuel used in international aviation and maritime transport would need to be carefully coordinated andlegal obstacles, in particular those related to levying a charge on aviation fuel, would need to be resolved.
The flexibility operators have in the location where they take up fuel can undermine the application offuel charges. Treaty obligations and bilateral air service agreements could impede applying fuel charges
in international aviation. New governance frameworks would be needed to determine how charges (oremission levels) are set, control use of revenues and monitor and implement compensation arrangements.
The impact on developing countries of such charges would likely be modest and could be largely offset
by explicit compensation schemes. Closer analysis of impacts is needed in order to design practicablecompensation schemes but enough has already been done to provide confidence that solutions can befound. Compensation for developing countries is unlikely to represent more than about 40 percent of
estimated global revenues, leaving $22 billion or more for climate finance and other purposes.
7.
Policy reforms, institutional development and public outlays can leverage much larger flows
of private or multilateral climate finance. These include options for buttressing carbon offset markets,other options to leverage private finance and expanded flows of climate finance from multilateraldevelopment banks (MDBs) in particular through promising new pooled financing arrangements.
Carbon offset markets can play an important role in catalyzing low-carbon investment indeveloping countries but now face major challenges. Offset markets through the Clean Development
Mechanism have resulted in $27 billion in flows to developing countries in the past 9 years, catalyzing
low carbon investments of over $100 billion. However, transaction value in the primary offset market fell
sharply in 2009 and 2010, amid uncertainties about future mitigation targets and market mechanisms after
2012. Depending on the level of ambition with which countries implement national mitigation targets
under the Copenhagen Accord and Cancun Agreements, offset market flows could range from $5 - 40
8.

6

billion per year in 2020. A scenario targeting a two degree pathway, which would require a much higher
level of ambition, could stimulate offset flows in excess of $100 billion. Other steps to strengthen offset
markets include institutional reforms to increase the scope and efficiency of the market, innovative
financial instruments to leverage future offset flows into upfront project financing, and steps to strengthen
capacity to design eligible projects and programs in developing countries. Given that offset flows so far
have largely gone to a relatively small set of middle income countries, broadening access amongdeveloping countries is an important priority.
9.
Private flows for climate mitigation related investment in developing countries have grown
rapidly but remain hampered by market failures and other barriers. Investments in clean energy(including renewable energy, energy efficiency, and energy-motivated transport investments exceeded
half a trillion dollars in 2010, with over $200 billion in developing countries. This consisted of
combination of public and private, domestic and foreign investment. Only a small part of this was
financed by subsidized climate funds, although the modest amount of concessional funding that iscurrently available is demonstrating strong leverage if financial packages are carefully designed.
Experience from the portfolios of MDBs, official donors and U.N. agencies suggests that private leveragefactors can vary considerably according to the type of public financing that is deployed, the sector, thenovelty of the technology and the level of informational and other barriers to investment. Broadly
speaking, the experience of the MDBs suggests that leverage factors in the range of 3 to 6 for nonconcessional lending. Leverage ratios can be significantly higher where the public finance component is
the form of concessional lending, grants or equity, running at 8 to 10 or even higher. It is important thatconcessional resource be used with clear understanding of the extent to which they are addressing climate
externalities, reducing investment risk, or addressing informational or other externalities. However, theextent to which subsidized funds can be used to leverage other flows is likely to depend as much or moreon the domestic policy environment as on the financial engineering of the deal. Consistent with scenarios
developed by the AGF, this report confirms that a package of public sources, MDB flows and carbon
offset flows could leverage around $100-200 billion in 2020 in additional gross international climaterelated private flows and an equivalent amount of domestic private resources.
10.
Although there is limited current headroom for MDBs to greatly expand climate financing
on their own balance sheets, there are significant opportunities for them to mobilize resources
through new pooled financing arrangements. The Climate Investment Funds (CIFs) and Global
Environment Fund (GEF) are examples of such instruments. Such instruments could provide growing
opportunities for MDBs to mobilize off-balance sheet resources from multiple sources, including bilateralcontributions and from non-traditional sources like private foundations and emerging sovereigns. In thelonger term, MDB capital increases aimed at expanded climate finance could also be considered,potentially leveraging increased MDB climate lending by a factor of 3 to 4.
11.
It is important to determine which options for increased climate financing are mostpromising for prioritization in the near term and which for development over the medium term.
This report provides a technical analysis of the range of options available to countries, the selection andcombination of which they will need to consider in the light of their national circumstances. The task ismade more challenging by the present difficult economic conditions in the developed world – the most
severe in over seventy years – and by growing fiscal pressures in many developed countries. In thisenvironment, reform of fossil fuel subsidies in developed countries is an important near-term option
because of its potential to improve economic efficiency and raise revenue in addition to environmental
7

benefits. Carbon pricing shares these advantages, by placing a price on a negative externality andimproving efficiency, while also generating substantial domestic revenues for fiscal consolidation,
reduction in less efficient taxes and other desirable policy objectives. Simultaneous efforts could becontinued to lay the technical foundation for implementation of market based instruments for fuels used
in international aviation and shipping. Progress by countries on their national targets under the
Copenhagen Accord and Cancun Agreements would also be helpful to underpin a recovery in carbon
offset flows, especially if combined with reforms to expand the scope and increase the efficiency of thesemarkets. Efforts to expand pooled financing arrangements can yield substantial results in the near termwhen harnessed with efforts to engage with and leverage private investment. All these initiatives will
benefit from improved monitoring and tracking of flows, given the relatively limited currently available
data on adaptation and on private flows. Building the political consensus for implementation of these andother major policy options discussed in the report will be critical.
12.
Table 1 below provides some purely illustrative scenarios for elements of international climate
finance flows in 2020. The public sources listed here illustrate potential revenues from three carbon
linked sources reviewed in more detail in Section 2.1 of this report. These can, of course, be
supplemented by allocations from non-carbon linked public sources and from general budget revenues, as
discussed in Section 2.2 of the report. (The coverage of public finance instruments in the report isconsistent with and in some respects broader than that in the AGF report, while following a somewhat
different presentation.) The potential revenues in the Table reflect various assumptions that are spelled
out in the report and would vary widely according to the scenarios adopted by policy makers, including
assumptions about the share allocated for climate finance flows to developing countries. The individual
climate finance potentials shown here should not be added together because of possible interactions andtrade-offs across sources. The breakdown between and within public and private sources will be theresult of the political process.

8

Table 1: Illustrative Scenarios for Potential Elements of International Climate Finance Flows in2020 *($ Bn.)

Illustrative
climatefinanceallocations
(%)

250

10(a) --20

25--50

Revenuebase

Climatefinanceflow($ Bn.)

Sources of Public Finance
Carbon Pricing ($25 per ton CO2) in Annex II countries
MBIs for int‘l aviation/maritime fuels ($25 per ton CO2)
Fossil Fuel Subsidy Reform

(b)

(a)

33 --50

7--11

40--60

10--20

4--12

22

(c)

Instruments to Leverage Private and Multilateral Flows
Carbon Offset Market Flows (various scenarios) (d)20--100

Private flows leveraged by public policies and instruments
MDB finance – pooled arrangements and/or capital

(f)

(e)

100--200
30--40(a) Consistent with AGF assumptions of 10 percent allocation for carbon pricing and 25-50 percent for MBIs.
(b) Revenues accruing to developed countries only. (c) As discussed in Section 2.1.3, not all support mechanisms
are necessarily inefficient and in need of reform. Precise revenue potential will depend on demand effects of reforms
and interaction among tax expenditures, among other factors. (d) $20 billion consistent with $20-25 per ton CO2
scenario; $100 billion with 2 degree pathway scenario, as per Section 3.1 in main text. (e) Gross foreign private
flows to developing countries as per scenario in Table 3 and Section 3.2 in the main text. (f) Reflects assumption
discussed in Section 3.3 in the main text that every $10 billion in additional resources could be leveraged 3-4 times in
additional MDB climate flows.

* Notes
Table 1 outlines some purely illustrative scenarios for mobilizing international public and private climate financeflows to developing countries. The Table includes three carbon-linked public sources reviewed in more detail in
Section 2.1 of the report, while Section 2.2 discusses non-carbon linked sources and general public revenues. The
results reflect various assumptions that are spelled out in the report and would vary widely according to thescenarios adopted by policy makers. For simplicity the potential revenue numbers are shown as point estimates but
reflect broad ranges spelled out in the text. The individual climate finance potentials shown here should not be added
together because of possible interactions and trade-offs across sources. The estimate for private flows, for example,
depends on specific assumptions (spelled out in the main text) about how public sources are used to leverage private
flows.

9

Mobilizing Sources of Climate Finance3
1

Introduction

1.
The communiqué of the meeting of G-20 Finance Ministers and Central Bank Governors inWashington DC on 14-15 April 2011 states that:"We tasked the World Bank, working with Regional Development Banks, and the IMF, in coordination
with other relevant organizations, to conduct the analysis on mobilizing sources of climate change
financing, including public and private bilateral and multilateral as well as innovative sources, drawing
inter alia on the AGF report consistent with the objective, provisions and principles of the UN
Framework Convention on Climate Change."2.
The context for the G-20 request includes the Copenhagen Accord and Cancun Agreements
reached by the Conference of the Parties to the UNFCCC.4 These agreements established and confirmed
a collective commitment by developed countries to provide new and additional resources for adaptationand mitigation activities in developing countries approaching $30 billion for the period 2010-12 (socalled Fast Start Finance) and to mobilize $100 billion per year by 2020 (from a wide variety of sources,
public and private, bilateral and multilateral, including alternative sources).5 In Cancun governments alsodecided to establish the Green Climate Fund (GCF) to support climate activities in developing countries
using thematic funding windows. Recommendations for the design of the GCF will be submitted to the
Durban Conference of the Parties in December 2011.
3.
In November 2010 the U.N. Secretary General‘s High Level Advisory Group on Climate Change
Financing (AGF) published a report on potential sources of revenue for climate financing in conformity
with the $100 billion goal (AGF, 2010). This paper and the background material underlying it draw on
and aim to update and extend the work carried out by the AGF in several directions, in conformity withthe mandate received: 6

3Work on this paper was coordinated by the World Bank Group, in close partnership with the IMF, the OECD and
the Regional Development Banks (RDBs, which include the African Development Bank, the Asian Development
Bank, the European Bank for Reconstruction and Development, the European Investment Bank and the InterAmerican Development Bank). The IMF led the work stream on sources of public finance. The OECD contributed
the analysis of fossil fuel support, monitoring and tracking of climate finance and other inputs. The IFC and EBRD
led the work stream on private leverage, and the World Bank those on leveraging multilateral flows and carbon
offset markets, with inputs from other RDBs. Comments and information were kindly supplied by the International
Civil Aviation Organization (ICAO) and the International Maritime Organization (IMO).
4
Reflecting the long-standing principles of non-discrimination in the governance of international aviation andmaritime transport, there is no differentiation between developed and developing countries in the work undertakenby the ICAO and IMO.
5The Cancun Agreements recognize ―that developed country Parties commit, in the context of meaningful
mitigation actions and transparency on implementation, to a goal of mobilizing jointly USD 100 billion per year by2020 to address the needs of developing countries.‖ (Decision 1, CP16, para.98).
6
The coverage of sources of finance in the report is consistent with and in some respects broader than that in the
AGF report, while following a somewhat different presentation. Appendix 1 lists contributions and backgroundworking papers that provide more analytical and empirical detail upon which this report draws.

10More detailed analysis of the costs, incidence and impact on CO2 emissions of various carbon pricing
schemes, together with ways to improve their political feasibility, for example by scaling back othertaxes (e.g. on electricity) or adjustments to the tax-benefits system;Further evaluation of the potential for charges on international maritime and aviation fuel use,
including impact on CO2 emissions, implications for revenues and climate finance, incidence, ways
to protect developing countries from adverse effects and issues in implementation;

Updated estimates of fossil fuel subsidies and other support in developed countries and evaluation of
the revenue and other implications of their reform;A review of options for strengthening the effectiveness of carbon offset markets, and broadening theirscope, reach and scale, including through innovative financing, together with updated scenarios ofmarket flows to developing countries;

Updated estimates of the scope for leveraging private climate finance using public investment andpolicy initiatives, drawing on the latest lessons on public policies and instruments to foster private
engagement in climate-friendly investment;Innovative avenues to make the most of the leveraging capabilities of multilateral development banks(MDBs) to multiply climate financing in developing countries.

Definition of Climate Finance4.
At present there is no precise internationally agreed definition of climate finance. However,broadly speaking, the term refers to resources that catalyze low-carbon and climate-resilient development
by covering the costs and risks of climate action, supporting an enabling environment and capacity foradaptation and mitigation, and encouraging research, development, and deployment of new technologies.7
Climate finance can be mobilized through a range of instruments from a variety of sources, internationaland domestic, public and private. Consistent with the focus of the Copenhagen and Cancun
understandings, this paper concentrates on climate finance flows from developed to developing
countries.8

Rationale for Climate Finance Flows from Developed to Developing Countries
5.
It is important to reiterate that the rationale for climate finance flows from developed todeveloping countries is both economic and ethical, as reflected in the principle of common but
differentiated responsibilities and respective capabilities of Parties to the UNFCCC.
6.
From a global efficiency perspective, climate stabilization requires mitigation to occur in bothdeveloped and developing countries. The World Bank‘s World Development Report 2010: Development
and Climate Change estimates that the global least-cost mitigation pathway would require about 65
7

A more extended discussion on the definition and measurement of climate finance is provided in Buchner, Brown
and Corfee-Morlot (2011).
8
In this paper developed countries are understood as Annex II countries, those which have pledged to provide Fast
Start Finance for adaptation and mitigation activities in developing countries. They comprise the 27 EU member
states, Australia, Canada, Iceland, Japan, New Zealand, Norway, Switzerland and the United States. Though it has
pledged to provide Fast-Start Finance, Liechtenstein is not listed under Annex II.

11percent of efforts to occur in developing countries by 2030 (compared to a ‗Business As Usual‘ baseline).
The bulk of future emissions growth is expected to occur in developing countries, where many low cost
mitigation options also arise. The bulk of climate damage and adaptation needs are also expected to occur
in these countries. Developing countries are concerned that shouldering the cost of mitigation andadaptation will hinder rapid and sustained economic growth, particularly when they have historicallycontributed little to the current stock of greenhouse gas emissions. By separating who finances climate
action from where it occurs, flows of climate finance from developed to developing countries are a key
way to reconcile economic efficiency with equity in dealing with the challenge of climate change.

