FAQ on EC's Global Financing Plan to Fight Climate Change

September 11, 2009 // Published as a news service by IHS

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What is the aim of the EC's communication of Sept. 10?
This communication presents a blueprint for scaling up international finance to help developing countries combat climate change.

The communication aims to facilitate the conclusion of a fair and effective United Nations climate change agreement that sets the world on a pathway to preventing global warming from reaching dangerous levels.

An agreement is due to be concluded at the U.N. climate conference in Copenhagen in December 2009. It would create the international framework for further international action on climate change, following on from the first commitment period of the Kyoto Protocol, which ends in 2012.

The financing issue will be central to the prospects for reaching an ambitious post-2012 agreement in Copenhagen. Developing countries are indicating that they want to see a clear position from developed countries on finance to enable the negotiations to move forward.

The EC's communication seeks to break this impasse. It focuses specifically on this issue of finance, providing a blueprint for the type and level of finance that will be necessary to support action in developing countries to combat climate change.

It complements the EC's previous communication from January 2009, "Towards a comprehensive climate change agreement in Copenhagen," which set out concrete proposals on all the different building blocks that will need to be addressed in the Copenhagen agreement, including mitigation targets and actions, adaptation, finance and technology.

Some progress has been made at the international level since then, most notably at the L'Aquila summit in July at which the leaders of developed and developing countries belonging to the Major Economies Forum endorsed the scientific view that the increase in global average temperature ought not to exceed 2°C. The challenge in Copenhagen will be to agree on greenhouse gas emissions reduction targets and actions that collectively deliver on this objective.

What are the key points of the communication?
The key points can be summarized as follows:

• Assuming an ambitious post-2012 agreement is reached in Copenhagen, it is estimated that the scale of finance required for mitigating emissions and adapting to climate change in developing countries will reach roughly €100 billion per year by 2020. (This figure represents the net additional investment required compared to business as usual).
• This finance will need to come from a combination of three main sources: domestic finance (public and private) in developing countries, the international carbon market and international public finance. The more ambitious the overall agreement will be in terms of mitigation, the more it will require financial support from industrialized countries to the developing world. At the same time, more ambitious and widespread cap and trade systems will also generate increased flows of private sector resources for mitigating emissions in developing countries.
• The international carbon market, if designed properly, will create an increasing financial flow to developing countries and could potentially deliver as much as €38 billion per year in 2020. To facilitate flows of that scale, the Copenhagen agreement needs to establish a new sectoral crediting mechanism, while focusing the Kyoto Protocol's Clean Development Mechanism on Least Developed Countries (LDCs). The European Union (EU) should create an incentive for this transition under the EU Emissions Trading Scheme (ETS).
• As a contribution to the overall financial flows needed of around €100 billion by 2020, international public finance in the range of €22-50 billion per year should be made available in 2020. Not only industrialized countries but also economically more advanced developing countries should contribute. Starting in 2013, public funding contributions should be shared on the basis of ability to pay and responsibility for emissions. On this basis, the EU's contribution to international public finance would be from around 10-30%.
• Support for adaptation to climate change should give priority to the most vulnerable and poor developing countries.
• International aviation and maritime transport could provide an important source of innovative financing if a global market-based instrument instrument addressing their emissions were introduced. This possibility should be further explored.
• Governance of the future international financial architecture should be decentralized and bottom-up. It must also be transparent, allow for effective monitoring, and respect agreed upon standards for aid effectiveness. A new High-level Forum on International Climate Finance should monitor and regularly review gaps and imbalances in financing mitigation and adaptation actions.
• All countries, except LDCs, should prepare low-carbon growth plans by 2011, including credible mid-term and long-term objectives and prepare annual greenhouse gas inventories. The EU should present its own low-carbon growth plan for the period to 2050 by 2011.
• Between 2010-2012, assuming a successful agreement in Copenhagen, fast-start financing will be needed for adaptation, mitigation, research and capacity building in developing countries in the range of €5-7 billion per year. The EU should consider making an immediate contribution of at least €500 million to €2.1 billion per year, starting in 2010.
• For the period after 2012, the EC would make a proposal for a single, global EU offer, including whether to fund this from the EU budget or to establish a separate Climate Fund, or a combination of the two. Direct contributions from individual EU member states could also form an important source of funding as part of the overall EU effort.

