component of the second strategy will be finding a comprehensive approach to landscape management that overcomes coordination problems and opportunistically takes advantage of carbon finance streams.

# <u>Promoting private project investment</u>

Early on, negotiators of the Kyoto Protocol saw the two project-based mechanisms as a form of direct bilateral foreign investment, with firms or governments in countries with pledged commitments acquiring offsets by participating directly in projects hosted in developing countries under the CDM and transition countries under JI. As discussed in the section on new markets, alternative investment structures emerged. Often, companies and governments purchase shares of a pool of projects in order to better manage project risks and to avoid the direct costs of managing individual projects. In the case of large projects, funding frequently comes from multiple sources as well. Consequently, in a strictest sense, an ―investing country‖ is the country responsible for certifying the conditions for a CDM or JI projects have been met, rather than the source of funding. In addition, there have been a number of so-called ―unilateral‖ projects, where the project is organized and often financed by firms, governments or other entities in the host country. In the case of CDM projects, the investments are speculative, since the underlying CERs have no domestic use.

The pie charts in figures 17 and 18 show the sources of investment for the CDM and JI offsets expected from current projects by 2012.<sup>52</sup> Globally, about 62 percent of project offsets are funded by financing flowing through the UK, Switzerland, Japan, or the Netherlands; another 15 percent of offsets come from unilateral projects. For ECA projects, unilateral projects account for about 27 percent of anticipated offsets. The Netherlands, the UK, Denmark, Japan and Switzerland account for another 56 percent.

It seems reasonable to think that both the general investment environment and the specific institutions related to carbon markets should influence the location of investments. However, in the case of ECA these relationships are hard to discern. For example, figure 19 reports on six key business environment indicators that are based on firm surveys. Two of the indicators reflect firm views about governance: whether the head of the firm thinks that the domestic court system is fair and impartial; and whether corruption is a problem for doing business. The remaining four indicators have to do with firm characteristics: whether any foreign investors have an ownership stake in the firm; whether a third-party certifies the quality of the goods or services produced by the firm; whether the firm has a line of credit available to it; and whether the firm reports a financial statement that has been audited by an outside accounting firm. The bars in the graph correspond to the percentage of surveyed firms that answer in the affirmative.

All things equal, direct foreign investment should be higher when governance is good and where firms have access to credit and where third parties verify the quality of their output and the veracity of their financial statements. The number of firms with foreign participation is an outcome, which hints at the overall climate for foreign investors. However, when averages are calculated over the countries that host investment projects and those that do not, it is difficult to distinguish between the two sets of averages. Nor is there a clear distinction between ECA and other regions.

The same is true when a measure of climate-related institutions is used. Figure 20 reports on the Climate Laws, Institutions and Measures (CLIM) index, ―a comparative assessment of the extensiveness and quality of climate change mitigation legislation, policies, measures and institutions project investment under the CDM and JI programs‖ (EBRD 2011, p. 61).<sup>53</sup> The index is bounded between zero and one, with a higher value indicated an institutional environment more conducive to project investment. The figure ranks the ECA

> 52 In the case of multiple investing countries, the expected offsets were allocated equally among countries to facilitate calculations.

> 53 For details about the index, seeTeytelboym and Steves (forthcoming).

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