Public and Private Elements of Climate Finance
7.
Both public and private flows are indispensable elements of climate finance. The dominant scaleand scope of global private capital markets and the growing fiscal challenges in many developed
economies suggest that the large financial flows required for a successful climate stabilization effort must,in the long run, be largely private in composition. With properly structured incentives, competitive andprofit-oriented private initiatives will play an essential role in seeking out and implementing the least cost
options for climate mitigation and adaptation.
8.
Public policy and public finance nonetheless have a crucial dual role to play: first, by establishingthe incentive frameworks (price signals) needed to catalyze high levels of private investment in mitigation
and adaptation activities, and second, by generating public resources for specific needs that private flows
may address only imperfectly.
9.
As regards the incentive framework, the public sector needs to play a key role by creating anappropriate price for carbon, using fiscal instruments such as carbon taxes or tradable emission permits,which ensures that emitters‘ decisions properly reflect the externality associated with greenhouse gas(GHG) emissions and which guides private consumption and investment decisions towards low emission,
climate-resilient options.
10.
While ―getting the (carbon) prices right‖ is a crucial policy from the perspective of reducing
emissions, promoting carbon markets, and stimulating clean technology development, there is also a
critical broader role for public policy and public finance because of other difficulties that aggravate theproblem of the GHG externality. These include market failures affecting innovation and dissemination of
new technologies (creating a role for public incentives for climate related R&D and technology
deployment for mitigation and adaptation), network externalities that lead to private underinvestment insome kinds of infrastructure (e.g. pipe infrastructure to transport captured CO2 to underground storagesites), and various informational and other problems affecting private financial markets that create an
economic rationale for multilateral development banks (MDBs) and for other types of public financial
flows. Grant-based financing for adaptation in low income countries is a characteristic example.99For a more extensive discussion of the fundamental economic rationales for the public sector role in climate
finance, see Bowen (2011).

12

Overview of the Structure of the Paper
11.

This paper discusses mobilizing additional sources of climate finance under two broad headings.

12.
Section 2 - sources of public finance - considers options to help underpin a growing publicprivate partnership on climate finance. The section gives most attention to carbon linked fiscal
instruments, especially carbon taxes and cap-and-trade systems with allowance auctions. These sources
are distinctive in that they serve the double purpose noted above: they create incentives for reducing
emissions, promote clean technology development and stimulate flows of climate finance through carbon
markets, and they also generate potential funds for climate finance. The discussion looks at somepossibilities for alleviating political concerns about carbon pricing, for example by reducing other taxes or
through ―feebate‖ variants of carbon pricing.
13.
This section then looks at options for the introduction of charges (taxes or emission trading
systems) for international maritime and aviation fuel use or activity 10 and for reform of fossil fuelsubsidies in developed countries. The rationale for these broader pricing reforms is that they scale backcurrent tax and subsidy provisions that undermine other emissions mitigation efforts. It should be
stressed that the potentially significant revenues raised through such carbon-linked fiscal instruments canbe allocated not only for climate action but also for other socially valuable public expenditures or for
fiscal adjustment.
14.
Finally, recognizing that climate finance need not come only from instruments related to carbon–
pricing this section briefly discusses options for other sources of public financing.
15.
Section 3 - instruments that leverage private and multilateral flows - considers cases where
innovative and carefully designed and selected policy reforms and public outlays can potentially leveragemuch larger flows of private or multilateral climate finance. This includes options for buttressing the roleof carbon offset markets, an important vehicle for private cross-border climate finance flows todeveloping countries. The section then considers options for developing other innovative instruments forleveraging private finance. It concludes by considering options for expanding flows of climate financefrom multilateral development banks, using the wide range of leverage, risk mitigation and other tools
available to these institutions.
16.
A number of criteria are used to evaluate the various instruments that are discussed in Sections 2
and 3, including revenue potential, impact on GHG emissions, cost-effectiveness, incidence (―who reallypays‖) and practical feasibility of implementation.
17.
Section 4 concludes by discussing suggestions for strengthening systems for monitoring andtracking climate finance flows, to build trust and accountability with regard to climate financecommitments and monitor trends and progress in climate-friendly investment.

10International maritime transport and aviation are generally exempted from taxes routinely paid in other sectors.
They are subject to charges for airport and port services and the like, which are, however, payments for services
provided rather than taxes.

13

2

Sources of Public Finance

2.1

Carbon-linked Fiscal Instruments

2.1.1 Carbon pricing policies11
18.
As noted in the AGF report, climate financing does not necessarily require new financing
instruments—it could rely on mobilizing traditional revenue sources, such as taxes on income andconsumption. Some new sources of public revenue merit serious attention however, most importantly
carbon or energy related taxes. These are generally designed to correct for market failures by putting a
price on emissions, so discouraging socially undesirable behavior and reducing social costs. Such taxes orother economic instruments should also raise public revenues, although the revenue aspect is distinct fromthe corrective role of such charges. Revenue could flow into national budgets while burden sharing forclimate financing could be based on factors other than the base for these new financing sources. Indeed
public finance economists do not generally recommend earmarking the proceeds of particular taxes forparticular uses because of the risk of creating inflexible and inappropriate spending patterns. Nonetheless,allocating some of the revenue from carbon pricing as a new public source for climate finance is an option
with apparent political salience and appeal.
19.
Comprehensive pricing policies applied to the carbon content of fossil fuels are widely viewed asa highly promising option. They are more efficient at raising revenue than broader fiscal instruments
because they correct for a huge and largely unaddressed market failure—excessive global emissions ofgreenhouse gases. As the carbon price is reflected in higher prices for fuels, electricity, and so on,
economic agents have an incentive to exploit all possibilities for reducing energy-related CO2 emissions
across the economy. These opportunities include reducing electricity demand, promoting a shift to cleaner
fuels for power generations, reducing the demand for transportation fuels, and reducing direct use of fuelsby households and industry. Regulatory measures (e.g. energy efficiency standards or minimum
generation shares for renewable fuels) on their own are much less effective at exploiting all emission
reduction opportunities: they are a more costly way to achieve any given emissions reduction, because
they do not automatically equate the incremental cost of emissions reductions across different sources.
20.
Carbon pricing policies are also more environmentally effective than other domestic, climaterelated, fiscal instruments. Pure taxes on electricity, for example, exploit only one way of reducing
emissions, by cutting electricity demand. Within the transportation sector, vehicle ownership taxes do not
encourage people to drive less and may, depending on their design, do little to increase vehicle fueleconomy. A petroleum duty is more environmentally effective than vehicle ownership taxes, but in itself
misses the bulk of low-cost options for cutting CO2, for example by shifting from coal to low and zerocarbon fuels.
21.
Comprehensive carbon pricing also provides incentives across all sectors for the development ofclean technologies—ultimately needed for global climate stabilization—by rewarding any new,emissions-saving technology. And, not least, by promoting international carbon markets, carbon pricing
11This section draws on the background paper ―Promising Domestic Fiscal Instruments for Climate Finance‖.
While the section focuses mainly on carbon pricing as the most promising option, the background paper considers awide range of other domestic carbon-related instruments in more detail.

14

with appropriate crediting provisions can potentially leverage large private sources of climate finance fordeveloping countries, as discussed in Section 3 below. This could be as true for carbon taxes withappropriate provisions for domestic firms to claim tax credits for financing emission reduction projects inother countries as for cap-and-trade systems with similar crediting provisions.
22.
The choice between carbon taxes or cap-and-trade systems is less vital than getting right thedesign features of whichever instrument is chosen, and using the revenues generated productively.
Important design features include achieving comprehensive coverage of fossil fuel emissions rather thanpricing just one fuel, and, in the case of cap-and-trade, auctioning allowances to raise revenues andincluding provisions like allowance banking and borrowing to limit allowance price volatility. Productive
uses of revenue include climate finance, cutting broader taxes that distort incentives for work effort orcapital accumulation, or – an urgent concern in many advanced economies – for fiscal consolidation.
Failing to raise revenues by giving away emissions allowances for free or by providing excessive tax
exemptions, or failing to use revenues productively, substantially raises the overall cost of carbon pricing
policies.
23.
Roughly speaking, given the difficulties of making such long range projections, a carbon price of$25 per ton - corresponding to the medium damage scenario studied in the AGF - if applied to all CO2
emissions in developed economies might reduce their 2020 emissions on the order of 10 percent
compared to baseline emissions in that year.12 If implemented for OECD Annex II countries throughcarbon taxes or a cap-and-trade system with allowance auctions, the revenue raised at this price would bearound $250 billion in 2020. ―Low‖ and ―High‖ case scenarios with carbon prices of $15 and $50 per ton
are estimated to raise revenues of around $155 billion and $450 billion respectively.13
24.
Most of this revenue would presumably be retained for domestic purposes, for example to support
fiscal consolidation or reduce other taxes. Nonetheless, allocating 10 percent of $250 billion for climate
finance would meet a quarter of the funding target of $100 billion (from public and private sources
combined) for 2020 established by the Copenhagen Accords. This revenue would be raised with no directburden on developing countries, while within the developed economies the tax burden (and revenues)
would be lower for greener economies (i.e., those with lower emissions intensity).
25.
The overall economic costs of a $25 per ton carbon pricing policy in developed economies (suchas the costs of switching to cleaner but more expensive fuels) are likely to be modest: around 0.03 percent
of GDP for the average developed economy. 14 Higher energy prices caused by the pass through of carbon
pricing can nonetheless have social and competitiveness effects - though they are not unusually large
when set against normal volatility in energy prices. Lower income households in developed economies
tend to have relatively high budget shares for electricity and fuels, and are therefore more vulnerable to12This price level is about a third higher than prices currently prevailing in the EU Emissions Trading Scheme(ETS). Carbon pricing is assumed to apply to the approximately 15 percent of CO2 emissions already in the EU
Emissions Trading Scheme (implicitly though allowance auctions).
13
OECD analysis shows that if the Cancun Agreements/Copenhagen Accord pledges and actions for Annex I
countries were to be implemented as a carbon tax or a cap-and-trade with fully auctioned permits, the fiscal revenues
would amount to 0.6 percent of their GDP in 2020, i.e. more than US $250 billion (OECD, 2012).
14
This assumes productive use of domestically retained revenues. If revenues are not used to improve economic
efficiency (e.g., by alleviating other tax distortions) costs could easily be two or three times higher.

15higher energy prices. Energy-intensive firms competing in global markets (e.g., steel, aluminum) would
suffer somewhat relative to similar activities in developing economies, exacerbating the risk of emissions‗leakage‘.15
26.
There are, however, many options for mitigating these effects, some more promising than others.
Distributional concerns about the impact on low-income families can be addressed through broader fiscal
adjustments, for example using some domestically retained revenues to expand earned income tax credit
schemes, raising personal income tax thresholds (as proposed in Australia‘s carbon pricing scheme) or
adjusting social contributions. For vulnerable industries, returning some revenues to these industries tohelp them adjust to the change in relative prices, or some free allowance of allocations, might be initiallyprovided. But there is a risk that such compensation schemes will become permanent and come at a higheconomic cost, by diverting revenue from more socially productive purposes like cutting distorting taxes.
Another option is to mitigate competitiveness effects through border tax adjustments applied to theembodied carbon content of imports, though carbon content (especially for final products) can be difficult
to measure and border adjustments may run afoul of international trade obligations. In addition, bordertax adjustments can be costly to the country implementing them and yet may have only limited benefits
for the competitiveness of energy-intensive industries.
27.
A more promising option for dealing with concerns about equity and competitiveness is to offset
burdens from carbon pricing by scaling back pre-existing energy taxes that raise prices to consumers but
have little effect on emissions. In many developed countries much of the burden of higher electricity
prices on households and industry could be neutralized by reducing excise taxes on electricity.16
Similarly, burdens on motorists from higher fuel prices can often be offset by reducing taxes on vehicle
ownership. While such offsetting tax reductions dampen net revenue gains, they may enhance thelikelihood of carbon pricing being adopted, while also shifting the tax structure to one that more precisely
targets emissions and provides environmental benefits in a cost-effective way.
28.
If broad carbon pricing is infeasible, so-called ―feebates‖ are another possibility. Feebates impose
taxes (fees) on relatively emission-intensive firms or on products with low energy efficiency, whileproviding subsidies (rebates) for firms with relatively low emissions intensity or for products withrelatively high energy efficiency. For example, new vehicles with emissions per mile above some ―pivot
point‖ would be charged a fee in proportion to excess emissions, while vehicles with emission rates below
the pivot point would receive a corresponding subsidy. Similarly, power generators would pay taxes, orreceive subsidies, according to whether their average CO2 emissions per kilo-watt hour are above or
below a specified rate.17

15

Leakage also results from increased use of fuels in developing countries as reduced demand from developed
countries lowers world fuel prices.
16
VAT or other taxes on general consumption are often also applied to residential electricity use, but these areappropriate to avoid distorting households‘ spending between electricity-using and other consumption goods.
17
Feebates miss out on some opportunities for emissions reduction, such as encouraging people to use vehicles or
air conditioners less. Nonetheless, for the economy as a whole, the majority of emissions reduction opportunities
typically reflect potential improvements in energy efficiency or reductions in the emissions intensity of power
generation all of which, in principle, could be addressed through feebate schemes.

16

29.
Feebates are cost effective because all firms face the same reward for reducing emissions,regardless of whether they are above or below the relevant pivot point. But there is a tension between
revenue and feasibility: raising more revenue requires setting lower pivot points which in turn implies
greater impacts on energy prices, since a greater number of firms will be paying taxes rather thanreceiving subsidies. The revenue potential of feebates (even if simultaneously applied to power
generators, vehicles, appliances, and so on) is much smaller than for comprehensive carbon pricing(implying that a larger share would need to be allocated towards climate finance goals).

2.1.2 Market-based instruments for fuels used in international aviation and shipping 18
The potential for climate finance and environmental gain
30.
Market-based instruments (MBIs) for international aviation and maritime fuels—either emissions(fuel) charges or emissions trading schemes—have been proposed as innovative sources of climate
finance. These international activities are currently taxed relatively lightly from an environmental
perspective: unlike domestic transportation fuels, they are subject to no excise tax that can reflect
environmental damages in fuel prices. These sectors also receive favorable treatment from the broader
fiscal system. For these reasons MBIs for aviation and maritime fuels are likely a more cost-effective way
to raise finance for climate or other purposes than are broader fiscal instruments: increasing from zero a
tax on an activity that causes environmental damage is likely to be a more efficient way to raise revenue
than would be increasing a tax (on labor income, for instance) that already causes significant distortion.
31.
A globally implemented carbon charge of $25 per ton of CO2 on fuel used could raise around $12
billion from international aviation and around $25 billion from international maritime transport annually
in 2020, while reducing CO2 emissions from each industry by perhaps 5 percent, mainly by reducing fueldemand. Compensating developing countries for the economic harm they might suffer from such charges– ensuring that they bear ‗no net incidence‘ – is widely recognized as critical to their acceptability, as
discussed further below. Such compensation seems unlikely to require more than 40 percent of global
revenues. This would leave about $22 billion or more for climate finance or other uses.19
32.
A lower price of $15 per ton would imply combined annual revenues in 2020 (setting aside thesame proportion for compensation) of about $14 billion. Revenues would be higher if, in addition toaddressing environmental considerations, charges were also set to reflect the wider fiscal issues noted
above. However, securing an initial international agreement with more ambitious pricing goals may be
more challenging.
33.
MBIs are widely viewed as the most economically-efficient and environmentally-effective
instruments for tackling environmental challenges in these sectors. Under the auspices of the International
Maritime Organization (IMO) and the International Civil Aviation Organization (ICAO), both sectors aretaking important steps to improve the fuel economy of new planes and vessels. In maritime, notably,
18

This section draws on the background paper on ―Market-based Instruments for International Aviation andShipping as a Source of Climate Finance.‖
19
Some of the revenue should also be retained by the collecting agency to provide performance incentives. The
amount potentially depends on the form of scheme adopted but is likely on the order of 5 percent of revenues.
Industry discussions have envisaged part of the proceeds being returned to the sectors for climate research andtechnical cooperation in these sectors.