What are the requirements for increased financial flows in developing countries to limit temperature increase to +2°C?
Assuming the EU's ambitions for the Copenhagen agreement are met, the EC estimates the total net additional (incremental) costs that need to be financed for both mitigation and adaptation in developing countries at €104-118 billion (in 2005 prices) per year by 2020.

The additional costs for mitigation are estimated at €94 billion. The largest share is for the energy and industry sectors, with €71 billion. Additional costs in the forestry and agriculture sector are estimated at €23 billion.

Costs for adaptation are estimated at €10-24 billion by 2020.

Where would this finance come from?
The EC sees three main sources for the finance needed:

• Domestic sources (public and private) in developing countries themselves.
• An expanded international carbon market.
• International finance from public sources.

Domestic finance could deliver between 20-40% of the total finance needed, the carbon market could provide around 40% and international public finance could contribute to cover the remainder. The more ambitious the carbon market is, the less need there will be for international finance from public sources.

What would be the role of domestic finance (public and private)?
The largest part of the investment necessary will need to come from domestic private finance in developing countries themselves. A major part of the necessary investment, especially in energy efficiency improvements, is already commercially viable as investment costs are recouped via reduced energy bills.

Low-cost energy efficiency measures can deliver two-thirds of the potential emission reductions in the energy sector, for instance. Private investment in the energy sector can be stimulated through the establishment of the right policy framework, including setting up emission trading systems covering key emitting sectors, national regulations and financial incentives.

 Many developing countries are already introducing energy efficiency standards that leapfrog old carbon-intensive technologies. Other innovative instruments can spur private investments in developing countries. For instance, the EU directive on renewable energy also allows for investments in new renewable energy infrastructure in North Africa.

Furthermore, depending on their stage of development, many developing countries, especially those that are economically more advanced, have sufficient financial resources of their own at their disposal to stimulate the necessary domestic investment. Brazil, for instance, has already announced that it will carry a significant part of the costs of reducing emissions from deforestation.

A large part of the funding for adaptation should come from private households and private firms, as it is in their own economic interest. By minimizing their risk exposure, they ensure that their private assets, such as buildings, are made increasingly "climate-proof."

However, the poorest countries, in particular the Least Developed Countries, and the poorest segments of the populations in developing countries, will not have sufficient means to invest in adaptation measures to cope with the adverse effects of climate change. They will depend largely on public assistance, both domestic and international.

What is the likely role of the carbon market in generating the necessary financial flows?
The international carbon market has proven to be an effective tool to leverage private sector investment in developing countries while enabling developed countries to achieve their emission-reduction targets more cost effectively. However, the current market mechanisms are based on pure offsetting - that is, for every ton of emissions reduced in developing counties, an extra ton can be emitted in developing countries. Thus, the mechanisms in their current form are not contributing to global mitigation efforts.

A well-designed, expanded international carbon market could generate an increasing flow of finance to developing countries through their sale of carbon credits, while providing incentives for developing countries to make their own contributions to global mitigation efforts.

The EC estimates the carbon market's potential financial flows to developing countries at up to €38 billion per year in 2020. The actual scale of the flows will depend on a number of key elements of the Copenhagen agreement. For the market to deliver its full potential, developed countries need to take on emission-reduction targets with a high level of ambition. In addition, surplus national emission quotas from the Kyoto Protocol's first commitment period - so-called 'hot air' - must be kept out of the carbon market.

The EU is seeking to build, by 2015, a robust carbon market throughout the Organisation for Economic Co-operation and Development (OECD) by linking the EU Emissions Trading Scheme with comparable domestic cap and trade systems planned in the U.S., Australia and other developed countries.

