In any case, the following issues would need to be addressed:

- **At the mitigation level,** the logic of the system needs to evolve from focusing on the project activity to focusing on the policy that spurs the emission reductions. Decarbonization will simply not occur without the necessary regulatory framework. Only regulatory certainty will stimulate an adequate and reliable new source of risk capital to finance technology shifts on the scale of whole economies. In addition to promoting activity-based emission reductions  as in the traditional CDM, the next (or expanded) emission reduction mechanism must promote the necessary sector-wide transformation, attained by cost effectively channeling capital and knowhow to decarbonize carbon intensive sectors such as energy, transport and infrastructure (Figueres and Newcombe 2007). The focus of the market would have to shift “from measuring tons to affecting trends” (Figueres 2007a).

- **At the financing level** , mitigation action needs to be appropriately rewarded reflecting the different strengths and constraints of private vs public financing. The conditions under which the private sector accepted the CDM as an international incentive mechanism include: (i) low exposure to host country risk, which in the CDM is limited to the issuance of a letter of approval; (ii) ability to control project risk and independence of carbon credit allocation to an individual project from broader policy failure; and (iii) despite all flaws, trust that the international governance structure will reward emission reductions with tradable carbon credits. Governments on the other hand rarely act as carbon speculators. They are unlikely to create budget lines on the basis of a future promise of carbon credits unless they receive a price guarantee and assurance that credits will actually be issued. Experiences with the establishment of AAU-backed Green Investment Programs in countries with an overallocation of AAUs in Eastern Europe have shown that trading of carbon credits by governments, even if they come in the form of allocated allowances as in the case of AAUs, raises issues related to state budget rules, sale of state assets, ownership of emission rights, constitutional limitations, predictability of funding, allocation of proceeds.<sup>51</sup> As a result, the sale of AAUs from these countries has been very limited. Turf battles among ministries and questions on a fair price of carbon have further paralyzed the sale of carbon credits on the state level. Lessons learned from this process could help in designing a post-2012 incentive system which takes into account the need for stable and predictable funding of government agencies.

- **At the crediting level** , governments could have the right to propose sectoral crediting schemes involving tradable carbon credits or opt for other negotiated and determined incentives (e.g. cash, loans, guarantees). Performance could be measured against an agreed and adopted baseline, a SNLT or any other performance indicator. The mechanism could foresee the allocation of tradable carbon credits based on a reduction of emissions below a certain baseline. In order to reduce the price risk governments could negotiate the sale of the credits in advance against a fixed price per ton of CO2e reduced. Annex I Governments would have to decide

> 51 The World Bank has funded GIS studies in Bulgaria (2004), Ukraine (2006) and Latvia (2007). _[Add link to the relevant studies and other sources]_

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