17

agreement was reached in July 2011 within IMO on the first mandatory GHG reduction regime for aninternational industry.20 However, higher fuel prices resulting from MBIs would be additionally effective
because, for example, they would also reduce the demand for transportation (relative to trend), promoteretirement of older more polluting vehicles, and encourage use of routes and speeds that economize on
fuel.
34.
The principles of good design of MBIs are the same in these as in other sectors. For emissions
charges this means minimizing exemptions and targeting environmental charges on fuels rather than onpassenger tickets or on arrivals and departures. For emissions trading, it means auctioning allowances toprovide a valuable source of public revenue, including provisions to limit price volatility and developing
institutions to facilitate trading markets.
35.
Failure to price emissions from either industry should not preclude pricing efforts for the other.
Though commonly discussed in combination, the two sectors are not only different in important respects– for example, ships primarily carry freight while airlines primarily serve passengers – but they also
compete directly only to a limited degree. Nonetheless, simultaneous application to both is clearly
preferable, and could enable both a common charging regime (enhancing efficiency) and, perhaps, asingle compensation scheme for developing countries.

Cooperation, incidence and compensation
36.
Extensive cooperation in designing and implementing international transportation fuel charges(either taxes or auctioned permits) would be needed—especially for maritime transport—to avoid revenue
erosion and competitive distortions.21 Underlying the current tax-exempt status of internationaltransportation fuels is a fear that unilateral taxation would harm local tourism, commerce and thecompetitiveness of national carriers and would raise import prices and reduce the demand for exports, aswell as causing fuelling to take place in countries without similar policy measures. If governments set
taxes unilaterally, they would be under pressure to set lower rates than in other countries, to protect theirdomestic industries and revenues. Some degree of international coordination is thus needed. In the case ofinternational aviation, even an agreement with substantially less than universal coverage—for example
one that exempted some vulnerable developing countries—could still have a significant effect on global
emissions and revenue potential, given the relatively limited possibilities for carriers to simply re-fuelwherever taxes are lowest. For maritime bunker fuels, however, globally comprehensive pricing is morecritical, since vessels can more easily avoid a charge by re-flagging towards countries where such charges
do not apply, or by re-fueling at their ports.22
37.
Both the ICAO and IMO are firmly committed to principles of uniform treatment for carriers andnations. A globally applied charge would be consistent with this, and could be reconciled with the
UNFCCC principle of common but differentiated responsibilities and respective capabilities by a system
20

Through measures added to Annex VI of the International Convention for the Prevention of Pollution from Ships(MARPOL).
21
With most ships registered in developing countries, less than 30 percent of the CO 2 emitted by international
shipping is emitted in ships registered in developed countries.
22
Container ships and other volume carriers may take fuel for an entire round-the-world voyage tanking in ports
with competitive prices because these ships use fuel as ballast and replace it with water as the fuel is consumed.

18

of compensatory transfers to developing countries, or to some subset thereof—identified by clear criteria,
and likely evolving over time as economic circumstances change. More generally, combining a global
charge with targeted compensation provides an effective and feasible way to pursue efficiency and equity
objectives.
38.
Ensuring ‗no net incidence‘ for developing countries requires careful consideration of the ‗real‘
incidence of these charges—who it is that suffers a consequent loss of real income. This can be quite
different from who bears legal responsibility for the payment of the charge. In these sectors these twogroups may well be resident in different countries. It is the real incidence that matters for potential
compensation, and this is sensitive to views on demand and supply responses. It will also vary acrosscountries according to their share of trade by sea and air, the importance of tourism, and so on.
39.
The first step in determining the incidence of these charges is their impact on fuel prices. Jet andmaritime fuel prices might not rise by the full amount of any new charge on their use. Some portion of thereal burden is likely to be passed back to refiners of oil products. If it is fairly easy for refiners to shift
production from jet and maritime fuels to other products (as may be plausible, given possibilities forreconfiguring refineries over the longer term), then the amount refiners have to absorb will be relatively
small; a charge of 10 cents per liter on fuels used in both sectors might then increase the price to operators
by about 9.5 cents per liter.
40.
Even with full pass through to fuel prices, however, the impact on final prices of aviation services
and landed import prices—and on the profitability of the aviation and maritime industries—is unlikely to
be large. A charge of $25 per ton of CO2 might raise average air ticket prices by around 2-4 percent andthe price of most seaborne imports by around 0.2-0.3 percent. The modest scale of these effects meansthat the real burden on the international aviation and shipping industries is likely to be small—and, in any
case, reflects a scaling back of unusually favorable fuel tax treatment for these industries rather than the
introduction of unfavorable treatment.
41.
The overall burden imposed by a $25 per ton carbon pricing policy for these sectors on
developing countries (and on developed too) is thus likely to be small. Further work is needed to identify
possible outlying cases, but the broad picture is clearly one of very modest impacts.
42.
Nonetheless, there may be a need to provide adequate assurance of no net incidence on
developing countries by providing compensation. Significant challenges arise in designing such a scheme
because of the jurisdictional disconnect between the points at which a charge is levied and the resulting
economic impacts—especially for maritime transport. Practicable compensation schemes require someverifiable proxy for the economic impact as a key for compensation. More work is needed to identify
good (reasonably accurate and acceptably verifiable) proxies, but enough has been done to giveconfidence that they can be found. Fuel take-up provides a good initial basis in aviation, and simple
measures of trade values may have a role in relation to maritime (see below). The prior and in somerespects deeper issue is to understand the extent of compensation required.23
43.
Fully rebating aviation fuel charges for developing countries (or giving them free allowance
allocations) would be a promising way to protect them from the adverse effects of fuel charges. Indeed
23

The background paper elaborates on possible compensation schemes.

19this could more than compensate them: that is, they might be made better off by participating in such aninternational regime even prior to receiving any climate finance. This is because much of the real
incidence of charges paid on jet fuel disbursed in developing countries, (especially tourist destinations,this having emerged as a particular concern), would likely be borne by passengers from other (wealthier)countries. While this compensation proposal needs further study (for example, to find a way to deal withhubs), it appears to be a reasonably practicable approach.
44.
In contrast, there can be less confidence that rebating charges on maritime fuel taken up in
developing countries would adequately compensate most developing countries. Unlike airlines, shipping
companies cannot be expected to normally tank up when they reach their destination. Some countries—
hub ports like Singapore—disperse a disproportionately large amount of maritime fuel relative to theirimports, while the converse applies in importing countries that supply little or no bunker fuel, including
landlocked countries.24 Revenues from charges on international maritime fuels could instead be passed toor retained in developing countries in proportions that reflect their share in global trade.25 Whilerelatively straightforward to administer, further analysis is needed to validate whether this approach
would provide adequate compensation, for example for countries that import goods with relatively low
value per tonnage.
45.
More generally, compensation could be based on relative per capita income; and could be larger
for low-income countries in which higher fuel prices are a particular concern. Much detailed work
remains to be done to design compensation schemes, but practicable approaches can surely be found.

Implementation
46.
Implementing globally coordinated charges on international aviation and/or maritime fuels would
raise significant governance issues. Even leaving aside those concerning the use to which funds are put,
new frameworks would be needed to govern the use of funds raised, to determine how and when charges(or emissions levels) are set and changed, to provide appropriate verification of tax paid or permits held
and to monitor and implement any compensation arrangements. While the EU experience on tax
coordination indicates that agreements can be reached, it also shows how sensitive are the sovereignty
issues at stake in tax setting and collection. One possibility is to link an emissions charge on internationaltransportation to the average carbon price of the largest economy-wide emission reduction scheme, forinstance, limiting the need for a separate decision process. The various detailed proposals being
considered by the IMO suggest however that practical issues can be resolved, irrespective of which
specific MBI instrument is chosen. There could indeed be some role for the ICAO and IMO, with theirunparalleled technical expertise in these sectors, in implementing these charges, though there are otherpossibilities.
24

In principle, this problem can be addressed if hub ports only claim fuel tax rebates when ships unload, or if
importing countries can claim rebates for fuel purchases by unloading ships associated with that trip. But thisapproach is administratively complex when one shipping trip has multiple country destinations.
25
As for instance in the import-based rebate mechanism proposed by IUCN (2010) and WWF (2011). Stochniol(2011) also provides country-specific estimates of the compensation implied by this scheme based on a country‘sshare of imports by sea and air. For instance, Ethiopia‘s annual rebate would be $6 million for total cost of carbon
pricing of international maritime transport of $10 billion (i.e. 0.06 percent of $10 billion). The rebate and attribution
keys for all countries have been submitted to the IMO in WWF (2011).

20

47.
The familiarity of operators and national authorities with fuel excises suggests that
implementation costs would be lower with a tax-based approach than with an ETS. Collecting fuel taxes isa staple of almost all tax administrations, and very familiar to business; implementing trading schemes isnot. Ideally, taxes would be levied to minimize the number of points to control—which usually means as
upstream in the production process as possible. If taxation at refinery level is not possible, the tax could
be collected where fuel is disbursed from depots at airports and ports, or directly from aircraft and ship
operators. Implementation would be simplest—and environmental efficiency greatest—if no distinction
were made between fuels in domestic and international use. Indeed, eliminating the differentiation
imposed at present could in itself be a simplification.
48.
Policies might be administered nationally, through international coordination or in somecombination of the two—with the appropriate institutions for monitoring and verification depending on
the approach taken. For example, national governments might be responsible for implementing aviationfuel charges or trading schemes on companies distributing fuel to airlines or ships. All revenue-raising
MBI proposals being considered by IMO, on the other hand, assume a global charge or ETS: operators
might then be required to make electronic transfers to an international fund.26 In such a case, flexibility
might be needed to accommodate various national circumstances by, for example, allowing certain
countries to opt for national collection that is linked to an international approach. On the other hand, tax
collection from ships of other nations may be possible only in a regime established under an international
treaty instrument. Many ships never sail in waters of or call a port in their flag State, so enforcement ofshipping regulations would need to occur through international mechanisms.
49.
For aviation the current fuel tax exemptions are built into multilateral agreements within the
ICAO framework and bilateral air service agreements, which operate on a basis of reciprocity.27
Amending the Chicago Convention and associated resolutions would remove these obstacles, although
the EU experience on intra-union charging seems to suggest the possibility of overcoming them without
doing so. An alternative approach would be to use an ETS in this sector, although the consistency of thiswith international aviation agreements is currently the subject of litigation. Thorough consideration of thelegal challenges arising in the aviation sector is needed. For maritime fuels, there are no formal
agreements prohibiting excise taxes, so there appear to be no legal obstacles to fuel charges in this sector.
50.
If regional emissions trading programs develop for international transportation (e.g., in theEuropean Union) giving away free allowances is especially problematic. Not only does this forgo
revenue, it provides windfall profits for covered airlines or ships that would likely increase resistance tothe introduction of fuel charges in other countries.
51.
While implementation details need further study, especially in terms of governance, it is clear thatfeasible operational proposals for pricing international aviation and maritime emissions can be
developed.28

2.1.3 Fossil fuel subsidy reform

26

A precedent is the International Oil Pollution Compensation Fund of the IMO.
See ICAO (2000).
28
Several MBI possibilities have been developed and closely examined under the auspices of the IMO.
27

21

52.
Many governments in both developed and developing countries have in place policies that
explicitly or implicitly subsidize the production or consumption of fossil fuels. Many of thesemechanisms effectively subsidize the emission of carbon dioxide. Reform of these policies would not
only reduce greenhouse gas emissions, it would also improve economic efficiency and free up scarcepublic resources – resources that could be directed to climate finance and to other public priorities.
53.
The AGF report estimated a potential $3-8 billion in public finance savings from reform of thosefossil fuel subsidies that developed G20 economies had identified as inefficient and leading to wasteful
consumption, and which they had therefore announced plans to phase out. It assumed that all of theseresources could be devoted to public climate finance. This paper draws on a new OECD inventory ofvarious mechanisms that effectively support fossil-fuel production or consumption in 24 OECD countries.
(OECD, 2011).29 The total value of the reported individual support mechanisms for fossil fuel in OECD
Annex II countries listed in the inventory, estimated in most cases using benchmarks and valuations fromthe respective governments, amounted to about $40-60 billion per year over the 2005-2010 period. Not
all of these support mechanisms are inefficient or lead to wasteful consumption, and, as such,governments may wish to maintain some. Moreover, given interactions among support mechanisms, andthe potential effect on fossil fuel demand of removing support, the exact revenues that could be raised
from removing the support measures might be lower than the total amount of the individual tax
expenditures. Nevertheless, assuming for illustration that as a result of reforms 10-20 percent of thecurrent value of support was redirected to public climate finance, this would yield on the order of $4-12
billion per year.
54.
Systems for fossil fuel support in developed countries are extraordinarily complex, using adiverse array of instruments. Governments support energy production in a number of ways, including by:intervening in markets in a way that affects costs or prices, transferring funds to recipients directly,
assuming part of their financial risk, selectively reducing the taxes they would otherwise have to pay (taxexpenditures), and by undercharging for the use of government-supplied goods or assets. Support toenergy consumption is also provided through several common channels: price controls intended toregulate the cost of energy to consumers, direct financial transfers, schemes designed to provide
consumers with rebates on purchases of energy products, and tax relief. Appendix Table 1 outlines theorganizing framework for the different types of support mechanisms.
55.
Over 250 individual producer or consumer support mechanisms for fossil fuels are identified in
the inventory. The estimates were identified based on the existing Producer and Consumer Support
Estimate (PSE and CSE) methodology used by the OECD to estimate government supports in othersectors, notably agriculture. Given limitations on data reported by governments and other time andresource constraints, the current estimates focus mainly on budgetary transfers and tax expenditures at thenational level and a sampling of support provided by states, provinces or Länder in federal systems. Itomits numerous other support measures that it would be desirable to quantify in the future, notably those
provided through risk transfers, concessional credit, injections of funds (as equity) into state-owned
enterprises, and market price support. Nevertheless, caution is required in interpreting and aggregating
29

Note that G20 Leaders agreed in 2009 to ―rationalize and phase out over the medium term inefficient fossil fuelsubsidies that encourage wasteful consumption‖. The OECD inventory takes stock of a very broad range of
mechanisms that may effectively support fossil fuel production or use; further analysis of the impacts of the different
mechanisms would be needed to determine which may be inefficient and encourage wasteful consumption.