To generate financial flows on the scale necessary, the Copenhagen agreement needs to establish a new sectoral crediting mechanism for internationally competitive sectors in economically more advanced developing countries. The Clean Development Mechanism should be reformed and focused on Least Developed Countries. The EU should create an incentive for this transition under the EU ETS.

How much international finance from public sources will be needed?
Under an ambitious Copenhagen agreement, substantial international finance from public sources is likely to be needed by developing countries as a complement to the financing provided from their domestic sources and the international carbon market.

The more financing the carbon market generates, the less need there will be for international finance from public sources. Assuming an ambitious global agreement that is in line with the EU's position, the EC estimates that developing countries could need €9-13 billion of financing from international public sources in 2013, rising to €22-50 billion per year by 2020.

These estimates are built on the assumption that developed countries commit to emission-reduction targets of 30% in aggregate and that developing countries limit the growth of their emissions to roughly 15-30% below business as usual by 2020. However, the less ambitious emission-reduction pledges made by developed countries to date would increase the international public finance needs by €120 billion per year in 2020.

How should the bill for international public finance be split worldwide?
Given that responsibility for global emissions today is shared between developed and developing countries, all countries, except LDCs, should contribute to the international public finance that will be needed.

Several "scales" or keys to determine each country's contribution from 2013 are currently being discussed at the international level. The European Council has endorsed basing contributions on two criteria: responsibility for emissions and ability to pay.

How much would the EU contribute?
Based on the two criteria above, and depending on the relative weighting given to each, the EU's contribution to international public funding for developing countries from 2013 onwards would be between 10% (reflecting the EU's share of global emissions) and 30% (the EU's share of global gross domestic product).

These ranges imply EU contributions of €900 million to €3.9 billion in 2013 (10-30% of €9-13 billion globally) and €2-15 billion per year by 2020 (10-30% of €22-50 billion globally).

A significant proportion of the EU contribution could be covered by revenues from the auctioning of EU Emissions Trading Scheme allowances, since it has been agreed that at least 50% of revenues from auctioning for the third phase of the EU ETS should be used for domestic and international action to combat climate change.

Would the EU's contribution to international public finance come from the EU budget?
For the period after 2012, and as part of the package of proposals for the EU's financial framework post-2013, the EC would make a proposal for a single, global EU offer on international public finance. The proposal would address whether such an offer should be funded from 2013 onwards from within the EU budget, or whether to establish a separate Climate Fund outside the EU budget, or a combination of the two.

The EC's clear preference would be to use the EU budget, which would also allow the European Parliament to play its full role. Using the EU budget would require the proposal of a temporary solution for the year 2013, which is covered by the current financial framework. Direct contributions from individual member states could also form an important source of EU funding as part of the overall EU effort.

If the EU budget were not used, the organization of contributions from within the EU should follow the same contribution criteria as used at the international level, while taking into account the special circumstances of member states.

When would developing countries start receiving international public finance?
Assuming an ambitious Copenhagen deal is reached, international public finance to support developing countries should get off to a fast start in 2010. Estimates indicate the amount of international public finance needed for adaptation, mitigation, research and capacity building could be €5-7 billion a year between 2010 and 2012.

Based on the 10-30% share mentioned above, the EU should consider an immediate contribution of €500 million to €2.1 billion per year starting in 2010. Moreover, given the importance of early capacity building and adaptation in developing countries, the EU should consider contributing more than a 10-30% share of fast-start funding. Both the EU budget and national budgets should be ready to contribute to this funding.

Will these financial flows be additional to current and committed future spending, including Official Development Assistance?
Most of the international public grant financing for adaptation and mitigation by developing countries so far has met the agreed upon definition of Official Development Assistance (ODA). It has thus been counted towards OECD countries' targets of increasing ODA targets to 0.7% of gross national product by 2015.