22

support amounts, particularly as the majority of support mechanisms identified in the inventory are tax
expenditures, which are measured with reference to a benchmark tax treatment that is generally specific toa given country. Since support is therefore measured in relative terms within the tax system of the given
country, the estimates are not comparable across countries.30
56.
Bearing these caveats in mind, the aggregate of reported fossil fuel supports in OECD Annex II
countries has, as noted, been running in the range of $40-60 billion in recent years. In 2010 a little overhalf of this fossil fuel support was estimated to be for petroleum, with a little under a quarter for coal andnatural gas respectively. Viewed by type of support, about two thirds of total fossil fuel support in 2010
was estimated to be for consumer support, with a little over 20 percent being producer support and justover 10 percent general services support.
57.
The evolution of the country estimates underlying these aggregates reflects some important policychanges. Germany‘s decision to phase out support for its domestic hard-coal industry by the end of 2018is reflected in a decline in the value of this support from about EUR 5 billion in 1999 (about 0.24 percent
of GDP) to about EUR 2 billion (about 0.09 percent of GDP) in 2009. In the case of the United States, theOECD inventory estimates that total producer support, including tax expenditures at the federal level andfor some states, represented slightly more than $5 billion in 2009 (about 0.04 percent of GDP): the federal
budget for FY2012 proposes to eliminate a number of tax preferences benefitting fossil fuels, which could
increase revenues by more than $3.6 billion in 2012.
58.
While the primary focus of this discussion is on fossil fuel subsidy reform in developed
economies, it is worth noting that there is also considerable scope for such reforms in developing andemerging economies. Such reforms would have multiple benefits for developing economies, including
improvements in economic efficiency and real income gains, reduced greenhouse gas emissions andincreased government revenues available for development purposes. Most relevant from the perspectiveof climate finance, such reforms would also improve the overall policy environment and incentive
structure for encouraging private climate finance flows from developed to developing countries, a point
further elaborated in the discussion below on leveraging private climate finance.
59.
Using the ENV-Linkages global general equilibrium model, OECD analysis projects thatphasing-out fossil-fuel consumption subsidies in emerging and developing countries by 2020 could lead
to about a 6 percent reduction in global greenhouse gas emissions in 2050 compared with a business-asusual scenario. The analysis suggests that most countries or regions would record real income gains andGDP benefits from unilaterally removing their subsidies to fossil-fuel consumption, as a result of a more
efficient allocation of resources across sectors. OECD analysis also suggests that elimination of fossilfuel subsidies could lead in 2020 to extra government revenues equal to between 0.5 and 5 percent of
GDP in various developing economies.
60.
Experience shows that subsidy reforms are often difficult to accomplish given political sensitivity
to distributional consequences and concerns about affected industries and workers. A number ofdeveloped and developing countries have nevertheless made some progress in reforming consumer and

30

These qualifications are spelled out more fully in the background paper for this report ―Fossil-fuel Support‖.

23

producer fossil fuel subsidies in recent years.31 In implementing fossil fuel consumer subsidy reforms,
governments need to consider broader distributional implications of reform and the need for well targetedsafety net programs to protect the poor and vulnerable, in addition to providing transparent information
about the expected impacts and incidence of the reform. To make progress on reform of fossil fuelproducer support, governments may consider assistance for affected firms, for example to restructure
operations, exit the industry or adopt alternative technologies. Assistance to affected workers may be partof such packages and could include initiatives for worker retraining or relocation, or the provision of
incentives to diversify the regional economic base. In general, it is important that any assistance for
economic restructuring or industry adjustment in response to subsidy reform be well-targeted, transparent
and time-bound.

2.2

Other Revenue Sources

61.
Although carbon pricing is critical to efficiently curbing CO2 emissions, there is in principle nonecessity to earmark funds from carbon pricing for climate finance: the revenue from carbon pricing
could flow into national budgets instead. Conversely funding for climate finance could come from generalbudget resources, drawing on sources other than carbon charges. This raises the question as to what otherdomestic revenue sources would be appropriate in developed countries to generate additional
contributions for climate finance.
62.
The possibilities for funding climate finance by traditional sources are limited, in principle, only
by so-called Laffer curve effects—limits, that is, on the maximum possible revenue that can be raised—and by countries‘ willingness to cut other spending. This makes it hard to meaningfully assess the
additional revenue that could be raised from such sources, which can also be expected to reflect thesignificant fiscal pressures that many advanced countries face. Precisely how any additional (net) revenue
might best be raised will of course also depend on countries‘ circumstances and preferences. Nonetheless,recent work (and experience)—much of it focused on how best to restore fiscal sustainability in the faceof fiscal pressures from population aging—has pointed to ways in which additional public resources
could be found in most advanced economies (IMF, 2010a). Common themes include the scope forincreasing revenue without increasing rates by limiting exemptions and special treatments under theincome tax and the VAT.
63.
New taxes on the financial sector have also been proposed as a way to raise money for climate
finance. These include most prominently a broad-based Financial Transactions Tax (FTT)—levied on thevalue of a wide range of financial transactions—and a Financial Activities Tax (FAT)—levied on the sumof the wages and profits of financial institutions. Both were considered and compared extensively in the
IMF‘s 2010 report to the G20 on financial sector taxation.32 Broadly speaking, the FTT has acquired
greater political momentum, (notably with the recent proposal from the European Commission), while the
FAT has acquired greater support from tax policy specialists (as a way to redress distortions arising fromthe exemption of most financial services from VAT). Both, nonetheless, are technically feasible—with
the appropriate degree of international cooperation—and both could raise significant revenues.

31

Some of the country reform experiences are summarized in the background paper on fossil fuel subsidy reform
accompanying this report.
32
IMF (2010b). See also European Commission (2010) and, on administrative aspects of the FTT, Brondolo (2011).

24

3

Policies and Instruments to Leverage Private and Multilateral Flows64.
As noted in the introduction to this paper, a successful climate stabilization effort will, in the longrun, draw largely on competitive, profit-oriented private investment to seek out and implement the least
cost options for climate mitigation and adaptation. This is consistent as well with the dominant scale andscope of global private capital markets and the growing fiscal challenges in many developed economies.
Public policy and public finance nevertheless have a crucial role in catalyzing high levels of private
investment in climate friendly activity, first, by establishing the necessary incentive frameworks and,second, by making carefully selected public investments that help alleviate a range of other barriers to
private investment. We begin this section with a review of some of the critical barriers that tend tohamper private investment in climate mitigation and adaptation. We then review some of the major
approaches to addressing these barriers, including carbon markets (Section 3.1), other instruments toengage private finance (Section 3.2), and multilateral development bank leverage (Section 3.3).
Barriers to private climate finance65.
Although the scale and growth of climate related investment in developing countries are reachingpromising levels, private investment in climate mitigation and adaptation remains limited compared to its
potential and is hampered by market, institutional and policy failures or barriers that tend to depress riskadjusted private rates of return on these activities (even though social returns may be high).
66.
An important factor depressing private returns on virtually all types of climate mitigation
investment is the absence of policy to internalize the global climate externality: in the absence of a robust
carbon pricing regime, economic agents suffer little of the damage caused by their own carbon emissions,and, conversely, are able to internalize little of the potential social gains from mitigating such emissions.
Domestic policy distortions such as fossil fuel subsidies often aggravate the problem of low private
returns on low emission investment by rewarding investment in high emission activity. Private returns
are also affected by the public good externality associated with knowledge and in some cases bycoordination failures and so-called network externalities. The knowledge externality is in particular likely
to hamper private investment in innovation and – more relevant for most developing countries – in theimport, adaptation to local conditions and commercialization of new climate technologies.
67.
Linked to these factors, risk perceptions for climate-related investments are often high because of
uncertainties about future global and domestic climate policy frameworks, technological uncertainties,
uncertainties about future climate outcomes, project risks and so on. And even where risk-adjusted
private returns are estimated to be high – for example in many energy efficiency projects – actual
investments are restrained by lack of awareness and information, agency problems and status quo bias.
68.
Difficulties also arise from informational failures and other problems affecting financial markets,
which can contribute to lack of access to finance (especially for long term financing), excessive volatility,
contagion, sudden stops in capital flows, mispricing of risks and incomplete availability of commercial
insurance and other risk management instruments. These problems are often exacerbated by the lack ofor weak development of domestic capital markets in many developing countries. They are particularly
relevant for investments in renewable energy that have large upfront capital costs and long payback
periods.

25

69.
Finally, both risk-adjusted returns and access to finance will be greatly influenced by the broader
factors that affect all private investment, such as the domestic investment climate, institutional capacity
and the enabling policy environment. Markets in many new clean technologies are still immature indeveloping countries. Measures to foster market development will be required to foster low-carbon
investment, including awareness raising and building capacity to understand technical solutions. Suchcapacity building extends across the value chain, including the financial sector. The appropriate policy
response varies with different barriers but, as discussed below, public policies and creative use of publicfinance can often leverage significant private investment.

3.1

Carbon Markets

3.1.1 Rationale for and recent trends in carbon offset markets
70.
The Kyoto Protocol to the UNFCCC laid the groundwork for a global carbon market that offers acost-effective way to reduce the greenhouse gas (GHG) emissions of industrialized countries.33 It
provides them with three ways to meet their 2008-12 mitigation commitments. They can take domestic
actions to reduce emissions. They can trade emission allowances with other industrialized country
signatories. Or they can purchase emission reductions (―carbon offsets‖) generated by low-emission
projects in developing countries (the Clean Development Mechanism, CDM) or in industrialized country
signatories (Joint Implementation, JI). To qualify, such projects must be certified as generating emission
reductions that are genuinely additional, in that they would not have occurred without the incentive
provided by participation in the offset market. There is evidence on the ground that offsets provide aneffective way, at scale, to reduce the costs of mitigation. Many buyers in the CDM (&JI) market areindeed meeting a portion of their obligations at less than $15 per ton CO2e, a marginal abatement costlower than many alternatives, including purchase of allowances, internal abatement or national policies
and measures.34
71.
The experience of the past decade shows that carbon offset markets can play an important role incatalyzing low-carbon investment in developing countries, complementing and leveraging other financial
resources. In principle carbon offset revenues provide an additional revenue stream that enhances theoverall financial viability of low-emission projects. More particularly, they can help incentivize the often
large up-front capital investments needed for low carbon projects (as illustrated in Figure 1), as well as
providing incentives to overcome social inertia, lack of awareness and various transaction costs that tend
to hinder climate-friendly investment. The ―pay-upon-performance‖ nature of the asset also creates
positive incentives for good management and operational practices to sustain emission reductions over
time.
72.
The value of transactions in the primary CDM market – the largest offset market by far – totaled
around $27 billion in 2002-10, which is estimated to have been associated with around $125 billion in
low-emission investment. Since the bulk of transactions are forward purchase agreements with payment
33

The Kyoto Protocol commits industrialized countries signatories to collectively reduce their GHG emissions by atleast 5.2 percent below 1990 levels on average over 2008-12 while developing countries can take no-regrets actions
and participate voluntarily in the carbon market.
34
For instance, the Climate Cent Foundation (Switzerland) estimates that the reduction of CO 2 emissions abroad ischeaper than in Switzerland by a factor of five (http://klimarappen.ch/en/foundation/portrait.html).

26

on delivery, actual financial flows through the CDM have actually been lower, about $5.4 billion through2010. A 2 percent levy on issuance of CDM credits has also mobilized $150 million for the Adaptation
Fund (see Box 1 below). All in, this makes of the CDM an important conduit for international climate
action resources to developing countries. By contrast with other major international resource flows
dedicated to mitigation, the CDM channels primarily private resources (as more than 80 percent of CDM
credits are purchased by the private sector). Finally, the CDM provides opportunities to support basic
development needs (e.g., access to sustainable energy services and waste management solutions, etc.) andcontributes to technology transfer and diffusion.35
73.
That said, carbon offset markets – and carbon markets as a whole – now face major challenges.
The value of transactions in the primary CDM market declined sharply in 2009 and further in 2010 (Table2), amid chronic uncertainties about future mitigation targets and market mechanisms after 2012. A
number of other factors are further constraining the potential of carbon finance, including market
fragmentation in the absence of a global agreement, transaction costs associated with complex
mechanisms, low capacity in many countries, lack of upfront finance, weaknesses in the current ‗projectby project‘ approach and non-inclusion of some sectors with significant abatement potential (e.g.,
agriculture).
Figure 1: Carbon Finance Provides an Additional Revenue Stream to Low-emission Projects 36
Cashin= annual carbon payments= other sources of revenue from service or production= debt servicing

Debt

Carbon revenues
Operating revenues

EquityConstruction

Yrs 0 1 2 3 4 5 6 7 8 …………………………………….15-20

Cash
out

Box 1: Levies on Carbon Offset Markets
At present a 2 percent levy on emission reductions issued to activities under the Clean Development
Mechanism (CDM) is the main source of funding for the Adaptation Fund established in 2007.37 So far
about $150 million has been raised for the Fund through this means. The prospects for raising additional
public climate finance from this source clearly depend on the health of carbon offset market, which, as
discussed in Section 3.1 below, depend heavily on the ambitiousness of the emission mitigation targets
35

Though considerably smaller in size, the voluntary market provides another window on the carbon market fordeveloping countries, in particular around opportunities in agriculture, forestry and other land use (AFOLU). The
voluntary market caters for the demands of individuals, companies and public entities that wish to reduce theircarbon footprint in the absence of a regulatory constraint.
36
Simplified illustration of the cash-flow of a low-emission project (e.g. a windfarm). Carbon revenues start toaccrue to the project once it is operational and are linked to its performance. However, as a performance-based
mechanism, carbon finance by itself can do little to address upfront financing needs. Source: World Bank (2010b).
37
The CDM is so far the only flexibility mechanism to be taxed in this way under the Kyoto Protocol.

27

adopted by developed countries, as well as on the extent of supplementarity limits, which are theproportion of mitigation targets that can be met by offset purchases from developing countries. In the
Copenhagen-Low and Copenhagen-High case scenarios discussed in Section 3.1, for example, revenues
from the 2 percent levy could run at $150-750 million per year in 2020, rising to $2 billion in a 2 degree
pathway scenario.
It is worth noting that the levy entails some economic costs since it is taxing a good (climate finance)
rather than a bad (emissions), although such costs are estimated to be relatively minor. Although the
charge is levied on credits issued to projects in developing countries, the actual incidence of the levy will
depend, as with all taxes, on the relative responsiveness to price changes as between buyers and sellers ofoffsets. In scenarios where demand is constrained by supplementarity limits, much of the burden of thelevy is passed onto buyers in developed countries. However developing country sellers would be likely tobear more of the burden of the levy in a scenarios where such constraints are eased and buyers become
more sensitive to price. In the latter scenario, rather than transferring funds from developed to developing
countries, the levy would primarily transfer funds from big CDM host countries like China, Brazil andIndia to vulnerable countries eligible for adaptation funding (World Bank 2010a).
Table 2: Carbon Market Evolution, 2005-10 ($ billion)

2005
2006
2007
2008
2009
2010

EU ETS
Allowances

Other
Allowances

Secondary
CDM

Primary
CDM

Other
Offsets

Total

7.9
24.4
49.1
100.5
118.5
119.8

0.1
0.3
0.3
1.0
4.3
1.1

0.2
0.4
5.5
26.3
17.5
18.3

2.6
5.8
7.4
6.5
2.7
1.5

0.3
0.3
0.8
0.8
0.7
1.2

11.1
31.2
63.0
135.1
143.7
141.9

Source: World Bank (2011a). Note: Numbers may not add up due to rounding.

74.
Despite the recent slowdown in market activity, a number of recent developments do show
continued interest in advancing carbon market solutions in both developed and developing countries. The
2010 United Nations Climate Change Conference in Cancun adopted important improvements andreforms to enhance the efficiency of the CDM and agreed to consider the establishment of one or moremarket-based mechanisms to enhance the cost-effectiveness of mitigation actions by Parties. The
Conference formally recognized developing countries‘ Nationally Appropriate Mitigation Actions(NAMAs), some of which plan the use of market mechanisms. It also recognized the contribution offorest-related activities in efforts to tackle climate change, making not only projects but also developing
countries and sub-national regions within them eligible for incentives, subject to verification that such
REDD+ activities have reduced emissions against a reference level.38
75.
New market initiatives are also underway in both developed and developing countries, despite theuncertainties about the international regulatory environment. For developed economies, these include anupcoming cap-and-trade scheme in California and several other regional initiatives in North America,38

REDD+ refers to all activities that reduce emissions from deforestation and forest degradation, and contribute toconservation, sustainable management of forests, and enhancement of forest carbon stocks.

28

city-wide emissions trading systems in Japan, and proposed carbon trading legislation in Australia (which
could become, after EU and New Zealand, the third regulation establishing a country-wide or supranational emissions trading system in developed countries). Building on the experience and achievementsof the CDM, a number of other countries are also experimenting on a voluntary basis with market
approaches to cost-effectively reduce emissions, mobilize domestic and international resources for lowemission development and potentially deliver additional benefits such as increased technology transfer,energy security or competitiveness. In the developing world, a broad range of instruments are being
considered in countries such as Brazil, China, Chile, Colombia, Costa Rica, Indonesia, Korea, Mexico,
Turkey and Ukraine.
Box 2: Scenarios for Carbon Offset Market Flows to Developing Countries by 2020
Given that the outlook for offset markets depends crucially on the international mitigation framework andcarbon pricing, a number of scenarios ranging from less to more ambitious levels of mitigation werereviewed to evaluate the potential for offset markets to mobilize private climate flows: 39



Low scenario. This assumes only currently enacted mitigation initiative, essentially only thetargets under the EU ETS and EU non-ETS initiatives, as well as some U.S. regional initiatives, resulting
in a 7 percent abatement of developed countries‘ GHG emission below 1990 levels. Under this scenario
carbon offset prices were estimated in a $10-15 per ton range, associated with carbon offset flows of $1-2
billion per year, about the same as the 2010 level.

Copenhagen-Low scenario. This assumes, in addition, expanded regional initiatives in the U.S.
and Canada and the adoption of national mitigation targets in Japan, Australia and New Zealand, resulting
in 9 percent abatement. Here carbon offset prices are estimated in a $15-25 range, with offset flows in a
$5-9 billion range.

Copenhagen-High scenario. This assumes the adoption of more ambitious mitigation targets inall major developed as well as key developing economies, contributing to 18 percent abatement below
1990 levels (which, however, would still remain substantially less than abatement levels estimated to beneeded for a least-cost 2 degree emission pathway). Here, offset prices are estimated in a $25-35 range,
with offset flows reaching $31-43 billion.

A two degree (2C) scenario. Depending on burden-sharing, offset prices could be above $40 andoffset flows could surpass $100 billion per year in 2020.

3.1.2 Options to scale up carbon market flows to developing countries
76.
The health of the carbon market will ultimately depend upon three factors. First, there aredemand factors, in particular the ambition of mitigation targets and the scope for market mechanisms(which drive the size of demand), as well as eligibility criteria (which influence the type of carbon assets
included in the market). Second, supply which is notably affected by the lead time and capacity required
to develop eligible projects and deliver scaled-up abatement in a broader range of opportunities. Lastly
there are market rules and institutions, which influence transactions costs, the level of efficiency of themarket and the level of capacity needed for market functioning.
39

Details of the scenarios and the methodology employed are set out in more detail in the background paper
accompanying this report ―How to Keep Up Momentum in Carbon Markets?‖

29

77.
We discuss these drivers, with options to help address current and emerging challenges to carbon
markets.
78.
As the scenario analysis in Box 2 emphasizes, the most important determinant of carbon offset
market flows to developing countries is clearly the level of international mitigation targets: the more
ambitious the targets the greater the scope for such flows. Developed countries can also encourage flows
by increasing supplementarity limits, which are the proportion of mitigation targets that can be met bypurchases from developing countries. Greater use of market mechanisms, taking advantage of thediversity in costs of abatement across sectors and regions, could encourage countries to scale up their
mitigation efforts while lowering the cost of doing so.
79.
Improving long term policy clarity about future frameworks is an urgent priority. Currently
market activity (and associated low-emission investment) is seriously hampered by multiple uncertainties
about future demand, the eligibility of various market mechanisms, project types, technology and countryof origin, among others. Given the heavy toll of a potential market disruption in terms of both capacity
and confidence, governments could work towards sustaining momentum in the market while new
initiatives are being developed. They could, for example, dedicate a fraction of their international climate
finance pledges to support testing and showcasing new approaches, such as concepts for country or sector
programs, new methodologies, CDM reforms and new mechanisms. This would be a cost-efficient use ofclimate finance as it would target least cost-options and would be performance-based. It would also help
build up a supply pipeline for a future scaled-up market, preventing supply shortages and price pressures.
80.
As regards supply, innovative steps to broaden the scope, scale and reach of carbon markets canbe considered in several directions. First, steps could be taken to include sectors bypassed under existing
regimes, notably the large mitigation opportunities from REDD+ activities and agricultural soil carbon.
The sequestration of carbon in soils is currently a neglected part of the climate solution, yet the carbon
market could provide incentives for sustainable land management programs that deliver a triple win forsociety: improved yields, enhanced resilience to climate change, and global mitigation. Second, steps
could be taken to scale-up the impact of carbon finance through programmatic approaches that help
overcome the high costs and constraints inherent in the current project-by-project approach. This could
include building on the existing CDM Programme of Activities (PoA), which has proved successful inpromoting small-scale, dispersed activities such as distribution of cookstoves, efficient light-bulbs, biogas
digesters and solar water heaters. It could also explore new approaches such as a city-wide approach tocarbon finance, incorporating GHG mitigation concerns into urban planning, landscape approaches orpolicy crediting. Finally, steps could be taken to increase the participation of the poorest countries in the
carbon market, in particular by simplifying and adapting carbon finance procedures to the realities ofthese countries (e.g., finding solutions for the treatment of suppressed demand or of non-renewablebiomass which currently hinders clean energy uptake in these regions).
81.
Encouraging innovation to turn future carbon offset flows into finance is another option.
Difficulties in securing sufficient up-front long term financing have proven a major constraint inadvancing most carbon finance projects. So far, there have been few attempts by financial institutions tomonetize forward carbon revenue streams as a way of providing upfront investment capital for suchprojects, because of factors such as underlying project risk, low familiarity with carbon finance and post-30

2012 uncertainty. Several institutions including MDBs40 are developing a range of solutions such as
frontloading mechanisms that turn anticipated carbon revenues into upfront finance, risk mitigation toolsthat enhance the confidence of financiers in the value and predictability of future carbon credits, revolving
funds where accruing revenues can support a next tranche of investments, and structured finance with
innovative use and combination of instruments, each addressing specific barriers and needs. Some ofthese existing or potential inspiring solutions are further detailed in Box 3.
Box 3: Turning Carbon into Finance








Risk-mitigation tools addressing delivery risks can maximize the value of carbon credits (as buyers
are willing to pay a higher price for more predictable deliveries) and unlock low-emission investment(as financiers are more confident in the value and predictability of future carbon credits). IFC’s
Carbon Delivery Guarantee, a structured financial product developed specifically for the carbon
market, which assures delivery of future carbon credits from projects in developing countries tobuyers in developed countries, is such an example.
Frontloading mechanisms that turn anticipated carbon revenues into upfront finance. For instance, aGuaranteed Carbon Sales Contract would help convert the future flow of carbon offsets into an
upfront payment that can help finance the low carbon project. Specifically, offset buyers would makean upfront payment in return for a shortfall agreement by the sellers which would be guaranteed by an
MDB or, possibly, a pooled arrangement like the Clean Technology Fund (CTF) (the MDB or poolbeing protected by a counter-guarantee from the host sovereign).
Carbon Mezzanine Debt Facility, which can address the need to limit senior debt and achieve greater
equity participation in risky projects. Such a facility could be funded through multilateral, otherpublic and private sources, possibly through a pooled arrangement like the CTF.
Instruments to address price volatility, such as a Carbon Price Support Facility. With this kind of
product a price support facility (funded by an MDB or a pooled arrangement like the CTF) would
provide a minimum floor for carbon offset prices, thereby helping address the problem of pricevolatility and uncertainty, something that also that dampens incentives for low emission investments.

82.
Given the possibility that the carbon market will develop in a fragmented way, through numerous
regional and national initiatives, there would be a significant payoff from greater harmonization of rules
across regimes to ensure minimum fungibility of carbon assets. This would control transaction costs andkeep capacity needs manageable, which would otherwise multiply with the diverse specific requirementsof each new carbon regime in a fragmented carbon world, with real risks of restricting access to thecarbon market and increasing the maturity time of supply. Harmonization would also maintain liquidity
and efficiency, as the gains from indirect linking through well-functioning crediting mechanisms appears
to be very large, reflecting the vast low-cost abatement potential in developing countries. To ensure
market integrity, greater clarity and harmonization are also needed on the framework for monitoring andaccounting. A number of options are available for international GHG accounting including some that40

MDBs are actively supporting the development of the carbon market, including through 21 carbon funds andfacilities with $4.2 billion in capital, some of which are targeting segments not yet tapped by carbon finance,bringing continuity by purchasing credits beyond 2012, and providing upfront financing and risk-management
products.

31

combine elements of a top-down approach based on the Kyoto Protocol and more decentralized countryled approaches.
83.
Finally, there remains a considerable need for innovation, awareness-raising and capacity
building in public and private institutions in developing countries, to increase their participation in the
carbon market and build and enabling environment for low-emission development. (See Box 4 forselected on-going initiatives.)
Box 4: Innovation, Capacity and Awareness for Greater Market ReadinessResponding to growing demand from countries across Latin America, the Inter-American Development
Bank is actively supporting governments, regional authorities and municipalities develop low-emission
strategies, including assessment of mitigation opportunities, sources of finance and regulatory
frameworks (Colombia, Mexico, and Peru). It is piloting NAMAs, for urban mobility (Brazil, Mexico
and Colombia), for renewable energy and energy efficiency (Barbados), and for waste management (Peru,
Colombia, Mexico and Brazil). The IDB is also engaging domestic financial institutions to raiseawareness and build capacity around carbon finance, and, more broadly, low-emission opportunities,
including national development banks (Brazil, Colombia, Mexico, and Peru) and local commercial banks(Argentina, Colombia, Mexico and Panama).
The Partnership for Market Readiness (PMR) provides grant-funding and technical assistance forcollective innovation and piloting of market-based instruments. The Partnership brings together
developed and developing countries, as well as other key experts and stakeholders, and serves as aplatform for technical discussions on market instruments, to foster South-South exchange, facilitatecollective innovation for pilot efforts and harness financial flows for implementation and scale up. The
PMR has already provided preparation grants to 8 implementing countries, with a target of 15. The
World Bank serves as the Secretariat of the Partnership.

3.2

Other Instruments to Engage Private Finance3.2.1 Current investment in climate related activity
84.
While there are at present few comprehensive and consistent data on climate related investment indeveloping countries, particularly as regards cross-border private flows, a survey of the available
evidence suggests that such investment is growing rapidly and achieving a significant scale. Analysis forthis report by McKinsey drawing on recent estimates by Bloomberg New Energy Finance (BNEF) and
HSBC suggests that total investment in developing countries in low carbon energy, low carbon transportand energy efficiency (public and private, foreign and domestic) totaled around $200 billion in 2010, with
about 60 percent of that occurring in just the top 5 countries – China, Brazil, India, Mexico and Turkey.41
Developing countries now comprise well over a third of worldwide investments of this type. (Figure 2
below). However data on the private sector share in these flows is incomplete, as is that on the foreign
versus domestic share. UNCTAD separately estimates that foreign direct investment (FDI) in developing
economies in renewable energy, recycling and low carbon technology manufacturing amounted to $37
billion in 2009 (UNCTAD, 2010). Nevertheless, although data on private climate finance flows is still41

For further details see the background paper for this report ―Climate Finance: Engaging the Private Sector‖.

32

partial and often inconsistent, there is a general appreciation that large amounts of climate-related private
investment have begun to flow to developing countries.
Figure 2: Sustainable Energy Investment, 2010 ($Bn.)
By region/country
China

54 80

Low carbon
energy135

EE & low
carbontransport

Brazil

19

India

10

Mexico6

Turkey3

Other dev'ing
countries
Total dev'ing
countries

Wind

43 67

Developing
countries

109

Developed
countries
80

Solar

Other renewables

28

Biofuels20

Efficiency & low
carbontech/services

6

28
81

119

Developed
countries

200
127
127

187
187

314

EE and low carbon
transport

119

187

307

35

R&D
Total

By sector

243

307

550

Total

214

336

550

Source: BNEF, HSBC, staff estimates.

85.
As regards the pace of growth in climate-related investment, Bloomberg estimates thatinvestment in renewable energy in developing countries experienced a dramatic 19 fold increase in just 6
years from 2004 to 2010. Growth slowed in 2009 with the global financial crisis but rebounded in 2010
with a strong 29 percent increase, led in particular by sharply higher renewable investment in China.42
86.
The private sector will not be immune to climate risk and impact, and will have a key role to play
in investment for adaptation. An activity could be considered an adaptation investment if it reduces therisk, exposure or sensitivity of human or natural systems to climate change; increases climate resiliency;
builds capacity to develop responses to climate change or addresses impacts exclusively linked to climate
variability and change. Building climate resiliency into project design, particularly for long-lived assets;
incorporating climate models into hydrological surveys for dam construction; taking climate
considerations into account when designing and building new infrastructure in coastal areas – these are all
examples of adaptation investments that are also sound development in the face of a changing climate.
87.
However, given the relatively limited experience to date, it has not yet been possible to develop atypology of or quantify flows into private sector adaptation investment, much less draw lessons on
financing structures or leverage. There are estimates that climate finance flows for adaptation indeveloping countries may be about $5 billion per year (Buchner et al., forthcoming), with bilateral

42

UNEP and Bloomberg New Energy Finance (2011). The estimates refer to renewable investment financed
primarily by venture capital, public markets and asset financing.

33

sources providing a significant share, about 80 percent (UNEP, 2010).43 However, as with otherpublished information on climate finance, a number of definitional caveats and issues will affectcomprehensiveness and consistency. The portion of flows directed to and coming from the private sector
remains unknown. Clearly, this is an area where further work is needed.

3.2.2 Public policies and instruments to leverage private climate finance88.
Public finance and policies can leverage private resources at different levels. At the retail level
the term leverage in this context generally refers to the ability of a public financial commitment tomobilize some larger multiple of private capital for investment in a specific project or undertaking. At abroader level it refers to the potential for catalytic or transformational public investments or initiatives toencourage much more widespread climate-friendly changes in behavior by private firms across the whole
economy – rather than only those involved in a specific climate-related project – typically by addressing
economy-wide market failures or barriers to investment. The need for leverage to be also understood inthis broader transformational context is clear when one compares the relatively small size of any
conceivable increase in public climate finance flows from developed countries relative to total capitalformation in developing countries – in the range of $6.4 trillion in 2010, projected to rise to $10.3 trillion
by 2015.44
89.
Leveraging private resources in either the wholesale or retail sense is best accomplished throughsome combination of policy reforms that change incentives for private investment and address key market
failures, combined with public financial interventions or investments. Such public resources can comefrom multilateral development banks (MDBs), bilateral or domestic public sources or pooled financing
arrangements. Pooled financing is a relatively new class of structured vehicle that facilitates mobilizationof concessional resources from a variety of public and private sources. Examples of such pooledarrangements, which are discussed more fully in Section 3.3 on MDBs, include the Global Environment
Facility and the two Climate Investment Funds (CIFs), among others. (Boxes 5 and 6 provide further
information respectively on the role of bilateral aid and national development banks in climate finance.)