In the short term, grants and highly concessional loans that are eligible for inclusion as ODA will continue to play the central role in the public financing of adaptation measures, particularly in the LDCs and Small Island Developing States. Likewise, a number of ongoing or planned initiatives from the EU budget and by member states have goals similar to the proposed fast-start funding in 2010-2012. These efforts should thus be considered a contribution to fast-start funding.

Beyond 2012, the EU will need to provide additional finance for the fight against climate change - in accordance with the Bali Action Plan, which is guiding the Copenhagen negotiations - on top of the significant funding EU development aid already provides to address climate change.

Meeting the 0.7% ODA goal will more than double world development aid, as the present average for the OECD's Development Assistance Committee (DAC) is 0.3% (0.42% for the EU OECD/DAC countries). In absolute and real terms, this means moving from $120 billion in 2008 to around $280 billion by 2015. Over this period, EU ODA will equally increase by some $50 billion.

Within this increase it will be possible to accommodate some of the additional public funding required to cope with climate change, while maintaining the overall focus on reaching the Millennium Development Goals. As climate change imposes an additional burden on developing countries, finance provided for adaptation and mitigation should not come at the expense of traditional development finance.

In the medium to long term after 2013, climate financing could become a blend of ODA and non-ODA resources. In this context, ODA and additional climate change finance should be seen as complementary. Both financing streams should support the development and implementation of national sustainable development strategies integrating climate resilience and low-carbon development paths.

Why does the EC propose to include emissions from international aviation and shipping in the Copenhagen agreement?
International aviation and maritime transport are large and rapidly growing sources of greenhouse gas emissions, which are not covered by the Kyoto Protocol. Emissions from these sources should now be included in the overall targets set in the Copenhagen agreement. The targets should reduce the climate impact of these sectors below 2005 levels by 2020, and significantly below 1990 levels by 2050.

Given the international nature of these sectors, global measures should be taken to address shipping and aviation emissions. The use of market-based instruments to address these emissions has the potential to provide a significant additional source of finance to support developing countries' mitigation and adaptation efforts. One such approach is cap and trade systems. Taxes and/or levies are another. However, it is recognized that establishing such a global framework is likely to face challenges.

How can a decentralized and bottom-up financial architecture ensure adequate and predictable flows to support developing countries?
It is important for any financial governance structure to be transparent, allow for effective monitoring and respect agreed upon standards for aid effectiveness. In a decentralized and bottom-up architecture, the element of monitoring and transparency becomes even more important to ensure adequacy and predictability of financial support to developing countries. Therefore, the EC proposes a new High-level Forum on International Climate Finance, which should monitor and regularly review gaps and imbalances in financing mitigation and adaptation actions.

For mitigation support, the EC blueprint proposes country-driven low-carbon growth plans as a key tool. These plans would incorporate, for instance, all nationally appropriate mitigation actions, to be recorded in a central registry of all actions and of financial support, and backed up by annual emission inventories and regular peer reviews. The process of matching mitigation actions with appropriate financial support would be facilitated by an independent coordinating mechanism.

For support to adaptation, a simplified bottom-up approach is foreseen. This would include, for example, the gradual integration of adaptation into national development strategies or poverty eradication plans, regular reporting and exchange of good practices information.

The key advantage of this decentralized bottom-up approach is that it would build on existing institutions - reformed and strengthened as appropriate - and developing countries' own structures. It would thus avoid creating parallel structures.

How will Least Developed Countries be supported if they are not developing low-carbon growth plans?
The EC is proposing to exempt LDCs from any commitment to put forward low-carbon growth plans. LDCs should, however, be supported in the design and implementation of nationally appropriate mitigation actions if they so wish. These countries are among those most vulnerable to the impacts of climate change; thus, support for adaptation will need to focus on them.

Where can I find further information?
For more information, see the press release, Climate change: Commission sets out global finance blueprint for ambitious action by developing nations (IP/09/1297) and the EC's web page, A post-2012 global climate regime: the EU's contribution.

Source: European Commission (EC).