43

UNEP estimates that bilateral support to adaptation amounted to almost $4 billion in 2009 from four institutions
alone.
44
IMF World Economic Outlook database, April 2011.

34

Box 5: Bilateral Support for Action on Climate Change
OECD-DAC estimates that bilateral official development assistance (ODA) for mitigation-related
activities averaged $9.4 billion per year in 2008-09.45 Mitigation-related aid represented 7.4 percent of
DAC members‘ total bilateral ODA, with the largest donors being Japan and Germany. These figures
include contributions to specific climate funds, such as the Climate Investment Funds. In addition,
countries provide support through the multilateral system; in the same period such assistance amounted to$429 million through the Montreal Protocol, the Global Environment Facility and IDA (OECD-DAC,
2011). According to UNEP, three bilateral financial institutions and the European Investment Bank
together provided $13 billion for climate action in developing countries in 2009, with over two-thirds
towards mitigation. However, this includes both concessional and non-concessional assistance. The fouragencies covered in that study are the Agence Française de Développment (AFD), Japan‘s JICA (thelargest contributor at $6.4 billion), Germany‘s KfW and the European Investment Bank (EIB). (UNEP,
2010).

Box 6: National Development Banks and Climate Finance
Data gathered by Bloomberg New Energy Finance (BNEF) indicate that national development banks
accounted for $5.8 billion in clean energy financing in 2010 (BNEF, 2011). BNEF defines clean energy
as renewable energy, which does not cover energy efficiency, large hydro, or finance to supply chain
projects like component manufacture. Wind and bioenergy were the biggest recipient sectors. National
development banks (NDBs) covered included Brazil‘s BNDES, Germany‘s KfW, France‘s AFD, theChina Development Bank, the Indian Renewable Energy Development Agency (IREDA) and theOverseas Private Investment Corp (OPIC) of the USA. Most NDBs are focused on the country or regionin which they are based. Some NDBs have an explicit mandate of working with the private sector, suchas OPIC. BNDES‘ client base consists primarily of private companies and entrepreneurs. However,assembling a true picture of financial flows from these institutions to private climate related activity
remains difficult. IREDA is said to source more than half its funds from other development banks, so thedata presented above may include some double-counting. More work is needed to assemble a true pictureof climate-related investment flows attributable to NDBs.
90.
Resources from these various sources can be applied through a wide range of available
instruments to leverage private investment, either individually or, increasingly, in combined packages ofinterventions.46 Such instruments include grants, concessional and/or non-concessional lending, equity
investments, often through MDB private sector windows, technical assistance and a range of loan
guarantee and other risk mitigation instruments. Box 7 provides some examples of engaging the private
sector through packaged interventions via the Climate Investment Funds.
45

This figure relates to mitigation (and related capacity building) only; first data on adaptation, relating to 2010flows, will become available at the end of 2011. In future, OECD-DAC data on climate finance will cover nonconcessional support as well.
46
UNDP (2011) discusses National Climate Funds as an instrument for developing countries to collect, coordinate
and blend public, private, multilateral and bilateral sources of climate finance, as well as to coordinate and deploy
these funds for country-wide climate change activities that promote national development priorities.

35Box 7: Scaling-up Partnerships through Climate Investment Funds
A partnership among MDBs, recipients and contributors, with $6.5 billion in pledges, the Climate
Investment Funds are providing innovative climate financing to developing countries for low-emission
technology, climate resilience and forestry, pursuing a strategy that combines public sector reform andprivate sector action. Here are three examples from a much broader portfolio of activities in 45 countries.
Accelerating the deployment of Concentrated Solar Power (CSP) in five countries in the Middle East andNorth Africa: $750 million of highly concessional funding from the CIFs will catalyze a $4.8 billion
package, including $1.3 billion from private sector, $2 billion from local government and $1.5 billion
from the African Development Bank and the World Bank. This initiative will help deploy the largest
CSP capacity in the world (around 1GW), tripling current global installed capacity and investment in CSP
and achieving the scale necessary to bring down costs and promote global learning and deployment.
Deepening domestic capital markets for clean energy in Turkey: The Turkish Sustainable Energy Finance
Facility incentivizes commercial banks to enter the new climate lending market using a combination ofcommercial-priced finance from the EBRD with concessional co-finance and substantial technicalassistance support from the Clean Technology Fund (a CIF) and the EU. The facility will cover five local
private banks and is expected to lead to a total of 160 projects, with abatement of 232,000 tCO2e.
Piloting index-based agriculture insurance in Niger: This initiative aims to provide contingency funding
to farmers in the event of weather and climate-related shocks, collaborating with the Global Index
Insurance Facility (GIIF), the private sector and others to develop the insurance index and implementation
framework. The pilot will also investigate possibility of risk transfer to the international market. This ispart of a broader $100 million program (70 percent from the CIF) to help design social safety nets for
extremely poor households vulnerable to climate risks. Index-based insurance schemes have been shownto increase farm income stability and provide incentives to pursue more high-risk, high return strategies.
They also enhance access to rural finance through reduced default rates.
91.
In the rest of this section we organize the discussion of policies and instruments to leverage
private finance according to the key barriers to climate investment which they help address. As noted in
the discussion of barriers at the beginning of Section 3, these include the global climate externality,
knowledge externalities, problems with access to finance and high levels of risk and uncertainty. Itshould be noted that there is often no simple one-to-one mapping between instruments and barriers, assome instruments can be useful in addressing more than one type of problem. Additional insight can also
be obtained by mapping policies and instruments not to barriers but to the main types of climate
investment projects, e.g. energy efficiency, various types of renewable energy projects etc. Appendix
Table 2 provides such an illustrative mapping of policies and instruments to projects organized along a
stylized marginal abatement cost curve.

Leveraging private finance by tackling the climate externality
92.
Interventions to address the climate externality and improve returns on climate friendly
investment through some form of carbon pricing are likely to be among those actions with the highest
leverage at the wholesale or economy-wide level. At the global level, under current market rules, robust
carbon pricing in developed countries provides incentives for significant private flows to developing36

countries through carbon offset markets. Carbon offset flows are discussed separately in Section 3.1
above, which notes how they create an additional revenue stream for and improve profitability in low
carbon projects in developing countries, thereby increasing incentives for domestic and foreign private
investment.
93.
But there is also considerable scope for stronger carbon pricing in developing countries
themselves. The most obvious opportunity relates to ‗no-regret‘ reforms to reduce or eliminate fossil fuelsubsidies, as discussed in Section 2.1.3 above. More broadly, some 22 non-Annex II developing
economies have now set economy-wide mitigation targets, as indicated by information provided under the
Copenhagen Accord. Advance market commitments such as feed-in tariffs to subsidize renewable energy
sources are also being considered in many economies, although they are less efficient than carbon pricing
and can have significant fiscal implications, depending on factors such as the size of the cost differential
between renewable and fossil fuels. Interest is also increasing in regulation to improve energy efficiency,
for example through economy-wide efficiency standards and codes or power sector reforms.
94.
But it has to be stressed that none of these reforms are easy to accomplish or without cost. A
particularly valuable use for developed country public finance is therefore through policy support (forexample development policy operations) for climate policy reforms and programmatic initiatives, using
some combination of development assistance in the form of concessional and non-concessional lending,
grants and technical assistance.

Addressing knowledge externalities
95.
Public climate finance can also achieve broad leverage at the wholesale level through investmentsthat address other key market failures, for example the public good externality that hampers innovationand dissemination of climate technology. All new technologies contain a substantial component that istacit and uncodifiable, that needs to be mastered through costly experimentation, particularly when thetechnology is being adapted for use in a new developing country environment. However, a developing
country firm making such an investment in technology adaptation may find competitors quickly copying
its advances at much less cost, which reduces the incentive for the firm to introduce the technology in thefirst place. Lack of information and status quo bias are also a particular source of problems in promoting
investment in energy efficiency, a sector which otherwise promises not only high social but also private
returns.
96.
Here carefully designed and scaled public investments in demonstration projects to pilot anddebug new technologies and institutions can have a major impact in promoting learning and the diffusionof new ideas. Such investments also generate valuable new project and sector information and reduce
policy risks by establishing safeguards and other standards. Careful monitoring and evaluation of lessons
from learning investments are low-cost public goods that can accelerate the flow of private finance andnew technologies. Experience with such projects shows that a blend of grant, concessional, nonconcessional and carbon-offset financing can be used to provide an effective mixture of financial
incentives and technical assistance that encourages private firms to invest in new clean energy
technologies, stimulating learning-by-doing and knowledge diffusion for the economy at large.
97.
Some examples include the China Renewable Energy Development Project (supported by an
IBRD loan and a Global Environment Facility grant) to encourage manufacturing of small scale solar
37home systems, the EBRD‘s Sustainable Energy Initiative, which supports both energy efficiency andrenewable energy projects with a strong emphasis on transfer of skills and learning, and the China Energy
Conservation Project which helped pilot hitherto unknown Energy Service Companies (ESCOs) toprovide both finance and technical know-how for energy efficiency. Another example of implementing a
mix of information, regulatory and market-based policy instruments to catalyze private action is the South
African Wind Energy Programme (SAWEP), implemented by UNDP with GEF funding. This initiative
has assisted in creating a sector-wide market-enabled environment for large-scale wind energy
investment.

Access to finance and risk mitigation issues
98.
Development lenders are also gaining experience in how to address problems of lack of accessand missing insurance markets in climate finance. Public lenders provide an important element ofstability through their ability to undertake large-scale, long-duration, non-concessional lending for climate
action, especially during periods of high volatility and sudden stop in global capital markets, such as therecent global financial crisis. In addition they are able to provide core or anchor financing that, creatively
blended with concessional finance, grants, risk mitigation and learning, can also leverage increased
climate lending by domestic commercial banks and other private lenders. Export credits are also being
used creatively by countries to stimulate private investment in developing countries in low carbon
development, with more favorable terms and conditions reflecting the higher initial investment costs andexpected useful lives of such projects.47
99.
In China, commercial bank lending for energy efficiency was being hindered by apparent lack ofcollateral for such lending. The China Utility-Based Energy Efficiency (CHUEE) project has helped
banks structure efficiency loans as project finance with collateral, also providing an IFC first loss
guarantee and technical assistance for capacity building in local banks, supported by GEF concessional
funding. As local banks have gained experience the amount of loss coverage from international sources
has been reduced while bank lending has risen substantially.
100.
The India Solar Power Guarantee Facility ($150 million) approved by ADB‘s board in 2011
aims to reduce the overall cost of financing and lengthen loan tenors for solar projects. The Facility
covers up to 50 percent of the payment default risk on commercial bank loans of up to 15 years to private
sector developers of small solar power projects. The UK Government will provide a $10 million untied
grant to ADB to subsidize the guarantee fee rate and help buy down the risks/costs of financing. The
Islamic Development Bank has identified renewable energy and energy efficiency as priorities for its
interventions in Turkey‘s energy sector, including through strategic partnerships with local financial
intermediaries.
101.
Subordinated or mezzanine debt— financing with a lower payment priority than senior loans—can be a useful way for the public lender to take on more of the risk, strengthen a project‗s equity profile
47

Export credit agencies (ECAs) typically provide loans or guarantees to facilitate exports. In recent years the
majority of medium and long-term official export credit flows from OECD governments to developing countries
have been to transport and energy sectors (37 and 26 percent respectively), followed by energy projects (11 percent,including 1 percent estimated for renewable energy and energy efficiency in the power sector). OECD statistics onexport credits in 2010 as cited in Buchner, Brown and Corfee-Morlot, 2011.

38

and encourage additional commercial lenders to provide senior debt financing. This approach was used by
IFC to support one of the first wind projects in Mexico. Over time, public support can be decreased andeventually phased out as commercial lenders gain experience and confidence about the viability of theseinvestments.
102.
A variety of other risk sharing instruments can further help address the risk-return tradeoff,
including tools such as policy and loan guarantees, insurance products and hedging instruments.
Increasing access to risk-sharing instruments is an important strand of comprehensive adaptation
strategies, given the likelihood of more frequent extreme events as a result of climate change. There havealready been some promising applications of innovative mechanisms such as index-linked insurance andweather derivatives – for example, the Caribbean Catastrophe Risk Insurance Facility, which combines
index insurance with risk pooling. At the local level, analysis suggests that microfinance can be a
promising instrument for adaptation. For example, in Bangladesh, analysis found that 70 percent ofexisting microfinance portfolios were related to climate change adaptation (Agrawala and Carraro, 2010).
In the longer-term these instruments have the potential to be self-sustaining, but there is a need for publicfunding to pilot new methods and initiate new projects. It is also well understood that such instruments
are only one component of a comprehensive adaptation strategy.48
103.
Green bonds could be another innovative instrument where asset-backed corporate bonds are used
to refinance operational cash-flow from low-carbon infrastructure projects. These types of structures
could help access large pools of institutional capital, reduce the average cost of capital, and provide a
low-cost exit for construction phase capital and bank debt. The bonds would allow institutional investors(pension and insurance funds) to match stable long-term returns from operational infrastructure with their
liabilities. (Della Croce, Kaminker and Stewart, 2011).

3.2.3 Potential for leveraging private climate finance104.
As noted, the potential for leveraging private climate finance can be assessed at ‗wholesale‘ or‗retail‘ levels, the former looking to economy-wide changes in climate-friendly private investment as aresult of broad changes in incentives, the latter more narrowly at private capital mobilized in specificprojects. While wholesale leverage will undoubtedly be of the greatest significance in the long run,arriving at reasonable estimates of such broad potential changes is a difficult challenge, especially giventhat private investment behavior in general is among the less well understood aspects of economics. We
leave this challenge for future work, and, following the AGF, concentrate on leverage at the retail level,using leverage ratios that are derived from the lending experience of the MDBs.
105.
Experience from the lending portfolios of MDBs and other donors suggests that private leveragefactors can vary considerably according to the type of public financing that is deployed, the sector, thenovelty of the technology and the level of informational and other barriers to investment. Broadly
speaking, the experience of the MDBs suggests that leverage factors in the range of 3 to 6 for nonconcessional lending, although they can be significantly higher in projects such as for power sector
energy efficiency, with well-established private players and relatively few technological surprises.
48

The World Bank Group finances on average $2-3 billion per year in disaster risk reduction and recovery,
resources that could potentially be leveraged for adaptation related investments through improved screening andtargeting of investments.

39

Leverage ratios can be significantly higher where the public finance component is the form ofconcessional lending, grants or equity, running at 8 to 10 or even higher.
106.
The AGF Report developed scenarios in which public climate finance from developed countries,
MDB finance and carbon offset flows could leverage in the range of $100 – 200 billion of gross private
climate finance flows from developed to developing countries in 2020.49 These findings are broadly
consistent with the analysis of instruments andoptions discussed in this report. Table 3
summarizes the AGF approach and also provides a
Table 3: AGF Scenario for Additional
Private Climate Finance in 2020*
transparent way for readers to vary any of the$ bn.
assumptions and develop alternative scenarios.
1. Developed country public and
35-60
The AGF discussion considered scenarios where
MDB financedeveloped country public sources and MDB
2. Plus carbon offset flows
30-50
finance could together provide additional annual
65-110flows of $35-60 billion to leverage private finance3. Times private leverage factor
x3
in 2020, a range also within the combined scope of
195-330
the various public finance and MDB instruments
4. Plus ―negative cost‖ investments
50
and approaches discussed respectively in Section 2
5. Total additional private flows
above and Section 3.3 below. The AGF also245-380
considered complementary annual carbon offset
6. Times assumed foreign ratio
x½
market flows of $30-50 billion in 2020, similar to
7. Additional international private **123-190
the Copenhagen High scenario discussed in Box 2* AGF Working Stream Paper 7 (2010), pp. 30-31. **and Section 3.1 above.
Rounded to $100-200 billion in the AGF discussion.
107.
The AGF method applies a conservative
private leverage factor of 3 to the total of $65-$110 billion of additional MDB, other public and carbon
offset flows noted in Table 3, yielding additional leveraged private flows of $195-330 billion. The AGF
also estimated that there could be around $50 billion of so-called ―negative cost investments‖ (e.g. inenergy efficiency) identified using the McKinsey Marginal Abatement Cost Curve (MACC). Adding insuch investments yields an estimate for 2020 of total additional gross private flows (both foreign anddomestic) of $245-380 billion. Assuming with the AGF that half of this total comes from internationalsources yields an estimate of around $120-190 billion for north-south private financing flows, which,given the inherent uncertainties surrounding the embedded assumptions, the AGF rounds to a range of$100-200 billion. This would represent a significant share of the overall capital investment requirement indeveloping countries that has been estimated as consistent with a 2C pathway.
108.
These estimates might be substantial under-estimates in that they do not attempt to capture all of
the broader changes in private investment behavior that would result from policy efforts to tackle
economy-wide market failures and improve the economy-wide structure of incentives. On the other handthese scenarios do rely on assumptions of significant additional flows of public finance from developed
countries, which may prove a challenge given the very difficult economic and fiscal conditions
confronting these economies.

3.3
49

Multilateral Development Bank Leverage

AGF Workstream 7 Paper: Public Interventions to Stimulate Private Investment in Adaptation and Mitigation.

40

109.
In an important respect multilateral development banks (MDBs) are themselves an institutional
device to help mobilize private savings for development purposes. Specifically, MDBs are able to fund –leverage – investments several times their shareholder capital because of their ability to borrow in private
capital markets. Like all banks, MDBs provide economic services such as risk sharing or asset
transformation services which allow them to serve as financial intermediaries between savers on the one
hand and opportunities for productive investment on the other. But MDBs also have specific features
which allow them to address various problems that otherwise hinder private capital flows to developing
countries. In particular, the multilateral shareholding structure and preferred creditor status of MDBs
serves as a commitment device to better deal with the problem of a lack of institutions for contract
enforcement in international lending to sovereign governments. These features also give MDBs a
comparative advantage in collection and dissemination of information about the investment environment
in developing countries, something that the private sector may under-provide because of the public goodnature of such knowledge. Finally, MDBs also serve as mechanisms for reallocating subsidies – that is,resources that they derive from their preferred creditor status and access to a subsidized shareholder
capital base, which they are able to use for development objectives, for example through concessional
lending. 50
110.
Such features should also help MDBs address some of the problems that tend to inhibit private
investment in low carbon and climate resilient development outlined in Section 3.2 above. Annual MDB
investment in mitigation activities in developing countries was about $19 billion in 2010.51 In this section
we first examine the potential for MDBs to leverage shareholder capital as a source for additional climate
financing, looking both at the available headroom under the existing capital structure of the MDBs, andalso, in the longer term, through possible new climate-related MDB capital increases.52 Second, we
examine the potential for expanding pooled financing arrangements that allow MDBs to mobilize andchannel a variety of concessional flows through structured vehicles for climate investment.

3.3.1 Leveraging shareholder capital111.
At the operational level the extent to which MDBs can leverage shareholder capital is determinedby their capital adequacy policies, which vary across MDBs to some extent, and also according to the risk
profile of the borrower, concentration levels, asset type and other relevant factors. Broadly speaking,however, a useful rule of thumb for the current mix of non-concessional loans on MDB balance sheets isthat minimum capital adequacy ratios (expressed as the required on-balance-sheet equity for backing
loans) range between 25 and 33 percent.53 This is broadly consistent with the assumption in the AGF
report that every $1 billion of paid in capital leverages $3-4 billion of lending. MDBs can also more

50

For further discussion of these points see for example Buiter and Fries (2002), Hagen (2009) and Rodrik (1995).
Background paper for this report on ―Climate Finance: Engaging the Private Sector‖.
52
A similar proposal is made in an IMF Staff Position Note for a Green Fund that would use an initial capital
injection from developed countries in the form of reserve assets to leverage resources from private and official
investors by issuing low-cost ―green bonds‖ in global capital markets. (Bredenkamp and Patillo, 2010).
53
Loans and guarantees create broadly similar credit exposures and hence are treated alike for capital adequacy
purposes. As a result, increased usage of guarantees would not enable MDBs to achieve higher leverage on theirshareholder capital. However, guarantees remain an attractive means of achieving more private sector leverage, asubject dealt with in more detail in Section 3.2 above.
51

41

effectively target lending to strengthen climate resilience in developing countries by improving theclimate-screening of their overall development portfolios.

Use of existing headroom
112.
The AGF report itself did not venture an estimate of how much additional climate financing
MDBs could in theory leverage from any available headroom in their existing paid-in capital, noting that
there were different perspectives on whether such an increase should count as new and additional. It istrue that before the recent global financial crisis some MDBs had a certain amount of headroom within
their capital structure that could have been used for additional climate finance. This headroom
disappeared as the MDBs undertook levels of crisis-related lending that stretched their balance sheets,raising the prospect of a sharp contraction in post-crisis lending capacity. To avoid this scenario
shareholders agreed to an MDB capital replenishment calibrated in most cases to the relatively modest
aim of meeting existing post-crisis lending needs, rather than creating room for newly identified needs
such as climate finance. While additional climate financing could in theory be achieved by increasing theshare of climate finance within the existing headroom constraints, there may not in general be a sufficientmandate from the recent capital replenishments to justify an extraordinary use of MDB capital for climate
purposes, as the AGF report notes. This is particularly so in light of developing country concerns about
crowding out of more traditional areas such as infrastructure, health care and education. In some cases,
however, for example the Inter-American Development Bank (IDB), the recent capital increase did
include specific climate-related lending targets.54

MDB capital increase: technical aspects
113.
Given that the latest capital replenishment agreements were concluded just recently and therelated capital increases have a number of years remaining to be fully subscribed, extended discussion ofa future capital increase for MDBs is premature today. Nonetheless some initial technical analysis may
be warranted given the special issues that would arise with a capital increase specially targeted at climate,
the long run nature of the climate issue and the likelihood that views may evolve over time, particularly as2020 approaches. The background paper ―The Scope for MDB Leverage and Innovation in Climate
Finance‖ provides more details of this analysis.
114.
Assuming that the riskiness and pricing of climate financing loans would be comparable to thecurrent mix of loans on MDB balance sheets, and assuming a 25-33 percent capital requirement, every$10 billion of additional paid-in capital could be initially leveraged to support $30-40 billion of additionalloans. In addition the repayments from these loans would support further lending of $3-4 billion per year
over the longer term, assuming an average loan maturity of about 10 years. Finally, the income from nonconcessional climate lending could be used to further supplement the leverage achieved by a capitalincrease. More specifically, most of such net income would arise from the savings to MDBs from nothaving to pay charges or dividends on their shareholder capital. Assuming a 5 percent interest rate onloans, every $10 billion of new paid-in capital would generate annual income of $500 million, which
could also be dedicated to climate investment. If all income was retained to support climate lending, thenshareholder capital and lending would both grow at 5 percent per year. After ten years, retained earnings
54

The IDB‘s Ninth General Capital Increase approved in 2010 includes a target to increase lending for climatechange, sustainable energy and environmental sustainability to 25 percent by 2015.

42

would total an additional amount exceeding $5 billion, leveraging additional loans over $15-20 billion.
Alternatively net income could be used to increase the concessionality in climate loan pricing, or inproviding grant financing.
115.
A key challenge would be how to accommodate a capital increase which aims to increase theflow of climate finance from developed to developing countries within the capital structure of the MDBs.
A capital contribution restricted to developed countries (referred to as ‗Part I‘ countries in some MDBs)
would normally result in the voting power of these countries increasing relative to that of developing (PartII) countries, a change contrary to the spirit of recent ‗Voice and Representation‘ reforms.
116.
There are a number of possible approaches to this problem. One would be for both developed
and developing members to subscribe to a general capital increase that would leave the shareholding
structure unchanged, but with only the former subscription including a paid-in portion while the latter
would be entirely callable. This is legally perhaps the soundest approach, although an analysis of MDB
charters would be needed to ascertain if it works for all. An alternative approach would be a selective
capital increase with only Part I countries subscribing for non-voting shares. Some Part I members may
not be willing or able to forgo such voting rights, however, and further analysis would also be needed toascertain the legality of this approach under existing MDB charters. Finally, Part I countries could donate
money to MDBs, increasing their reserves and allowing leverage. However members would not be
entitled to recover donations upon a withdrawal from membership or dissolution of the MDB, reducing
the desirability of this option for potential donors.
117.
A somewhat separate issue is that a climate finance focused capital increase would tend toincrease the lending capacity of the non-concessional arms of MDBs, the bulk of whose operations are
directed to creditworthy middle income countries, creating a potential mismatch with the objectives ofshareholders, who may wish to focus on concessional financing for low income countries. Other
solutions may be more appropriate to fund climate finance in low income countries, for example theoptions discussed in the next section.

3.3.2 Pooling flows to support targeted concessional lending
118.
Given the limited scope for mobilizing additional financing by leveraging their capital in thenear-term, MDBs can explore other alternatives for "pooled‖ financing arrangements which allow them tomobilize and channel concessional flows through structured vehicles for climate finance.
119.
These pooled arrangements offer a number of advantages. They allow MDBs to mobilize offbalance- sheet resources from multiple sources, including traditional sovereign donors as well as nontraditional sources such as private foundations and emerging sovereigns. They allow new ways fordonors to contribute (beyond traditional grants), for example through long-term concessional loans.
Pooled arrangements can be structured in ways that accommodate the different risk-return appetites ofdonors, while also allowing great flexibility in providing instruments tailored to the needs of a wide
variety of recipients. Large pooled arrangements also offer significant economies of scale andadministrative efficiencies. MDBs could also better align disaster risk reduction and reconstruction
financing and climate-financing, including under a variety of pooled arrangements.

43

120.
A number of types of pooled financing arrangements have evolved in recent years, providing
ideas for expansion in coming years as well as opportunities for cross-sectoral learning.

Climate-specific financial intermediary funds
121.
There are now six multi-donor financial intermediary funds (FIFs) that focus on climate, withmore than $10 billion in cumulative pledges and contributions and approved outlays for projects of $6.7
billion.55 The World Bank acts as a trustee to these FIFs, and the Bank, other MDBs and UN agencies areamong the implementing agencies used to channel resources to recipients. Examples of innovations infund-raising developed by these FIFs include:

Bilateral donor contributions in the form of concessional loans, for example concessional loans to the
Clean Technology Fund under the Clean Investment Funds (CIFs) totaling €703 million by Franceand Germany;Funding through monetization of offsets, for example financing of the Adaptation Fund through alevy on Certified Emission Reductions (CERS) issued under the Clean Development Mechanism;Funding from private foundations. A small but growing share of the contributions of private
foundations has targeted climate change: U.S. foundations (which comprise about three-quarters ofglobal foundation giving) gave about $338 million for international climate change purposes in 2007,of which about 39 percent was donated through global programs such as the CIFs and about onequarter funded policy work.56 Foundation giving for climate change has focused in particular on
helping low-income populations, both by improving resilience to climate change and by supporting
mitigation efforts, in sectors such as sustainable forestry and agriculture. Many of these efforts, suchas the Global Alliance for Clean Cookstoves, have used a partnership model where participants
contribute in a range of ways, both financially and in-kind. MDBs have worked with thesefoundations both by managing global programs and by supporting partnerships financially andthrough knowledge-sharing and convening of stakeholders.

122.
These funds have expanded the pool of resources dedicated to climate finance by enabling a
range of donors to contribute in both traditional and non-traditional ways, thereby facilitating additional
co-financing of climate investment by MDBs. Lower all-in financing costs resulting from the blending ofconcessional terms with standard MDB terms improve the viability of low-carbon investments.

Targeted investment vehicles
123.
Targeted investment vehicles enable donors and investors to focus resources on specific sectors,
often by providing complementary tranches that each have different risk and return profiles. Tranching in
55

These comprise the Global Environment Facility (GEF), the two UNFCCC GEF-managed special funds (Special
Climate Change Fund, or SCCF, and Least Developed Countries Fund, or LDCF), the two Climate Investment
Funds (Clean Technology Fund, or CTF, and Strategic Climate Fund, or SCF), and the Adaptation Fund establishedunder the Kyoto Protocol. All but the Climate Investment Funds operate as financial mechanisms under the
UNFCCC, and, in the case of the GEF, other conventions. See World Bank (2011b).
56
The U.S. Overseas Private Investment Corporation (OPIC) has also committed over $500 million to date tosupport private equity funds investing in international clean energy projects.

44this way helps mobilize funding from investors whose investment parameters would not otherwise enable
them to invest in emerging-market clean-energy projects. An example of this approach is the Global
Climate Partnership Fund (GCPF) developed by the IFC as a debt investment vehicle (proposed for up to
US$500 million) that will provide financing mainly for on-lending through financial institutions forrenewable energy and energy efficiency projects by small and medium-sized enterprises and households
in developing countries. The Fund will issue a range of senior, mezzanine and junior shares and notesthat aim to accommodate the investment parameters of a wide range of investors.57

Learning opportunities: Pooled financing arrangements in the health sector
124.
Pooled financing arrangements that have proven valuable in addressing financing challenges forcommunicable diseases could provide useful lessons for climate finance. (See Appendix 2 for further
information on these examples of pooled financing arrangements.)One example is the pilot Advance Market Commitment (AMC), a ―market pull mechanism‖ thatincentivizes private sector pharmaceutical companies to deliver vaccines to developing-country
markets by guaranteeing a minimum level of demand and a stable product price for a set period oftime. The AMC brings together resources from traditional donors with a foundation (the Bill &Melinda Gates Foundation) and an emerging BRIC country (Russia). Drawdowns under long-term,
legally binding donor commitments are structured to accommodate the disbursement schedule of the
AMC. Pull mechanisms can have wider applicability in areas such as climate change mitigation bysimilarly removing obstacles to private sector investment. For example, they could be replicated in
the renewable energy sector to provide long-term, legally-binding donor commitments to support
payment of feed-in tariffs.

Another example is the International Finance Facility for Immunization (IFFIm), which ―front-loads‖
financing needed for immunization programs in the poorest countries. Using legally binding, longterm, future donor commitments to issue bonds, IFFIm makes more money available now for vaccine
purchase and delivery. The applicability of this structure to the climate finance arena merits further
analysis, particularly in areas where large upfront capital investments are needed.

Key considerations and challenges
125.
A number of issues will need to be carefully considered in expanding the use of pooled financing
arrangements. First, proposals for new financial arrangements need to be reviewed in the context of thebroader international financial architecture, with an eye on whether they mobilize additional resources
and complement existing arrangements or present potential competition and fragmentation of aid
delivery. Second, pooled arrangements have not yet been able to attract large sums from non-traditional
57

The Fund is intended to have four tranches: (i) junior C shares, (ii) mezzanine B shares, (iii) senior A shares, and(iv) senior notes. KfW, IFC and one other development finance institution are expected to invest up to US$75
million each in A and B shares. Germany and Denmark have invested €22.5 million and €5 million, respectively,
for C shares.

45

donors – the challenge here is to provide compelling value propositions that clearly demonstrate value formoney. Finally, one size does not fit all. Mechanisms such as IFFIm could be structured to address
climate finance needs only if there is a compelling case for front-loading, and if donors are able to makethe long-term, legally-binding commitments required under such schemes.

4

Monitoring and Tracking Climate Finance Flows 58

126.
The Copenhagen Accord and Cancun Agreements formalize a collective commitment by
developed countries to provide new and additional funding for action on climate change in developing
countries both in the short- and longer-term ―from a wide variety of sources, public and private, bilateraland multilateral, including alternative sources”. This collective financial commitment requires a system
to measure, report and verify (MRV) the relevant financial flows across a variety of sources. Such asystem should help assess – individually and collectively - whether or not commitments are being met,
and to facilitate the implementation of these commitments by identifying where progress could be made.
Ideally, such a system should ensure transparency and accountability. This in turn would requirecomprehensive, accurate and comparable information such that aggregation across sources of informationis possible.
127.
There is considerable agreement, however, that the existing effort to track climate finance lacks
transparency, comparability and comprehensiveness. One problem is that, despite a number of provisions
in the UNFCCC outlining key principles, there is no internationally agreed definition of what counts as―climate finance.‖ There is therefore no agreed basis for measurement or methodology for tracking.
Measuring adaptation finance is particularly challenging given its intricate linkages with development.
There is also currently no formal definition of private climate finance and no dedicated systems to track
private climate finance. This is compounded by confidentiality issues. Matters are somewhat better for
public climate finance flows, where working definitions already exist, for example related to the Creditor
Reporting System of the OECD DAC which has clearly defined Policy Markers for Climate Change
Mitigation and Adaptation (the so-called ―Rio Markers‖ – see also Box 5). These can be built upon using
ongoing work in the aid community, for example to also monitor in-country flows of public climate
finance.
128.
The Cancun Agreements recognize the shortcomings of current reporting of climate finance under
the UNFCCC and have called for significant improvements on this issue, both regarding the frequency
and coverage of reporting. They call for strengthening national communications, increasing the frequencyof reporting via biennial reports to be reported by developed and developing countries, and the creation ofa registry to record developing countries‘ mitigation action seeking international support and associatedfunding needs. All these items include some elements of climate finance reporting. Importantly, theAgreements call for strengthened reporting on climate support both from developing countries asrecipients and from developed country donors.
129.
Recent work by the OECD/IEA Secretariats (Buchner, Brown and Corfee-Morlot, 2011) proposes
a useful multidimensional conceptual framework (Figure 3) to organize thinking about the kinds ofinformation that could be tracked in a comprehensive MRV system for climate finance and to provide a58

This discussion draws on Buchner, Brown and Corfee-Morlot (2011).

46

basis for discussion. Development of a comprehensive framework would clearly be a step-by-stepprocess, on the basis of dialogue to achieve consensus on key definitions, methods and approaches,allowing reporting countries, relevant inter-governmental organizations and other stake-holders to build
capacity to provide higher quality and more complete information over time. Among the steps that can beprioritized for action:
Figure 3: The Dimensions of Climate FinanceSources – origin(country)

PublicfinancePublicprivate

Privatefinance

Intermediaries

Instruments

Recipients
adaptation /mitigation(or relevant
sectors)

NorthSouthbilateralclimate andinvestment
policies

SouthSouth

multilateral

offsetfinancedomestic…

…

grantsspecific uses
(e.g. sector
endpoint,
project type)concession
al loans
capital…

Source: Buchner, Brown and Corfee-Morlot (2011).








Adopt clear definitions of climate finance spanning both public and private sources and prioritize
work to improve standardized tracking of international climate finance flows from both a donor
and a recipient perspective.
Explore various avenues of tracking climate finance within a more comprehensive MRV system,
drawing the lessons from existing information systems.
Improve reporting of public climate finance flows from both a donor and a recipient perspective
building on existing information systems, ongoing efforts to improve these (e.g. inter alia,
UNFCCC national communications, DAC CRS) and new reporting tools established under the
Cancun Agreements (i.e. biennial reports, registries).
Extend reporting to include a basic reporting of private climate finance. A minimum level of
information could be ensured by requesting public finance sources to report on leveraging ratios
and by streamlining the reporting on finance flowing through carbon markets.

126.
In support of collective action to develop a comprehensive system to MRV climate change
finance, the World Bank is in the process of introducing a system that will measure the share ofinvestments that provide adaptation and mitigation co-benefits in each new project in its portfolio, down47

to the project sub-component level. This is considered a promising start and a step towards building on
the Rio markers currently in use by OECD DAC countries. The World Bank is cooperating closely withother MDBs and the OECD DAC secretariat with a view to harmonising the methodologies across thesesystems so that climate finance data will be comparable across the multilateral banks and bilateral donors.
The tracking system will be operationalized for the World Bank‘s portfolio in fiscal year 2012.

48

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50

Appendix 1. List of contributions and background papers
Milan Brahmbhatt and Jane Ebinger of the World Bank were, respectively, principal author and teamcoordinator for this synthesis report on ―Mobilizing Climate Finance‖. Andrew Steer, the World Bank‘sSpecial Envoy for Climate Change, and Otaviano Canuto, Vice President of the World Bank‘s Poverty
Reduction and Economic Management Network, provided overall guidance and oversight for the work.
Michael Keen (IMF) led the work stream on sources of public finance. Helen Mountford led OECD
contributions on the analysis of fossil fuel support, monitoring and tracking of climate finance and other
inputs. The work stream on private leverage was led by Shilpa Patel and Josue Tanaka, at the IFC and
EBRD respectively. Philippe Ambrosi, Priya Basu and Lisa Finneran of the World Bank led the work
streams on carbon markets and leveraging multilateral flows. Jane Hupe and Eivind Vagslid coordinatedcomments and information on behalf of the International Civil Aviation Organization (ICAO) and theInternational Maritime Organization (IMO) respectively. RDB input to the synthesis paper wascoordinated by Martin Poulsen at AfDB, Samuel Tumiwa at ADB, Josue Tanaka at EBRD, Matthias
Zoellner at EIB and Walter Vergara at IDB. Valuable comments were also provided by the UN and the
UNDP.
Contributions to the preparation of the synthesis report and background materials were also provided by:Philippe Benoit, Veronique Bishop, Ari Huhtala, Masami Kojima, Aditi Maheshwari, Susan McAdams,
Alan Miller, Klaus Opperman, Lasse Ringius, Chandra Shekhar Sinha, Jon Strand, Trichur
Sundararaman, Stacy Swann, Maria Vagliasindi, Vikram Widge (World Bank Group); Ian Parry andRuud de Mooij (IMF); Julia Benn, Jan Corfee-Morlot, Robertus Dellink, Valerie Gaveau, James Greene,
Christopher Kaminker, Tamara Levine, Virginie Marchal, Remy Paris, Andrew Prag, Jehan Sauvage,
Cristina Tebar-Less, Marie-Christine Tremblay (OECD); Monojeet Pal, Obi Okoye (AfDB); Robert
Schoellhammer, Lu Xuedu (ADB); Claudio Alatorre, Maria Netto (IDB); Tetsuya Tanaka, Theodore
Thrasher (ICAO); Jo Espinoza-Ferrey, Leigh Mazany (IMO). Andre Stochniol (IMERS) provided helpfulcomments and information. Team support was provided by Elif Kiratli and Alexandra Sears (World
Bank).
Detailed background papers prepared for the report are listed below:
IMF (2011). Promising Domestic Fiscal Instruments for Climate Finance, International Monetary Fund.
IMF and World Bank (2011). Market-based Instruments for International Aviation and Shipping as a
Source of Climate Finance, International Monetary Fund/ World Bank.
OECD Secretariat (2011). Fossil-fuel Support, OECD.
Ambrosi, Philippe, Klaus Opperman, Philippe Benoit, Chandra Shekhar Sinha, Lasse Ringius, Maria
Netto, Lu Xuedu and OECD Secretariat,59 (2011). How to Keep Up Momentum in Carbon Markets?
World Bank.
Patel, Shilpa (2011).60 Climate Finance: Engaging the Private Sector, International Finance Corporation.

59

OECD Secretariat providing inputs to this background paper include: Jan Corfee-Morlot, Robertus Dellink,
Andrew Prag
60
With inputs by Josue Tanaka, EBRD.

51

Basu, Priya, Lisa Finneran, Veronique Bishop and Trichur Sundararaman, (2011). The Scope for MDB
Leverage and Innovation in Climate Finance, World Bank.

52

Appendix 2. Learning opportunities for innovative climate financing: IFFIm
and AMCs
Pooled financing arrangements, such as the International Finance Facility for Immunization (IFFIm) and
Advance Market Commitments (AMCs), have proven valuable in addressing financing challenges forcommunicable diseases. They could provide useful lessons for climate finance.
IFFIm: Using long term, legally binding, future donor commitments to issue bonds, IFFIm makes moremoney available now for vaccine purchase and delivery. IFFIm was able to front load $1 billion of future
donor commitments in the first year of operations, which would have taken nearly 7 years to raiseotherwise. It followed that success with an additional $2.4 billion in the next 4 years that would not havebeen available for a further decade. The early investment of this $3.4 billion into vaccinating children
will have a tremendous leveraging effect for recipient countries. Frontloading of funds to achieve a
climate objective provides similar leveraging benefits as the cost of addressing climate change impacts
will grow the longer the problem is unchecked. The applicability of this model to the climate financearena merits further analysis, particularly in areas where large upfront capital investments are needed.
IFFIm Profile

Bond issuance
Donor commitments$1,200$1,000

US$ millions

$800
$600
$400
$200
$0

The Pilot AMC: offers long-term, results-based payment contracts to private sector manufacturers to
produce and deliver pneumococcal vaccines to markets that they had considered too risky. From anonexistent market to a current contracted market of 60 million doses of per year (and rising), the AMC
has been successful in pooling $1.5 billion of traditional donor funds to engage significant investment ofprivate sector funds. ―Pull‖ mechanisms such as these can have wider applicability in areas such as
climate change mitigation by similarly removing obstacles to private sector investment, notably, the lackof sufficient bankable revenue streams to enable sponsors of low-carbon investments to secure sufficientloan funding. For example, a pull mechanism could be constructed to support renewable energy feed-in
tariffs (FiTs) in developing countries for a set period of time. Participation in such a mechanism could bein exchange for the right to emission reduction credits, which in the current market do not provide abankable source of revenue.

53

2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020

Doses Supplied (millions)
250

200

150
Projected Additional
Supply Agreements

100
Signed Supply
Agreements

50

0

54

Appendix Table 1: Matrix of fossil fuel support measures, with examples
Statutory or Formal Incidence (to whom and what a transfer is first given)
Production

Transfer Mechanism (how a transfer is created)

Output returns

EnterpriseincomeCost ofintermediate
inputsDirect consumption
Costs of Production Factors

LabourLand

CapitalKnowledge

Unit cost of
consumption

Household orenterpriseincomeDirecttransfer offunds

Output bounty ordefficiency
payment

Operating grant

Input-price subsidy

Wage subsidy

Capital grantlinked toacquisition of land

Capital grantlinked to capital

Government R&D

Unit subsidy

Governmentsubsidized life-line
electricity rate

Tax revenue
foregone

Production tax
creditReduced rate ofincome tax

Reduction inexcise tax on input

Reduction in social
charges (payroll
taxes)

Property-tax
reduction or
exemption

Investment tax
creditTax credit for
private R&D

VAT or excise-tax
concession on fuelTax deduction
related to energy
purchases thatexceed given
share of income

Governmenttransfer ofintellectual
property right

Under-pricing ofaccess to a natural
resource
harvested by final
consumerOthergovernment
revenue
foregone

Reduced resourcerent tax

Under-pricing of agood, government
service or accessto a natural
resource

Under-pricing ofaccess togovernment land;
reduced royalty
payment

Transfer ofrisk togovernment

Provision ofGovernment buffer Third-party liability
security (e.g.,
stock
limit for producers military protectionof supply lines)

Assumption ofCredit guarantee
occupational
linked tohealth andacquisition of land
accident liabilities

Credit guarantee
linked to capital

Wage control

Credit control(sector-specific)

Inducedtransfers

Import tariff orexport subsidy

Monopolyconcession

Monopsonyconcession; export
restriction

Land-use control

Deviations fromstandard IPR rules

Price-triggered
subsidy

Means-tested coldweather grantRegulated price;cross subsidy

Mandated life-line
electricity rate

Source: OECD secretariat background paper for this report on fossil-fuel support.

55

Appendix Table 2: Stylized Marginal Abatement Cost Curve,

Abatement Cost

Financial instruments and support mechanisms to facilitate energy sector investments
Low Carbon Investment Pre-requisites
 Conducive policy environment, e.g. remove energy pricing distortions, price carbon externality, consistent and predictable re gulation,
overall ease of doing business Clean Technology (upstream): R&D, technology transfer, venture capital /private equity
 Supply chain (e.g. access to finance for component manufacture) Awareness raising (e.g. education campaigns demonstration projects)
 Regulation (e.g. technicalstandards for buildings,
transportation)
 Access to finance (e.g.
credit lines)
 Risk mitigation (e.g.
guarantees) TA & capacity building Carbon credits

Energy Efficiency (e.g.
lighting, HVAC,
insulation, industry,transportation)

Renewable Energy(e.g. small hydropower, wind,biomass, solar)
 Effective carbon pricing
 Carbon credits
 Targeted systems for agriculture anddeforestation linked to national
development agendas
 Risk mitigation (e.g. guarantees,
subordinated debt, mezzanine,
equity, concessional loans) Feed-in tariffs
 TA & capacity building

Source: Adapted from Pathways to a Low-Carbon Economy, Version 2 of the Global Greenhouse Gas
Abatement Cost Curve, McKinsey & Company, 2009

Commercially Unproven
Technologies(e.g. carbon capture & storage,
wave power, 2nd generation
biofuels)
 Mechanisms to drive selected key
technologies down the learningcurve
 Research and development
 Risk mitigation (e.g. cost buy
down, patient capital)
 CAPEX subsidies
 Feed-in tariffs

GtCO₂e/yr

Source: Background paper for this report on ―Climate Finance: Engaging the Private Sector‖.

56